The opinion
T.C. Memo. 1997-174
UNITED STATES TAX COURT
ESTATE OF ROMINE C. HOGARD, DECEASED, JAMES C. ELLIOTT, PERSONAL
REPRESENTATIVE, AND BILL F. STEWART, PERSONAL REPRESENTATIVE, AND
WANDA L. HOGARD, ET AL.,1 Petitioners v. COMMISSIONER
OF INTERNAL REVENUE, Respondent
Docket Nos. 3319-89, 19780-89, Filed April 8, 1997.
27132-89, 27225-89.
Paul R. Hodgson, for petitioners.
David G. Hendricks and Osmun R. Latrobe, for respondent.
MEMORANDUM OPINION
DAWSON, Judge: These consolidated cases were assigned to
Special Trial Judge Lewis R. Carluzzo pursuant to section
7443A(b)(4) and Rules 180, 181, and 183. All section references
1
Cases of the following petitioners are consolidated
herewith: Gilmore & Wilson Construction Co. & Subsidiary, docket
No. 19780-89; Charles T. and Bettye Gilmore, docket No. 27132-89;
and Jerry L. Wilson, docket No. 27225-89.
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are to the Internal Revenue Code in effect for the years in
issue. All Rule references are to the Tax Court Rules of
Practice and Procedure. The Court agrees with and adopts the
Special Trial Judge's opinion, which is set forth below.
OPINION OF THE SPECIAL TRIAL JUDGE
CARLUZZO, Special Trial Judge: Respondent determined
deficiencies, additions to tax, and increased interest with
respect to Romine C. and Wanda L. Hogard's Federal income taxes
as follows:
Additions to Tax and Increased Interest
Sec. Sec. Sec. Sec. Sec.
Year Deficiency 6653(a) 6653(a)(1) 6653(a)(2) 6659 6621(c)
1979 $22,580.00 $1,129.00 --- --- $6,774.00 2
1980 28,358.00 1,417.90 --- --- 8,507.40 2
1981 28,662.00 --- $1,433.10 1 8,598.60 2
1982 15,366.40 --- 768.32 1 4,609.92 2
1 50 percent of the interest due on the deficiency.
2 Interest on the entire deficiency to be computed at 120 percent of the
standard underpayment rate.
Respondent determined deficiencies, additions to tax, and
increased interest with respect to Gilmore & Wilson Construction
Co. & Subsidiary's Federal income taxes as follows:
Additions to Tax and Increased Interest
Sec. Sec. Sec. Sec. Sec.
TYE Deficiency 6653(a) 6653(a)(1) 6653(a)(2) 6659 6621(c)
7/31/80 $27,845.00 1,392.25 --- --- $8,353.50 2
7/31/81 10,595.20 --- $529.76 1 3,178.56 2
7/31/83 --- --- 2,149.31 1 12,895.84 2
1 50 percent of the interest due on the deficiency.
2 Interest on the entire deficiency to be computed at 120 percent of the
standard underpayment rate.
Respondent determined deficiencies, additions to tax, and
increased interest with respect to Charles T. and Bettye
Gilmore's Federal income taxes as follows:
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Additions to Tax and Increased Interest
Sec. Sec. Sec. Sec. Sec. Sec.
Year Deficiency 6653(a) 6653(a)(1) 6653(a)(2) 6659 6621(c) 6661(a)
1979 $2,647 $132 --- --- $794 2 ---
1980 12,047 602 --- --- 3,614 2 ---
1981 6,332 --- $317 1 1,900 2 ---
1982 29,649 --- 1,482 1 7,667 2 $1,023
1 50 percent of the interest due on the deficiency.
2 Interest on the entire deficiency to be computed at 120 percent of the
standard underpayment rate.
Respondent determined deficiencies, additions to tax, and
increased interest with respect to Jerry L. Wilson's Federal
income taxes as follows:
Additions to Tax and Increased Interest
Sec. Sec. Sec. Sec. Sec. Sec.
Year Deficiency 6653(a) 6653(a)(1) 6653(a)(2) 6659 6621(c) 6661(a)
1979 $11,657 $583 --- --- $3,497 2 ---
1980 1,397 70 --- --- 419 2 ---
1982 49,452 --- $2,473 1 12,180 2 $2,213
1 50 percent of the interest due on the deficiency.
2 Interest on the entire deficiency to be computed at 120 percent of the
standard underpayment rate.
These cases are part of the Plastics Recycling group of
cases. For a detailed discussion of the transactions involved in
the Plastics Recycling cases, see Provizer v. Commissioner, T.C.
Memo. 1992-177, affd. without published opinion 996 F.2d 1216
(6th Cir. 1993). The underlying transactions involving the
Sentinel recyclers in this case are substantially identical to
the transactions considered in the Provizer case.
Consistent with the resolution of some of the disputed
issues in Provizer, in each of these cases petitioners filed a
Stipulation of Settled Issues concerning the adjustments related
to their participation in the Plastics Recycling Program. Each
stipulation states:
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1. Petitioners are not entitled to any deductions,
losses, investment credits, business energy credits or
any other tax benefits claimed on their tax returns for
the taxable years in issue as a result of their
participation in the Plastics Recycling Program.
2. The underpayments in income tax attributable to the
investment credit and business energy investment credit
claimed with respect to petitioners' participation in
the Plastics Recycling Program are subject to the
addition to tax for valuation overstatements determined
under I.R.C. section 6659 using an applicable
percentage of 30 percent.
3. The underpayments in income tax attributable to
petitioners' participation in the Plastics Recycling
Program are substantial underpayments attributable to
tax motivated transactions, subject to the increased
rate of interest established under I.R.C. section
6621(c) as set forth in the notice of deficiency.
4. This stipulation resolves all issues that relate to
the items claimed on petitioners' tax returns resulting
from their participation in the Plastics Recycling
Program, with the exception of petitioners' potential
liability for additions to tax for negligence under the
applicable provisions of section 6653(a).
The issue remaining for decision is whether petitioners are
liable for the additions to tax for negligence under the relevant
provisions of section 6653 for the years in issue. Although not
specifically addressed in the Stipulation of Settled Issues,
because neither evidence nor argument was presented on the point
by the affected petitioners, we deem those petitioners to have
conceded respondent's determinations with respect to the section
6661 addition to tax. Rule 149(b); Murphy v. Commissioner, 103
T.C. 111, 119 (1994); Rothstein v. Commissioner, 90 T.C. 488, 497
(1988).
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Background
Some of the facts have been stipulated, and they are so
found. When the petitions were filed in these cases, all of the
individual petitioners resided in Tulsa, Oklahoma, which is also
the principal place of business of the corporate petitioner.
Romine C. Hogard and Bettye Gilmore died after their petitions
were filed.
In 1982, Romine C. Hogard (Hogard) was the president and
apparently the sole shareholder of a corporation whose business
involved coin-operated entertainment machines. He had a high
school education. Neither the educational nor employment
background of Wanda L. Hogard has been placed in the record. The
parties stipulated that she was a "housewife" during 1982.
Charles T. Gilmore (Gilmore) graduated from Oklahoma A&M
College in 1952 with a bachelor of science degree in marketing.
Gilmore was in the military from 1952 through 1954. From 1954
through 1966, Gilmore worked for Knuckles Construction Co.
The record contains no information regarding the educational or
employment background of Bettye Gilmore.
Jerry Wilson (Wilson) has a bachelor of science degree from
the University of Arkansas. After graduation, he worked for an
architect and later became employed by Knuckles Construction Co.
In 1966 Gilmore and Wilson organized the Gilmore & Wilson
Construction Co. (G&W), a corporation through which they
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conducted a business engaged in the construction of houses and
commercial buildings. Since the formation of G&W, Gilmore has
been the office manager and handled its business affairs, and
Wilson has been the president and design planner.
Prior to 1982, the Gilmores owned stocks, maintained a
savings account, and invested in certificates of deposit. Prior
to 1982, Wilson maintained a savings account and invested in
certificates of deposit. In addition, the Gilmores invested in
residential real estate properties that they held for rent, as
did Gilmore and Wilson through a partnership. The investment
history of the Hogards is unknown.
When Knuckles Construction Co. experienced accounting
problems in 1962, Bill F. Stewart (Stewart), who was a friend of
the construction company's owner, was consulted for assistance in
resolving the problems. This is how Stewart met, and later
secured as clients, Gilmore and Wilson.
Stewart has a bachelor of science degree in commerce and
business administration. He has taken courses towards a master's
degree in accounting and a few law school courses. Stewart
became a certified public accountant in 1947 and began his career
as such with a national accounting firm. In 1951, Stewart
started his own accounting business which focused primarily on
preparing individual income tax returns and providing tax advice.
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Wilson and Gilmore relied on Stewart for accounting and tax
assistance in organizing G&W, including establishing the
company's record-keeping systems and a profit sharing plan.
Stewart also assisted Gilmore and Wilson in the formation of a
partnership to acquire and manage certain real estate. G&W's
books and records were maintained by Stewart, who typically
prepared the corporation's Federal income tax returns, including
the returns for the years in issue. G&W's returns were reviewed
by Gilmore and Wilson before the returns were filed.
The Hogards became clients of Stewart in the mid-1960's.
Details regarding the nature and extent of their relationship or
the services that Stewart provided to the Hogards are unclear.
It appears that Stewart, or one of his associates, prepared
all of the relevant Federal income tax returns and applications
for tentative refunds involved in these cases; however, we note
that the record contains only unfiled copies of some of these
documents, so our finding on this point is not established. We
also note that Exhibit 3-C, which was attached to the stipulation
of facts, is a copy of a 1981 individual Federal income tax
return for Romine C. Hogard. Unlike the other years in issue, we
do not have a copy of a joint Federal income tax return for the
Hogards for that year. Nevertheless, the notice of deficiency
for the Hogards makes determinations as though they filed a joint
return for that year, and the parties have proceeded accordingly.
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Neither party has addressed this apparent inconsistency, and we
proceed as though Exhibit 3-C was not, in fact, a copy of a
return that was actually filed with respondent.
With respect to the preparation of their individual Federal
income tax returns, the Gilmores and Wilson accumulated and
forwarded the necessary documentation to Stewart. Stewart
received the Hogards' tax information from Hogard's secretary.
Before the returns were signed and filed, the Gilmores and Wilson
reviewed their respective returns. It is unknown whether the
Hogards did the same.
In early 1982, Stewart learned about the Clearwater group
partnership (Clearwater), Southeast Recovery Associates
(Southeast), and Esplanade Associates (Esplanade) through Bill
Storey (Storey), who was the accountant of a friend of one of
Stewart's clients. Clearwater, Southeast, and Esplanade are
limited partnerships which purportedly engaged in licensing
Sentinel expanded polyethylene (EPE) recyclers manufactured by
Packaging Industries, Inc. (PI), of Hyannis, Massachusetts.
At some point, Stewart reviewed the Clearwater offering
memorandum. Stewart later received the offering memoranda for
Esplanade and Southeast and was advised that they were similar to
the Clearwater offering memorandum. The respective offering
memoranda for Southeast and Esplanade allocate 10 percent of the
proceeds from each offering to the payment of sales commissions
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and offeree representative fees. In addition, the offering
memoranda list significant business and tax risks associated with
an investment including: (1) A substantial likelihood of an
audit by the Internal Revenue Service (IRS) and that the purchase
price paid by F&G to ECI would probably be challenged as being in
excess of fair market value; (2) that Southeast and Esplanade had
no prior operating history; (3) that Samuel Winer, the general
partner of southeast and Esplanade, had no prior experience in
recycling or similar equipment; (4) that the limited partners had
no control over the conduct of Southeast's and Esplanade's
business; (5) that there was no established market for the
recyclers; (6) that there were no assurances that market prices
for virgin resin would remain at their current costs per pound or
that the recycled pellets would be as marketable as virgin
pellets; and (7) that certain potential conflicts of interest
existed. The value of the Sentinel recyclers was grossly
overstated in the promotional materials.
Stewart read the marketing opinion of Stanley Ulanoff
(Ulanoff), the technical opinion of Samuel Z. Burnstein
(Burnstein), and the tax opinion of John Y. Taggart (Taggart).
Ulanoff owns a 1.27-percent interest in Plymouth Equipment
Associates and a 4.37-percent interest in Taylor Recycling
Associates, both of which leased Sentinel recyclers. Burnstein
owns a 2.605-percent interest in Empire Associates and a 5.82-
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percent interest in Jefferson Recycling Associates, both of which
leased Sentinel recyclers. Both Ulanoff and Burnstein's opinions
are included in all offering memoranda involving the recyclers.
Taggart and other members of the law firm of Windels, Marx,
Davies & Ives prepared the offering memorandum, tax opinion, and
other legal documents for the initial Plastics Recycling
partnership, Clearwater, and 16 other Plastics Recycling
partnerships. Taggart was the head of the tax department of
Windels, Marx, Davies & Ives and taught tax law as an adjunct
professor at New York University (NYU) Law School. Taggart had
previously been employed by the U.S. Department of the Treasury
and as a full-time faculty member of NYU Law School. Taggart
owned a 6.66-percent interest in a second-tier Plastics Recycling
partnership.
Samuel L. Winer (Winer) is the general partner of Esplanade
and Southeast. Aside from being the general partner of Esplanade
and Southeast, Winer is also an investment banker and financial
consultant with offices in Clearwater, Florida. He is also the
general partner in other plastics recycling limited partnerships
including Clearwater, Poly Reclamation Associates, and Sunbelt
Partnership Group. For his services to Esplanade and Southeast,
Winer received $60,000 from each partnership out of the proceeds
of the Esplanade and Southeast private offerings.
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PI is a closely held corporation which manufactures
thermoplastic and other types of packaging machinery. PI holds
itself out as the world's largest manufacturer of blister
packaging machinery and as fabricating the industry's widest line
of thermoforming machinery including highly specialized
disposable medical and food packaging systems. PI also
manufactures both the Sentinel EPE and EPS Recyclers, which
recycle expanded polyethylene and expanded polystyrene.
Stewart and Storey decided to visit PI's facilities in
Hyannis, Massachusetts, to see whether the recyclers performed as
described in the offering memorandum. At their own cost, they
flew to New York where they met Winer, who provided them with
transportation to Hyannis. At PI's facilities, they observed a
demonstration of the recyclers and listened to a presentation
about the recyclers. Stewart, Storey, and 10 to 12 other people
attended a luncheon paid for by PI at which they discussed the
investment. During this trip, Stewart was told that the disposal
of plastic was expensive, the recycler was unique, the price of
the recycler was reasonable, there were no patents on the
recycler, and some recyclers had sold for prices in excess of
those in the offering memorandum. Other than Winer, Stewart did
not recall the names of the individuals with whom he spoke at PI.
The recycler demonstration convinced Stewart that the
recycler performed as stated in the offering memorandum.
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However, Stewart performed no tests on the quality of its output.
He did not know the names of companies who would use the
recyclers and did not inquire about the market for scrap pellets
or the cash-flow to be generated by the recyclers, pellets, or
the investment as a whole.
Storey advised Stewart that he was entitled to a commission
in connection with an investment by any of Stewart's clients in
Southeast or Esplanade. Storey and Stewart agreed to split the
commissions resulting from any subsequent investment by Stewart's
clients in Southeast or Esplanade.
Stewart has no detailed knowledge or expertise in plastics
recycling, machinery, or materials. Instead, he relied on the
individuals associated with Southeast and Esplanade and the
authors of the various opinions appended to the offering
memoranda to have the necessary expertise with regard to the
transactions involved in Southeast and Esplanade.
Stewart advised Gilmore and Wilson about the Clearwater
partnership and told them that it was fully subscribed; however,
he also informed them of the opportunity to invest in Southeast
and/or Esplanade. Prior to investing in Southeast, Gilmore and
Wilson met with Stewart several times. It is unclear whether
Gilmore and Wilson attended these meetings separately. During
these meetings, the energy crisis, the price of oil, and the
benefits of recycling plastic were discussed. Stewart described
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his visit to PI, the demonstration of the recycler, and his
discussions with various individuals at PI. Stewart advised them
that the operation looked viable because it solved the problem of
plastic disposal, because the recyclers could be used by
companies which did not have to purchase the recyclers, and
because of the effect of rising oil prices on the plastics
industry. The tax benefits of the investment were also
discussed. Stewart informed Gilmore and Wilson that he intended
to make an investment in one of the partnerships, and
subsequently did so. Gilmore and Wilson were aware that Stewart
had no background in plastics recycling, machinery, or materials.
Stewart provided Gilmore and Wilson with Southeast's
offering memorandum. Although Gilmore reviewed the offering
memorandum, he did not read it "cover to cover". Gilmore read
Ulanoff's marketing report and Taggart's tax opinion, and he was
impressed with their credentials. Gilmore made no independent
investigation of the projections in the offering memorandum.
Gilmore did not know the value of the recyclers and was
unfamiliar with nonrecourse notes.
Wilson looked at the offering memorandum and attempted to
understand it to "the best of his ability", although the extent
of his review of the offering memorandum is unclear. Wilson was
not concerned by the warnings on the front page of the offering
memorandum, the conflicts of interest described therein, or the
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fact that Southeast had no operating history. Wilson did not
seek another opinion regarding the investment, the recycler, or
the transactions involved in the investment.
The Gilmores, Wilson, and G&W each invested $25,000 in
Southeast for a 2.91-percent interest in Southeast. Stewart was
entitled to commissions related to the Gilmores', Wilson's, and
G&W's investments in Southeast. Gilmore and Wilson were aware of
Stewart's commission arrangements with the promoters of
Southeast.
Stewart apparently introduced the Hogards to the Esplanade
investment; however, the events leading to their decision to
invest in Esplanade are unknown. In February 1982, the Hogards
invested $50,000 in Esplanade for 5.82-percent interest in the
profits, losses, and capital of Esplanade.
After the investments, Stewart had some contact with Winer,
and he received letters regarding the recyclers. The substance
or extent of any direct contacts among the Gilmores, Wilson, G&W,
the Hogards, and Winer, or any other individual associated with
Southeast, is unknown.
From 1979 through 1981, the Gilmores' average adjusted gross
income was $70,488. In 1982 their adjusted gross income
increased substantially to $220,713 due to a gain realized on the
disposition of a capital asset. On their 1982 return, they
claimed investment tax credits of $43,042 and carried back
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credits of $21,176 to 1979, $18,479 to 1980, and $6,332 to 1981.
These credits resulted from their investment in Southeast. They
did not claim any losses with respect to Southeast on any of
these returns.
From 1979 through 1980, Wilson's average adjusted gross
income was $82,444. In 1982, his adjusted gross income increased
substantially to $231,282 due to a gain realized on the
disposition of a capital asset. On his 1982 return, he claimed
investment tax credits of $43,042 and carried back credits of
$13,054 to 1979 and $881 to 1980. The credits resulted from his
investment in Southeast. Wilson did not claim any losses with
respect to Southeast on any of these returns.
On its 1983 return, G&W claimed a loss of $20,452 related to
Southeast. G&W also carried back investment tax credits of
$4,472 to 1980 and $10,514 to 1981. These credits resulted from
G&W's investment in Southeast.
On their 1982 return, the Hogards claimed a loss of $40,884
and investment tax credits of $81,200, which items related to
their investment in Esplanade. They used $1,600 of the credits
in 1982 and carried back investment tax credits of $22,580 to
1979, $28,358 to 1980, and $28,662 to 1981.
With respect to each petitioner, in the applicable notice of
deficiency, respondent disallowed all items of income, loss,
deductions, and credits attributable to Southeast or Esplanade.
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Respondent also disallowed all of the investment tax credit
carrybacks claimed by petitioners. Respondent also determined
that petitioners were liable for additions to tax as set forth in
the opening paragraphs of this opinion and that the
increased rate of interest under section 6621(c) was applicable
to each year in issue.
Petitioners have stipulated substantially the same facts
concerning the underlying transactions as we found in Provizer v.
Commissioner, T.C. Memo. 1992-177, with the exception of certain
facts concerning the Provizers, the expert opinions, and other
matters that we consider of minimal significance.
Those facts may be summarized as follows. In 1981, PI
manufactured and sold six Sentinel EPE Recyclers to ECI Corp. for
$981,000 each. ECI Corp., in turn, resold the recyclers to F&G
Corp. for $1,162,666 each. F&G Corp. then leased the recyclers
to Clearwater, which licensed the recyclers to FMEC Corp., which
sublicensed them back to PI. The sales of the recyclers from PI
to ECI Corp. were financed with nonrecourse notes. Approximately
7 percent of the sales price of the recyclers sold by ECI Corp.
to F&G Corp. was paid in cash with the remainder financed through
notes. These notes provided that 10 percent of the notes were
recourse but that the recourse portion of the notes was only due
after the nonrecourse portion, 90 percent, was paid in full.
All of the monthly payments required among the entities in
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these transactions offset each other and were made
simultaneously. Although the recyclers were sold and leased
under the structure of simultaneous transactions, the fair market
value of a Sentinel EPE Recycler in 1981 was not in excess of
$50,000, and the nuts and bolts, or manufacturing cost, was
$18,000. Other recycling machines were commercially available
during the years in issue including the Buss-Condux
Plastcompactor, Nelmor/Weiss Densification System (Regenolux),
Cumberland Granulators, and Foremost Densilator.
PI allegedly sublicensed the recyclers to entities that
would use them to recycle plastic scrap. The sublicense
agreements provided that the end-users would transfer to PI 100
percent of the recycled scrap in exchange for payment from FMEC
Corp. based on the quality and amount of recycled scrap.
Like Clearwater, Southeast and Esplanade leased Sentinel EPE
Recyclers from F&G Corp. and licensed those recyclers to FMEC
Corp. The transactions of Southeast and Esplanade differ from
the underlying transactions in Provizer v. Commissioner, supra,
in the following respects: (1) The entity that leased the
machines from F&G Corp. and licensed them to FMEC Corp; and (2)
the number of machines sold, leased, licensed, and sublicensed.
In Provizer v. Commissioner, supra, a test case for the
Plastics Recycling group of cases, this Court found that each
Sentinel EPE recycler had a fair market value not in excess of
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$50,000; (2) held that the transaction, which is almost identical
to the transactions in this case, was a sham because it lacked
economic substance and a business purpose; (3) upheld the section
6653(a)(1) and (2) additions to tax for negligence; (4) upheld
the section 6659 addition to tax for valuation overstatement
since the underpayment of taxes was directly related to the
overstatement of the value of the Sentinel EPE recyclers; and (5)
held that losses and credits claimed with respect to Clearwater
were attributable to tax-motivated transactions within the
meaning of section 6621(c). In reaching the conclusion that the
transaction lacked economic substance and a business purpose,
this Court relied heavily upon the overvaluation of the Sentinel
EPE recyclers.
Since our opinion in Provizer v. Commissioner, supra, we
have decided numerous Plastics Recycling cases and, with one
exception, have found the taxpayers liable for the addition to
tax under section 6653(a). See Friedman v. Commissioner, T.C.
Memo. 1996-558, and cases cited therein; see also Henry v.
Commissioner, T.C. Memo. 1997-86; Skyrms v. Commissioner, T.C.
Memo. 1997-69. Set against this background, we consider whether
the addition to tax for negligence should be imposed on any
petitioners.
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Discussion
Section 6653(a) for 1979 and 1980 and section 6653(a)(1) for
1981, 1982, and 1983 impose an addition to tax equal to 5 percent
of the underpayment if any part of any underpayment in tax is due
to negligence or disregard of rules or regulations. Section
6653(a)(2) for 1981, 1982, and 1983 imposes an addition to tax
equal to 50 percent of the interest payable with respect to the
portion of the underpayment attributable to negligence or
disregard of rules or regulations. Petitioners bear the burden
of proving that any underpayment was not due to negligence. Rule
142(a); Bixby v. Commissioner, 58 T.C. 757, 791-792 (1972).
Negligence is defined as the failure to exercise the due
care that a reasonable and ordinarily prudent person would employ
under the circumstances. Neely v. Commissioner, 85 T.C. 934, 947
(1985). The question is whether a particular taxpayer's actions
in connection with the transactions were reasonable in light of
his or her experience and the nature of the investment or
business. Henry Schwartz Corp. v. Commissioner, 60 T.C. 728, 740
(1973). When considering the negligence addition to tax, we
evaluate the particular facts of each case, judging the relative
sophistication of the taxpayers, as well as the manner in which
they approached their investment. McPike v. Commissioner, T.C.
Memo. 1996-46. Compare Spears v. Commissioner, T.C. Memo. 1996-
341 with Zidanich v. Commissioner, T.C. Memo. 1995-382.
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Petitioners contend that they were not negligent because
they reasonably relied in good faith upon the advice of a
qualified, independent adviser, to whom they made full
disclosure. In addition, petitioners contend that they were not
negligent because they reasonably expected to make a profit from
their investment in Southeast or Esplanade. Respondent, on the
other hand, contends that petitioners were negligent because
their reliance on Stewart was not reasonable and they failed to
adequately or reasonably investigate the validity of the
underlying transactions or the value of the recyclers involved
with their investments.
Turning our attention first to the Hogards, we note that the
record contains no evidence that they, or either of them, relied
upon the advice of Stewart, or any other adviser. Respondent's
determination that they are liable for the addition to tax under
section 6653(a) is presumptively correct, and the burden is upon
the Hogards to prove otherwise. Rule 142(a); Neely v.
Commissioner, supra; Bixby v. Commissioner, supra. This they
have failed to do. Accordingly, respondent's determinations are
sustained with respect to the Hogards.
As for the Gilmores, Wilson, and G&W, under some
circumstances a taxpayer may avoid liability for the additions to
tax under section 6653(a) if reasonable reliance on a competent
professional adviser is shown. United States v. Boyle, 469 U.S.
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241, 250-251 (1985); Freytag v. Commissioner, 89 T.C. 849, 888
(1987), affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S. 868
(1991). Reliance on professional advice, standing alone, is not
an absolute defense to negligence, but rather a factor to be
considered. Freytag v. Commissioner, supra. For reliance on
professional advice to excuse a taxpayer from the negligence
addition to tax, the taxpayer must show that the professional had
the expertise and knowledge of the pertinent facts to provide
informed advice on the subject matter. David v. Commissioner, 43
F.3d 788, 789-790 (2d Cir. 1995), affg. T.C. Memo. 1993-621;
Goldman v. Commissioner, 39 F.3d 402 (2d Cir. 1994), affg. T.C.
Memo. 1993-480; Freytag v. Commissioner, supra.
Reliance on representations by insiders, promoters, or
offering materials has been held an inadequate defense to
negligence. Goldman v. Commissioner, supra; LaVerne v.
Commissioner, 94 T.C. 637, 652-653 (1990), affd. without
published opinion 956 F.2d 274 (9th Cir. 1992), affd. without
published opinion sub nom. Cowles v. Commissioner, 949 F.2d 401
(10th Cir. 1991). Pleas of reliance have been rejected when
neither the taxpayer nor the advisers purportedly relied upon by
the taxpayer knew anything about the nontax business aspects of
the contemplated venture. Freytag v. Commissioner, supra; Beck
v. Commissioner, 85 T.C. 557 (1985).
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Southeast's offering memorandum contains a description of
various business and tax risks associated with an investment.
Despite a review of the offering memorandum, Stewart made no
effort to verify the information contained in the offering
memorandum beyond visiting PI's facilities and discussing the
investment with unknown individuals at PI. While Stewart claims
to have discussed the investment with fellow C.P.A.'s, the
substance and details surrounding any purported discussions are
unclear, and there is no indication that these C.P.A.'s had any
background or experience in the plastics industry. Despite his
lack of knowledge regarding the recycler, the target market for
the recycler, and the technical aspects of the transactions,
Stewart did not contact an expert in plastics recycling or
engineering or recommend that the Gilmores, Wilson, or G&W do so.
Although Stewart visited the PI plant in Hyannis and
observed a demonstration of the recycler, he was not qualified to
analyze or assess the recyclers on display or the facility.
Stewart made no adequate investigation into the value of the
recycler, although an investigation would have revealed the
existence of other plastics recycling machines available in 1981
and 1982 ranging in price from $20,000 to $200,000. See Provizer
v. Commissioner, T.C. Memo. 1992-177. Despite his lack of
special qualifications and professional skills in plastics
engineering, recycling, or materials, Stewart made no effort to
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contact or consult with anyone who possessed such qualifications.
Given Stewart's background and experience, he undoubtedly was
aware that the tax benefits outlined in the offering memorandum
and claimed by petitioners depended in large part on the value of
the recycling machines. Nevertheless, having no knowledge or
background regarding the value of the recyclers, he did nothing
sufficient to verify the representations made in the promotional
materials and by individuals associated with the promotion. As
we view the matter, Stewart's trip to inspect the recyclers was
essentially superficial. In effect, he relied not upon the
information he gathered through his own investigation, but upon
representations made by Southeast's promotional materials and
promoters.
Taking the above into consideration, the Gilmores', Wilson's
and G&W's (through Gilmore and Wilson) reliance upon Stewart was
not reasonable. A taxpayer may rely upon his adviser's
expertise, in this case financial planning and tax advice, but it
is not reasonable to rely upon an adviser regarding matters
outside his field of expertise or with respect to facts which he
does not verify, in this case the value of the recycler. Skeen
v. Commissioner, 864 F.2d 93 (9th Cir. 1989), affg. Patin v.
Commissioner, 88 T.C. 1086 (1987).
Moreover, Stewart was not an independent adviser since he
was entitled to receive compensation from Southeast for the
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Gilmores', Wilson's, and G&W's investments in Southeast. Because
Stewart was paid to sell the investment, his advice was suspect.
The Gilmores, Wilson, and G&W (through Gilmore and Wilson)
contend that they reviewed Southeast's offering memorandum. The
extent of their review of the offering memorandum is unclear;
however, a review of that document would have indicated the
numerous business and tax risks associated with an investment.
The preface to the offering memorandum warned the potential
investor not to consider its contents as expert advice and to
seek advice from the investor's own advisers. The offering
memorandum also clearly stated that the transactions involved
significant tax risks and that in all likelihood the IRS would
challenge the validity of the transactions and the purported
value of the recycling machines. The "business risks" section of
the offering memorandum warned that there was no history for
Southeast and that there was no established market for the
recyclers or pellets produced therefrom. The Gilmores, Wilson,
and G&W failed to carefully consider the offering memorandum and
to take into account its warnings. Statements regarding the
business and tax risks and the warnings placed on the front page
of the offering memorandum would have alerted a prudent and
reasonable investor to the questionable nature of the promised
deductions and credits. See Collins v. Commissioner, 857 F.2d
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1383, 1386 (9th Cir. 1988), affg. Dister v. Commissioner, T.C.
Memo. 1987-217.
The Gilmores', Wilson's, and G&W's contention that they
reasonably relied upon Stewart's advice is further undermined by
their successful business backgrounds. In view of their success
in the construction business and profitable real estate
investments, we find it difficult to accept the proposition that
they did not know or have reason to know that the value of the
recyclers was grossly overstated. We find it more likely than
not that they were so interested in the expected tax benefits
that would result from the investment that they failed to
investigate and seek advice on the underlying transactions that
were to generate those tax benefits. Our conclusion on this
point is supported by the fact that the Gilmores' and Wilson's
investments in Southeast, which were not consistent with their
prior investment histories, occurred in a year that capital
transactions were expected to, and did, generate large capital
gains.
The Gilmores, Wilson, and G&W also contend that the
investment was reasonable because they expected to make a profit.
We have severe reservations about the validity of their claims on
this point; however, even if true, their profit motives are not
dispositive of the issue here in dispute. Whether or not they
intended to profit from their investments in Southeast, they
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failed to exercise due care in claiming tax benefits from that
investment. Their subjective intent does not excuse them from
the consequences of claiming deductions and credits to which
under the circumstances they were clearly not entitled. See
Klieger v. Commissioner, T.C. Memo. 1992-734.
We have considered and find unpersuasive petitioners'
arguments comparing this case with other cases that were resolved
in the taxpayers' favor with respect to the negligence addition
to tax.
The Gilmores, Wilson, and G&W failed to exercise due care in
claiming the deductions and tax credits relating to their
respective investments in Southeast. We find that they did not
reasonably rely upon Stewart or in good faith investigate the
aspect of the investment that generated the "attractive" tax
benefits--the value of the Sentinel recycler. Therefore, we hold
that these petitioners and the Hogards are liable for the
negligence additions to tax under the provisions of section
6653(a) for 1979 and 1980 and section 6653(a)(1) and (2) for
1981, 1982, and 1983.
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To reflect the foregoing, and to ensure that each of the
Stipulations of Settled Issues is properly taken into account,
Decisions will be entered
under Rule 155.