The opinion
T.C. Memo. 1997-403
UNITED STATES TAX COURT
MELVIN J. LANEY AND CAROLYN A. LANEY, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 24510-90. Filed September 11, 1997.
Petitioners (Ps) claimed on the Schedule C of
their 1983 tax return a $16.3 million “theft/casualty”
loss. Ps carried forward this loss as a net operating
loss to their 1986, 1987, and 1988 tax returns. Ps
contend they are entitled to the claimed deductions,
even if the deductions are not otherwise allowable,
because of a settlement agreement with the Department
of Justice in connection with a suit in the Court of
Claims. Ps also contend that they had a binding
settlement agreement with the Internal Revenue Service
in the instant case, allowing a net operating loss of
more than $0.5 million.
1. Held: Ps did not have a settlement agreement
with either the Department of Justice or the Internal
Revenue Service.
2. Held, further, Ps are not entitled to loss
carryover deductions on account of theft, casualty, or
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trade or business; respondent concedes Ps are entitled
to capital loss carryover deductions.
3. Held, further, Ps are liable for additions to
tax under sec. 6651(a), I.R.C. 1986, for 1987, and
under sec. 6653(a), I.R.C. 1986, for 1986, 1987, and
1988.
4. Held, further, Ps are not liable for additions
to tax under sec. 6661, I.R.C. 1986, for 1986, 1987,
and 1988.
Melvin J. Laney and Carolyn A. Laney, pro sese.
Diane D. Helfgott, Robert Dietz, and Kristine A. Roth, for
respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
CHABOT, Judge: Respondent determined deficiencies in
Federal individual income tax and additions to tax under sections
6651(a)1 (failure to timely file tax returns), 6653(a)(1)
(negligence, etc.), and 6661 (substantial understatement of
income tax liability) against petitioners as follows:
Additions to Tax
Sec. Sec. Sec. Sec. Sec.
Year Deficiency1 6651(a) 6653(a)(1)(A) 6653(a)(1)(B) 6653(a)(1) 6661
2
1986 $14,096 $331 $705 --- $3,524
2
1987 9,159 2,052 458 --- 2,290
1988 8,582 429 --- --- $429 2,146
1
Of these amounts, $3,070 for 1987 and $3,776 for 1988 are self-employment taxes
under ch. 2; the remainders are income taxes under ch. 1.
1
Unless indicated otherwise, all section and chapter
references are to sections and chapters of the Internal Revenue
Code of 1986 as in effect for the years in issue.
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2
Fifty percent of the interest due on the entire deficiency. Some parts of the
notice of deficiency that list the additions to tax do not show that respondent
determined any additions to tax under sec. 6653(a)(1)B), but Schedules 5, 8, and 14 of
the notice of deficiency do show these determinations. Taking the 20-page notice of
deficiency as a whole, and in light of the fact that par. 3 of respondent’s answer
specifically refers to sec. 6653(a)(1)(B) and that petitioners have not raised any
objection to that reference, we conclude that petitioners were not misled by
respondent’s failure to note the sec. 6653(a)(1)(B) determinations on several pages of
the notice of deficiency where one would have expected the determinations to be noted.
Accordingly, we hold that respondent made the above-noted sec. 6653(a)(1)(B)
determinations in the instant case’s notice of deficiency. Bokum v. Commissioner, 94
T.C. 126, 127 n.2 (1990), affd. 992 F.2d 1132 (11th Cir. 1993); Saint Paul Bottling
Co. v Commissioner, 34 T.C. 1137 (1960).
After concessions by respondent2 and a deemed concession by
petitioners,3 the issues for decision are as follows:
2
Among respondent’s concessions are the following:
(1) Respondent concedes that petitioners timely filed
their 1986 and 1988 tax returns, and thus that petitioners
are not liable for the sec. 6651(a) addition to tax for 1986
and 1988.
(2) Respondent concedes that the Rodriguez Key project
was a transaction entered into for profit.
(3) Respondent concedes, for purposes of the instant
case, that petitioners’ 1984 and 1985 tax returns are
correct, with the exception of the net operating
“theft/casualty” loss carryover deductions claimed thereon.
(4) Respondent concedes that Laney had a 1983 loss from
the foreclosure of the Rodriguez Key property and that
petitioners may carry this loss forward to 1986 and later
years, but contends that the amount available for 1986 is
$90,578.21 and that the loss is a capital loss, subject to
the limitations of secs. 165(f) and 1211. The effect of
this concession would be to allow petitioners to deduct
$3,000 from ordinary income for each of the years in issue.
3
Although petitioners dispute the self-employment tax
determinations, it appears that this is merely a consequence of
their contention that they are entitled to deduct theft/casualty
net operating loss carryovers, and not because they otherwise
dispute the application of ch. 2. As infra table 2 shows,
(continued...)
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(1) Whether petitioners had a binding settlement
agreement entitling them to deduct a net operating loss
carryover for the years in issue.
(2) Whether petitioners had a 1983 theft loss, or
casualty loss, or trade or business loss that could
properly be carried over to the years in issue and, if
so, then in what amount.
(3) Whether petitioners are liable for a late
filing addition to tax under section 6651(a) for 1987.
(4) Whether petitioners are liable for negligence,
etc., additions to tax under section 6653(a)(1) for
1986, 1987, and 1988 and if so for 1986 or 1987, then
in what amounts.
(5) Whether petitioners are liable for additions
to tax under section 6661 for 1986, 1987, and 1988.
3
(...continued)
petitioners reported self-employment tax liabilities for each
year from 1978 through 1982. However, see sec. 1402(a)(4),
which, for purposes of self-employment taxes expressly disallows
net operating loss deductions in computing net earnings from
self-employment. Apart from the disallowance of the claimed
theft/casualty net operating loss deductions, respondent has not
made any adjustments to the amounts, categories, or accounting
methods that petitioners reported on the Schedules C attached to
petitioners’ tax returns for the years in issue. Apart from
these disallowed deductions, the amounts shown on petitioners’
Schedules C would result in a net profit of $24,959 for 1987 and
$29,000 for 1988. See infra table 1. As a result, it appears
that respondent’s determination of self-employment tax
liabilities is correct, regardless of our conclusions as to the
proper treatment of petitioners’ claimed deductions.
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FINDINGS OF FACT
Some of the facts have been stipulated; the stipulations and
the stipulated exhibits are incorporated herein by this
reference.
When the petition was filed in the instant case, petitioners
Melvin J. Laney (hereinafter sometimes referred to as Laney) and
Carolyn A. Laney resided in Spencerville, Maryland.
Background
Laney has a degree in medicinal chemistry.4 Laney began to
develop an expertise in computer work during the 1950's as a high
school student. About 1957 Laney won a national prize for a
computer program. Laney also received other awards for his
computer skills. After he completed his schooling, Laney
frequently was called on to use his expertise in designing
computer and information systems both in a university setting and
professionally.
From about 1971 through 1974 Laney was the Executive
Director of the Society for Computer Medicine. He conducted, or
was the keynote speaker of, several national conferences for this
organization. He also edited journals in the field of computer
medicine.
4
In addition, in December 1970 Laney received a J.D.
degree from American University, in the District of Columbia. He
noted this on his resume, but he is not admitted to practice in
any jurisdiction, and he did not hold himself out as selling his
services as a lawyer.
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For more than 2 years in the mid-1970's Laney provided
consulting services exclusively to the Federal Government. In
this period Laney worked as an expert consultant to the National
Institutes of Health (hereinafter sometimes referred to as NIH)
to develop a national database for laboratory animals. Laney
obtained national recognition because of his work at NIH. As a
result of the renown and expertise he developed, when Laney left
NIH, he was approached by pharmaceutical companies to perform
consulting work. In late 1976 or early 1977 Laney began to do
consulting work for the Lederle Laboratories Division of American
Cyanamid Co., hereinafter sometimes referred to as Lederle. By
the end of July 1977 this arrangement was formalized in a
consulting contract for work in “toxicology computer systems
development”.
After Laney began to do consulting work for Lederle, he also
began to do consulting work for several other pharmaceutical
companies, including the following: Dow Chemical Co., Monsanto
Co., Merrill Pharmaceutical Co., and Sterling-Winthrop Research
Institute, hereinafter sometimes referred to as Dow, Monsanto,
Merrill, and Sterling-Winthrop, respectively.
Laney began his consulting work for Dow in 1979. Around
this time Laney visited divisions of Dow in order to meet with
scientists who were involved with the production of animal data,
and to view the information systems and procedures of these
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scientists. Laney did this in order to get knowledge to enable
him to relate their information systems to the type of
information systems that Laney would put into place at the
Rodriguez Key project (hereinafter sometimes referred to as
R.K.), described infra. Laney’s work with Dow continued into at
least 1982. Laney consulted with Dow about a computerized system
for managing animal data in Dow’s toxicology studies. Laney was
initially invited to work for Dow because he was working on the
information system prototype for R.K. Laney’s initial work for
Dow was not related to R.K., but was to help Dow’s Health and
Safety Division construct its own computer centers that could be
designed, programmed, and run independent of Dow’s controller’s
office. At some point, Laney also consulted with Dow about
problems with “Agent Orange”. Eventually Laney advised Dow on
how to develop an information system that could communicate with
outside sources such as (1) other divisions of Dow located in
various places around the world and (2) R.K. As a result of
Laney’s work with Dow, Dow built a computer center that was tied
into an international communications network; the software that
was used in this computer center was consistent with software
that Laney designed for Lederle and Sterling-Winthrop.
In or around 1978 Laney began to consult for Monsanto.
Laney was initially invited to work for Monsanto because he was
working on the information system prototype for R.K. Laney
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consulted with Monsanto about the development of integrated,
centralized, information systems for health and safety testing.
The information system that Monsanto developed was consistent
with the information system that would be put into place at R.K.
Laney’s consulting work for Monsanto did not involve Monsanto’s
sponsorship of research at R.K.
During the time that Laney was working on the information
system prototype for R.K., he began his consulting work for
Merrill. Laney consulted with Merrill about designs for a
centralized and integrated information system. This was
consistent with the use of the information system prototype for
R.K. Although Merrill expressed an interest in sponsoring
research at R.K., this sponsorship never occurred.
Laney did consulting work for Sterling-Winthrop from 1980 to
at least 1982. Laney was initially invited to work for Sterling-
Winthrop because he had designed the information system prototype
for R.K. Laney consulted for Sterling-Winthrop to design a
centralized and integrated information system for health and
safety testing that could communicate with outside sources, such
as (1) Sterling-Winthrop divisions, (2) Sterling-Winthrop
contractors, and (3) the information system that would be put
into place at R.K. As a result of Laney’s work for Sterling-
Winthrop, Sterling-Winthrop spent substantial amounts for an
information system.
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In the early 1970's, Laney created a sole proprietorship
known as Melvin J. Laney Associates. On March 19, 1981, Laney
incorporated Melvin J. Laney Associates, Inc. These businesses
are hereinafter sometimes referred to as the Laney Proprietorship
and the Laney Corporation, respectively, and as the Laney
Entities, in the aggregate. Laney was the sole owner of each of
the Laney Entities. The Laney Corporation’s only consulting
contract was with Sterling-Winthrop.
Laney did some of his consulting work in his office, which
was located in a building on the same property as his residence.
Laney also traveled to do consulting work. Laney either was
reimbursed for his travel related to his consulting work, or he
included these costs in his fees; however, Laney was often housed
in a corporate suite or motel room when he traveled. In or
around 1980 Laney almost completely stopped doing consulting work
that was not related to the information system prototype for R.K.
The Rodriguez Key Project
Overview
In 1977 Laney began to work on R.K. R.K. involved the
development of a primate breeding and vaccine testing facility.
On June 24, 1978, Laney bought an island, Rodriguez Key
(hereinafter sometimes referred to as the Island), in Monroe
County, Florida; the Island was to be used as a situs for R.K.
Laney bought the Island for a total of $184,442.20 (purchase
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price $183,750, closing costs $692.20), with a purchase-money
mortgage in the amount of $147,000, a term of 4 years, and an
interest rate of 8-1/2 percent. Laney did not make any principal
payments on the mortgage, but he made $46,856.25 in interest
payments.5 Laney intended to house 40,000 primates on the Island
to be used by pharmaceutical companies to test drugs and for AIDS
research.
Laney filed for appropriate permits from the Army Corps of
Engineers and a Florida agency. He eventually received the
Florida agency permit, but not the Army Corps of Engineers
permit. He sued in the United State Court of Claims,6 which
denied both sides’ summary judgment motions and remanded the case
for trial. In the meanwhile, Laney could not make mortgage
5
Also, Laney paid at least the following amounts in
connection with R.K.: (a) $9,673.14 in property taxes, (b)
$24,334.45 in engineering and consulting fees, (c) $28,550.22 in
legal fees, (d) $270.50 for permits, and (e) $1,326.74 for
services.
6
The Federal Courts Improvement Act of 1982, Pub. L. 97-
164, 96 Stat. 25, merged the United States Court of Claims into
the newly created Court of Appeals for the Federal Circuit and,
in effect, reconstituted the trial division of the Court of
Claims into a newly created United States Claims Court, a so-
called Article I court. More recently, the United States Claims
Court was renamed the United States Court of Federal Claims.
Federal Courts Administration Act of 1992, Pub. L. 102-572, sec.
902(a)(1), 106 Stat. 4506, 4516. These changes in status and
name do not affect the substance of any action for purposes of
the instant opinion. In order to avoid the confusions attendant
on name and status changes during the course of Laney’s damages
litigation, we will generally refer to the forum for that
litigation as the Court of Claims.
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payments, and the Island was sold at foreclosure. Then Laney
filed for bankruptcy. Then Laney voluntarily dismissed his Court
of Claims petition.
The Property and Lawsuits
The Island was well situated to house a large-scale primate
breeding and research facility, because of its (1) subtropic
climate, (2) isolation, and (3) biological conditions. R.K., as
contemplated by Laney, would have been the largest primate
research center of its kind in the world. Laney planned to make
a profit from R.K. by renting primate cage space. He also
expected to rent housing and other facilities for the people that
the pharmaceutical companies would send to the Island to conduct
studies. Thus, he worked on a design for hurricane-proof housing
for humans. Also, Laney expected to be able to charge the
pharmaceutical companies for his consulting services in
connection with their studies. He planned to offer the
combination of his expertise in computer planning, his scientific
background, and his understanding of Federal Drug Administration
requirements for approval of drugs. However, he did not intend
to require that the companies that rented facilities on the
Island use his consulting services.
Laney designed a computer system to control R.K. and the
research expected to be conducted in that project. The initial
design for this computer system was completed in 1978. The
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information systems Laney worked on at Dow, Lederle, Monsanto,
Merrill, and Sterling-Winthrop were designed to be able to
communicate with the computer system that would be put into place
at R.K.
Although much time, effort, and money were spent in the
design and planning of R.K., the only improvements ever made to
the Island were trails, boardwalks, and some improvements to the
landing sites. R.K. did not become operational, either as a
primate facility or as a source of data for computer systems.
Laney ordinarily did not use accountants in connection with
his consulting trade or business. However, around the start of
his work on R.K., Laney told an accountant that R.K. was separate
from his consulting activities and that he expected to put a lot
of money into R.K., and that he wanted advice as to how to
account for his R.K. expenditures for tax purposes and for
accounting purposes. The accountant advised him to separately
account for expenditures that were investments in R.K., that
Laney had a choice of deducting certain expenditures when paid or
capitalizing the expenditures and deducting them later, and that
it probably was better to capitalize and deduct later. Laney
agreed, and capitalized his R.K. expenditures. As early as 1977
Laney capitalized his expenditures for rental of certain computer
equipment used exclusively for foundation planning for R.K.
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When most of Laney’s consulting work related to R.K., his
practice was to pay himself a “salary”, “my typical salary at the
time”. Petitioners reported these “salary” amounts on their tax
returns. See infra table 2 note 1. Petitioners did not report
as income the amounts in excess of this “salary” that Laney
received for his consulting work related to R.K. In particular,
petitioners did not report on their 1977 tax return at least
$14,162.73 that Laney had received for consulting work and that
he spent on R.K. For the years 1977 through 1982, petitioners
omitted to report, in this manner, about $480-490 thousand of
Laney’s consulting fee receipts.
When Laney asked the accountant for advice on the treatment
of expenditures, Laney did not ask for and did not receive advice
about the treatment of receipts.
Laney understood from his questioning of the accountant that
there would come a time when petitioners could deduct their
capitalized R.K. expenditures. However, Laney did not believe
that he would ever have to include in income the 1977 through
1982 consulting fees that petitioners had omitted to report when
received; petitioners did not include these amounts in income on
their 1983 tax return, even though they did report their
capitalized R.K. expenses on that tax return.
Laney bought a Data General computer. In 1981 Laney sold it
to Sterling-Winthrop and made a profit of about $18,000 on the
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sale. Laney used the $18,000 to pay R.K. expenses. Petitioners
did not report the sale, the $18,000 income therefrom, or the
R.K. expenditures on their 1981 tax return. Petitioners deducted
the $18,000 expenditures on their 1983 tax return, but did not
report the $18,000 income on their 1983 tax return.
On July 31, 1978,7 Laney filed a joint permit application
with the Army Corps of Engineers and the Florida Department of
Environmental Regulations for permits to develop the Island as a
primate breeding and vaccine testing facility. In a “FINAL
ACTION” dated October 22, 1979, the Army Corps of Engineers
denied Laney’s permit application to (1) discharge fill material
in navigable waters in order to form a permanent concrete capped
pier, and (2) construct a floating pier in navigable waters, both
of which Laney believed were necessary in order to develop the
Island as a primate breeding and vaccine testing facility.
On March 16, 1980, Laney sued in the Court of Claims,
alleging (1) that the action, described supra, of the Army Corps
of Engineers denied any access to or use of the Island, and thus
(2) that the action constituted a taking for which Laney should
be compensated in the amount of $16,347,250. Laney’s counsel in
7
So stipulated. The Court of Claims found that the
application was filed on July 9, 1978. Laney v. United States,
228 Ct. Cl. 519, 661 F.2d 145, 146 (1981). The difference in
dates is not material for our purposes.
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the Court of Claims case was Thomas C. Henry, hereinafter
sometimes referred to as Henry.
On August 19, 1981, the Court of Claims denied Laney’s
motion for summary judgment and also denied the United States’
cross-motion for summary judgment on the takings issue, holding
that “Under any view of the law short of these inadmissible
extremes there are relevant issues of fact requiring trial.”
Laney v. United States, 228 Ct. Cl. 519, 661 F.2d 145, 150
(1981). The Court of Claims remanded the case to its trial
division for further proceedings.
On October 23, 1981, the Florida Department of Environmental
Regulations granted Laney’s permit application to develop the
Island as a primate breeding and vaccine testing facility.
On May 17, 1983, a Florida court granted a foreclosure sale
of the Island to the holder of the mortgage note, Frederick
Poppe, hereinafter sometimes referred to as Poppe. The Island
was sold for $50,000 to Poppe, and Poppe also received a $75,000
deficiency judgment against Laney. A trial date had not yet been
set in his Court of Claims suit, and on December 6, 1983, Laney
voluntarily dismissed his Court of Claims petition.
On October 25, 1983, the Laney Corporation filed for relief
under chapter 11 of the Bankruptcy Code. On January 6, 1984,
this case was converted to a case under chapter 7, on motion of
the Laney Corporation. On Mach 20, 1984, Laney, t/a (trading as)
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the Laney Proprietorship, filed for relief under chapter 7 of the
Bankruptcy Code. On July 24, 1984, Laney was granted a discharge
under chapter 7 which, among other matters, discharged the
$75,000 foreclosure deficiency judgment.
On February 25, 1992, Laney filed a motion to reopen the
Court of Claims suit that he had previously dismissed. This
motion was denied on June 18, 1992. Laney v. United States, 26
Cl. Ct. 318 (1992).
Tax Returns
Petitioners did not attach Schedules C to their tax returns
for 1977 through 1982. See infra table 2 note 1. On the
Schedules C attached to their tax returns for 1983 through 1988,
petitioners showed the business name as the Laney Proprietorship
and the main business activity as “Consulting & Primate Farm”.
Table 1 summarizes information appearing on the Schedules C
attached to petitioners’ tax returns for 1983 through 1988.
Table 1
1983 1984 1985 1986 1987 1988
1 1 1
Gross receipts $564,189.13 $91,723.54 $110,448.33
Gross income 345,282.92 $9,465.00 $183.49 $3,398.00 91,723.54 110,448.33
2
Total deductions 230,449.78 15,762.39 3,985.52 4,942.42 66,764.54 81,448.28
excluding theft/
casualty loss
deduction
2
Net profit(loss) 114,833.14 (6,297.39) (3,802.03) (1,544.42) 24,959.00 29,000.05
excluding theft/
casualty loss
deduction
Theft/casualty loss 16,347,250.00 16,194,002.60 16,182,867.55 16,142,546.20 16,072,854.77 16,047,895.77
deduction
2
Net profit (loss) (16,232,416.86) (16,200,299.99) (16,186,669.58) (16,144,090.62) (16,047,895.77) (16,018,895.77)
1
Petitioners did not show any amounts on the “Gross receipts or sales” lines of the indicated Schedules C.
2
The total of the 1988 Schedule C deductions shown on the tax return is 5 cents less than the amount shown on the
“total deductions” line of the 1988 Schedule C. This 5-cent error does not affect the amount of the “rounded-off”
deficiency.
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The $564,189.13 amount that petitioners reported as gross
receipts on their 1983 tax return represents the amount that
Laney believed his clients had spent on R.K., both the actual
outlays of his clients and the value of the time of his clients’
personnel. This amount does not include any amounts that Laney’s
clients paid to him. The claimed $16,347,250 theft/casualty loss
deduction includes some $480-490 thousand that petitioners had
omitted from gross income over the period 1977 through 1982 and
had spent on R.K.
Petitioners chose not to carry back their claimed 1983 net
operating loss, but instead to carry it only forward, and
attached statements to this effect to their 1983 and later tax
returns.
Table 2 summarizes information appearing on the first and
second pages of petitioner’s tax returns for 1977 through 1988.
Table 2
1977 1978 1979 1980 1981 1982
1 1 1 1 1
Wages, etc. $19,841.96
1 1 1 1 1
Business inc -0- $6,500.00 $18,150.00 $26,000.00 $25,000.00 $19,032.97
(loss)
Int., div., tax 382.26 265.68 35.08 -0- -0- 8,726.79
refund, cap
gain inc.
(unexplained)
Misc. inc. -0- 5,763.29 -0- -0- -0- -0-
AGI 20,224.22 12,528.97 18,185.08 26,000.00 25,000.00 27,759.76
Ch. 1 tax 1,023.00 24.00 394.00 1,829.00 1,692.00 2,162.00
(regular income)
Ch. 2 taxes -0- 526.50 1,458.00 2,097.90 2,325.00 1,779.58
(self employ-
ment)
1
Petitioners reported this income on Form 1040, line 8 (wages, etc.), and not line 13 (business income). Also,
the retained copy of the tax return did not include a Schedule C or a Schedule SE. However, the amounts of the
self-employment taxes shown on petitioners’ tax returns for 1978 through 1982 appear to be correct for the amount
of income shown.
Table 2 Cont.
1983 1984 1985 1986 1987 1988
Wages, etc. $33,310.59 -0- $38,833.30 $63,710.73 $14,993.18 -0-
Business inc. (16,232,416.86) ($16,200,299.99) (16,186,669.58) (16,144,090.62) (16,047,895.77) (16,018,895.77)
(loss)
Int., div., tax 5,103.67 17,432.44 5,290.08 7,525.12 7,743.67 14,770.02
refund, cap
gain inc.
Misc. inc. -0- -0- -0- -0- -0- 27.00
AGI (16,194,002.60) (16,182,867.55) (16,142,546.20) (16,072,854.77) (16,025,158.92) (16,004,098.75)
Ch. 1 tax -0- -0- -0- -0- -0- -0-
(regular income)
Ch. 2 taxes -0- -0- -0- -0- -0- -0-
(self employ-
ment)
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Petitioners timely filed tax returns for 1986 and 1988.
Petitioners timely filed for an automatic extension of time,
until August 15, 1988, to file their 1987 tax return. On August
15, 1988, petitioners timely filed a request for a further
extension, until May 5, 1989, to file their 1987 tax return.
Petitioners were granted an extension only until October 17,
1988. Petitioners filed their 1987 tax return on May 11, 1989.
Petitioners did not file their 1987 tax return, or a “first”,
“initial”, or “preliminary” 1987 tax return, before the May 11,
1989, filing referred to supra.
After petitioners filed their petition in the instant case,
they dealt with an Appeals officer. After petitioner and the
Appeals officer failed to settle the case, petitioners sent a
letter to the Secretary of the Treasury, urging him to enter into
a section 7121 closing agreement with petitioners. The letter
and accompanying materials were referred to the Philadelphia
Internal Revenue Service Center. An employee at this Center
somehow came to the conclusion that the Appeals Office and
petitioner had entered into a binding settlement agreement and
thus a section 7121 closing agreement would not be appropriate.
Respondent did not audit petitioners’ 1983, 1984, and 1985
tax returns.
On May 5, 1988, the Maryland Tax Court issued an Order and
Memorandum of Grounds for Decision in a proceeding involving
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petitioners’ Maryland income taxes for 1983, 1984, and 1985. In
its opinion the Maryland Tax Court concluded that petitioners
lost $563,784 in 1983 on account of the foreclosure sale of the
Island.
Petitioners did not enter into a binding settlement
agreement with the Department of Justice in connection with
Laney’s Court of Claims suit.
Petitioners and respondent did not have a binding settlement
agreement in the instant case, nor did they enter into a section
7121 agreement with respect to the instant case or any issue
therein.
The Army Corp of Engineers did not criminally appropriate
the Island or any other asset connected with R.K. Poppe did not
criminally appropriate the Island or any other asset connected
with R.K.
R.K. was not part of Laney’s trade or business of offering
his services as a consultant. R.K. had not gone into operation
before Laney suffered his losses and was forced to give up the
Island and the entire project.
Petitioners did not use due care in claiming the $16.3
million theft and casualty loss with a 15-year net operating loss
carryforward; and they failed to do what a reasonable and
ordinarily prudent person would do under the circumstances.
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Petitioners’ failure to file their 1987 income tax return
until May 11, 1989, was not due to reasonable cause.
Petitioners substantially understated their income tax
liabilities for 1986, 1987, and 1988; however, they adequately
disclosed in a statement attached to their tax returns the
relevant facts affecting the tax treatment of their claimed net
operating loss carryforward.
OPINION
Every matter that we are to resolve in the instant case
stems directly from, or is substantially affected by, R.K.
I. Settlement
A. With Justice Department
Petitioners argue that they are entitled to a 1983
theft/casualty loss deduction with a 15-year net operating loss
carryover because Laney had an agreement with the Department of
Justice that he is entitled to deduct this net operating loss
carryover in exchange for voluntarily dismissing the Court of
Claims petition in which he alleged a taking of R.K. by the
United States.
Respondent contends that petitioners did not have an
agreement with the Department of Justice.
We agree with respondent.
In their pretrial memorandum, the first witness petitioners
listed was Henry, who was expected to testify about “the
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settlement agreement [in Laney’s Court of Claims suit] forced by
the United States on Petitioner to take a theft/casualty loss on
their tax returns.” At trial, Laney stated petitioners’
intention to have Henry testify. On the third day of the trial
Laney stated that Henry was to testify on the fifth day of the
trial. On the fourth day of the trial Laney again assured us
that Henry was to appear and testify on the fifth day. Henry did
not testify on the fifth day. As one of the first items of
business on the sixth day, the Court noted the importance of
Henry’s testimony on the negligence issue, as part of an effort
to make sure that both sides understood the Court’s concerns
about apparently missing pieces of the puzzle presented in the
instant case. The trial lasted 7 days.
In the final analysis, petitioners chose not to call Henry,
and he did not testify. We are entitled to, and we do, infer
that if Henry had testified, then his testimony would have been
unfavorable to petitioners on this issue. O’Dwyer v.
Commissioner, 266 F.2d 575, 584 (4th Cir. 1959), affg. 28 T.C.
698, 703 (1957); Stoumen v. Commissioner, 208 F.2d 903, 907 (3d
Cir. 1953), affg. a Memorandum Opinion of this Court dated March
13, 1953; Wichita Terminal Elevator Co. v. Commissioner, 6 T.C.
1158, 1165 (1946), affd. 162 F.2d 513 (10th Cir. 1947).
We observed Laney at the trial in the instant case. On the
basis of these observations and the evidence of record, it is
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obvious that Laney is intelligent, perceptive, cautious, and
self-protective to a fault. He generally refused to concede
anything he thought might be to his disadvantage, no matter how
clear the matter was. We are convinced that, if Laney understood
that the Department of Justice conceded his entitlement to a
$16.3 million deduction in exchange for his dropping his Court of
Claims suit, then (1) Laney would not have proceeded to drop that
suit unless he had the Department of Justice’s concessions in
writing, (2) Laney would have preserved this writing, and (3)
Laney would have produced this writing for the record in the
instant case. Petitioners did not present any such written
settlement agreement or any evidence that there ever was a
written settlement agreement. From the foregoing we infer that
(1) there was not a written settlement agreement, and (2) there
was no oral concession by the Department of Justice that Laney
would be entitled to the claimed deduction in consideration for
dropping his Court of Claims suit.
On the first day of the trial petitioners offered into
evidence an affidavit by Henry. Laney explained that the
affidavit was offered as an expert witness report. The Court
indicated doubt that the affidavit would so qualify but noted
that ordinarily an expert witness report “is admissible if it is
identified [and adopted] by the expert at the trial and the
expert is made available for cross examination.” The Court
- 26 -
suggested that, if Laney wanted to offer the affidavit as an
expert witness report, then the time to do so was when Henry
appeared as a witness, as we had been informed would be the
situation. In the absence of agreement by respondent, the Court
declined to receive the affidavit into evidence on the first day
of the trial.
Before the trial in the instant case, Laney had sought to
reopen his prior Court of Claims case. In support of his motion
before the Court of Claims (see supra note 6), Laney presented
what appears to be the same Henry affidavit that petitioners
offered into evidence in the instant case.8 We note that, in
the opinion denying Laney’s motion to reopen, the chief judge of
that court quoted from the affidavit and concluded that the
Department of Justice attorney did not make a settlement offer
and further “[concluded] that no settlement agreement was ever
consummated.” Laney v. United States, 26 Cl. Ct. 318, 322, 323
(1992).
On the record in the instant case, we conclude, and we have
found, that petitioners did not enter into a binding settlement
8
Compare Rule 143(b), that ex parte affidavits are not
evidence, with, e.g., Rule 121 to illustrate proper use of
affidavits in certain aspects of motion practice before this
Court. Unless otherwise indicated, all Rule references are to
the Tax Court Rules of Practice and Procedure.
- 27 -
agreement with the Department of Justice in connection with
Laney’s Court of Claims suit.9
We hold for respondent on this issue.
B. With Respondent
Petitioners argued at trial that they had entered into a
binding settlement agreement with respondent for the years in
issue. Petitioners explained that they believed perhaps
respondent had settled their case without their knowledge.
Respondent contends that the parties in the instant case did
not enter into a binding settlement agreement.
We agree with respondent.
Petitioners were aware that they did not have a binding
settlement agreement with the Appeals officer. Petitioners’
letter to the Secretary of Treasury illustrates that, when they
wrote that letter, petitioners did not believe that they had a
binding settlement agreement with respondent.
Petitioners rely on documents in which one or more of
respondent’s employees refer to binding settlement agreements.
Testimony was presented by respondent’s employees as to how it
came to be that respondent advised the Secretary of the Treasury
that the Secretary could not enter into a closing agreement under
9
Thus it is not necessary to decide whether, if the
Justice Department had made an agreement with petitioners, that
agreement would be binding on respondent. See Graff v.
Commissioner, 74 T.C. 743 (1980), affd. 673 F.2d 784 (5th Cir.
1982).
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section 7121 because there was a binding settlement agreement in
the instant case. We did not come away from this part of the
case with the belief that we understand substantially everything
that happened. We do not understand how it came to be that
petitioners’ letter to the Secretary of the Treasury elicited the
response that there was a binding settlement agreement.
We have recently discussed the nature of, and requirements
for, binding settlement agreements. Dorchester Industries, Inc.
v. Commissioner, 108 T.C. 320 (1997). We have reexamined the
record in the instant case; we conclude, and we have found, that
petitioners and respondent did not have a binding settlement
agreement, nor did they enter into a section 7121 agreement with
respect to the instant case or any issue therein.
Respondent’s significant concessions, whether by stipulation
or unilateral, are limited as described supra note 2. Those
concessions will be given effect in the Rule 155 computation, but
do not have the far-reaching effect that petitioners seek.
Because we conclude that there was not a settlement
agreement in the instant case, we do not need to consider, and we
do not consider, whether any individuals with whom petitioners
dealt had authority to enter into settlement agreements on behalf
of respondent.
We hold for respondent on this issue.
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II. Carryover Deductions
The years in issue in the instant case are 1986, 1987, and
1988. The deficiencies that respondent determined in the instant
case result from the disallowance of deductions carried over from
1983. In order to redetermine these deficiencies we must
consider whether an item arose in 1983, whether the item is of
the sort that might give rise to a carryover to the years in
issue, and if so, then what is the nature and amount of the item.
Sec. 6214(b);10 Hill v. Commissioner, 95 T.C. 437, 439-444
(1990), and cases cited therein. In general, the nature and
amount of the carryover item is determined and redetermined under
the law in effect for the year in which the carryover item arose
(1983), rather than the year(s) to which the carryover item is
carried. Sec. 172(e).
10
Sec. 6214 provides, in pertinent part, as follows:
SEC. 6214. DETERMINATIONS BY TAX COURT.
* * * * * * *
(b) Jurisdiction Over Other Years and Quarters.--The
Tax Court in redetermining a deficiency of income tax for
any taxable year or of gift tax for any calendar year or
calendar quarter shall consider such facts with relation to
the taxes for other years or calendar quarters as may be
necessary correctly to redetermine the amount of such
deficiency, but in so doing shall have no jurisdiction to
determine whether or not the tax for any other year or
calendar quarter has been overpaid or underpaid.
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Petitioners contend that they suffered a “theft/casualty”
loss in 1983 in the amount of $16,347,250, which is treated in
effect as a business loss for net operating loss deduction
purposes.11 See 172(d)(4)(C). Their deduction of this item on
the Schedule C attached to their 1983 tax return resulted in a
net loss in the amount of $16,232,416.86. They contend that they
properly elected to waive the carrybacks (sec. 172(b)(3)) and
instead claim to be entitled to carry this loss forward for 15
years including the years in issue as a net operating loss (sec.
172(b)(1)(A)(ii)).
Respondent contends that (1) petitioners’ loss was much less
than petitioners claim, (2) the loss was not from a theft or
11
Petitioners’ original claim, and the expert witness
evidence they presented at trial, go to the expected value of the
enterprise that was expected to arise from R.K. Petitioners
initially overlooked the effect of sec. 165(b), as follows:
SEC. 165. LOSSES.
* * * * * * *
(b) Amount of Deduction.--For purposes of
subsection (a), the basis for determining the amount of
the deduction for any loss shall be the adjusted basis
provided in section 1011 for determining the loss from
the sale or other disposition of property.
At one point in their answering brief petitioners contend
that their basis in the property involved in R.K. was “at least
$563,784”, but for the most part they still contend that they are
entitled to deduct $16,347,250 for 1983 and to carry over to the
years in issue the amounts shown on their tax returns for these
years. See supra table 1.
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casualty, and (3) R.K. was not a trade or business, so
petitioners did not have a net operating loss, and so petitioners
are not entitled to net operating loss carryover deductions for
the years in issue. Respondent concedes that (1) petitioners had
a loss from R.K., (2) R.K. was a transaction entered into for
profit, and (3) petitioners are entitled to capital loss
carryover deductions for the years in issue. Because petitioners
did not have any capital gains for the years in issue, the
capital loss carryover deductions are only $3,000 per year. For
1986, see sec. 1211(b)(2)(B). For 1987 and 1988, see sec.
1211(b)(1).
We agree with respondent.
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Losses are deductible under section 165.12 Individuals are
not permitted to deduct losses unless the losses are (1) incurred
12
Sec. 165, as in effect for 1983, provides, in pertinent
part, as follows:
SEC. 165. LOSSES.
(a) General Rule.--There shall be allowed as a
deduction any loss sustained during the taxable year and not
compensated for by insurance or otherwise.
* * * * * * *
(c) Limitations on Losses of Individuals.--In the case
of an individual, the deduction under subsection (a) shall
be limited to--
(1) losses incurred in a trade or business;
(2) losses incurred in any transaction entered
into for profit, though not connected with a trade or
business; and
(3) except as provided in subsection (h) [relating
to presidentially proclaimed disasters], losses of
property not connected with a trade or business, if
such losses arise from fire, storm, shipwreck, or other
casualty, or from theft.
* * * * * * *
(e) Theft Losses.--for purposes of subsection (a), any
loss arising from theft shall be treated as sustained during
the taxable year in which the taxpayer discovers such loss.
Although the years in issue are 1986, 1987, and 1988, we use
the statute as in effect for 1983 because that is the year for
which the loss was claimed and from which the loss was carried
forward. The later amendment of subsec. (c)(3), by sec.
711(c)(2)(A)(i) of the Deficit Reduction Act of 1984, Pub. L. 98-
369, 98 Stat. 494, 943, does not affect the instant case.
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in a trade or business, or (2) incurred in a transaction entered
into for profit, or (3) arise from a casualty or a theft. Sec.
165(c).
Laney began to work on R.K. in 1977. He bought the Island
in 1978, and applied for permits to develop the Island and make
it accessible. The Army Corps of Engineers turned him down in
1979. Laney sued in the Court of Claims in 1980. The Court of
Claims denied both sides’ summary judgment motions in 1981, and
the case was returned to the trial division of the Court of
Claims. Laney failed to make the principal payment on his
purchase-money mortgage, and Poppe, the then holder of the
mortgage note, foreclosed; the Florida court granted foreclosure
in 1983. Later in 1983 the Laney Corporation filed a chapter 11
bankruptcy petition. In 1984 this was converted to a chapter 7
proceeding; then Laney trading as the Laney Proprietorship filed
under chapter 7; then Laney was granted a discharge under chapter
7.
A. Loss From Theft
In order to be treated as a theft loss under section 165,
the loss must arise from a criminal appropriation of the
taxpayer’s property. Edwards v. Bromberg, 232 F.2d 107, 110 (5th
Cir. 1956); Horn v. Commissioner, 90 T.C. 908, 940 (1988);
Nichols v. Commissioner, 43 T.C. 842, 884 (1965). A seizure of
property by a government under color of legal authority is not a
- 34 -
theft, whether or not the government conduct is arbitrary or
despotic. Farcasanu v. Commissioner, 436 F.2d 146, 149 (D.C.
Cir. 1970), affg. 50 T.C. 881 (1968); Powers v. Commissioner, 36
T.C. 1191, 1192 (1961). As to foreclosures and repossessions,
see Johnson v. United States, 291 F.2d 908, 909 (8th Cir. 1961);
Rafter v. Commissioner, 60 T.C. 1, 13 (1973), affd. without
published opinion 489 F.2d 752 (2d Cir. 1974).
Whether or not the Army Corps of Engineers acted within its
lawful authority,13 we conclude, and we have found, that the Army
Corps of Engineers did not criminally appropriate the Island or
any other asset connected with R.K.
We conclude, and we have found, that Poppe’s actions in
successfully enforcing his rights under the purchase-money
mortgage note did not constitute a criminal appropriation of the
Island or any other asset connected with R.K. Johnson v. United
States, 291 F.2d at 909.
Petitioners point out that respondent did not dispute their
1983, 1984, and 1985 theft/casualty loss deductions and
carryovers. As supra table 1 shows, petitioners reported a
substantial profit for 1983, but for this deduction. Also,
petitioners reported other income for 1984, and wage and other
income for 1985 (see supra table 2), in amounts substantially
13
See Laney v. United States, 661 F.2d at 147-149,
holding that the Army Corps of Engineers misinterpreted the law.
- 35 -
greater than the losses that petitioners reported for these
years, but for their theft/casualty deductions. Thus, it appears
that petitioners would have had tax liabilities for 1983, 1984,
and 1985 if respondent had disallowed the claimed theft/casualty
deductions. We do not know why respondent failed to audit
petitioners’ tax returns for these years. Respondent’s failure
to timely audit petitioners’ 1983, 1984, and 1985 tax returns may
have resulted in petitioners’ obtaining a windfall for those
years, but it does not estop respondent from auditing petitioners
for 1986, 1987, and 1988 on the theft/casualty loss deduction
carryover issue and determining deficiencies for these years on
this issue. Thomas v. Commissioner, 92 T.C. 206, 225-227 (1989),
and cases there cited.
We hold, for respondent, that Laney’s claimed 1983 loss did
not arise from theft.
B. Loss From Casualty
A loss must arise from fire, storm, shipwreck, or “other
casualty” in order to be treated as a casualty loss under section
165. Sec. 165(c)(3). Clearly, Laney’s R.K. loss did not arise
from a fire, a storm, or a shipwreck. Generally, in order for a
loss to arise from an “other casualty” (1) the event causing the
loss must be sudden, undesigned, violent or forceful, unexpected,
and accidental, and (2) the direct and proximate damage from the
event must cause a loss that is similar to losses arising from
- 36 -
fires, storms, and shipwrecks. Popa v. Commissioner, 73 T.C.
130, 132-133 (1979); White v. Commissioner, 48 T.C. 430, 434-435
(1967); Durden v. Commissioner, 3 T.C. 1, 3-4 (1944). As we put
it in Billman v. Commissioner, 73 T.C. 139, 141-142 (1979)--
We cannot believe that the Internal Revenue Code
was designed to take care of all losses that the
economic world may bestow on its inhabitants. It is
restricted in its description of a casualty loss to
“losses aris[ing] from fire, storm, shipwreck, or other
casualty, or from theft.” Certainly these taxpayers
did not suffer from “fire, storm, [or] shipwreck.” Of
course they suffered. But, was it from “other
casualty?” To us, “other casualty” means a similar
kind of occurrence to “fire, storm, [or] shipwreck.”
* * *
Firstly, Poppe’s successful foreclosure proceeding is not
the type of event that is sudden, undesigned, violent or
forceful, unexpected, and accidental. Secondly, even assuming
that petitioners lost all value of the Island and R.K. on account
of the Army Corps of Engineers’ action of denying permits to
develop the Island, that denial is not the type of event that is
sudden, undesigned, violent or forceful, unexpected, and
accidental. Thus, Laney’s loss was not from an “other casualty”.
Powers v. Commissioner, 36 T.C. at 1193; see Beltran v. United
States, 441 F.2d 954, 960 (7th Cir. 1971); Alvarez v. United
States, 431 F.2d 1261, 1264 (5th Cir. 1970).
We hold, for respondent, that Laney’s claimed 1983 loss did
not arise from fire, storm, shipwreck, or other casualty.
- 37 -
C. Loss From Trade or Business
As a result of subsections (c) and (d) of section 172, the
basic category of an individual’s losses that may constitute net
operating losses is losses from the conduct of a trade or
business. In general, expenditures paid or incurred in preparing
to enter a trade or business must be capitalized, even if those
expenditures are of a sort that ordinarily would be currently
deductible if the taxpayer had already entered the trade or
business. Hardy v. Commissioner, 93 T.C. 684, 687 (1989), affd.
on this issue and remanded to consider a new issue per order
(10th Cir., Oct. 29, 1990).
Because we conclude, for reasons described infra, that (1)
R.K. was not a part of Laney’s then-ongoing consulting trade or
business, and (2) R.K. had not yet gone into operation when Laney
suffered his losses therefrom, petitioners are not permitted to
carry over Laney’s R.K. losses as a net operating loss to the
years in issue.
Whether a transaction is an expansion of an existing
business, or creates a new and distinct trade or business depends
on the facts and circumstances. In First Security Bank of Idaho,
N.A. v. Commissioner, 63 T.C. 644 (1975), affd. 592 F.2d 1050
(9th Cir. 1979), this Court concluded that when First Security
Bank of Idaho and First Security Bank of Utah initiated consumer
credit card plans, the initial expenses were expenses of
- 38 -
expanding their already existing commercial banking activities,
and not preopening expenses of new businesses. On the other hand
in Hardy v. Commissioner, supra, this Court concluded that the
taxpayer’s intent to buy and thereafter to own and manage large
commercial hotel and motel properties was unrelated to the
taxpayer’s part-time work managing rental homes.
We believe that the situation in the instant case is more
like a rental real estate manager beginning a new business as a
manager and owner of hotels and motels, than it is like
commercial banks expanding into the credit card industry. Laney
worked as a computer programming consultant. In or around 1977
Laney began to do computer consulting for several pharmaceutical
companies. Laney designed integrated computer systems for these
companies that could communicate with other computer systems.
His work for these companies was performed either at their
facilities or at his home office. Laney’s consulting work
consisted of providing a service; it did not include rental of
space or ownership of real property. In the case of R.K.,
however, Laney’s plan was to profit from the rental of cage
space. He expected to offer his consulting services to the R.K.
researching entities, but none of those entities would be
required to use his consulting services.
Petitioners called Clement C. Darrow II (hereinafter
sometimes referred to as Darrow), as an expert witness, both to
- 39 -
show the legitimacy of R.K. and to provide Darrow’s opinion as to
the value of R.K., if that project had not been cut off in its
infancy. Darrow had been director of a primate center for Litton
Bionetics under contract to NIH in 1978, when he was approached
by American Cyanamid Co. (hereinafter sometimes referred to as
American Cyanamid) to review plans for R.K. In August 1978,
Darrow began to work for American Cyanamid. He was hired to
direct American Cyanamid’s primate breeding and research work
that was planned to be carried out on the Island. He continued
to work for American Cyanamid in this role until March 1982. The
Court was satisfied that Darrow’s prior experience in responsible
positions in creating or supervising primate research operations,
and his lengthy involvement in R.K. planning as an American
Cyanamid employee, qualified him as an expert witness in the
offered matters. Darrow valued R.K. at $19,200,000, entirely on
the basis of an analysis of the cage fees that Laney was likely
to receive from the operations of R.K. To us, Darrow’s analysis
emphasizes the substantial differences between R.K. and Laney’s
established trade or business as a consultant.
Also, Laney kept separate books and records for his
consulting services expenditures and his R.K. expenditures; he
generally deducted his consulting services expenditures currently
but capitalized his R.K. expenditures. Laney testified that he
- 40 -
regarded R.K. as “a separate entity” for tax and accounting
purposes.
We conclude, and we have found, that R.K. was not part of
Laney’s trade or business of offering his services as a
consultant.
Because R.K. had not yet gone into operation when Laney
suffered his reverses and, in 1983, his loss in connection
therewith, Laney’s 1983 R.K. loss was not a loss attributable to
a trade or business, and so could not enter into the computation
of a net operating loss. Sec. 172(d)(4); Todd v. Commissioner,
77 T.C. 246 (1981), affd. 682 F.2d 207 (9th Cir. 1982).
We hold, for respondent, that Laney’s claimed 1983 loss did
not arise from a trade or business.
D. Nature and Amount of Loss
Respondent concedes that R.K. was a transaction entered into
for profit, within the meaning of section 165(c)(2). We have
held that Laney’s 1983 R.K. loss could not be carried forward as
a theft loss, a casualty loss, or a trade or business loss.
Petitioners have not suggested, and we have not found, any other
ordinary loss that could be carried from 1983 to the years before
the Court.14
14
Neither side discusses sec. 195, relating to
deductibility of startup expenditures. Laney’s testimony about
his pre-1983 notions of proper accounting procedures, his
promises to clarify matters later in the trial, and his brief
(continued...)
- 41 -
Respondent concedes that Laney suffered a capital loss that,
under section 165(f), could be deducted and carried over within
the limits of sections 1211 and 1212. Respondent further
concedes that “the amount of loss available for carryforward as
of 1986 is $90,578.21". Petitioners have not reported any
capital gains or losses for 1986, 1987, or 1988. Under section
1211(b)(1), petitioners are entitled to deduct against ordinary
income up to $3,000 of this capital loss carryover for each of
the years before the Court.
It is evident that respondent’s concession exceeds the
maximum amount that petitioners could deduct for the entire
period before us. Accordingly, even if we were to conclude that
petitioners are entitled to carry over a greater amount of loss
than respondent has conceded, any such conclusion could not
result in any greater deduction by petitioners for any of the
years in issue, and so any such conclusion could not affect the
decision to be entered in the instant case.
As a result, we decline to determine in the instant case
whether petitioners are entitled to a greater capital loss
carryover than respondent has conceded. Chevron Corp. v.
14
(...continued)
explanations of only a small portion of his 1,300-plus exhibits,
do not leave us in a position to determine on the record in the
instant case whether petitioners would be entitled to deductions
under sec. 195 that would affect any of the years in issue.
- 42 -
Commissioner, 98 T.C. 590 (1992); LTV Corp. v. Commissioner, 64
T.C. 589 (1975).
We hold that petitioners are entitled to deduct $3,000
against ordinary income for each of the years before us, on
account of their capital loss carryover to these years.
III. Additions to Tax
A. Section 6651(a)(1)
Section 6651(a)(1)15 imposes an addition to tax of 5 percent
per month (with a maximum of 25 percent) in case of failure to
file a timely income tax return, unless it is shown that this
failure is due to reasonable cause and not due to willful
neglect. Petitioners have the burden of proving error in
respondent’s determination that this addition to tax should be
15
Sec. 6651(a) provides, in pertinent part, as follows:
SEC. 6651. FAILURE TO FILE TAX RETURN OR TO PAY TAX.
(a) Addition to the Tax.--In case of failure--
(1) to file any return required under
authority of subchapter A of chapter 61 * * *
on the date prescribed therefor (determined
with regard to any extension of time for
filing), unless it is shown that such failure
is due to reasonable cause and not due to
willful neglect, there shall be added to the
amount required to be shown as tax on such
return 5 percent of the amount of such tax if
the failure is for not more than 1 month,
with an additional 5 percent for each
additional month or fraction thereof during
which such failure continues, not exceeding
25 percent in the aggregate;
- 43 -
imposed against them. Funk v. Commissioner, 687 F.2d 264, 266
(8th Cir. 1982), affg T.C. Memo. 1981-506; Ehrlich v.
Commissioner, 31 T.C. 536, 540 (1958).
Respondent concedes that petitioners timely filed their 1986
and 1988 tax returns. See supra note 2.
Petitioners received an automatic extension of time, until
August 15, 1988, to file their 1987 tax return. They timely
filed a request for a further extension, until May 5, 1989; they
were granted an extension only until October 17, 1988. They
filed their 1987 tax return on May 11, 1989, almost 7 months
late.
At trial and on brief petitioners contend that they filed a
1987 “first return”, or “initial return”, on August 15, 1988,
together with their request for a further extension.
Respondent’s records show both extensions, but do not show any
1987 tax return for petitioners filed before May 11, 1989. We
note that petitioners’ August 15, 1988, request for further
extension states the following as the last sentence of their
explanation of why they need the further extension: “Tax Payer
will be due a refund of $953.08 when the Federal return is filed
and owes no tax.” (Emphasis added.) This language strongly
suggests that the request for further extension was not
accompanied by any tax return for 1987.
- 44 -
When this contention by petitioners first became apparent to
the Court, on the morning of the sixth day of trial, the
following colloquy occurred:
THE COURT: And all this time you have not
provided for the Court, and I gather not provided for
respondent, a copy of the document that you are now
telling us was your tax return for 1987.
THE WITNESS [Laney]: I discussed it at audit. I
discussed it with appeals. I have contended that we
did file on time and I have mentioned the fact that we
also asked for an extension and that a second return
was filed and petitioners have been consistent in that
position, Your Honor.
THE COURT: Mr. Laney, I had understood until now
that when you said that you contended that your tax
return was filed on time you were contending that you
had received extensions until May 5, 1989, and so the
question is whether or not you had indeed received such
an extension. But now, if I understand correctly, you
are telling us no, that’s not the deadline that is
applicable here and that is not the tax return that is
applicable here; the relevant deadline was August 15,
1988, and you satisfied that August 15, 1988, deadline
by mailing a tax return on August 15, 1988.
THE WITNESS: Yes, Your Honor. When the trial
began for this day and we were discussing penalties
petitioner said that he had a certified mail receipt
for the fact that he had filed his return on time and
that it was dated August 15, 1988.
THE COURT: But the only stipulated document as
the tax return was Exhibit 2-B, which clearly showed
your signature and Mrs. Laney’s signature of May 1989,
which was a flat out contradiction to your position.
THE WITNESS: But we still stated at that time
that we had filed a return on August 15th. We’ve never
varied from that. We also took extensive precautions
in case that return was in error to provide us with the
ability to file a second return without paying a
penalty for having the refund if we did not deserve it.
- 45 -
THE COURT: When, if at all, did you intend to
provide the Court with a copy of the return you claimed
to have filed on August 15, 1988?
THE WITNESS: Your Honor, I will go to my records
and make a copy of that and bring that in tomorrow. I
apologize for the confusion. When we were audited and
that copy was first produced for the convenience of the
auditor and then apparently passed in the
administrative file and on up, it now appears that we
should have provided a copy of the initial filing. We
apologize for not doing that.
Petitioners were given an opportunity to produce any retained
copy, or other evidence, of an earlier filed 1987 tax return.
They did not produce any such evidence.
We do not believe Laney’s testimony that petitioners sent to
respondent a tax return for their 1987 liability together with
their August 15, 1988, request for further extension. We do not
believe that petitioners sent to respondent any tax return for
their 1987 liability before they sent the tax return with the May
5, 1989, signature dates, which respondent filed on May 11, 1989.
We have so found.
Thus, petitioners’ tax return was filed almost 7 months
after the October 17, 1988, extended due date. Under section
6651(a)(1), this results in an addition to tax of 25 percent of
the amount of petitioners’ tax liability, “unless it is shown
that such failure [to file timely] is due to reasonable cause and
not due to willful neglect”.
Petitioners contend, and Laney testified, that they received
from respondent a notice that their August 15, 1988, request for
further extension was granted for “maximum time allowed”, and
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this was stated to be until May 5, 1989. The only documentary
evidence that petitioners presented on this point is a letter
attached to their 1987 tax return, as follows (emphasis in
original):
Melvin J. & Carolyn A. Laney
1515 Spencerville Rd.
Spencerville, Md. 20868
November 9, 1988
Director
Internal Revenue Service
Philadelphia, Pa. 19255
Dear Director:
Re: Verification of Special Extension to File 1987
Return for Account # 215 38 2691
On August 15, 1988 we filed Form 2688 plus a special
request to file our 1987 return by May 5, 1989. As part of
our special request we enclosed a copy of our May 5, 1988
Md. Tax Court opinion ruling in our favor. The Md.
Comptroller had taken no action on this ruling and we
requested a special extension. Yesterday we received a
notice from your office granting our request for “Maximum
time allowed”.
Today we called 488-3100 and spoke with a Mr. Hill in
the Problem Resolution Office and then with a Mr. Wilson of
the Accounts Office. Mr. Wilson assured us that we could
assume the words “Maximum time allowed” applied to our
special request and not to the standard Form 2688 extension
time. The time period for Form 2688 expired last month.
We are writing this letter to verify approval of our
special request based on the Maryland Tax Court opinion
previously enclosed. The final resolution of this case will
effect how our Federal Income Tax/Md. return is completed.
We will owe no federal tax and will receive a refund for
1987.
Sincerely,
Melvin J. Laney
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Respondent’s records show that, on August 22, 1988, it was
posted that petitioners’ request for further extension was
granted until October 17, 1988.
In evaluating the evidence we note the following:
(1) Petitioners appear to have made up their story
about a 1987 tax return filed on or about August 15,
1988.
(2) Petitioners have kept extensive tax-related
records dating back to 1977 but have not produced the
notice they received from respondent so that we could
view the language described in petitioners’ November 9,
1988, letter.
(3) Petitioners have not described with
particularity what they asked of respondent’s employees
in the telephone call described in petitioners’
November 9, 1988, letter.
Petitioners have to persuade us that it is more likely than
not that respondent’s employees advised petitioners that
petitioners had until May 5, 1989, to file their 1987 tax return,
that petitioners in fact relied on this advice, and that it was
reasonable for petitioners to rely on this advice.
We doubt the correctness of petitioners’ story; we doubt
that respondent’s employees really advised petitioners that the
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due date of petitioners’ 1987 tax return was extended to May 5,
1989; and in light of our lack of information as to the foregoing
we cannot conclude that petitioners acted reasonably in delaying
the filing of their 1987 tax return.16
We hold, for respondent, that petitioners filed their 1987
tax return more than 6 months late, and that petitioners have not
shown that their failure to file timely was due to reasonable
cause.
B. Section 6653(a)(1)
In the notice of deficiency respondent determined, and on
brief respondent contends, that petitioners were negligent in
claiming the theft/casualty loss deduction. At trial Laney
testified, and on brief petitioners contend, that they relied on
the advice of Henry, their lawyer, in claiming this deduction.
We agree with respondent.
16
For example, it may be that respondent’s employees
merely advised petitioners that, if petitioner in fact did not
have a tax liability (or no tax liability in excess of their
$953.08 of withholding), then petitioners would not be liable for
an addition to tax under sec. 6651(a)(1). As we have held on
other occasions, that advice would not protect petitioners in the
instant case, because they do have a 1987 tax liability in excess
of their withholding. E.g., Beales v. Commissioner, T.C. Memo.
1992-608; Morgan v. Commissioner, T.C. Memo. 1984-384, affd. 807
F.2d 81 (6th Cir. 1986); Wilkinson v. Commissioner, T.C. Memo.
1982-429; see also Patronik-Holder v. Commissioner, 100 T.C. 374,
379-381 (1993); Stevens Bros. Foundation, Inc. v. Commissioner,
39 T.C. 93, 133-134 (1962), affd. in part and revd. in part 324
F.2d 633, 646 (8th Cir. 1963).
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Section 6653(a)(1)(A)17 (sec. 6653(a)(1), as to 1988)
imposes an addition to tax of 5 percent of the underpayment if
17
Sec. 6653(a), as in effect for 1986 and 1987, provides,
in pertinent part, as follows:
SEC. 6653. ADDITIONS TO TAX FOR NEGLIGENCE AND FRAUD.
(a) Negligence.--
(1) In general.--If any part of any underpayment
* * * is due to negligence or disregard of rules or
regulations, there shall be added to the tax an amount
equal to the sum of--
(A) 5 percent of the underpayment, and
(B) an amount equal to 50 percent of the
interest payable under section 6601 with respect
to the portion of such underpayment which is
attributable to negligence for the period
beginning on the last date prescribed by law for
payment of such underpayment (determined without
regard to any extension) and ending on the date of
the assessment of the tax (or, if earlier, the
date of the payment of the tax).
Sec. 6653(a), as in effect for 1988, provides, in pertinent
part, as follows:
SEC. 6653. ADDITIONS TO TAX FOR NEGLIGENCE AND FRAUD.
(a) Negligence.--
(1) In general.--If any part of any underpayment
(as defined in subsection (c)) of tax required to be
shown on a return is due to negligence (or disregard of
rules or regulations), there shall be added to the tax
an amount equal to 5 percent of the underpayment.
The later amendment of this provision by sec. 7721(c)(1) of
the Omnibus Budget Reconciliation Act of 1989 (OBRA 89), Pub. L.
101-239, 103 Stat. 2106, 2399, does not affect the instant case.
The substance of this provision now appears in subsecs. (b)(1)
and (c) of sec. 6662.
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any part of the underpayment is due to negligence or intentional
disregard of rules or regulations. Section 6653(a)(1)(B) imposes
an additional addition to tax equal to 50 percent of the interest
payable under section 6601 with respect to the portion of the
underpayment attributable to the negligence, etc. Petitioners
have the burden of proving error in respondent’s determination
that these additions to tax should be imposed against them.
Korshin v. Commissioner, 91 F.3d 670, 671 (4th Cir. 1996), affg.
T.C. Memo. 1995-46; Bixby v. Commissioner, 58 T.C. 757, 791-792
(1972).
Broadly speaking, for purposes of this provision, negligence
is lack of due care or failure to do what a reasonable and
ordinarily prudent person would do under the circumstances.
Cluck v. Commissioner, 105 T.C. 324, 339 (1995); Neely v.
Commissioner, 85 T.C. 934, 947-948 (1985). Reasonable and good-
faith reliance by a taxpayer on an accountant or attorney may be
sufficient to avoid the addition to tax for negligence. See
United States v. Boyle, 469 U.S. 241, 251 (1985).
The $16 million-plus deduction that petitioners took on
their 1983 tax return and carried over to each of their tax
returns through at least 1988, was many times as great as any
other items on their tax returns from 1977 on. See supra tables
1 and 2. From 1983 on, these deductions took petitioners off the
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Federal tax rolls as to both the regular income tax and, they
contended, the self-employment taxes. See supra table 2.
Clearly, the ordinarily prudent taxpayer would consult with a
qualified tax adviser before claiming a deduction of such
relative size and consequence.
Petitioners claim that they did just that--they consulted
with Henry and they acted on Henry’s advice. However,
petitioners did not tell us exactly what Henry’s advice was, nor
did they provide us with information from which we could conclude
that it was reasonable for them to rely on Henry’s advice.
Finally, as discussed supra (I. Settlement A. With Justice
Department), petitioners promised that we would have Henry’s
testimony, but then did not call Henry. As discussed supra in
Part I.A., we are entitled to, and we do, infer that if Henry had
testified, then his testimony would have been unfavorable to
petitioners on this issue. O’Dwyer v. Commissioner, 266 F.2d at
584; Stoumen v. Commissioner, 208 F.2d at 907; Wichita Terminal
Elevator Co. v. Commissioner, 6 T.C. at 1165.
Also apart from the effect of the Wichita Terminal doctrine,
when taxpayers rely on the claim that they are not negligent
because they merely followed competent professional advice, it is
particularly important that they present their adviser, that they
show with some precision what their adviser advised them to do,
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and that they show that they followed that advice. Zfass v.
Commissioner, 118 F.3d 184 (4th Cir. 1997), affg. T.C. Memo.
1996-167. Petitioners failed on all these counts in the instant
case. We do not credit petitioners’ contention that they relied
on Henry’s advice.
Petitioners point out that respondent did not dispute their
1983, 1984, and 1985 theft/casualty deductions and carryovers.
Respondent’s failure to audit merely results in an apparent
windfall to petitioners; it does not relieve petitioners from
their obligation to act prudently and obtain advice from
competent tax counsel.18
We conclude, and we have found, that petitioners were
negligent in claiming the theft/casualty carryover deductions for
each of the years in issue.
For each of the years in issue the entire deficiency in tax
is due to petitioners’ negligence in claiming the theft/casualty
carryover deduction. For each of the years in issue the
deficiency is equal to the “underpayment of tax”, which is the
18
We have held that, under some circumstances, an audit
for an earlier year and a concession by the Commissioner that the
corresponding deduction for the earlier year was correct, might
relieve a taxpayer from the obligation to thereafter obtain
advice from competent tax counsel. See, e.g., Bermingham v.
Commissioner, T.C. Memo. 1994-69; see also Washburn v.
Commissioner, 44 T.C. 217, 225-226 (1965). There was no such
audit in the instant case, and no apparent approval by respondent
as to the claimed theft/casualty loss deductions.
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base for the negligence additions to tax. Sec. 6653(c), now to
be found in sec. 6664(a).
Consequently, we hold, for respondent, that for each of the
years in issue19 the entire underpayment of tax is due to
petitioners’ negligence.
C. Section 6661(a)
Section 6661(a)20 imposes an addition to tax of 25 percent
of the amount of any underpayment attributable to a substantial
understatement of tax. Cochrane v. Commissioner, 107 T.C. 18, 29
(1996); Pallottini v. Commissioner, 90 T.C. 498 (1988). An
understatement is substantial if it exceeds the greater of 10
percent of the correct tax or $5,000. Sec. 6661(b)(1)(A). (Our
19
See Emmons v. Commissioner, 92 T.C. 342, 347-351
(1989), affd. 898 F.2d 50 (5th Cir. 1990), as to the effect that
the late filing of petitioners’ 1987 tax return would have on the
negligence addition for 1987. We have not engaged in an Emmons-
type analysis in the instant case because the parties did not
present the point, and such an analysis would not affect the
conclusions we reached on different grounds.
20
SEC. 6661. SUBSTANTIAL UNDERSTATEMENT OF LIABILITY.
(a) Addition to Tax.--If there is a substantial
understatement of income tax for any taxable year, there
shall be added to the tax an amount equal to 25 percent of
the amount of any underpayment attributable to such
understatement.
Sec. 6661 was repealed by sec. 7721(c)(2) of OBRA 89, 103
Stat. 2399. The substance of former sec. 6661 now appears as
secs. 6662(b)(2), 6662(d), and 6664(c)(1).
- 54 -
holdings make it clear that petitioners have substantial
understatements for 1986, 1987, and 1988.)
If an item is not attributable to a tax shelter, then the
understatement shall be reduced on account of the item, and the
addition to tax accordingly reduced, if (1) the taxpayer’s
treatment of the item was based on substantial authority, or (2)
the taxpayer adequately disclosed on the tax return or in a
statement attached to the tax return the relevant facts affecting
the item’s tax treatment. Sec. 6661(b)(2)(B).
Petitioners were not involved with a tax shelter, and they
attached a note to their tax returns explaining that the
carryover loss they claimed originated from a 1983 net operating
loss from business property seized by the Army Corps of
Engineers. We believe that this disclosure is adequate in the
context of the instant case.
We hold for petitioners on this issue.
To reflect the foregoing, and respondent’s concessions, see
supra note 2,
Decision will be entered
under Rule 155.