The opinion
T.C. Memo. 2000-372
UNITED STATES TAX COURT
JAMES D. BARBER AND BETTY L. BARBER, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 7777-95, 7778-95. Filed December 7, 2000.
George W. Gregory, for petitioners.
Alexandra E. Nicholaides, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
ARMEN, Special Trial Judge: In so-called affected items
notices of deficiency, respondent determined additions to tax to
petitioners’ Federal income taxes for the years and in the
amounts as shown below:
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Additions to tax
Sec. Sec. Sec.
6653(a)(1) 6653(a)(2) 6659
Year
1
1982 $1,162 $5,236
1
1983 10 —
1
50 percent of the interest payable with
respect to the portion of the underpayment
that is attributable to negligence or
intentional disregard of rules or regulations.
The underpayments for the years in issue were
determined and assessed pursuant to a partnership-
level proceeding. See secs. 6221-6233. In the
present cases, respondent determined that the
entire underpayment for each of the years in
issue is attributable to negligence or intentional
disregard of rules or regulations.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable years in
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
After concessions by petitioners,1 the issues for decision
1
Petitioners do not contest that the Sentinel EPS recyclers
that are involved in these cases were overvalued. See Gottsegen
v. Commissioner, T.C. Memo. 1997-314; see also Ulanoff v.
Commissioner, T.C. Memo. 1999-170. Petitioners therefore concede
(in par. 1. of the stipulation of facts) that they are liable for
the addition to tax for valuation overstatement under sec. 6659
for 1982. To the extent that petitioners’ concession may not
extend to sec. 6659(e), and assuming arguendo that petitioners
properly raised an issue under that section, then we decide such
issue in respondent’s favor. See, e.g., Addington v.
Commissioner, 205 F.3d 54, 62 (2d Cir. 2000), affg. Sann v.
Commissioner, T.C. Memo. 1997-259; Ulanoff v. Commissioner,
supra.
(continued...)
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are as follows:
(1) Whether petitioners are liable for additions to tax
under section 6653(a)(1) and (2) for negligence or intentional
disregard of rules or regulations. We hold that petitioners are
so liable.
(2) Whether petitioners are entitled to the terms of the
Plastics Recycling Project Settlement Offer proffered by
respondent in October 1988 to the tax matters partner of Whitman
Recycling Associates. We hold that petitioners are not so
entitled.
FINDINGS OF FACT
Some of the facts have been stipulated, and they are so
found. The stipulated facts and attached exhibits are
incorporated herein by this reference. Petitioners resided in
Plymouth, Michigan, at the time that each of their petitions was
filed with the Court.
1
(...continued)
Moreover, it would appear that petitioners have abandoned
their contention regarding the statute of limitations (the so-
called Davenport issue) in view of the recent affirmance of this
Court’s opinion on that issue by the Court of Appeals for the
Eleventh Circuit. See Davenport Recycling Associates v.
Commissioner, 220 F.3d 1255 (11th Cir. 2000), affg. T.C. Memo.
1998-347; see also Klein v. United States, 86 F. Supp.2d 690
(E.D. Mich. 1999); Clark v. United States, 68 F. Supp.2d 1333,
1342-1346 (N.D. Ga. 1999); Kohn v. Commissioner, T.C. Memo. 1999-
150. However, if we are mistaken in this regard, then we refer
the parties to paragraphs 1 and 22 of the stipulation of facts,
and we decide the Davenport issue in respondent’s favor based on
the foregoing precedent.
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A. The Whitman Transactions
These cases are part of the Plastics Recycling group of
cases. In particular, the additions to tax arise from the
disallowance of losses, investment credits, and energy credits
claimed by petitioners with respect to a partnership known as
Whitman Recycling Associates (Whitman or the partnership).
For a detailed discussion of the transactions involved in
the Plastics Recycling group of cases, see Provizer v.
Commissioner, T.C. Memo. 1992-177, affd. per curiam without
published opinion 996 F.2d 1216 (6th Cir. 1993). The underlying
transactions involving the Sentinel recycling machines
(recyclers) in petitioners’ cases are substantially identical to
the transactions in Provizer v. Commissioner, supra, and, with
the exception of certain facts that we regard as having minimal
significance, petitioners have stipulated substantially the same
facts concerning the underlying transactions that were described
in Provizer v. Commissioner, supra.
In a 4-step series of simultaneous transactions closely
resembling those described in the Provizer case and stipulated by
the parties herein, Packaging Industries of Hyannis,
Massachusetts (PI) manufactured and sold2 four Sentinel
2
Terms such as sale and lease, as well as their
derivatives, are used for convenience only and do not imply that
the particular transaction was a sale or lease for Federal tax
purposes. Similarly, terms such as joint venture and agreement
(continued...)
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EPS3 recyclers to ECI Corporation (ECI) for $1,520,000 each. ECI
simultaneously resold the recyclers to F&G Corporation (F&G) for
$1,750,000 each. F&G simultaneously leased the recyclers to
Whitman. Finally, Whitman simultaneously entered in a joint
venture with PI and Resin Recyclers Inc. (RRI) to “exploit” the
recyclers and place them with end-users. Under this latter
arrangement, PI was required to pay Whitman a monthly joint
venture fee.
For convenience, we refer to the series of transactions
between and among PI, ECI, F&G, Whitman, and RRI as the Whitman
transactions.
The sales of the Sentinel EPS recyclers from PI to ECI were
financed using 12-year nonrecourse notes. The sales of the
recyclers from ECI to F&G were financed using 12-year “partial
recourse” notes; however, the recourse portion of the notes was
payable only after the first 80 percent of the notes, the
2
(...continued)
are also used for convenience only and do not imply that the
particular arrangement was a joint venture or an agreement for
Federal tax purposes.
3
EPS stands for expanded polystyrene. The case of
Provizer v. Commissioner, T.C. Memo. 1992-177, affd. per curiam
without published opinion 996 F.2d 1216 (6th Cir. 1993), involved
Sentinel expanded polyethylene (EPE) recyclers. However, the EPS
recycler partnerships and the EPE recycler partnerships are
essentially identical. See Davenport Recycling Associates v.
Commissioner, T.C. Memo. 1998-347, affd. 220 F.3d 1255 (11th Cir.
2000); see also Gottsegen v. Commissioner, T.C. Memo. 1997-314
(involving both the EPE and EPS recyclers); Ulanoff v.
Commissioner, T.C. Memo. 1999-170 (same).
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nonrecourse portion, was paid. No negotiations for the price of
the recyclers took place between, or among, PI, ECI and F&G.
At the closing of the Whitman partnership, PI, ECI, F&G,
Whitman, and RRI entered into arrangements whereby PI would pay a
monthly joint venture fee to Whitman, in the same amount that
Whitman would pay as monthly rent to F&G, in the same amount that
F&G would pay monthly on its note to ECI, in the same amount that
ECI would pay monthly on its note to PI. Further, in connection
with the closing of the Whitman partnership, PI, ECI, F&G,
Whitman, and RRI entered into offset agreements providing that
the foregoing payments were bookkeeping entries only and were
never in fact paid. Also in connection with the closing of the
Whitman partnership, PI, ECI, F&G, Whitman, and RRI also entered
into cross-indemnification agreements.
B. Individuals Involved
Richard Roberts (Roberts) was a businessman and the general
partner in a number of limited partnerships that leased Sentinel
EPE recyclers. Roberts was also a 9-percent shareholder in F&G,
the corporation that leased the recyclers to Whitman in the
Whitman transactions.
Raymond Grant (Grant) was an investment banker, attorney,
and accountant. Grant was also the president and sole owner of
ECI, the corporation that sold the recyclers to F&G in the
Whitman transactions.
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From 1982 through 1985, Roberts and Grant were in the
business of promoting tax-sheltered investments. Roberts and
Grant also served as general partners in other investments.
Before the Whitman transactions, Roberts and Grant were clients
of the accounting firm H.W. Freedman & Co. (Freedman & Co.).
Harris W. Freedman (Freedman), a certified public accountant
and the named partner in Freedman & Co., was the president,
chairman of the board, and 9.1 percent owner of F&G. Freedman
was experienced with leveraged leasing, and he owned 94 percent
of a Sentinel EPE recycler.
Freedman & Co. prepared the tax returns for ECI, F&G, and
Clearwater Group, the partnership that was involved in Provizer
v. Commissioner, supra. Although Freedman & Co. did not prepare
the initial financial projections included in the Whitman private
placement offering memorandum, Freedman & Co. reviewed those
financial projections and made suggestions as to format and
substance.
Freedman & Co. also provided tax services to John D. Bambara
(Bambara). Bambara was the president and sole owner of First
Massachusetts Equipment Corp. (FMEC Corp.), another entity that
was involved in Provizer v. Commissioner, supra. Bambara was
also the president of PI and a member of its board of directors
and with his wife and daughter also owned 100 percent of the
stock of PI, the corporation that sold the recyclers to ECI in
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the Whitman transactions.
Elliot I. Miller (Miller), a practicing attorney who was
experienced in tax matters, was the corporate counsel to PI.
Miller represented Grant personally and Grant’s clients who
invested in programs that Grant promoted. Miller met Grant in
the 1970's when Grant was involved in marketing a coal mine.
Miller was also a 9.1-percent owner of F&G.
John Y. Taggert (Taggert) was a well-known tax attorney, the
head of the tax department of the New York law firm of Windells,
Marx, Davis & Ives, and an adjunct professor of tax law at the
New York University Law School. Taggert had been acquainted with
Miller for many years before 1982. Miller recommended that
Roberts employ Taggert and his firm as counsel to the general
partner in the initial Plastics Recycling partnership. Taggert
and other members of his firm prepared the offering memorandum,
tax opinion, and other legal documents for the initial Plastics
Recycling partnership, for the Clearwater partnership, and for
about 16 other Plastics Recycling partnerships, including
Whitman. Taggert owned a 6.66-percent interest in a second-tier
Plastics Recycling partnership.
Robert Gottsegen (Gottsegen) was a businessman active in the
plastics industry and a longtime business associate of Bambara.
Gottsegen was the sole owner of RRI, the corporation that was
involved in the joint venture in the Whitman transactions, and a
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9.1-percent owner of F&G. Gottsegen was the owner of several
Sentinel recyclers and also the petitioner in Gottsegen v.
Commissioner, T.C. Memo. 1997-314.
Samuel L. Winer (Sam Winer or Winer) was Whitman’s general
partner and tax matters partner, as well as a promoter of the
partnership. Winer purportedly paid $1,000 for a 1-percent
interest in all items of income, gain, deduction, loss, and
credit of the partnership.
C. The Private Offering Memorandum
By a private placement offering memorandum dated September
28, 1982 (the offering memorandum), subscriptions for 18 limited
partnership units in Whitman were offered by the partnership’s
promoter to potential limited partners at $50,000 per partnership
unit. Pursuant to the offering memorandum, the limited partners
would own 99 percent of Whitman and the general partner, Sam
Winer, would own the remaining 1 percent. Also pursuant to the
offering memorandum, each limited partner was required to have a
net worth (including residence and personal property) in excess
of $1 million, or net income in excess of $200,000, for each
investment unit.
The offering memorandum stated that Winer would receive
$62,000 for administrative and other services to be paid from the
proceeds of the private placement offering as “management fees”.
The offering memorandum also stated that the partnership would
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pay “fees of purchaser representatives and selling commissions”
from the proceeds of the offering in an amount equal to 10
percent of the aggregate price of the units. Thus, Winer would
earn a 10-percent commission upon selling an interest in the
partnership. In addition, the offering memorandum stated that
Winer could “retain as additional compensation all amounts not
paid as purchaser representative fees or sales commissions in
connection with the Offering”.
The face of the offering memorandum warned, in bold capital
letters, that “THIS OFFERING INVOLVES A HIGH DEGREE OF RISK”.
The offering memorandum also warned that “An investment in the
partnership involves a high degree of business and tax risks and
should, therefore, be considered only by persons who have a
substantial net worth and substantial present and anticipated
income and who can afford to lose all of their cash investment
and all or a portion of their anticipated tax benefits.” The
offering memorandum went on to enumerate significant business and
tax risks associated with an investment in Whitman. Among those
risks, the offering memorandum stated: (1) There was a
substantial likelihood of audit by the Internal Revenue Service,
and the purchase price paid by F&G to ECI might be challenged as
being in excess of the fair market value; (2) the partnership had
no prior operating history; (3) the management of the
partnership’s business would be dependent on the services of the
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general partner, who had limited experience in marketing
recycling or similar equipment; (4) the limited partners would
have no control over the conduct of the partnership’s business;
(5) 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
(6) certain potential conflicts of interest existed.
The offering memorandum informed investors that the Whitman
transactions would be executed simultaneously.
The offering memorandum prominently touted the anticipated
tax benefits for the initial year of investment for an investor
in the partnership. In this regard, the offering memorandum
stated, in part, as follows:
The principal tax benefits expected from an
investment in the Partnership are to be derived from
the Limited Partner’s share of investment and energy
tax credits and tax deductions expected to be generated
by the Partnership in 1982. The tax benefits on a per
Unit basis are as follows:
Projected
Regular Investment Projected Tax
Payment and Energy Tax Credits Deductions
1982 $50,000 $77,000 $38,940
The Limited Partners are not liable for any additional
payment beyond their cash investment for their Units,
nor are they subject to any further assessment.
The offering memorandum also included a tax opinion prepared
by the law firm of Boylan & Evans concerning tax issues involved
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in the Plastics Recycling program.4 William A. Boylan (Boylan)
and John D. Evans (Evans) were formerly partners at Windells,
Marx, Davis & Ives, the law firm that had provided the legal
opinion for Sentinel EPE recycler partnerships such as
Clearwater, before leaving in 1982 and forming their own law
firm.
Also included in the offering memorandum were the reports of
two “evaluators”, Samuel Z. Burstein (Burstein) and Stanley
Ulanoff (Ulanoff). Burstein was a professor of mathematics at
New York University. Burstein’s report concluded that the
Sentinel EPS recyclers were capable of continuous recycling. The
report also concluded that the recycling system would yield a
material having commercial value.
At the time Ulanoff prepared his report, he was a professor
of marketing at Baruch College and also the author of numerous
books on technical and marketing subjects. Ulanoff’s report
concluded that the price paid by F&G for the Sentinel EPS
recyclers, the rent paid by Whitman, and the joint venture
profits were fair and reasonable.
Burstein owned a 5.82-percent interest in another Plastics
Recycling partnership that leased Sentinel EPS recyclers.
Ulanoff owned interests in other Plastics Recycling partnerships
4
The tax opinion prepared by Boylan & Evans was part of
the private offering memoranda of approximately 92 other Sentinel
EPS recycler partnerships.
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that leased both Sentinel EPS and EPE recyclers.5
The offering memorandum represented that Sentinel EPS
recyclers were unique machines. However, they were not. Several
machines capable of densifying low density materials were already
on the market in 1982. Other plastics machines available at that
time ranged in price from $20,000 to $200,000, including the
Foremost “Densilator”, the Nelmor/Weiss Densification System
(Regenolux), the Buss-Condux Plastcompactor and the Cumberland
Granulator. See Provizer v. Commissioner, T.C. Memo. 1992-177,
and the discussion regarding respondent’s experts, infra.
Moreover, the recyclers were incapable of recycling expanded
polystyrene by themselves and had to be used in connection with
extruders and pelletizers.
D. Respondent’s Experts
At trial, petitioners did not offer expert testimony.
Rather, petitioners stipulated that the Court may adopt its
findings regarding the expert testimony and reports of Steven
Grossman (Grossman) and Richard S. Lindstrom (Lindstrom) as found
in Ulanoff v. Commissioner, T.C. Memo. 1999-170; Gottsegen v.
Commissioner, T.C. Memo. 1997-314; and Fine v. Commissioner, T.C.
Memo. 1995-222. In those cases, we found Grossman and Lindstrom
to be experts in the fields of plastics, engineering, and
5
Ulanoff was also the petitioner in Ulanoff v.
Commissioner, T.C. Memo. 1999-170.
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technical information, and they submitted reports regarding both
Sentinel EPS and EPE recyclers.6
1. Grossman
Grossman is a professor in the Plastics Engineering
Department at the University of Massachusetts at Lowell. He has
a bachelor of science degree in chemistry from the University of
Connecticut and a doctorate degree in polymer science and
engineering from the University of Massachusetts. He also has
more than 15 years of experience in the plastics industry,
including more than 4 years of experience as a research and
development scientist at Upjohn Company in its Polymer Research
Group.
Grossman is also a partner in the law firm of Hayes,
Soloway, Hennessey, Grossman & Hage, P.C.. The firm practices in
the area of intellectual property, including patents, trademarks,
copyrights, and trade secret protection.
Grossman's report concerning the value of the Sentinel EPS
recyclers discusses the limited market for the recycled plastic
material. Grossman concluded that these recyclers were unlikely
to be successful products because of the absence of any new
technology, the absence of a continuous source of suitable scrap,
6
Grossman and Lindstrom were also found to be experts in
Provizer v. Commissioner, T.C. Memo. 1992-177, as well as in a
number of other Plastics Recycling cases. See, e.g., Carroll v.
Commissioner, T.C. Memo. 2000-184.
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and the absence of any established market. Grossman suggested
that a reasonable comparison of the products available in the
polystyrene industry in 1982 with the Sentinel EPS recyclers
reveals that the recyclers had very little commercial value and
were similar to comparable products available on the market in
component form. For these reasons, Grossman opined that the
Sentinel EPS recyclers did not justify the "one-of-a-kind" price
tag that they carried.
Specifically, Grossman reported that there were several
machines on the market as early as 1981 that were functionally
equivalent to, and significantly less expensive than, the
Sentinel EPS recyclers. These machines included: (1) The Japan
Repro recycler, available in 1981 for $53,000; (2) the Buss-
Condux Plastcompactor, available before 1981 for $75,000; (3)
Foremost Machine Builders' "Densilator", available from 1978-1981
for $20,000; and (4) the Midland Ross Extruder, available in 1980
and 1981 for $120,000. Grossman observed that all of these
machines were "widely available".
Grossman examined both the Sentinel EPS recycler and a Japan
Repro recycler and found that the construction of the two
machines was "nearly identical". Further, Grossman concluded
that the recycled polystyrene produced by both machines would
also be nearly identical. In Grossman's opinion, neither the
Japan Repro recycler nor the Sentinel EPS recycler represented "a
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serious effort at recycling" because the end product from both
machines was not completely devolatized and required further
processing. It was also Grossman's opinion that an individual
who seriously wanted to recycle would not purchase either of
these machines.
Grossman's opinion regarding the Sentinel EPS recycler was
based on his personal examination of a Sentinel EPS recycler, as
well as the descriptions of such recyclers as set forth in the
writings of other professionals. Grossman did not, however,
observe the Sentinel EPS recycler in actual operation.
Finally, Grossman reported on the relationship between the
plastics industry and the petrochemical industry. Grossman noted
that although the development of the petrochemical industry is a
contributing factor in the growth of the plastics industry, the
two industries have a "remarkable degree of independence".
Grossman observed that the "oil crisis" in 1973 triggered "dire"
predictions about the future of plastics that had not been
fulfilled in 1981. Grossman stated that the cost of a plastic
product depends, in large part, on technology and the price of
alternative materials. Grossman's studies concluded that a 300-
percent increase in oil prices results in a 30- to 40-percent
increase in the cost of plastic.
Grossman did not specifically value the Sentinel EPS
recycler. However, as previously stated, Grossman concluded that
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existing technology was available that provided equivalent
capability of recycling polystyrene. Specifically regarding the
Sentinel EPS recycler, Grossman also concluded that recycling
equipment that achieved the same result as the Sentinel EPS
recycler sold for about $50,000 during the relevant period.
2. Lindstrom
Lindstrom graduated from the Massachusetts Institute of
Technology with a bachelor's degree in chemical engineering.
From 1956 until 1989, Lindstrom worked for Arthur D. Little,
Inc., in the areas of process and product evaluation and
improvement and new product development, with special emphasis on
plastics, elastomers, and fibers. At the time of trial,
Lindstrom continued to pursue these areas as a consultant.
In his report, Lindstrom determined that several different
types of equipment capable of recycling expanded polystyrene were
available and priced between $25,000 and $100,000 in 1982. With
respect to the Sentinel EPS recycler in 1982, Lindstrom stated:
“Several machines were available that could reprocess EPS into
higher quality, more useful, higher value product and these
machines or processing systems cost $50,000 to $100,000.”
Lindstrom examined the Buss-Condux Plastcompactor and the
Regenolux. Lindstrom found that these machines were functionally
equivalent to the Sentinel EPS recycler and were available in the
years and at the prices reported by Grossman, detailed supra.
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Lindstrom also reported that various equipment companies, such as
the Cumberland Engineering Division of John Brown Plastics
Machinery, were willing to provide customized recycling programs
to companies at a minimum cost of $50,000.
Lindstrom found that the Sentinel EPS recycler could process
between 100 and 200 pounds of plastic per hour.
Lindstrom observed a Sentinel EPS recycler in operation and
was allowed to inspect the machine closely. Lindstrom estimated
the manufacturing cost of the Sentinel EPS recycler to be
approximately $20,000 and the market value of the machine to be
approximately $25,000.
E. Fair Market Value of the Recyclers
At all relevant times, the fair market value of the Sentinel
EPS recycler did not exceed $50,000 per machine.7
F. Petitioners and Their Introduction to Whitman
Jim Barber (petitioner) is a well-educated individual,
having graduated from the University of Michigan in 1957 with a
bachelor of science degree in mechanical engineering. For most
of his career, petitioner has worked in the field of industrial
automation. In 1982, petitioner was employed by the Bendix
Corp., and he was about 48 years old.
7
Our finding is based on the expert reports and testimony
of Grossman and Lindstrom, as stipulated by the parties. We note
that petitioners independently stipulated that the Sentinel EPS
recycler had a maximum value of between $30,000 to $50,000 per
machine. That latter stipulation is consistent with our finding.
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Petitioner Betty L. Barber is also a well-educated
individual. During the years in issue, she was a college
professor at Eastern Michigan University.
Petitioners are financially successful. During the years in
issue, they received both compensation for services and income
from other sources in the total amount (exclusive of partnership
losses) as follows:
1982 1983
$90,990 $70,573
Petitioner is a relatively sophisticated investor, and he
generally made the investment decisions for his family.
Prior to purchasing a partnership interest in Whitman,
petitioner’s investment portfolio included a variety of
interests. For example, in 1978, petitioner invested in
University Associates, a real estate partnership that owned an
apartment complex in San Diego, California. In 1979 through
1981, petitioner invested in several oil and gas partnerships,
including Winer Development Co. In addition, petitioner
maintained an account with a national brokerage firm and invested
in publicly held securities. He also owned a receivable in the
form of a land contract.
Petitioner has a younger brother, John Barber (petitioner’s
brother), who, like petitioner, graduated from the University of
Michigan with a degree in engineering. Since the mid-1970's,
petitioner’s brother has been enrolled to practice before the
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Internal Revenue Service (an enrolled agent) and has prepared tax
returns. Although petitioner has occasionally consulted with his
brother, by telephone, on “complex” tax matters, petitioner has
never asked his brother to prepare petitioners’ tax returns.
Also, petitioner has never disclosed details regarding his own
personal financial status to his brother. However, petitioner
has asked his brother for investment advice, and his brother has
offered such advice. For example, it was petitioner’s brother
who recommended that petitioner invest in University Associates
in 1978, and it was petitioner’s brother who put petitioner in
touch with Sam Winer in 1979. Contact with Winer led petitioner
to invest in Winer-promoted oil and gas partnerships, including
Winer Development Co., from 1979 through 1981. These various
Winer-promoter partnerships produced tax benefits.
In September 1982, petitioner contacted Winer and expressed
an interest in investing in another oil and gas partnership.
Winer recommended instead that petitioner invest in the plastics
recycling industry, and Winer provided petitioner with a copy of
the offering memorandum for the Whitman partnership. See supra
C. In promoting the investment, Winer stated that petitioner
would receive tax benefits.
Petitioner looked at the offering memorandum. Petitioner
understood that if he invested in Whitman, then Winer, as
promoter, would receive a commission based on petitioner’s
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purchase of an interest in the partnership.
Before making a decision, petitioner asked Winer to send a
copy of the offering memorandum to petitioner’s brother.
Subsequently, petitioner telephoned his brother and, assuming
that his brother had read the offering memorandum, asked some
questions about making the investment. After petitioner’s
brother “didn’t raise any objections to it”, petitioner decided
to invest.
In or about October 1982, petitioner signed a subscription
agreement and purchased three-tenths of a limited partnership
unit (a 1.66 percent interest) in Whitman for $15,000.
Petitioner did not, before signing the subscription
agreement and investing in Whitman, seek the advice of any expert
in the plastics recycling industry, nor did he talk to anyone
involved in the plastics recycling industry. Likewise,
petitioner did not make any independent investigation of the fair
market value of the Sentinel EPS recycler; rather, he accepted,
and did not question, the $1,750,000 per machine value as
represented in the offering memorandum.
Petitioner was influenced to sign the subscription agreement
by Winer and petitioner’s brother. However, Winer did not have
an engineering background, and he was not an expert in either
plastics materials or plastics recycling. Moreover, Winer did
not represent that he possessed specialized knowledge of the
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plastics recycling industry, and he had, at most, only limited
experience in marketing recycling or similar equipment.
Petitioner’s brother had no specialized knowledge of the plastics
recycling industry, and he had no expertise in appraising either
the value of property in general or plastics recycling machines
in particular. Petitioner did not know whether his brother had
any knowledge regarding the value of the Sentinel EPS recyclers,
nor did petitioner know whether his brother talked to anyone in
the plastics industry before giving him “advice”. Petitioner
also did not know whether his brother read the offering
memorandum.
At the time that petitioner signed the subscription
agreement and invested in Whitman, petitioner did not have any
education or work experience in either plastics materials or
plastics recycling, nor did petitioner have any specialized
knowledge about either the plastics industry in general or the
Sentinel EPS recycler in particular.
In contrast, at the time that he signed the subscription
agreement, petitioner knew that his investment in Whitman offered
immediate tax benefits in excess of his $15,000 investment.
Petitioner had not previously made any investment that offered
immediate tax benefits in excess of his investment. Petitioner
was influenced to invest in Whitman by the tax benefits described
in the offering memorandum and the statements made by Winer
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regarding such benefits.
G. Ultimate Finding Regarding Petitioner’s Motivation
Petitioner invested in Whitman principally because the
investment offered immediate tax benefits in excess of his
investment.
H. Events Leading to the Filing of Petitioners’ 1982 Return
Early in 1983, petitioner received from Sam Winer a Schedule
K-1 (Partner’s Share of Income, Credits, Deductions, etc.) for
the Whitman partnership for the taxable year 1982. The Schedule
K-1 disclosed that petitioner’s share of Whitman’s loss for 1982
was $11,852 and that petitioner’s share of the partnership’s
basis in the 4 EPS recyclers for investment credit purposes was
$116,200. Although these amounts were actually consistent with
the tax benefits promised in the offering memorandum, petitioner
was sensitive to their magnitude and mindful of the fact that
they might flag his investment as a tax shelter. Petitioner was
also uncertain how to convert his share of the partnership’s
basis in the recyclers into the regular investment tax credit and
the energy tax credit on his individual return. Accordingly,
petitioner contacted a certified public accountant for
assistance.8
The accountant that petitioner contacted was unable to help
8
Petitioner did not contact his brother because petitioner
did not disclose personal financial information to him.
- 24 -
and suggested instead that petitioner consult a tax attorney.
Accordingly, petitioner sought out Gerald Thompson (Thompson), a
young attorney who was affiliated with Krandle, Thompson & Mier
P.C. (KT&M), a small law firm in Livonia, Michigan.9 The firm’s
brochure indicated that the firm specialized in all areas of
business and corporation law and taxation. Neither KT&M nor
Thompson had any relationship with either Winer or Whitman.
Petitioner provided Thompson with copies of the Whitman
offering memorandum and his Schedule K-1.
Thompson did not have any specialized knowledge regarding
the plastics recycling industry, and he did not have any
specialized knowledge regarding the nontax business aspects of
petitioner’s Sentinel EPS recycler investment. Further, Thompson
did not make any independent attempt to evaluate the Whitman
partnership or to value the EPS recycler; rather, he confined
himself to the offering memorandum and petitioner’s Schedule K-1.
As an attorney, Thompson did not consider himself qualified
to provide investment advice, and his practice was not to provide
such advice. Thompson did not provide petitioner with any
investment advice. Rather, Thompson provided petitioner with a
2-page letter dated April 4, 1983 (Thompson’s letter), together
with a completed Form 3468 (Computation of Investment Credit) and
a copy of an article on partnership audits.
9
Thompson was the son of one of the firm’s named partners.
- 25 -
The opening paragraph of Thompson’s letter read as follows:
You have retained us to review the Confidential Private
Offering Memorandum (“Memorandum”) of Whitman Recycling
Associates for the purpose of preparing and advising you
with regard to Form 3468 to be filed with your 1982 tax
return. Based upon our review of the Memorandum, we have
prepared a Form 3468 as enclosed (with lines 18-27 yet to be
completed), showing a full crediting of the amounts shown on
your K-1 from the Partnership. It is our belief that the
tax treatment of such items is more likely than not the
proper treatment. However, we do not opine as to any other
matters which may or may not be covered in the Memorandum or
the opinion of the counsel therein.
Thompson did not consider his letter to be a rousing
endorsement of the investment; rather, he considered the
investment to be “aggressive”, and his letter was replete with
“areas of concern” and various disclaimers. One area of concern
focused on the value of the EPS recyclers:
Obviously, the fair market value (“FMV”) of the
Sentinel EPS Recyclers (“Recyclers”) is important
because it is the starting point for determining the
amount of credits available to the Partnership.
Although I am not in a position to judge the FMV of the
Recyclers, the valuation made in the Memorandum is
challengeable. First of all, with regard to Ex. F,
[Burstein’s and Ulanoff’s reports], neither evaluator
appears to be primarily a property appraiser, and
neither engages in an economic analysis of cost of
production of the Recyclers, reasonable profit,
comparables, capitalization of income, or other factors
normally used in equipment appraisals.
Other areas of concern focused on the step-up in purchase price
from ECI to F&G, potential conflicts of interest, possible lack
of arm’s-length negotiations, F&G’s purported $7 million basis in
the recyclers, use of nonrecourse financing, and the circular
nature of the transactions.
- 26 -
Thompson’s letter concluded with the following paragraph:
Notwithstanding the foregoing risks, however, the
items on your Partnership K-1 may be used as is for the
reason that both the valuation overstatement penalty
and the substantial understatement of income tax
penalty are waived whenever the taxpayer (i.e., you)
can show there was a reasonable basis for the claims
made and that such claims were made in good faith. The
[offering] memorandum, as well prepared as it is,
should be an adequate “reasonable basis” upon which to
base the filing of your Form 3468. Additionally, I
believe you may rely upon it in good faith
notwithstanding this letter, for this letter is no more
legally enforceable than the Memorandum.
After petitioner received Thompson’s letter, petitioner
prepared Form 3468 in his own hand, using the partially completed
copy prepared by Thompson as a model. Petitioner then completed
petitioners’ Federal income tax return (Form 1040), which
petitioners signed on April 11, 1983.
In preparing petitioners’ tax return for 1982, petitioner
followed his custom of preparing petitioners’ returns himself
without the assistance of a return preparer.10
I. Petitioners’ Tax Returns
1. The Whitman Partnership
The tax benefits claimed by petitioners on their Federal
income tax return for 1982, the initial year of investment in
Whitman, exceeded their $15,000 investment in the partnership.
Thus, on their 1982 return, petitioners claimed a regular
10
Petitioner also prepared petitioners’ tax return for
1983 without the assistance of a return preparer.
- 27 -
investment tax credit and energy tax credit in the aggregate
amount of $17,511. Petitioners also claimed a loss in the amount
of $11,852 for their distributive share of the partnership’s
reported loss for 1982. The investment credits and the
partnership loss served to reduce petitioners’ liability for
Federal income tax as reported on their 1982 return by $23,240.11
2. Other Partnerships
Petitioners reported losses from partnerships other than
Whitman on their income tax returns for 1982 and 1983, as
follows:
Partnership 1982 1983
University Associates $589 $554
Winer Development 255 —
Columbian Oil & Gas –-- 3,441
Enterprise Energy –-- 3,074
Petitioners did not report any income or gain in respect of
any partnership on either their 1982 or 1983 tax return.
J. The Partnership-Level Proceeding
Whitman is a so-called TEFRA partnership subject to the
unified partnership audit and litigation procedures set forth in
sections 6221 through 6233. See Tax Equity and Fiscal
11
Petitioners also claimed a loss on their 1983 return in
the amount of $594 for their distributive share of Whitman’s
reported loss for that year. The partnership loss served to
reduce petitioners’ tax liability for 1983 by $193.
The record does not reveal whether petitioners claimed
losses from Whitman on their returns for years after 1983;
however, the record does establish that petitioner never made a
profit in any year from his investment in Whitman.
- 28 -
Responsibility Act of 1982 (TEFRA), Pub. L. 97-248, sec. 402(a),
96 Stat. 648. On May 30, 1989, respondent mailed a Notice of
Final Partnership Administrative Adjustment (FPAA) to Sam Winer,
the tax matters partner of the Whitman partnership, for each of
the taxable years 1982 and 1983.12 A copy of each FPAA was also
mailed to petitioners.
The FPAA’s advised petitioners of adjustments respondent
proposed to make to the partnership returns (Forms 1065) filed by
Whitman. Specifically, the FPAA’s disallowed all deductions and
credits claimed by Whitman in connection with its plastics
recycling activities for 1982 and 1983.13
On June 22, 1989, a case was commenced in this Court at
docket No. 14535-89 and captioned “Whitman Recycling Associates,
Sam Winer, Tax Matters Partner, Petitioner v. Commissioner of the
12
Respondent also mailed FPAA’s to Winer for the taxable
years 1984 and 1985, which years were also in issue as part of
the partnership action described infra in the text.
13
In October 1988, some 7 months before respondent mailed
the FPAA’s, respondent made the so-called Plastics Recycling
Project Settlement Offer (the settlement offer). The settlement
offer was made in writing to Winer as Whitman’s tax matters
partner. The terms of the settlement offer are described in
detail in section “I” of the Background portion of Davenport
Recycling Associates v. Commissioner, T.C. Memo. 1998-347, affd.
220 F.3d 1255 (11th Cir. 2000). Suffice it to say that the
transmittal letter stated that the settlement offer would not be
repeated and that the offer would expire 30 days from the date of
the letter. Winer did not accept the settlement offer on behalf
of the partnership. Accordingly, respondent mailed the FPAA’s
that are described above in the text.
- 29 -
Internal Revenue, Respondent”.14 Subsequently, on February 23,
1994, the Court entered decision in the Whitman case pursuant to
the Commissioner’s Motion for Entry of Decision under Rule
248(b). The Court’s decision, which reflected the full
concession by Whitman of all items of income, loss, and the
underlying valuation used for the Sentinel EPS recyclers for tax
credit purposes for 1982 and 1983, completely sustained the
Commissioner’s FPAA determinations for those years.15
At no time during the pendency of the proceedings in docket
No. 14535-89 did petitioners file with the Court a notice of
election to participate in the partnership action pursuant to
Rule 245(b).
OPINION
We have decided many Plastics Recycling cases. Most of
those cases have presented issues regarding additions to tax for
negligence. See, e.g., Barlow v. Commissioner, T.C. Memo. 2000-
339; Carroll v. Commissioner, T.C. Memo. 2000-184; Ulanoff v.
Commissioner, T.C. Memo. 1999-170; Gottsegen v. Commissioner,
T.C. Memo. 1997-314; Greene v. Commissioner, T.C. Memo. 1997-296;
14
All of the limited partners of Whitman who had an
interest in the outcome of the partnership proceeding were
treated as parties to the proceeding. See sec. 6226(c) and (d).
See also Title XXIV, Tax Court Rules of Practice and Procedure,
regarding partnership actions.
15
Similarly, the Court’s decision completely sustained the
Commissioner’s FPAA determinations for 1984 and 1985.
- 30 -
Kaliban v. Commissioner, T.C. Memo. 1997-271; Sann v.
Commissioner, T.C. Memo. 1997-259 n.13 (and cases cited therein),
affd. Addington v. Commissioner, 205 F.3d 54 (2d Cir. 2000). We
found the taxpayers liable for the additions to tax for
negligence in nearly all of those cases.
I. Section 6653(a)(1) and (2) Negligence
Respondent determined that petitioners are liable for
additions to tax under section 6653(a)(1) and (2) with respect to
the underpayment attributable to petitioners’ investment in
Whitman. Petitioners have the burden of proof to show that they
are not liable for the additions to tax. See Addington v.
Commissioner, supra; Goldman v. Commissioner, 39 F.3d 402, 407
(2d Cir. 1994), affg. T.C. Memo. 1993-480; Luman v. Commissioner,
79 T.C. 846, 860-861 (1982); Bixby v. Commissioner, 58 T.C. 757,
791-792 (1972). See generally Rule 142(a); INDOPCO, Inc. v.
Commissioner, 503 U.S. 79, 84 (1992); Welch v. Helvering, 290
U.S. 111, 115 (1933).16
Section 6653(a)(1) and (2) imposes additions to tax if any
part of the underpayment of tax is due to negligence or
intentional disregard of rules or regulations. Negligence is
defined as the failure to exercise the due care that a reasonable
16
Cf. sec. 7491(c), effective for court proceedings
arising in connection with examinations commencing after July 22,
1998. In the present cases, the examination of petitioners’
income tax returns for 1982 and 1983 commenced well before July
22, 1998.
- 31 -
and ordinarily prudent person would exercise under the
circumstances. See Neely v. Commissioner, 85 T.C. 934, 947
(1985). The pertinent question is whether a particular
taxpayer's actions are reasonable in light of the taxpayer's
experience, the nature of the investment, and the taxpayer's
actions in connection with the transactions. See Henry Schwartz
Corp. v. Commissioner, 60 T.C. 728, 740 (1973). In this regard,
the determination of negligence is highly factual. "When
considering the negligence addition, we evaluate the particular
facts of each case, judging the relative sophistication of the
taxpayers as well as the manner in which the taxpayers approached
their investment." Turner v. Commissioner, T.C. Memo. 1995-363.
Under some circumstances, a taxpayer may avoid liability for
negligence if reasonable reliance on a competent professional
adviser is shown. See United States v. Boyle, 469 U.S. 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. See Freytag v. Commissioner, supra. For reliance on
professional advice to excuse a taxpayer from negligence, the
taxpayer must show that the professional had the requisite
expertise, as well as knowledge of the pertinent facts, to
provide informed advice on the subject matter. See David v.
- 32 -
Commissioner, 43 F.3d 788, 789-790 (2d Cir. 1995), affg. T.C.
Memo. 1993-621; Goldman v. Commissioner, supra; Freytag v.
Commissioner, supra.
In making the investment in Whitman, petitioner contends
that he reasonably relied on the advice of two individuals,
namely, his brother and Winer.
A. Petitioner’s Reliance on Winer
Petitioner contends that before he invested in Whitman, he
had a history of investing with Winer and that such investments
were financially successful. Therefore, petitioner argues, he
was justified on relying on Winer’s advice in deciding to invest
in Whitman. We disagree.
Although the record demonstrates that petitioner did invest
in several Winer-promoted investments from 1979 to 1981, there is
no evidence, other than petitioner’s unsupported allegation, that
such investments were financially successful. In this regard, it
is well established that the Court is “not required to accept the
self-serving testimony of petitioner * * * as gospel.” Tokarski
v. Commissioner, 87 T.C. 74, 77 (1986). See Niedringhaus v.
Commissioner, 99 T.C. 202, 219-220 (1992). It should have been a
simple matter for petitioner to produce documentary evidence
(e.g., investment reports, prior years’ tax returns) to support
his allegation. However, he did not. In this regard, it is also
well established that a party’s failure to introduce documentary
- 33 -
evidence that is within his possession or control and that he
implies would be favorable to him, gives rise to the presumption
that, if produced, such evidence would be unfavorable. See
Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165
(1946), affd. 162 F.2d 513 (10th Cir. 1947). Furthermore, the
documentary evidence introduced at trial suggests that
petitioner’s Winer-promoted investments may have been successful
only in producing tax benefits. Thus, on petitioners’ 1982
return, petitioners claimed a partnership loss from Winer
Development Co.; on petitioners’ 1983 return, petitioners claimed
partnership losses from two other oil and gas partnerships. It
is at least noteworthy that petitioners did not report any income
or gain from any partnership on either their 1982 or 1983 tax
return.
In addition, reliance on representations by insiders or
promoters has been held to be an inadequate defense to
negligence. See Pasternak v. Commissioner, 990 F.2d 893, 903
(6th Cir. 1993) (reliance on promoter of tax shelter is not a
defense to the negligence addition), affg. T.C. Memo. 1991-181;
Leuhsler v. Commissioner, 963 F.2d 907, 910 (6th Cir. 1992)(even
an unsophisticated taxpayer may not reasonably rely on “advice”
from a promoter of a tax shelter); 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),
- 34 -
affd. without published opinion sub nom. Cowles v. Commissioner,
949 F.2d 401 (10th Cir. 1991). Advice from such individuals “is
better classified as sales promotion”. Vojticek v. Commissioner,
T.C. Memo. 1995-444. The rationale for this view is based on the
insider’s or promoter’s self-interest, which makes such “advice”
inherently suspect. See Addington v. Commissioner, 205 F.3d at
59 (“It is unreasonable for taxpayers to rely on the advice of
someone who they should know has a conflict of interest.”);
Goldman v. Commissioner, 39 F.3d at 408; LaVerne v. Commissioner,
supra at 652-653.
In the present cases, Winer’s self-interest is clearly
demonstrated by the offering memorandum. Thus, the offering
memorandum stated: (1) Winer would receive a 1-percent interest
in “all items of income, gain, deduction, loss or credit arising
from the operations of the Partnership”; (2) Winer would receive
$62,000 for administrative and other services to be paid from the
proceeds of the private placement offering as “management fees”;
(3) Whitman would pay “fees of purchaser representatives and
selling commissions” from the proceeds of the offering in an
amount equal to 10 percent of the aggregate price of the units;
and (4) Winer could “retain as additional compensation all
amounts not paid as purchaser representative fees or sales
commissions in connection with the Offering”. The incentives to
Winer to tout the investment were therefore readily apparent.
- 35 -
At trial, petitioner admitted understanding that if he
invested in Whitman, then Winer, as promoter, would receive a
commission based on petitioner’s purchase of an interest in the
partnership. Petitioner also admitted that he looked at the
offering memorandum and therefore should have known, if he did
not know in fact, that Winer stood to benefit financially in the
other ways enumerated above. See Addington v. Commissioner, 205
F.3d at 59.
Pleas of reliance have also been rejected when neither the
taxpayer nor the adviser knew anything about the nontax business
aspects of the contemplated venture. See id. at 58 (“In general,
it is unreasonable to rely on an adviser who lacks knowledge
about the industry in which the taxpayer is investing.”); Freytag
v. Commissioner, supra; Beck v. Commissioner, 85 T.C. 557 (1985);
see also Patin v. Commissioner, 88 T.C. 1086, 1131 (1987), affd.
without published opinion 865 F.2d 1264 (5th Cir. 1989), affd.
sub nom. Gomberg v. Commissioner, 868 F.2d 865 (6th Cir. 1989),
affd. sub nom. Skeen v. Commissioner, 864 F.2d 93 (9th Cir.
1989), affd. per curiam without published opinion sub nom.
Hatheway v. Commissioner, 856 F.2d 186 (4th Cir. 1988); Klieger
v. Commissioner, T.C. Memo. 1992-734. Insofar as Winer is
concerned, Winer did not have an engineering background, and he
was not an expert in either plastics materials or plastics
recycling. Moreover, Winer never represented that he possessed
- 36 -
specialized knowledge of the plastics recycling industry, and he
had, at most, only limited experience in marketing recycling or
similar equipment. Indeed, Winer’s limited experience (at best)
in marketing recycling or similar equipment was one of the
business risks that the offering memorandum specifically
identified.
In sum, we do not think that petitioner’s professed reliance
on Winer’s advice was reasonable.
B. Petitioner’s Reliance on His Brother
Petitioner also contends that he relied on his brother’s
advice in deciding to invest in Whitman and that such reliance
was reasonable. Although the record demonstrates that petitioner
relied on his brother, we do not think that such reliance was
reasonable.
As previously stated, pleas of reliance have been rejected
when neither the taxpayer nor the adviser knew anything about the
nontax business aspects of the contemplated venture. E.g.,
Addington v. Commissioner, supra; Freytag v. Commissioner, supra;
Beck v. Commissioner, supra; see also Patin v. Commissioner,
supra; Kleiger v. Commissioner, supra. In the present cases,
petitioner’s brother had no specialized knowledge of the plastics
recycling industry and had no expertise in appraising either the
value of property in general or plastics recycling machines in
particular. In fact, the record suggests that petitioner knew
- 37 -
that his brother had no knowledge regarding the value of the
Sentinel EPS recyclers. Moreover, petitioner did not know
whether his brother even talked to anyone in the plastics
industry before giving him “advice”. In addition, petitioner did
not know whether, but rather merely assumed that, his brother
read the offering memorandum before giving him “advice”.
It is noteworthy that petitioner did not call his brother to
testify at trial. Petitioner’s failure to do so gives rise to
the inference that his brother’s testimony would not have been
favorable to petitioner. See Mecom v. Commissioner, 101 T.C.
374, 386 (1993), affd. without published opinion 40 F.3d 385 (5th
Cir. 1994); Pollack v. Commissioner, 47 T.C. 92, 108 (1966),
affd. 392 F.2d 409 (5th Cir. 1968); Wichita Terminal Elevator Co.
v. Commissioner, 6 T.C. 1158, 1165 (1946), affd. 162 F.2d 513
(10th Cir. 1947).
Petitioners rely on Dyckman v. Commissioner, T.C. Memo.
1999-79, for the proposition that reliance on a trusted friend or
adviser (such as petitioner’s brother) relieves a taxpayer from
liability for negligence. That case, however, is clearly
distinguishable from the present ones.
In Dyckman v. Commissioner, supra, we held for the taxpayers
on the issue of negligence based on special and unusual
circumstances, including the taxpayers’ complete lack of
sophistication in investment matters and the long-term
- 38 -
relationship of trust and friendship that existed between the
taxpayers and their C.P.A. Also determinative was the fact that
the taxpayers did not invest as a means of obtaining tax
benefits; rather, their sole motivation was to provide for their
retirement, and they were not even aware that their investment
was in a partnership designed to produce tax benefits. Further,
the taxpayers were not provided with any literature, such as an
offering letter or prospectus, regarding their investment.
In contrast, petitioner is a relatively sophisticated
investor and possessed investment experience at the time that he
invested in Whitman. Moreover, petitioner was also provided with
a copy of the offering memorandum. Furthermore, petitioner was
aware that his investment in Whitman produced immediate tax
benefits in excess of his investment. Indeed, the promise of
such benefits was the principal factor that motivated petitioner
to invest in Whitman.
For the foregoing reasons, petitioners’ reliance on Dyckman
v. Commissioner, supra, is misplaced. Likewise, petitioners’
reliance on Zidanich v. Commissioner, T.C. Memo. 1995-382, is
misplaced for essentially the same reasons.
In addition to the foregoing, we are not convinced that
petitioner regarded his brother as a trusted adviser. First, the
contacts between petitioner and his brother on financial matters
appear to have been casual in nature, and those contacts were
- 39 -
invariably over the telephone. Second, petitioner has never
disclosed details regarding his own personal financial status to
his brother. Petitioner’s reticence in making disclosures to his
brother is illustrated by the following passage from the trial
transcript:
Q: Mr. Barber, we’ve heard a lot about your
brother. You rely on him almost exclusively for
investment advice?
A: I rely on him as a major [source] of advice.
As I indicated earlier I also have an Olde [brokerage
firm] stockbroker that’s done pretty good too. But my
brother’s support goes back a long time because he’s
been an enrolled agent and tax preparer for a long
time, and certainly whenever I have a complex tax
question or things like that, I do go to him.
Q: Okay. Did you ask your brother about how to
prepare the form to attach to your 1982 return?
A: No, I did not. I only ask him questions over
the phone. I don’t show him my own personal financial
data. I do keep that separate from him.
Q: Okay. So he doesn’t have a full picture of
your financial status, so to speak?
A: Probably not.
Q: So he doesn’t know how much money you earn?
A: Right.
Q: He doesn’t know all the different investments
that you end up making?
A: I don’t talk to him about my Olde stock,
because that’s through my stockbroker I do that.
Q: Okay. So you call upon him when you want some
advice from him?
- 40 -
A: Right. Complex tax questions, things like
that.
In sum, we do not think that petitioner’s professed reliance
on his brother’s advice was reasonable.
C. Petitioner’s Reliance on Thompson
Petitioner does not contend that he relied on Thompson in
making the investment in Whitman. However, after having made the
investment, petitioner contends that he relied on Thompson in
claiming the associated tax benefits on his income tax returns.
Petitioner also contends that such reliance was reasonable. We
acknowledge that neither Thompson nor his firm had any
relationship with either Winer or Whitman. However, for the
following reasons we disagree that petitioner’s professed
reliance on Thompson was reasonable.
First, Thompson was not an investment adviser. Indeed, he
did not consider himself qualified to provide investment advice,
and his practice was not to provide such advice. Thompson did
not purport to, nor did he, provide petitioner with investment
advice. Cf. Anderson v. Commissioner, 62 F.3d 1266, 1268 (10th
Cir. 1995) (wherein the taxpayers relied on their own investment
adviser regarding the soundness of their investment), affg. T.C.
Memo. 1993-607.
Second, Thompson did not have any specialized knowledge
regarding the plastics recycling industry. In addition, Thompson
did not have any specialized knowledge regarding the nontax
- 41 -
business aspects of petitioner’s Sentinel EPS recycler
investment. Thompson was therefore in no position himself to
evaluate either the technology of the Sentinel EPS recyclers or
whether the Whitman partnership was a viable economic enterprise.
See, e.g., Addington v. Commissioner, 205 F.3d at 58 (“In
general, it is unreasonable to rely on an adviser who lacks
knowledge about the industry in which the taxpayer is
investing.”).
Third, Thompson did not make any independent attempt to
evaluate either the technology of the EPS recyclers or whether
the Whitman partnership was a viable economic enterprise. He was
therefore in no position to opine on either of these matters.
Fourth, Thompson had no knowledge of the value of the
Sentinel EPS recyclers, and he made no independent attempt to
determine their value. Yet Thompson recognized, and he so
advised petitioner, that “the fair market value * * * of the
Sentinel EPS Recyclers * * * is * * * the starting point for
determining the amount of credits available to the Partnership.”
Fifth, Thompson based his advice solely on the materials
furnished to him by petitioner, namely, the offering memorandum
and the 1982 Schedule K-1.
Sixth, Thompson regarded the Whitman investment to be
“aggressive”, and he so advised petitioner. At trial, Thompson
described what “aggressive” meant:
- 42 -
A: * * * So, yes, they [Whitman and its promoter]
were making maximum use, pushing the limit right to the
edge. It was very aggressive or I wouldn’t have said
it was. You know, you have to know how to deal with
aggressive investments. Doesn’t mean it’s wrong, just
means you take your chance.
Q: I’m sorry. You said you must “take your
chance”?
A: You just take your chance.
Q: And this is the kind of investment that you
thought–-
A: How close can you walk to the line without
getting caught or tripped.
Finally, Thompson’s letter expressed so many misgivings, and
was filled with so many qualifications, reservations, and
disclaimers, as to undermine any contention that the letter
justified petitioner’s reporting position. Thus, numerous “areas
of concern” were identified in the letter. First and foremost
among such “areas of concern” was the value of the recyclers,
which Thompson identified as “the starting point for determining
the amount of credits available to the Partnership.” Thompson
expressly advised petitioner that “I am not in a position to
judge the FMV of the Recyclers”. Yet Thompson, even with his
lack of appraisal skills, was able to conclude that “the
valuation made in the Memorandum is challengeable.” He then went
on to explain why:
First of all, with regard to * * * [Burstein’s and
Ulanoff’s reports], neither evaluator appears to be
primarily a property appraiser, and neither engages in
an economic analysis of cost of production of the
- 43 -
Recyclers, reasonable profit, comparables,
capitalization of income, or other factors normally
used in equipment appraisals.
In other words, no rational basis existed for the exorbitant
value assigned to the recyclers in the offering memorandum.
At trial, Thompson testified that “I don’t consider my
letter to be a rousing endorsement of the investment”, an
assertion that can only be described as an understatement when
one considers the conclusion expressed in the letter: “I believe
you may rely upon [the offering memorandum] notwithstanding this
letter, for this letter is no more legally enforceable than the
Memorandum.” (Emphasis added.) We regard this conclusion as
tantamount to a total disclaimer, a view that is supported by
Thompson’s testimony at trial:
Q: Is there any reservation that you have on this
* * * [conclusion] of the letter?
A: Do I have a reservation? You mean would I
take anything back of what I said?
Q: Sure.
A: No, I don’t think I gave very much away.
There’s nothing to take back.
Petitioner’s contention that he regarded Thompson’s letter
as positive justification for claiming the tax credits and loss
deductions is, of course, self-serving. See Tokarski v.
Commissioner, 87 T.C. at 77; Niedringhaus v. Commissioner, 99
T.C. at 219-220. To accept petitioner’s contention would require
us to ignore the clear tenor of the letter and take several
- 44 -
statements out of context. We are unwilling to do that.
As the trier of fact, “it is our duty to listen to the
testimony, observe the demeanor of the witnesses, weigh the
evidence, and determine what we believe.” Kropp v. Commissioner,
T.C. Memo. 2000-148; cf. Diaz v. Commissioner, 58 T.C. 560, 564
(1972). In the present cases, we are convinced that petitioner
invested in Whitman principally because the investment offered
immediate tax benefits in excess of his investment. We are
convinced that petitioner was determined to reap those benefits
if at all possible.
Petitioner consulted with Thompson for two reasons. First,
petitioner was uncertain how to convert his share of the
partnership’s basis in the recyclers as reported on the 1982
Schedule K-1 into tax credits on his individual return. This is
borne out by the opening sentence of Thompson’s letter, which
states that petitioner retained the firm to review the offering
memorandum “for the purpose of preparing and advising you with
respect to Form 3468 to be filed with your 1982 tax return.”
(Emphasis added.) This statement suggests that the filing of
Form 3468 with the sought-after tax credits was virtually a
foregone conclusion.
Petitioner also consulted Thompson because petitioner was
sensitive to the magnitude of the tax benefits shown on his 1982
Schedule K-1, and he was concerned that the magnitude of those
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benefits might expose his investment to be the tax shelter it
clearly was. In this regard, we are convinced that petitioner
consulted Thompson in order to provide “cover” and
“plausibility”; likewise, we are convinced that petitioner was
determined to “interpret” whatever advice that he received as
justification for the tax benefits that he had purchased.
In sum, we do not think that petitioner’s professed reliance
on Thompson was reasonable. See, e.g., Addington v.
Commissioner, 205 F.3d 54 (2d Cir. 2000), affg. Sann v.
Commissioner, T.C. Memo. 1997-259.
D. Other Matters
Petitioners contend that investors such as themselves should
not be burdened with the obligation of performing independent
investigations of the ventures in which they invest. In
petitioners’ view, such a requirement would impose an economic
burden and prevent taxpayers such as themselves from investing.
As applicable to the present cases, however, this argument is
flawed in that it virtually presumes, among other things that:
Petitioner should not have been expected to carefully read the
offering memorandum; petitioner should not have been expected to
consider the numerous caveats and warnings regarding the business
and tax risks inherent in the Whitman investment; petitioner was
not principally motivated by the prospect of receiving immediate
tax benefits in excess of his investment; and petitioner was
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justified in relying on an individual whom he knew had a conflict
of interest.
As applied to the present cases, petitioners’ argument is
also flawed in that it ignores the various red flags that should
have alerted petitioner, a relatively sophisticated investor with
a technical background, that the Sentinel EPS recyclers were
overvalued and independent expert advice was therefore required.
Obvious red flags included the exorbitant cost of the recyclers
(i.e., $7 million) and the fact that the Whitman transactions, as
described in the offering memorandum, were to be executed
simultaneously in what was nothing other than a circular flow of
apparent payments made only through bookkeeping entries.
Finally, mention should be made of two Plastics Recycling
cases that were decided after petitioners’ briefs were filed,
namely, Thompson v. United States, 223 F.3d 1206 (10th Cir.
2000), and Klein v. United States, 94 F. Supp.2d 838 (E.D. Mich.
2000).
In Thompson v. United States, supra, the Court of Appeals
for the Tenth Circuit held that the District Court did not abuse
its discretion in instructing the jury that reasonable, good-
faith reliance on the advice of a professional adviser
constitutes a defense to negligence within the meaning of section
6653. This holding served to uphold the jury’s verdict in favor
of the taxpayers on the issue of negligence.
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In Thompson v. United States, supra, the Government relied
heavily on the unpublished opinion of the Court of Appeals for
the Tenth Circuit in a similar Plastics Recycling case, Gilmore &
Wilson Constr. Co. v. Commissioner, 166 F.3d 1221 (10th Cir.
1999), affg. Estate of Hogard v. Commissioner, T.C. Memo. 1997-
174. The Court of Appeals dismissed the Government’s assertion
that its holding in that case was dispositive of the issue before
it:
In that case we reviewed the tax court’s factual
determination, made after a bench trial, that the
taxpayers were negligent. Here we consider the more
limited question of whether a reliance instruction was
warranted. Had we been presented with such a question
in Gilmore & Wilson, we would likely have upheld the
instruction. See id. at *5 (“The evidence introduced,
both at trial and through stipulation, presents a close
question regarding whether taxpayers were negligent.”)
For this reason, the government’s reliance on Gilmore &
Wilson is misplaced. [Thompson v. United States, supra
at 1210; fn. ref. omitted.]
In the present cases, we have considered petitioners’
contention regarding reliance. However, we have concluded, based
on the totality of the facts and circumstances presented at
trial, that petitioners’ professed reliance on Winer,
petitioner’s brother, and Thompson was not reasonable.
Accordingly, we regard Thompson v. Commissioner, supra, as
distinguishable from the present cases.
In Klein v. United States, supra, the District Court denied
the Government’s motion for summary judgment on the issue of the
taxpayers’ liability for additions to tax for negligence. The
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District Court held that on the record before it, the issue of
negligence could not be decided as a matter of law but rather was
an issue to be decided by the trier of fact.
In the present cases, we have addressed the issue of
negligence as an issue of fact, which we have decided based on
the totality of the facts and circumstances presented at trial.
Thus, Klein v. United States, supra, is distinguishable from the
present cases.
E. Conclusion
Upon consideration of the entire record, we hold that
petitioners are liable for the additions to tax for negligence
under section 6653(a)(1) and (2). Respondent is therefore
sustained on this issue.
II. The Plastics Recycling Project Settlement Offer
Petitioners contend that they are entitled to the terms of
the Plastics Recycling Project Settlement Offer. See Davenport
Recycling Associates v. Commissioner, T.C. Memo. 1998-347, affd.
220 F.3d 1255 (11th Cir. 2000).
It should be recalled that in October 1988, respondent made
the settlement offer, in writing, to Winer as the tax matters
partner of the Whitman partnership. Respondent’s transmittal
letter stated that the settlement offer would not be repeated and
that the offer would expire 30 days from the date of the letter.
Winer did not accept the settlement offer on behalf of the
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partnership. Respondent then mailed the notices of final
partnership administrative adjustment; Winer commenced the
partnership action at docket No. 14535-89; and, ultimately, the
Court entered decision, pursuant to the Commissioner’s motion
under Rule 248(b), which completely sustained the Commissioner’s
FPAA determinations.
Petitioners allege that they were never informed of the
settlement offer by respondent at the time that the offer was
made. Respondent counters that the settlement offer was made to
Winer as Whitman’s tax matters partner and that any failure by
Winer to inform all of the limited partners of the existence of
the offer does not require respondent to renew the offer. We
agree with respondent.
There is no statutory or regulatory provision that obligates
respondent, when making a settlement offer to the tax matters
partner of a TEFRA partnership, to provide notice to the
partnership’s limited partners of the fact of such offer. To the
contrary, section 6223(g) provides, in part, that “the tax
matters partner of a partnership shall keep each partner informed
of all administrative and judicial proceedings for the adjustment
at the partnership level of partnership items.” In other words,
to the extent that Whitman’s limited partners were entitled to
notice regarding respondent’s making of the October 1988
settlement offer, the duty to provide such notice lay with Winer
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and not with respondent. See also sec. 301.6223(g)-1T(b)(1)(iv),
Temporary Proced. & Admin. Regs., 52 Fed. Reg. 6786 (March 5,
1987), which specifically obligates the tax matters partner to
furnish to the partners information with regard to the acceptance
by the Commissioner of any settlement offer.17 Cf. Computer
Programs Lambda v. Commissioner, 90 T.C. 1124, 1126-1127 (1988),
regarding the central role played by, and the duties imposed on,
the tax matters partner during litigation at the partnership
level.
Further, the fact that Winer may have failed in his duty to
provide notice regarding the fact of respondent’s settlement
offer does not serve to “revive” the offer insofar as petitioners
are concerned. In this regard, section 6230(f) expressly states:
The failure of the tax matters partner * * * or any
other representative of a partner to provide any notice
or perform any act required under this subchapter
[sections 6221-6233] or under regulations prescribed
under this subchapter on behalf of such partner does
not affect the applicability of any proceeding or
adjustment under this subchapter to such partner.
Conclusion
Petitioners have made other arguments that we have
considered in reaching our decision. To the extent that we have
not discussed those arguments, we find them to be irrelevant or
17
Petitioners also appear to mistakenly place on the
Commissioner the duty to serve copies of a Rule 248(b) motion in
a partnership action. However, Rule 248(b)(3) squarely places
this duty on the tax matters partner. See also sec. 6230(l).
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without merit.18
To reflect our disposition of the disputed issues, as well
as petitioners’ concessions, see supra note 1,
Decisions will be entered
for respondent.
18
We also decline to consider arguments for which there is
no factual predicate in the evidentiary record. See Rule
143(b)(“statements in briefs * * * do not constitute evidence.”).
Further, insofar as additional interest under sec. 6621(c) may be
concerned, we refer petitioners to sec. 6621(c)(3)(A)(i), (v), as
well as Barlow v. Commissioner, T.C. Memo. 2000-339.