The opinion
T.C. Memo. 2000-389
UNITED STATES TAX COURT
KEITH E. AND MARILYN B. WEST, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
WARREN S. AND ELIZABETH A. WEST, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 3076-95, 15324-95. Filed December 22, 2000.
Terrance A. Costello, for petitioners.
David L. Zoss, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
DAWSON, Judge: These consolidated cases were assigned to
Special Trial Judge Norman H. Wolfe pursuant to the provisions of
section 7443A(b)(4) in effect when these proceedings commenced,
and Rules 180, 181, and 183. All section references are to the
Internal Revenue Code, and all Rule references are to the Tax
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Court Rules of Practice and Procedure. The Court agrees with and
adopts the opinion of the Special Trial Judge, which is set forth
below.
OPINION OF THE SPECIAL TRIAL JUDGE
WOLFE, Special Trial Judge: In so-called affected items
notices of deficiency, respondent determined additions to tax
with respect to petitioners’ Federal income taxes for the years
and in the amounts as shown below:
Keith E. & Marilyn B. West
Additions to Tax
Year Sec. 6653(a)(1) Sec. 6653(a)(2) Sec. 6659
1979 $808 -0- $4,848
1
1982 1,607 8,467
1
1983 25 -0-
1
1984 10 -0-
Warren S. & Elizabeth A. West
Additions to Tax
Year Sec. 6653(a)(1) Sec. 6653(a)(2) Sec. 6659
1979 $953 -0- $5,717
1980 204 -0- 1,191
1
1982 1,239 4,787
1
Fifty percent of the interest payable with respect to the
portion of the underpayment that is attributable to negligence.
The underpayments were determined and assessed pursuant to a
partnership-level proceeding. See secs. 6231-6233. With regard
to petitioners Keith E. and Marilyn B. West, respondent
determined underpayments attributable to negligence of $32,147,
$498, and $207 for 1982, 1983, and 1984, respectively. With
regard to petitioners Warren S. and Elizabeth A. West, respondent
determined an underpayment attributable to negligence for 1982 of
$24,772.
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The issues for decisions1 are: (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, and
(2) whether petitioners are liable for additions to tax under
section 6659 for underpayments of tax attributable to valuation
overstatements.
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 Keith E. and
Marilyn B. West resided in Edina, Minnesota, at the time they
filed the petition in this case. Petitioners Warren S. and
Elizabeth A. West resided in Burnsville, Minnesota, at the time
they filed the petition in this case.
1
It would appear that petitioners have abandoned any
contention regarding the statute of limitations (the so-called
Davenport issue) in view of the 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); Barlow v. Commissioner, T.C. Memo. 2000-339; Kohn v.
Commissioner, T.C. Memo. 1999-150. However, if we are mistaken
in this regard, then we refer the parties to paragraphs 61-63 of
the supplemental stipulation of facts, and we decide the
Davenport issue in respondent’s favor based on the foregoing
precedent.
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A. The Masters Transactions
These consolidated cases are part of the Plastics Recycling
group of cases. The additions to tax arise from the disallowance
of losses, investment credits, and energy credits claimed by
petitioners with respect to a partnership called Masters
Recycling Associates (Masters or the partnership).
For a detailed discussion of the transactions involved in
the Plastics Recycling cases, see Provizer v. Commissioner, T.C.
Memo. 1992-177, affd. without published opinion 996 F.2d 1216
(6th Cir. 1993). The underlying transactions involving the
Sentinel recycling machines (recyclers) in these 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 series of simultaneous transactions closely resembling
those in Provizer, that for convenience are referred to herein as
the Masters transactions, Packaging Industries Group (PI) of
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Hyannis, Massachusetts, manufactured and sold2 four Sentinel EPS3
recyclers to Ethynol Cogeneration, Inc. (ECI) for $1,520,000
each. The sale of the recyclers from PI to ECI was partially
financed with nonrecourse promissory notes. For each recycler,
ECI agreed to pay PI $112,750 in cash, with the remaining balance
of $1,407,250 financed through a 12-year nonrecourse promissory
note.
Simultaneously, ECI resold the recyclers to F & G Equipment
Corp. (F&G) for $1,750,000 per machine. For each machine, F&G
agreed to pay ECI $128,250 in cash, with the remaining balance of
$1,621,750 financed through a purportedly partial recourse
promissory note. The note was recourse to the extent of 20
percent of its face value. However, the recourse portion was
payable only after the nonrecourse portion was satisfied.
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
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 Ulanoff v. Commissioner, T.C. Memo. 1999-170
(same); Gottsegen v. Commissioner, T.C. Memo. 1997-314 (involving
both the EPE and EPS recyclers).
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In turn, F&G leased the recyclers to Masters. Pursuant to
the lease and in accordance with applicable provisions of the
Internal Revenue Code and Treasury regulations, F&G elected to
treat Masters as having purchased the recyclers for purposes of
the investment and business energy tax credits.
Simultaneously, Masters entered into a joint venture with PI
and Resin Recyclers, Inc. (RRI). The joint venture agreement
provided that RRI was to assist Masters with the placement of
recyclers with end-users. At the same time, PI, ECI, F&G,
Masters, and RRI entered into arrangements that provided that PI
would pay a monthly joint venture fee to Masters, in the same
amount that Masters would pay as monthly rent to F&G, in the same
amount as F&G would pay monthly on its note to ECI, in the same
amount that ECI would pay each month on its note to PI. In
connection with these arrangements, PI, ECI, F&G, Masters, and
RRI entered into offsetting agreements so that these monthly
payments were kept only as bookkeeping entries and no money
actually was transferred. Consequently, all of the monthly
payments required among the entities in the above transactions
offset each other, and the transactions occurred simultaneously.
On its 1982 tax return Masters reported that the four
recyclers had an aggregate basis of $7,000,000, or $1,750,000
each, for purposes of the investment and business energy tax
credits. In the present cases, the parties stipulated that in
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1982 the recyclers were not properly valued at $1,750,000 each,
but instead had only a maximum value of $30,000 to $50,000 each.
On its 1982, 1983, 1984, and 1985 tax returns, Masters reported
net ordinary losses of $713,291, $36,205, $16,720, and $15,832,
respectively. Losses and credits were reported by Masters on its
tax returns, and the portions attributable to petitioners,
respectively, were included on Forms K-1 issued to them and filed
with Masters’ tax returns.
B. The Private Offering Memorandum
Generally, Masters distributed a private offering memorandum
to potential investors. The offering memorandum informed
investors that Masters’ business would be conducted in accordance
with the transaction described above. The offering memorandum
also warned potential investors of significant business and tax
risks associated with investing in Masters.
Specifically, the offering memorandum warned potential
investors that: (1) There was a substantial likelihood of an
audit by the Internal Revenue Service (IRS); (2) “On audit, the
purchase price of the Sentinel EPS recyclers to be paid by F&G to
ECI may be challenged by the * * * [IRS] as being in excess of
the fair market value thereof, a practice followed by * * * [the
IRS] in transactions it deems to be tax shelters”; (3) the
partnership had no prior operating history; (4) the limited
partners would have no control over the conduct of the
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partnership’s business; (5) there was no established market for
the Sentinel EPS recyclers; (6) there were no assurances that
market prices for virgin resin would remain at then current
prices per pound or that the recycled pellets would be as
marketable as virgin pellets; and (7) certain potential conflicts
of interest existed.
The offering memorandum contained a marketing opinion by
Stanley Ulanoff (Ulanoff) and a technical opinion by Samuel
Burstein (Burstein). Ulanoff owned a 4.37-percent interest in
Taylor Recycling Associates, which purported to lease four
plastic recyclers, and Burstein owned a 5.82-percent interest in
Jefferson Recycling Associates, which also purported to lease
four plastic recyclers. The offering memorandum disclosed that
Burstein was a client of PI’s corporate counsel. The offering
memorandum also warned potential investors not to rely on the
statements and opinions contained in the memorandum, but to
conduct an independent investigation.
The private offering memorandum also projected that in the
initial year of investment an investor contributing $50,000
would receive investment tax credits and business energy credits
of $77,000 and tax deductions of $38,940. The private offering
memorandum provided that an investor in Masters was required to
have an individual net worth and/or net worth with a spouse of
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$1,000,000, inclusive of residences and personal property, or
income of $200,000 per year for each unit of investment.
C. Partnership-Level Litigation
On June 5, 1989, respondent issued Notices of Final
Partnership Administrative Adjustment (FPAA) to Masters’ tax
matters partner (TMP) for 1982, 1983, 1984, and 1985.
Subsequently, on June 19, 1989, copies of the FPAA’s for 1982,
1983, and 1984 were sent to Keith and Marilyn West. On the same
date, a copy of the FPAA for 1982 was sent to Warren and
Elizabeth West. In the FPAA’s, respondent disallowed the losses
that Masters had reported on its 1982, 1983, 1984, and 1985
Federal income tax returns and determined that Masters did not
incur “a loss in a trade or business or in an activity entered
into for profit or with respect to property held for the
production of income.” Respondent also determined that Masters’
basis in the recycling equipment was zero, rather than
$7,000,000, for purposes of the investment tax and business
energy credits.
Subsequently, a petition was filed by Masters’ tax matters
partner. On February 23, 1994, the Court entered a decision in
Masters Recycling Associates, Sam Winer, Tax Matters Partner v.
Commissioner, docket No. 18417-89. This decision reflects a full
concession by Masters of all items of income, loss, and the
underlying equipment valuation used for tax credit purposes.
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D. Keith and Marilyn West
In 1956, Keith West (Keith) graduated from the University of
Minnesota with a bachelor of science degree. After graduation,
Keith was employed in the engineering department of Benson
Optical Co. (Benson). Subsequently, Keith was promoted by Benson
to vice president of operations, then executive vice president,
and then ultimately president. Keith was the president of Benson
from 1977 to 1985. Benson had 1,600 employees and had offices
and laboratories in 23 States. Eight or nine vice presidents
reported directly to Keith, as president. In 1969, Benson was
acquired by a publicly held company, Frigitronics. At one time,
Keith also served on Frigitronics’ board of directors.
Prior to 1982, Keith had only made a small number of
investments. He had accumulated Benson Optical stock, and he had
Frigitronics stock after the acquisition. Also, he had made a
limited partnership investment in fourplexes in Minneapolis, at
the suggestion of a friend and neighbor who was a partner in the
selling company. In 1982, Keith was 51 years old and was
interested in planning for his future retirement. Upon the
recommendation of a friend, Keith contacted a Cigna
representative named Ernest Mejia (Mejia). Keith had some
familiarity with Cigna because he understood that Cigna was a
division of Connecticut General Life Insurance Co. (Connecticut
General). One of the alternative investments offered to
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employees by Benson’s profit-sharing trust, of which Keith was a
trustee, was a fund sponsored by Connecticut General.
Sometime during 1982, Keith met with Mejia to review his
income and retirement goals. During this meeting, Mejia
recommended investing in Hamilton Recycling Associates
(Hamilton). Keith contends that he was impressed by Hamilton
because Hamilton offered solutions to the United States’ energy
shortage and waste disposal problems. Keith also noted that
Benson received and used products for packaging similar to the
so-called peanuts produced by the recyclers. Keith further
asserts that Mejia represented that Hamilton was a Cigna-
researched investment. Keith did not review any Cigna materials
promoting Hamilton, nor did he make any independent inquiries as
to whether Hamilton was a Cigna-researched investment.
Keith contends that Mejia told him that he had traveled to
New York and met with Hamilton’s accountants. Keith also
contends that Mejia told him that he had traveled to a site where
a recycler was being used and had brought back some of the
peanuts the machine produced. Mejia did not testify at the
trial.
Keith received a copy of Hamilton’s offering memorandum and
spent 3 or 4 hours reviewing it. In reviewing the memorandum,
Keith noted and relied upon Ulanoff’s marketing report and
Burstein’s technical opinion, even though he was aware that the
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memorandum specifically warned potential investors not to rely on
the reports contained in it.
Subsequently, Keith and Mejia spoke with Gerald Grande
(Grande), a certified public accountant (C.P.A.) who had
previously given tax advice to Keith and had prepared Keith’s
income tax returns. Pursuant to this conversation, Grande had
one of his firm’s staff members review the offering memorandum.
Based upon the staff person’s review, Grande concluded that the
Hamilton transaction met the criteria for the energy tax credit
and that the offering memorandum was properly prepared. However,
Grande did not review Hamilton’s nontax business aspects. At
trial, Keith testified as follows: “Mr. Grande was not asked,
nor did he give an opinion on the investment. He was only asked
to review the document to see if it met the criteria for the
energy tax credit.” Neither Grande nor the staff person who
reviewed the offering memorandum had any experience or education
with plastics or plastics recycling. Moreover, Grande did not
contact any expert in the plastics or plastics recycling field as
part of his review. Grande also testified that he probably
referred to Hamilton as a tax shelter during his discussions with
Keith and Mejia.
Keith does not have any education or experience with the
plastics or plastics recycling industries. Keith also did not
consult with anyone who had any expertise with plastics or
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plastics recycling. However, Keith contends that he decided to
invest in Hamilton based upon Mejia’s and Grande’s advice.
Ultimately, Keith was unable to invest in Hamilton because
partnership interests in Hamilton were no longer available by the
time he decided to invest. Then Mejia told Keith that interests
in Masters, another recycling limited partnership identical to
Hamilton, were available. Keith received the Masters offering
memorandum, but he did not thoroughly review the Masters offering
memorandum because it was duplicative of the Hamilton offering
memorandum.
For 1979, 1982, 1983, and 1984, Keith and Marilyn West filed
joint Federal income tax returns. In 1982, Keith invested
$25,000 in Masters. As a result of his investment in Masters,
Keith claimed net operating loss deductions of $19,616, $995, and
$460 on his 1982, 1983, and 1984 Federal income tax returns,
respectively. On his 1982 Federal income tax return, Keith also
claimed investment tax and business energy credits totaling
$38,500, which was limited by his 1982 income tax liability (as
reduced by the partnership loss) and the alternative minimum tax.
On April 20, 1983, Keith filed an application for tentative
refund, Form 1045, carrying back investment and business energy
tax credits to 1979 to generate a tax refund of $16,161.
Keith did not actively monitor his investment in Masters.
At trial, Keith testified: “[T]here wasn’t a lot you could do to
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monitor. We certainly got the mail from the Internal Revenue
Service as well as from the partnership. And that’s about all we
could monitor.” Keith also acknowledged that he did not
undertake any independent investigation regarding the value of
the recyclers and that he was fully aware of the tax benefits
associated with investing in Masters.
E. Warren and Elizabeth West
In 1955, Warren West (Warren) received a bachelor of science
degree in civil engineering from the University of Minnesota.
After graduation, Warren was employed by the Center City Co.
(Center City). Eventually, Warren became the president of Center
City. At times, Warren also sat on the boards of three publicly
held companies.
Prior to 1982, Warren invested mostly in shares of publicly
traded companies. Sometime during 1982, Warren learned about
Hamilton from Mejia, an agent for Cigna who was working with
Warren with regard to his financial and estate planning. Warren
asserts that Mejia told him that he had traveled east and had
seen the recycling equipment and that Hamilton was a viable
ongoing operation. As result of his discussions with Mejia,
Warren spent an unspecified number of hours reviewing the
Hamilton offering memorandum. Warren also asserts that he asked
his C.P.A., Jim Maki (Maki), to review the Hamilton offering
memorandum. Warren claims that Maki told him that the Hamilton
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transaction satisfied certain tax regulations concerning the
organization’s qualification as a limited partnership so that it
could pass through tax benefits to limited partners. Warren
concedes that his conversations with Maki were limited to tax
issues surrounding Hamilton and not Hamilton’s economic or
financial aspects. Maki did not testify during the trial.
Warren did not invest in Hamilton because partnership
interests were no longer available when he reached his decision
to invest. Then Mejia told Warren that partnership interests in
Masters, another recycling partnership substantially identical to
Hamilton, were available. Accordingly, Warren received the
Masters offering memorandum. Warren did not review the Masters
offering memorandum because it was substantially identical to the
Hamilton offering memorandum. Warren did not undertake any
independent investigation concerning Masters’ economic or
financial aspects. At trial, Warren testified that “the only
thing I had to go on was in the prospectus. And it looked fairly
good.” Warren further testified as to why the Masters prospectus
looked good to him. “Two reasons: One is the relatively
generous tax benefit up front, and that in the long-run, it was
supposed to turn a profit.” Warren further testified that he did
“very little” to monitor his investment in Masters. Warren also
acknowledged that Mejia marketed Masters as a tax shelter.
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Warren does not have any experience or education in plastics
or plastics recycling. He did not consult with any experts in
the plastics or plastics recycling industries.
For 1979, 1980, and 1982, Warren and Elizabeth West filed
joint Federal income tax returns. In 1982, Warren invested
$25,000 in Masters. As a result of his investment in Masters,
Warren claimed a net operating loss deduction of $19,615 on his
1982 Federal income tax return. On his 1982 Federal income tax
return, Warren also claimed investment tax and business energy
tax credits totaling $38,502, which was limited to his 1982
income tax liability (as reduced by the partnership loss) and the
alternative minimum tax. On April 18, 1983, Warren filed an
application for tentative refund, Form 1045, carrying back
investment and business energy tax credits to 1979 and 1980 to
generate tax refunds of $19,057, and $3,970, respectively.
OPINION
We have decided many Plastics Recycling cases. Most of
these cases, like the present cases, raised issues regarding
additions to tax for negligence and valuation overstatement.
See, e.g., Barber v. Commissioner, T.C. Memo. 2000-372; Carroll
v. Commissioner, T.C. Memo. 2000-184; Ulanoff v. Commissioner,
T.C. Memo. 1999-170; Greene v. Commissioner, T.C. Memo. 1997-296;
Kaliban v. Commissioner, T.C. Memo. 1997-271; Sann v.
Commissioner, T.C. Memo. 1997-259 n.13 (and cases cited therein),
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affd. sub nom. Addington v. Commissioner, 205 F.3d 54 (2d Cir.
2000). In all but a few of those cases, we found the taxpayers
liable for the additions to tax for negligence. Moreover, in all
of the Plastics Recycling cases in which the issue has been
raised, we have found the taxpayers liable for additions to tax
for valuation overstatement.
In Provizer v. Commissioner, T.C. Memo. 1992-177, the test
case for the Plastics Recycling group of cases, this Court:
(1) Found that each recycler had a fair market value of not more
than $50,000; (2) held that the transaction, which was virtually
identical to the transactions in the present cases, was a sham
because it lacked economic substance and a business purpose; (3)
sustained the additions to tax for negligence under section
6653(a)(1) and (2); (4) sustained the addition to tax for
valuation overstatement under section 6659 because the
underpayment of taxes was directly related to the overvaluation
of the recyclers; and (5) held that the partnership losses and
tax credits claimed with respect to the plastics recycling
partnership at issue were attributable to tax-motivated
transactions within the meaning of section 6621(c). We also
found that other recyclers were commercially available during the
years in issue. See id. In reaching the conclusion that the
transaction lacked a business purpose, this Court relied heavily
upon the overvaluation of the recyclers. Similarly, in Gottsegen
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v. Commissioner, T.C. Memo. 1997-314, we found that each Sentinel
EPS recycler had a fair market value not in excess of $50,000,
and relied heavily on the overvaluation of the recyclers in
concluding that the taxpayer was negligent and liable for
accuracy-related penalties.
A. Section 6653(a)(1) and (2) Negligence
In these cases, respondent determined that petitioners were
liable for additions to tax for negligence under section
6653(a)(1) and (2) with respect to underpayments attributable to
petitioners’ investment in Masters. In each case, petitioners
contend that they were not negligent because: (1) They
reasonably relied in good faith upon the advice of advisers,
including a competent and experienced accountant, in deciding to
invest in Masters, and (2) they intended to make a profit from
their investment in Masters.
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
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
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actions in connection with the transactions. See Henry Schwartz
Corp. v. Commissioner, 60 T.C. 728, 740 (1973). When considering
the negligence additions to tax, we evaluate the particular facts
of each case, judging the relative sophistication of the
taxpayers, as well as the manner in which they approached their
investment. See McPike v. Commissioner, T.C. Memo. 1996-46.
1. Petitioners’ Purported Reliance on an Adviser
In these cases, petitioners claim that they reasonably
relied upon the advice of a qualified tax adviser. A taxpayer
may avoid liability for the additions to tax under section
6653(a)(1) and (2) if he or she reasonably relied on competent
professional advice. 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).
See also American Properties, Inc. v. Commissioner, 28 T.C. 1100,
1116-1117 (1957), affd. per curiam 262 F.2d 150 (9th Cir. 1958).
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 the negligence
additions to tax, the taxpayer must show that the professional
had the expertise and knowledge of the pertinent facts to provide
informed advice on the subject matter. See Chakales v.
Commissioner, 79 F.3d 726 (8th Cir. 1996), affg. T.C. Memo. 1994-
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408; David v. Commissioner, 43 F.3d 788, 789-790 (2d Cir. 1995),
affg. T.C. Memo. 1993-621; Freytag v. Commissioner, supra; Sann
v. Commissioner, T.C. Memo. 1997-259.
Moreover, reliance on representations by insiders or
promoters, or on offering materials has been held an inadequate
defense to negligence. See Pasternak v. Commissioner, 990 F.2d
893 (6th Cir. 1993), affg. Donahue v. Commissioner, T.C. Memo.
1991-181; LaVerne v. Commissioner, 94 T.C. 637, 652-653 (1990),
affd. without published opinion 956 F.2d 274 (9th Cir. 1992);
Sann v. Commissioner, supra. Pleas of reliance have been
rejected when neither the taxpayer nor the advisers purportedly
relied upon by the taxpayer knew anything about the nontax
business aspects of the contemplated venture. See David v.
Commissioner, supra; Freytag v. Commissioner, supra.
In these cases, petitioners’ purported reliance on Grande
and Maki does not relieve them of liability for the additions to
tax for negligence. Grande’s and Maki’s expertise was in
taxation, not plastics or plastics recycling. Moreover, neither
Grande nor Maki consulted with any persons who had such expertise
in plastics or plastics recycling. At trial, Keith and Warren
testified that Grande’s and Maki’s review was limited to
examining the offering memorandum to ascertain whether the
documents had been properly prepared so that they as limited
partners would be entitled to the tax benefits presented by the
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offering memorandum. In effect, the advice provided by Grande
and Maki did not suggest anything beyond the view that, if the
facts and circumstances proved to be as represented by Mejia and
in the offering memorandum, then the tax benefits described in
the offering memorandum should be allowed. Keith and Warren did
not rely upon Grande or Maki with regard to Masters’ nontax
business aspects.
Accordingly, petitioners, Grande, and Maki solely relied
upon the offering materials and Mejia’s representations with
regard to the recyclers’ value and Masters’ economic viability.
The offering memorandum contained reports by Ulanoff and
Burstein. Petitioners, Grande, and Maki never investigated
whether Ulanoff or Burstein had an interest in plastics recycling
transactions. In fact, Ulanoff and Burstein each invested in
plastics recycling partnerships. The offering memorandum also
disclosed that Burstein was a client and business associate of
PI’s corporate counsel. Moreover, the offering memorandum
specifically warned potential investors not to rely on the
statements or opinions contained in it. Lastly, as a broker,
Mejia clearly had a financial interest in selling the partnership
interests to petitioners. In this transaction, Mejia was engaged
in a selling function rather than an advisory function, and
petitioners, as experienced businessmen and educated persons,
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knew or should have known to exercise caution in relying upon the
seller’s representative for advice as to whether they should buy.
On this record, we hold that it was not reasonable for
petitioners to claim substantial tax credits and partnership
losses on the basis of Mejia’s, Grande’s, or Maki’s advice.
Neither Grande nor Maki had the requisite expertise or knowledge
of the pertinent facts to provide informed advice regarding the
claimed partnership losses and tax credits. A taxpayer may rely
upon his adviser’s expertise, but it is not reasonable or prudent
to rely upon an adviser regarding matters outside of his field of
expertise or with respect to facts that he does not verify. See
David v. Commissioner, supra at 789-790; Goldman v. Commissioner,
39 F.3d 402, 408 (2d Cir. 1994); Freytag v. Commissioner, 89 T.C.
849 (1991); Sann v. Commissioner, supra. Moreover, as indicated
above, in these cases there is no credible evidence that either
of them offered advice beyond his limited area of knowledge
relating to the technical tax aspects of the transaction.
Petitioners’ purported reliance on Mejia’s advice was also
unreasonable. We have consistently held that advice from such
persons is better classified as sales promotion. See Singer v.
Commissioner, T.C. Memo. 1997-325; Sann v. Commissioner, supra;
Vojticek v. Commissioner, T.C. Memo. 1995-444. We note that in
these cases, Mejia did not testify, and that circumstance
suggests that if he had testified, that testimony would have been
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unfavorable to petitioners. See Wichita Terminal Elevator Co. v.
Commissioner, 6 T.C. 1158, 1165 (1946), affd. 162 F.2d 513 (10th
Cir. 1947).
2. Petitioners’ Purported Profit Motive
In these cases, petitioners also contend that they were not
negligent because they invested in Masters for economic profits
and as a source of income for retirement. Keith and Warren each
had an extensive business background and had enjoyed a successful
career in his respective field. Moreover, Keith and Warren each
had been the head of a large company and each had experience with
complex financial decisions. Keith and Warren read Hamilton’s
offering memorandum, which was substantially identical to
Masters’ offering memorandum. The offering memorandum
specifically warned potential investors of significant business
and tax risks associated with investing in these types of
partnerships. The offering memorandum also warned potential
investors that the value of the recyclers might be challenged by
the IRS, a practice often followed by the IRS in transactions it
deems to be tax shelters. Nevertheless, petitioners disregarded
these warnings and failed to consult any independent advisers
with expertise in plastics or plastics recycling. Petitioners
also failed to conduct a reasonable independent investigation
into the market value of the recyclers or any of the other
economics of the Masters’ transaction. Moreover, Grande
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testified that he probably referred to Hamilton as a tax shelter.
Warren also testified that he knew that Masters was a tax
shelter.
Petitioners’ reliance on Krause v. Commissioner, 99 T.C. 132
(1992), affd. sub nom. Hildebrand v. Commissioner, 28 F.3d 1024
(10th Cir. 1994), is misplaced. The facts in Krause are
distinguishable from the facts in these cases. In Krause, the
taxpayers invested in limited partnerships whose investment
objectives concerned enhanced oil recovery (EOR) technology. The
Krause opinion states that during the late 1970’s and early
1980’s, the Federal Government adopted specific programs to aid
research and development of EOR technology. See id. at 135-136.
In holding that the taxpayers in Krause were not liable for the
negligence addition to tax, this Court noted that one of the
Government’s expert witnesses acknowledged that “investors may
have been significantly and reasonably influenced by the energy
price hysteria that existed in the late 1970s and early 1980s to
invest in EOR technology.” Id. at 177. While EOR was, according
to our opinion in Krause, at the forefront of national policy and
the media during the late 1970’s and early 1980’s, petitioners
have failed to demonstrate that the so-called energy crisis
provided a reasonable basis for them to invest in Masters.
In addition, the taxpayers in Krause were either experienced
in or investigated the oil industry and EOR specifically. One of
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the taxpayers in Krause undertook a significant investigation of
the proposed investment, including researching EOR. The other
taxpayer was a geological and mining engineer who hired an
independent expert to review the offering materials. See id. at
166. In contrast, petitioners did not have any experience or
education in plastics recycling. Moreover, neither Keith nor
Warren undertook an independent investigation of Masters.
Petitioners failed to hire an independent expert in plastics to
evaluate the transaction.
Keith and Warren were both sophisticated and well educated
businessmen. There were many factors that should have alerted
petitioners to conduct independent investigations of Masters.
The offering memorandum warned each prospective purchaser that he
should consult with his own professional adviser as to the legal,
tax, and business aspects of investing in Masters. Moreover, the
offering memorandum also warned potential investors about
numerous business and tax risks. Nevertheless, petitioners
disregarded these warnings and failed to undertake an appropriate
independent investigation.
3. Conclusion as to Negligence
Under the circumstances of these cases, petitioners failed
to exercise due care in claiming large deductions and tax credits
with respect to Masters on their Federal income tax returns. It
was not reasonable for petitioners to rely as they did on the
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offering memorandum, promoters, or insiders to the transaction.
Petitioners’ accountants were asked to make only a limited
technical examination of the documents presented to them as a tax
shelter, and that is all they did. Petitioners, Grande, and Maki
did not undertake a good faith investigation of the fair market
value of the recyclers or the underlying economic viability or
financial structure of Masters.
Upon consideration of this record, we hold that petitioners
are liable for the negligence additions to tax under section
6653(a)(1) and (2).
B. Section 6659 Valuation Overstatement
In the notices of deficiency in these cases, respondent
determined that petitioners were liable for section 6659
additions to tax on the portions of their respective
underpayments attributable to valuation overstatements. Under
section 6659, a graduated addition to tax is imposed when an
individual has an underpayment of tax that equals or exceeds
$1,000 and is attributable to a valuation overstatement. See
sec. 6659(a), (d). A valuation overstatement exists if the fair
market value (or adjusted basis) of property claimed on a return
equals or exceeds 150 percent of the amount determined to be the
correct amount. See sec. 6659(c). If the claimed valuation
exceeds 250 percent of the correct value, the addition is equal
to 30 percent of the underpayment. See sec. 6659(b).
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Petitioners claimed tax benefits, including investment tax
credits and business energy credits, based on a purported value
of $1,750,000 for each recycler. Petitioners have conceded that
the fair market value of a recycler in 1982 was not in excess of
$50,000. Accordingly, if disallowance of petitioners’ claimed
benefits is attributable to such valuation overstatements,
petitioners are liable for section 6659 additions to tax at the
rate of 30 percent of the underpayments of tax attributable to
tax benefits claimed with respect to Masters.
Petitioners contend that section 6659 does not apply in
their cases because (1) disallowance of the claimed tax benefits
was attributable to other than a valuation overstatement, and (2)
Masters’ concession in the underlying partnership case precludes
imposition of the section 6659 additions to tax.
1. The Grounds for Petitioners’ Underpayments
Petitioners argue that where, as here, the Commissioner
completely disallows a tax benefit, the tax underpayment cannot
be attributable to a valuation overstatement. Petitioners cite
the following cases to support their argument: Heasley v.
Commissioner, 902 F.2d 380 (5th Cir. 1990), revg. T.C. Memo.
1988-408; Gainer v. Commissioner, 893 F.2d 225 (9th Cir 1990),
affg. T.C. Memo. 1988-416; Todd v. Commissioner, 862 F.2d 540
(5th Cir. 1988), affg. 89 T.C. 912 (1987); McCrary v.
Commissioner, 92 T.C. 827 (1980).
- 28 -
Section 6659 does not apply to underpayments of tax that are
not “attributable to” valuation overstatements. Todd v.
Commissioner, supra; McCrary v. Commissioner, supra. “To the
extent taxpayers claim tax benefits that are disallowed on
grounds separate and independent from alleged valuation
overstatements, the resulting underpayments of tax are not
regarded as attributable to valuation overstatements.” Krause v.
Commissioner, 99 T.C. 132, 178 (1992) (citing Todd v.
Commissioner, supra). However, when valuation is an integral
factor in disallowing deductions and credits, section 6659 is
applicable. See Merino v. Commissioner, 196 F.3d 147 (3d Cir.
1999), affg. T.C. Memo. 1997-385; Zfass v. Commissioner, 118 F.3d
184 (4th Cir. 1997), affg. T.C. Memo. 1996-167; Illes v.
Commissioner, 982 F.2d 163 (6th Cir. 1992), affg. T.C. Memo.
1991-449; Gilman v. Commissioner, 933 F.2d 143, 151 (2d Cir.
1991), affg. T.C. Memo. 1989-684; Massengill v. Commissioner, 876
F.2d 616 (8th Cir. 1989), affg. T.C. Memo. 1988-427.
Petitioners’ reliance on Gainer v. Commissioner, supra, and
Todd v. Commissioner, supra, ignores that this Court as well as
the Court of Appeals for the Eighth Circuit, the court to which
appeals in these cases would lie, has held that “when an
underpayment stems from disallowed depreciation deductions or
investment credits due to lack of economic substance, the
deficiency is attributable to overstatement of value, and subject
- 29 -
to the penalty under section 6659.” Massengill v. Commissioner,
supra at 619-620; see also Zirker v. Commissioner, 87 T.C. 970
(1986).
We also find that the facts in these cases are
distinguishable from the facts in Gainer v. Commissioner, supra,
Todd v. Commissioner, supra, and McCrary v. Commissioner, supra.
In Gainer and Todd, it was found that a valuation overstatement
did not contribute to an underpayment of taxes. In those cases,
the underpayments were due exclusively to the fact that the
property in each case had not been placed in service. In
McCrary, the underpayments were deemed to result from a
concession that the agreement at issue was a license and not a
lease. Although property was overvalued in each of those cases,
the overvaluation was not the grounds on which the taxpayers’
liabilities were sustained. In contrast, a “different situation
exists where a valuation overstatement * * * is an integral part
of or is inseparable from the ground found for disallowance of an
item.” McCrary v. Commissioner, supra at 859. In the present
cases, we find that the overvaluation of the recyclers was
integral to and inseparable from petitioners’ claimed tax
benefits and the determination that Masters lacked economic
substance.4
4
To the extent that Heasley v. Commissioner, 902 F.2d 380
(5th Cir. 1990), revg. T.C. Memo. 1988-408, merely represents an
(continued...)
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In the present cases, petitioners have conceded that the
recyclers’ fair market value in 1982 did not exceed $50,000.
Petitioners have also conceded that the Masters transaction and
the recyclers in these cases are substantially identical to the
transactions and recyclers considered in Provizer v.
Commissioner, T.C. Memo. 1992-177. In Provizer, our finding that
the recyclers were overvalued was the dominant factor that led us
to hold that the transaction lacked economic substance. See Sann
v. Commissioner, T.C. Memo. 1997-259. Based on this record, we
find that the recyclers overvaluation was a dominant factor in
regard to: (1) The disallowed tax credits, and other benefits in
these cases; (2) the underpayments of tax; and (3) the
determination that the Masters transaction lacked economic
substance.
Lastly, we note that petitioners’ argument is similar to the
arguments that were raised in other plastics recycling cases.
See Merino v. Commissioner, 196 F.3d 147 (3d Cir. 1999); Singer
v. Commissioner, T.C. Memo. 1997-325; Kaliban v. Commissioner,
4
(...continued)
application of Todd v. Commissioner, 862 F.2d 540 (5th Cir.
1988), affg. 89 T.C. 912 (1987), we consider Heasley
distinguishable. To the extent that Heasley is based on a
concept that where an underpayment derives from the disallowance
of a transaction for lack of economic substance, the underpayment
cannot be attributable to an overvaluation, this Court, as well
as the Court of Appeals for the Eighth Circuit have disagreed.
See Massengill v. Commissioner, 876 F.2d 616 (8th Cir. 1989),
affg. T.C. Memo. 1988-427.
- 31 -
T.C. Memo. 1997-271; Sann v. Commissioner, supra. In all of
those cases, we rejected this argument.
2. Concession of the Deficiency
Petitioners also argue that Masters’ concession in the
underlying partnership case precludes imposition of the section
6659 additions to tax. Petitioners contend that Masters’
concession renders any inquiry into the grounds for such
deficiencies moot. Petitioners argue that absent such inquiry it
cannot be known if their underpayments were attributable to a
valuation overstatement or other discrepancy and that without a
finding that a valuation overstatement contributed to an
underpayment, section 6659 cannot apply. In support of this line
of reasoning, petitioners rely heavily upon Heasley v.
Commissioner, 902 F.2d 380 (5th Cir. 1990), and McCrary v.
Commissioner, 92 T.C. 827 (1980).
Masters’ concession does not obviate our finding that
Masters lacked economic substance due to overvaluation of the
recyclers. The value of the recyclers was established in
Provizer v. Commissioner, supra, and stipulated by the parties.
As a consequence of the inflated value assigned to the recyclers
by Masters, petitioners claimed deductions and credits that
resulted in underpayments of tax. Regardless of Masters’
concession in the underlying partnership case, in these cases the
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underpayments of tax were attributable to the valuation
overstatements.
Moreover, concession of the investment tax credit in and of
itself does not relieve taxpayers of liability for the section
6659 addition to tax. See Singer v. Commissioner, supra; Kaliban
v. Commissioner, supra; Sann v. Commissioner, supra; Dybsand v.
Commissioner, T.C. Memo. 1994-56; Chiechi v. Commissioner, T.C.
Memo. 1993-630. Instead, the ground upon which the investment
tax credit is disallowed or conceded is significant. See Dybsand
v. Commissioner, supra. Even in situations in which there are
arguably two grounds to support a deficiency and one supports a
section 6659 addition to tax and the other does not, the taxpayer
may still be liable for the addition to tax. See Gainer v.
Commissioner, 893 F.2d 225 (9th Cir. 1990); Irom v. Commissioner,
866 F.2d 545, 547 (2d Cir. 1989), vacating in part T.C. Memo.
1988-211; Harness v. Commissioner, T.C. Memo. 1991-321.
In these cases, petitioners each stipulated substantially
the same facts concerning the Masters transaction as we found in
Provizer v. Commissioner, supra. In Provizer, we held that the
taxpayers were liable for the section 6659 addition to tax
because the underpayment of taxes was directly related to the
overvaluation of the recyclers. The overvaluation of the
recyclers, exceeding 2325 percent, was an integral part of our
findings in Provizer that the transaction was a sham and lacked
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economic substance. Similarly, the records in these cases
plainly show that the overvaluation of the recyclers is integral
to and is the core of our holding that Masters was a sham and
lacked economic substance.
Petitioners’ reliance on McCrary v. Commissioner, supra, is
misplaced. In that case, the taxpayers conceded entitlement to
their claimed tax benefits, and the section 6659 addition to tax
was held inapplicable. However, the taxpayers’ concession of the
claimed tax benefits, in and of itself, did not preclude
imposition of the section 6659 addition to tax. In McCrary v.
Commissioner, supra, the section 6659 addition to tax was
disallowed because the agreement at issue was conceded to be a
license and not a lease. In contrast, the records in
petitioners’ cases plainly show that petitioners’ underpayments
were attributable to overvaluation of the recyclers.
Accordingly, petitioners’ reliance on McCrary v. Commissioner,
supra, is inappropriate.5
We held in Provizer v. Commissioner, supra, that each
recycler had a fair market value not in excess of $50,000. Our
5
Petitioners’ citation of Heasley v. Commissioner, supra, in
support of the concession argument is also inappropriate. The
Heasley case was not decided by the Court of Appeals for the
Fifth Circuit on the basis of a concession. Moreover, see supra
note 4 to the effect that the Court of Appeals for the Eighth
Circuit and this Court have not followed the Court of Appeals for
the Fifth Circuit’s rationale with respect to the application of
sec. 6659.
- 34 -
finding in Provizer that the recyclers had been overvalued was
integral to and inseparable from our holding of a lack of
economic substance. Petitioners stipulated that the transaction
in Masters was substantially similar to the transaction described
in Provizer, and that the fair market value of the recyclers in
1982 was not in excess of $50,000. Given those concessions, and
the fact that the records here plainly show that the
overvaluation of the recyclers was integral to and inseparable
from the determination that Masters lacked economic substance, we
conclude that the deficiencies were attributable to the
overvaluation of the recyclers.
For the foregoing reasons, we hold that petitioners are
liable for the section 6659 additions to tax for valuation
overstatement.
To reflect the foregoing,
Decisions will be entered
for respondent.