The opinion
T.C. Memo. 2006-131
UNITED STATES TAX COURT
MICHAEL W. KELLER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 9662-01. Filed June 22, 2006.
Asher B. Bearman, Jaret R. Coles, Jennifer A. Gellner, Terri
A. Merriam, and Wendy S. Pearson, for petitioner.
Catherine J. Caballero, Gregory M. Hahn, Nhi T. Luu-Sanders,
and Thomas N. Tomashek, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
HAINES, Judge: Respondent determined deficiencies in
petitioner’s Federal income taxes of $11,106 and $17,410 for 1994
and 1995, respectively. Respondent further determined that
petitioner was liable for accuracy-related penalties under
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section 6662(h) of $4,442 and $6,932, respectively.1 After
concessions,2 the only issues for decision are: (1) Whether
petitioner is liable for 40-percent accuracy-related penalties
under section 6662(h); and (2) in the alternative, whether
petitioner is liable for 20-percent accuracy-related penalties
under section 6662(b)(1) or (2).
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The first, second, and third stipulations of fact and the
attached exhibits are incorporated herein by this reference.
Petitioner resided in Escondido, California, when he filed his
petition.
A. Hoyt and the Hoyt Partnerships
The issues in this case revolve around petitioner’s
investment in a partnership organized and promoted by Walter J.
Hoyt III (Hoyt). Hoyt’s father was a prominent cattle breeder.
To expand his business and attract investors, Hoyt’s father
started organizing and promoting cattle breeding partnerships in
the late 1960s. Before his father’s death in early 1972, Hoyt
1
All section references are to the Internal Revenue Code,
as amended, and all Rule references are to the Tax Court Rules of
Practice and Procedure. Amounts are rounded to the nearest
dollar.
2
Petitioner concedes that: (1) He did not realize any
farm income in 1994 and 1995; and (2) he is not entitled to the
deductions claimed on Schedules F, Profit or Loss From Farming,
attached to his 1994 and 1995 Federal income tax returns.
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and other members of the Hoyt family were extensively involved in
organizing and operating numerous cattle breeding partnerships.
From about 1971 through 1998, Hoyt organized, promoted, and
operated more than 100 cattle breeding partnerships (Hoyt
partnerships). Hoyt also organized, promoted, and operated sheep
breeding partnerships.
From 1983 until his removal by the Tax Court in 2000 through
2003, Hoyt was the tax matters partner of each Hoyt partnership.
From approximately 1980 through 1997, Hoyt was a licensed
enrolled agent, and as such, he represented many of the Hoyt
partners before the IRS. In 1998, Hoyt’s enrolled agent status
was revoked.
Hoyt also operated tax return preparation companies,
including “Tax Office of W.J. Hoyt Sons”, “Agri-Tax”, and “Laguna
Tax Service” (Laguna). These companies prepared most of the Hoyt
investors’ tax returns.
B. Petitioner’s Background and Involvement With Hoyt
Petitioner is married and has two stepchildren. Petitioner
has a bachelor of science degree in marine transportation and
management and has been employed by Military Sealift Command
since June 1982.
Before his involvement with Hoyt, petitioner’s only
experience in investing included an investment of $20,000 in the
stock market in 1982 and the purchase of two homes in 1990 and
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1994, respectively. He had never been a partner in a
partnership.
Petitioner’s only experience in farming came in the late
1970s, when he spent a couple of weeks milking cows. Petitioner
has never purchased livestock. Petitioner is not an expert in
cattle or embryo valuation and has no knowledge of the success
rate of embryo transplants in cattle.
Petitioner first heard about the Hoyt organization in 1985
from several coworkers. At that time, petitioner understood that
Hoyt was in the business of breeding cattle, that the business
was profit motivated, and that investment in a Hoyt partnership
would minimize a partner’s tax liability. Petitioner did not
invest in 1985, taking a “wait-and-see attitude” because the
investment “just [sounded] too good to be true.”
In 1994, petitioner talked to current and former coworkers,
including Joe Trodglen (Trodglen), about Hoyt and the tax
benefits of investing in a Hoyt partnership. In December 1994,
petitioner told Trodglen that he wanted to invest in the Hoyt
organization. Trodglen provided petitioner with Hoyt promotional
materials, including a pamphlet entitled “Registered Livestock
Purchase Guide” (the purchase guide). The purchase guide
provides an outline of Hoyt’s partnerships and “investment
opportunities.” Many sections are devoted to tax considerations,
including tax benefits and tax risks. The purchase guide states:
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Cattle ranchers use the tax benefits Congress has
given us. Some of us bring the tax benefits to town,
sell them for cash to help pay to produce the beef.
The cows produce beef, and tax benefits for their
owners. Ranchers sell the beef at the store, and the
tax benefits to provide additional capital. The cash
raised from the selling of both items is enough to pay
for the cattle purchase and the operating expenses.
Those that buy the beef get a steak. Those that buy
the tax benefits have the opportunity for ownership in
the cattle herd.
Again, you only considered making an investment in
the cattle business AFTER you heard about the tax
benefits. Tax benefits were your incentive. They
encouraged you to make a high risk business investment.
* * * * * * *
In the country, tax accountants don’t read brands,
and cowboys don’t read tax law. If you must have a tax
man give you specific personal advice as to whether or
not you belong in the cattle business, stay out.
* * * * * * *
A change in the tax laws or an audit and
disallowance by the IRS could take away all or part of
the tax benefits, plus the possibility of having to pay
the tax along with penalties and interest.
Petitioner also received a pamphlet entitled “Registured [sic]
Livestock: The Real ‘Bull Market’ Business Opportunities” (the
business opportunities pamphlet). On its cover, the business
opportunities pamphlet states “HARVESTING TAX SAVINGS BY FARMING
THE TAX CODE”, and it contains much of the same information as
the purchase guide.
On February 14, 1995, petitioner sent to the Hoyt
organization a “Confidential Buyers Information” form, requesting
an “information package”. Dave Barnes (Barnes), a Hoyt employee,
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responded on February 17, 1995, thanked petitioner for his
interest, provided him with promotional materials, and requested
that he “fill out the enclosed credit application and return it
with copies of your tax returns for the years 1991, 1992, and
1993, so I can review your qualifications for your livestock
purchase.” The promotional materials included copies of the
purchase guide and the business opportunities pamphlet provided
to petitioner by Trodglen. Petitioner sent the requested
information to Barnes in March 1995.
Sometime in early 1995, petitioner met with Barnes at Elk
Grove, a Hoyt ranch, to further discuss “investment
opportunities”.3 Their meeting lasted approximately 3 hours,
during which Barnes explained Bales v. Commissioner, T.C. Memo.
1989-568 (the Bales case, or Bales) and spent at least 15 minutes
discussing tax benefits.
After talking to Barnes, petitioner decided to invest.
Petitioner did not consult a tax attorney, an accountant, or an
expert in the cattle industry before he invested.
On April 15, 1995, David Cross (Cross), a Hoyt employee,
sent petitioner a letter stating:
After reviewing your information we are
comfortable with your income, you can afford the
payments on 73 head [of cattle].
3
It is not clear whether this meeting took place before or
after petitioner requested information from Hoyt.
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You are now ready for the next step. As soon as
possible, please get your 1994 taxes to Laguna Tax
Service. Dave Barnes will take them, the copies of
your 1991, 1992 and 1993 returns. Laguna will
calculate your tax savings to verify what we have
figured.
On July 28, 1995, petitioner purportedly purchased 73
“Registured [sic] Durham Shorthorn Bred Heifers” and 73
“confirmed embryos” from W.J. Hoyt Sons Ranches MLP (Hoyt
Ranches) for $956,980. Hoyt determined the number of cattle
petitioner could purchase and set the purchase price without
petitioner’s input. Petitioner did not see any of the cattle
that he was purchasing. Petitioner initially thought he was
purchasing only cattle and did not realize he was also purchasing
embryos until he received the “Sales Order”, described infra.
In connection with the purchase, petitioner signed and/or
received a “Livestock Bill of Sale”, a “Certificate of Warranty”,
a “Sales Order”, a “Fifteen Year Promissory Note”, and a
“Security Agreement” on July 28, 1995.
The “Livestock Bill of Sale” (bill of sale) indicated that
petitioner, “D.B.A. Durham Genetic Engineering 1990-2”,4
purchased the Durham shorthorn cattle described on the attached
schedule for a “total purchase price” of $956,980. The schedule
included the names and other information for 73 Durham Shorthorn
heifers. The bill of sale did not mention confirmed embryos or
4
Petitioner was a partner in Durham Genetic Engineering
1990-2 J.V. (DGE). For more information, see infra note 5.
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indicate that any part of the total purchase price was paid for
those embryos.
The “Certificate of Warranty” guaranteed that all heifers
listed on the bill of sale would be able to reproduce for 10
consecutive years.
The “Sales Order” indicated that petitioner purchased 73
Durham Shorthorn heifers for $478,490 and 73 confirmed embryos
for $478,490.
To fund his purchase of cattle, petitioner signed a
“Fifteen Year Promissory Note” (promissory note), agreeing to pay
Hoyt Ranches $956,980. The promissory note provided that
petitioner was required to pay interest in 50 monthly
installments of $1,075, beginning on September 1, 1995.
Beginning in August 2000, petitioner was required to pay 10
percent of the unpaid principal each year until the entire debt
was satisfied. Petitioner did not keep a copy of the promissory
note for his records.
To secure repayment of the promissory note, petitioner
signed a “Security Agreement”, granting Hoyt Ranches a security
interest in all cattle purchased or bred by petitioner.
Petitioner did not keep a copy of the security agreement for his
records.
On July 31, 1995, petitioner signed a “Share-Crop Board
Agreement” (board agreement). The board agreement provided that
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W.J. Hoyt Sons Management Co. would breed and board all of
petitioner’s cattle. Petitioner did not keep a copy of the board
agreement for his records.
Petitioner did not have any records of what happened to the
cattle or the embryos after he purchased them. Petitioner did
not request from Hoyt, nor did Hoyt provide, any written account
of his cattle.
Other than a $50 application fee, petitioner did not incur
any upfront costs related to his investment. However, petitioner
agreed to remit to the Hoyt organization 75 percent of any tax
refunds received. In connection with his 1991, 1992, and 1993
refunds totaling $40,740, see infra, petitioner paid to Hoyt
$30,500. In connection with his 1994 refund of $11,773, see
infra, petitioner paid to Hoyt $10,500. Petitioner also made 10
interest payments to Hoyt of $1,075 between September 8, 1995,
and May 28, 1996.
C. Petitioner’s Tax Claims
Before investment in the Hoyt organization, petitioner
usually prepared his own tax returns. On his tax returns for
1991, 1992, and 1993, petitioner reported the following:
Year Total income Total tax
1991 $81,574 $10,662
1992 70,094 9,035
1993 107,841 21,043
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Petitioner’s 1994 and 1995 tax returns were prepared and
signed by Hoyt and listed Laguna as the preparer’s firm.
Petitioner provided Laguna with his Forms W-2, Wage and Tax
Statement, and with information regarding his Schedule A itemized
deductions. However, petitioner did not provide Laguna with any
of the information used to prepare the Schedules F. Laguna also
prepared for petitioner a Form 1045, Application for Tentative
Refund.
After the returns and the application for refund were
prepared, Laguna forwarded them to petitioner for his review and
signature. Petitioner signed and filed the returns and the
application without having them reviewed by an accountant or
attorney outside of the Hoyt organization.
Petitioner filed his 1994 Federal income tax return on
December 25, 1995. On an attached Schedule F,5 petitioner
5
This Court has heard numerous Hoyt-related cases. In the
majority of those cases, the issues for decision revolved around
partnership losses taken by taxpayers as partners in various
Hoyt-operated partnerships. See, e.g., Mortensen v.
Commissioner, 440 F.3d 375, 387 (6th Cir. 2006), affg. T.C. Memo.
2004-279; Van Scoten v. Commissioner, 439 F.3d 1243, 1253 (10th
Cir. 2006), affg. T.C. Memo. 2004-275; Hansen v. Commissioner,
T.C. Memo. 2004-269; cf. Jaroff v. Commissioner, T.C. Memo. 2004-
276.
Petitioner was a partner in DGE and was issued Schedules K-
1, Partner’s Share of Income, Credits, Deductions, Etc., for 1994
and 1995. However, unlike the majority of taxpayers in Hoyt
cases, petitioner did not report any partnership items on his
returns. Instead, petitioner reported income and losses on
(continued...)
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reported the following:
Farm income, sales of livestock $152,059
Depreciation (247,842)
Interest expense (8,830)
“1994 Sharecropboard Exp” (121,647)
“Expense for the cost basis of
purchased cattle that died” (76,558)
Net farm profit or (loss) (302,818)
With respect to the depreciation deduction, petitioner attached a
depreciation schedule reporting a cost basis in his “registured
[sic] cattle” of $880,423. Petitioner subtracted his net farm
loss of $302,818 from wage and interest income totaling $72,942
for total negative income of $229,876. Petitioner reported zero
taxable income and zero tax due. Petitioner reported taxes
withheld of $11,773 and requested a refund of that amount, which
respondent issued.
In December 1995, petitioner also filed a Form 1045 seeking
to carry back to 1991, 1992, and 1993 net operating losses of
$231,952 realized in 1994. As a result of the carryback,
petitioner reported decreases in tax of $10,662, $9,035, and
5
(...continued)
Schedules F as if he were directly involved in the farming
activity.
Respondent issued to petitioner a notice of final
partnership administrative adjustment (FPAA) with respect to his
partnership interest in DGE. In a motion to dismiss for lack of
jurisdiction, petitioner argued that this Court lacked
jurisdiction over the Schedule F items because they were
partnership items or affected items, referring to the FPAA.
Petitioner’s motion was denied because the Court concluded that
the Schedule F items were not partnership items or affected
items.
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$21,043 for 1991, 1992, and 1993, respectively. Respondent
issued refunds in those amounts on February 5, 1996.
Petitioner filed his 1995 Federal income tax return on
August 5, 1996. On an attached Schedule F, petitioner reported
the following:
Farm income, sales of livestock $80,928
Depreciation (83,351)
Interest expense (24,600)
“1994 Sharecropboard exp” (80,928)
Net farm profit or (loss) (107,951)
With respect to the depreciation deduction, petitioner attached a
depreciation schedule reporting a cost basis in his “registured
[sic] cattle” of $625,100. Petitioner subtracted his net farm
loss of $107,951 from wage, interest, and capital gains income
totaling $132,527 for total income of $24,576. After subtracting
other deductions, petitioner reported zero taxable income and
zero taxes due. Petitioner reported taxes withheld of $8,788 and
requested a refund of that amount. Respondent did not issue a
refund for 1995.
D. Respondent’s Review of Petitioner’s Tax Claims
On January 10, 1996, nearly 7 months before petitioner filed
his 1995 return, respondent sent petitioner a prefiling notice.
The prefiling notice informed petitioner that he had been
identified as an investor in a tax shelter promoted by Hoyt. It
further informed petitioner that deductions relating to the tax
shelter would not be allowed and that claiming such deductions
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could result in the imposition of an accuracy-related penalty
under section 6662.
After receiving the prefiling notice, petitioner visited
Barnes at Elk Grove Ranch. Barnes told petitioner that the
letter was a part of an “ongoing bitter battle” and that Hoyt was
still an enrolled agent. Barnes took petitioner on a tour of Elk
Grove and the Laguna office and showed him a copy of the Bales
case and other documents.
On February 24, 1997, respondent sent petitioner a letter
indicating that petitioner’s 1994 and 1995 tax years were under
examination.
On May 3, 2001, respondent sent petitioner a notice of
deficiency. Respondent disallowed all of petitioner’s Schedule F
deductions for 1994 and 1995 and determined that the “Farm
income, sales of livestock” listed on the Schedules F were not
includable in income.6 As a result, respondent determined
deficiencies in petitioner’s Federal income taxes of $11,106 and
$17,410 for 1994 and 1995, respectively. Respondent further
determined that the underpayments of tax were attributable to
gross valuation misstatements, and therefore petitioner was
liable for 40-percent accuracy-related penalties under section
6662(h) of $4,442 and $6,932, respectively.
6
Petitioner has conceded that he did not receive farm
income and is not entitled to any Schedule F deductions for 1994
and 1995. See supra note 2.
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In response to the notice of deficiency, petitioner filed
his petition with this Court on August 2, 2001.
In an amendment to answer filed May 18, 2005, respondent
asserted that, in the alternative to the 40-percent penalties
under section 6662(h), petitioner is liable for 20-percent
accuracy-related penalties under either section 6662(b)(1) or
(2).
OPINION
A. Accuracy-Related Penalties in General
Under section 6662(a), a taxpayer may be liable for a 20-
percent penalty on the portion of an underpayment of tax
attributable to negligence or disregard of rules or regulations
or to a substantial underpayment of tax. Sec. 6662(a) and (b)(1)
and (2). The section 6662(a) penalty is increased to 40-percent
when the underpayment of tax is the result of “gross valuation
misstatements”. Sec. 6662(h)(1). However, no penalty is imposed
under section 6662 if there is reasonable cause for the
underpayment of tax and the taxpayer has acted in good faith.
Sec. 6664(c)(1).
B. Burden of Proof
Generally, a taxpayer bears the burden of proving the
Commissioner’s determinations incorrect. Rule 142(a)(1); Welch
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v. Helvering, 290 U.S. 111, 115 (1933).7 However, the
Commissioner bears the burden of proof with respect to any new
matter raised in the answer. Rule 142(a). The parties agree
that petitioner bears the burden of proof with respect to the
penalties under section 6662(h). The parties also agree that
respondent bears the burden of proof with respect to the
penalties under section 6662(b)(1) and (2) because respondent
asserted these penalties in his amendment to answer.
C. Section 6662(h): Gross Valuation Misstatements
Under section 6662(h), a taxpayer may be liable for a 40-
percent penalty on any portion of an underpayment of tax
attributable to gross valuation misstatements. However, no
penalty is imposed unless the portion of such underpayment
exceeds $5,000. Sec. 6662(e)(2). A gross valuation misstatement
means any substantial valuation misstatement, as determined under
section 6662(e), by substituting “400 percent” for “200 percent”.
Sec. 6662(h)(2)(A). There is a substantial valuation
misstatement if “the value of any property (or the adjusted basis
of any property) claimed on any return * * * is 200 percent or
more of the amount determined to be the correct amount of such
7
While sec. 7491 shifts the burden of proof and/or the
burden of production to the Commissioner in certain
circumstances, this section is not applicable in this case
because respondent’s examination of petitioner’s returns did not
commence after July 22, 1998. See Internal Revenue Service
Restructuring and Reform Act of 1998, Pub. L. 105-206, sec.
3001(c), 112 Stat. 727.
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valuation or adjusted basis”. Sec. 6662(e)(1)(A). In other
words, there is a gross valuation misstatement when the value or
basis claimed on a return is 400 percent or more of the correct
value or basis.
Respondent determined that the full amounts of petitioner’s
underpayments of tax were attributable to gross valuation
misstatements. For 1994, petitioner’s underpayment was
attributable to the disallowance of the Schedule F deductions for
depreciation, “the cost basis of purchased cattle that died”
(cost basis deduction), interest, and “sharecropboard” expenses.
For 1995, petitioner’s underpayment was attributable to the
disallowance of the Schedule F deductions for depreciation,
interest, and “sharecropboard” expenses. Because the interest
and sharecropboard expenses did not depend on valuation or basis
statements, any underpayments of tax resulting from their
disallowance cannot be based on gross valuation misstatements.
See Jaroff v. Commissioner, T.C. Memo. 2004-276. However, the
depreciation and cost basis deductions depended on petitioner’s
reported bases in cattle. Therefore, 40-percent penalties may
apply to petitioner’s underpayments resulting from the
disallowance of the depreciation and cost basis deductions if the
bases petitioner reported were gross valuation misstatements.
See id.
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On his 1994 return, petitioner reported a “cost basis of
purchased cattle that died” of $76,558 and a cost basis in his
“registured [sic] cattle” of $880,423. On his 1995 return,
petitioner reported a cost basis in his “registured [sic] cattle”
of $625,100. As stated above, petitioner bears the burden of
proof with respect to the section 6662(h) penalties. Therefore,
petitioner bears the burden of proving that the reported bases
were not gross valuation misstatements.
Petitioner does not argue that the reported bases were
correct or were less than 400 percent of the correct bases (and
thus not gross valuation misstatements). Instead, “It is
Petitioner’s position that he never received the benefits and
burdens of ownership of the purported cattle--if such cattle even
existed, thus the overvaluation penalty cannot apply.”
Petitioner’s position is without support.
If we accept petitioner’s assertion that he never received
the benefits and burdens of ownership of the cattle, or that the
cattle never existed, then his bases in the cattle would be zero.
See Zirker v. Commissioner, 87 T.C. 970, 978-979 (1986) (finding
that no actual sale of cattle took place and the correct adjusted
basis of cattle was zero); Massengill v. Commissioner, T.C. Memo.
1988-427 (same as Zirker), affd. 876 F.2d 616 (8th Cir. 1989).
This conclusion is supported by petitioner’s concession that he
was not entitled to cost basis or depreciation deductions. If
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petitioner’s correct bases are zero, then the bases claimed on
his returns are considered to be 400 percent or more of the
correct amount, and are thus gross valuation misstatements. See
sec. 1.6662-5(g), Income Tax Regs.; see also Zirker v.
Commissioner, supra at 978-979.
Petitioner failed to meet his burden of proving that his
reported bases were not gross valuation misstatements. We hold
that petitioner’s underpayments of tax resulting from the
disallowance of the cost basis and depreciation deductions were
attributable to gross valuation misstatements. Unless the total
of the underpayments attributable to gross valuation misstatments
is less than $5,000, or petitioner had reasonable cause for the
underpayments, petitioner will be liable for 40-percent penalties
under section 6662(h) on the underpayments of tax attributable to
the items described in this paragraph.8
D. Section 6662(b)(1): Negligence or Disregard of Rules or
Regulations
Under section 6662(a) and (b)(1), a taxpayer may be liable
for a 20-percent penalty on an underpayment of tax which is
attributable to negligence or disregard of rules or regulations.
“Negligence” includes any failure to make a reasonable attempt to
8
As part of the Rule 155 computations, the parties shall
determine whether the total of petitioner’s underpayments
discussed in this paragraph exceeds $5,000. If the parties
determine that the total does not exceed $5,000, then those
underpayments will instead be subject to the 20-percent penalty
under sec. 6662(b)(1), as discussed infra.
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comply with the provisions of the Internal Revenue Code. Sec.
6662(c). The regulations under section 6662 provide that
negligence is strongly indicated where a taxpayer “fails to make
a reasonable attempt to ascertain the correctness of a deduction,
credit or exclusion on a return which would seem to a reasonable
and prudent person to be ‘too good to be true’ under the
circumstances”. Sec. 1.6662-3(b)(1)(ii), Income Tax Regs.
Negligence is defined as the “‘lack of due care or failure
to do what a reasonable or ordinarily prudent person would do
under the circumstances.’” Neely v. Commissioner, 85 T.C. 934,
947 (1985) (quoting Marcello v. Commissioner, 380 F.2d 499, 506
(5th Cir. 1967), affg. in part and remanding in part on another
ground 43 T.C. 168 (1964)); see Allen v. Commissioner, 925 F.2d
348, 353 (9th Cir. 1991), affg. 92 T.C. 1 (1989). Negligence is
determined by testing a taxpayer’s conduct against that of a
reasonable, prudent person. Zmuda v. Commissioner, 731 F.2d
1417, 1422 (9th Cir. 1984), affg. 79 T.C. 714 (1982). Courts
generally look both to the underlying investment and to the
taxpayer’s position taken on the return in evaluating whether the
taxpayer was negligent. Sacks v. Commissioner, 82 F.3d 918, 920
(9th Cir. 1996), affg. T.C. Memo. 1994-217. When an investment
has such obviously suspect tax claims as to put a reasonable
taxpayer under a duty of inquiry, a good faith investigation of
the underlying viability, financial structure, and economics of
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the investment is required. Roberson v. Commissioner, T.C. Memo.
1996-335 (citing LaVerne v. Commissioner, 94 T.C. 637, 652-653
(1990), affd. without published opinion sub nom. Cowles v.
Commissioner, 949 F.2d 401 (10th Cir. 1991), affd. without
published opinion 956 F.2d 274 (9th Cir. 1992), and Horn v.
Commissioner, 90 T.C. 908, 942 (1988)), affd. without published
opinion 142 F.3d 435 (6th Cir. 1998).
Petitioner testified that he invested in Hoyt’s program as a
means to provide for retirement. However, other than a couple of
weeks spent milking cows, petitioner had no background in farming
or cattle ranching. Before his investment, he had not been a
partner in a partnership. Petitioner was not an expert in cattle
or embryo valuation, nor had he purchased any livestock.
Petitioner relied on Hoyt to determine the number of cattle
he could purchase. He further relied on Hoyt to establish a
purchase price of $478,490 for 73 heifers and $478,490 for 73
embryos. To facilitate this purchase, petitioner signed a
promissory note for $956,980 and testified that he believed he
would be held personally liable for the entire amount. Before
signing the note and completing the transaction, petitioner did
not see the cattle he was purchasing, nor is there any indication
that he attempted to do so.
Despite his lack of experience or expertise with ranching,
partnerships, cattle and embryo valuation, and livestock
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purchases, petitioner put himself at risk for nearly $1 million
without consulting any independent investment advisers or cattle
valuation experts. Petitioner did not even have a clear
understanding of what he was purchasing. He initially thought he
was purchasing 73 head of cattle for $956,980, which was also
indicated in the letter from Cross and the bill of sale. Yet the
sales order indicates that he was purchasing 73 heifers for
$478,490 and 73 embryos for $478,490. There is no indication
that petitioner questioned this discrepancy. He did not examine
the cattle and the embryos he was purchasing. He did not even
keep copies of the promissory note, the security agreement, or
the board agreement. For these reasons, we conclude that
petitioner was negligent in entering into the investment.
The record is replete with facts that should have put
petitioner on notice of the suspect tax claims made on his tax
returns. First, and most obvious, is the timing of petitioner’s
deductions. Petitioner’s first contact with the Hoyt
organization was in February 1995. Petitioner did not begin his
investment until July 28, 1995. Despite this, petitioner claimed
Schedule F deductions on his 1994 return and then used the net
operating loss generated by those deductions to claim refunds for
1991, 1992, and 1993. Petitioner could not provide a rational
explanation of why he began taking Schedule F deductions in 1994
for an investment he entered into in 1995.
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On his self-prepared returns for 1991, 1992, and 1993,
petitioner reported total taxes of $10,662, $9,035, and $21,043,
respectively. On his returns for 1994 and 1995, prepared by
Laguna, petitioner reported zero total tax despite having roughly
the same total income (not including Schedule F items) as in 1991
through 1993. The relative change in petitioner’s total tax was
attributable solely to the Schedule F deductions. Petitioner
realized these significant tax benefits and received refunds from
the net operating loss carrybacks while incurring no upfront
costs.
Before petitioner filed his 1995 return, respondent informed
petitioner that he had been identified as an investor in a tax
shelter and his Hoyt-related deductions would not be allowed.
Despite this warning, petitioner did not seek independent advice
but continued to rely on the assurances of Barnes, a Hoyt
employee. After he received the warning, petitioner still
claimed Schedule F deductions related to his Hoyt investment on
his 1995 return.
Other facts that should have put petitioner on notice of the
suspect tax claims include: (1) The promotional materials
petitioner received from Hoyt included warnings about significant
tax risks; and (2) petitioner testified that he was investing in
a partnership, yet he claimed purported losses as Schedule F
losses instead of partnership losses.
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Despite these red flags, petitioner did not consult a tax
attorney or an accountant outside of the Hoyt organization, nor
did he have his returns reviewed by an independent tax return
preparer. Petitioner claimed the tax benefits from the Schedule
F losses solely on the advice he received from the promoters of
the investment. He relied exclusively on Laguna, a Hoyt entity,
to prepare his returns. In other words, he relied on the same
people who were to receive 75 percent of his tax refunds. Given
the suspect tax claims, petitioner did not meet his duty of
inquiry or make a good faith investigation. Petitioner did not
exercise due care and failed to do what a reasonable or
ordinarily prudent person would do given the facts surrounding
petitioner’s investment. Therefore, we find that respondent has
met his burden of proof and hold that petitioner’s underpayments
of tax for 1994 and 1995 were the result of negligence. Unless
petitioner had reasonable cause, petitioner will be liable for
20-percent penalties under section 6662(b)(1) on his
underpayments of tax to the extent that those underpayments are
not already subject to the 40-percent penalties under section
6662(h).
E. Section 6662(b)(2): Substantial Understatement of Income
Tax
The accuracy-related penalty under section 6662 cannot
exceed 20-percent of the underpayment of tax (or 40 percent if
attributable to gross valuation misstatements). Sec. 1.6662-
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2(c), Income Tax Regs. The penalties cannot be stacked, even
when the taxpayer’s understatement of income is attributable to
more than one of the types of misconduct listed in section
6662(b). Id. Because petitioner’s underpayments of tax were the
result of either gross valuation misstatements or negligence, we
need not consider whether those underpayments were also the
result of substantial understatements of income tax.
F. Alleged Defenses to the Accuracy-Related Penalties
1. Section 6664(c)(1): Reasonable Cause
No penalty is imposed under section 6662 if the taxpayer had
reasonable cause for the underpayment of tax and acted in good
faith. Sec. 6664(c)(1). “The determination of whether a
taxpayer acted with reasonable cause and in good faith is made on
a case-by-case basis, taking into account all pertinent facts and
circumstances.” Sec. 1.6664-4(b)(1), Income Tax Regs. The
extent of the taxpayer’s efforts to ascertain his proper tax
liability is generally the most important factor. Id.
a. Reliance on the Hoyt Organization
Good faith reliance on professional advice concerning tax
laws may be a defense to negligence penalties. United States v.
Boyle, 469 U.S. 241, 250-251 (1985); see also sec. 1.6664-
4(b)(1), Income Tax Regs. However, “Reliance on professional
advice, standing alone, is not an absolute defense to negligence,
but rather a factor to be considered.” Freytag v. Commissioner,
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89 T.C. 849, 888 (1987), affd. 904 F.2d 1011 (5th Cir. 1990),
affd. 501 U.S. 868 (1991). To be considered a defense to
negligence, the taxpayer’s reliance must be reasonable. Id. To
be objectively reasonable, the advice generally must be from
competent and independent parties unburdened with an inherent
conflict of interest, not from the promoters of the investment.
Mortensen v. Commissioner, 440 F.3d 375, 387 (6th Cir. 2006),
affg. T.C. Memo. 2004-279; Van Scoten v. Commissioner, 439 F.3d
1243, 1253 (10th Cir. 2006), affg. T.C. Memo. 2004-275; Goldman
v. Commissioner, 39 F.3d 402, 408 (2d Cir. 1994), affg. T.C.
Memo. 1993-480; LaVerne v. Commissioner, 94 T.C. at 652; Rybak v.
Commissioner, 91 T.C. 524, 565 (1988); Hansen v. Commissioner,
T.C. Memo. 2004-269.
Petitioner argues that he reasonably and in good faith
relied on Hoyt as an enrolled agent, on Laguna to prepare his
returns, and on “Hoyt’s outside advisors.” Petitioner places
strong emphasis on Hoyt’s status as an enrolled agent. However,
any significance that such status may have is clearly outweighed
by the fact that Hoyt was the creator and promoter of the
investment scheme. Petitioner’s reliance on Hoyt and his
organization, including Laguna, was not objectively reasonable
because Hoyt and his organization created and promoted the
investment, they completed petitioner’s tax returns, and they
received 75 percent of the refunds petitioner received.
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Petitioner argues:
Hoyt made certain that Petitioner was aware of outside
counsel by referencing outside counsel in newsletters
and other documents * * *. Hoyt made certain that
Petitioner (and other Hoyt investors) were aware that
Mr. MacDonald and Mr. Dismukes were the attorneys who
had won Bales * * *. In light of Petitioner’s lack of
sophistication, his reliance on the tax professionals
that won the Bales case is even more understandable.
Therefore, the negligence penalty is also inappropriate
due to Petitioner[’s] reasonable reliance on the Hoyt
outside advisors.
Whether or not petitioner was aware that Hoyt had “outside
advisors”, there is no evidence that petitioner sought or
received advice directly from these “outside advisors”. The
advisors were hired by Hoyt, and any advice that petitioner may
have received from them was filtered through Hoyt.
Petitioner testified that he did not seek advice from tax
attorneys or accountants outside of the Hoyt organization.
Petitioner’s reliance on Hoyt, Laguna, and persons hired by Hoyt,
coupled with his failure to seek independent advice, was
unreasonable.
b. Honest Misunderstanding of Fact
Reasonable cause and good faith under section 6664(c) may be
indicated where there is “an honest misunderstanding of fact or
law that is reasonable in light of all the facts and
circumstances, including the experience, knowledge and education
of the taxpayer.” Sec. 1.6664-4(b)(1), Income Tax Regs.
However, “reasonable cause and good faith is not necessarily
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indicated by reliance on facts that, unknown to the taxpayer, are
incorrect.” Id.
Petitioner argues that he had reasonable cause for his
underpayments of tax because he was defrauded by Hoyt and
therefore made an “honest mistake of fact”. He asserts that he
had insufficient information concerning his investment, and that
all “available independent evidence * * * supported Hoyt’s
assertions.” However, petitioner testified that he relied
exclusively on the assertions made by Hoyt, members of the Hoyt
organization, and other Hoyt investors. There is no indication
that petitioner attempted to verify any of the information he was
given. He did not seek an outside opinion from an investment
advisor, tax attorney, or accountant. Petitioner’s argument that
he had insufficient information, while at the same time admitting
he made no attempt to get additional information, is not
persuasive. If petitioner misunderstood the facts surrounding
his investment, it was not an honest misunderstanding but a
negligent one.
c. Reliance on the Bales Opinion
Petitioner argues he had reasonable cause for his
underpayments of tax because he relied on this Court’s opinion in
Bales v. Commissioner, T.C. Memo. 1989-568.9 Bales involved
9
Petitioner also argues that the opinion in Bales v.
Commissioner, T.C. Memo. 1989-568, provided substantial authority
(continued...)
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deficiencies determined against various investors in several Hoyt
partnerships. This Court found in favor of the investors on
several issues, stating that “the transaction in issue should be
respected for Federal income tax purposes.” Bales involved
different investors and different taxable years from the present
case. It also involved different underlying deductions; namely,
partnership deductions as opposed to Schedule F deductions.
Despite the differences between Bales and the present case,
petitioner argues that he relied on the Bales opinion in claiming
his Schedule F deductions. However, petitioner’s testimony on
direct examination is illuminating:
[Bales] was a court case. There was a--and I’m not
familiar with these type of documents, but in the left-
hand margin it had all these numbers in it, and it was
from the Supreme Court in California, Judge Divens, I
believe, was the name. I actually didn’t go through
the entire transcript. It was hard for me to follow
there, since I’m not a lawyer. But I read the abstract
that Hoyt provided with that that they sent out in a
newsletter where they--and they had highlighted that
the judge said that it was a legitimate business.
First, Bales was not decided by a Judge Divens of the Supreme
Court of California, but was decided by Judge Scott of the United
9
(...continued)
for the positions taken on his return, thus relieving him from
liability from any penalty under sec. 6662(b)(2) and (d). See
sec. 6662(d)(2)(B)(i). Because we find that petitioner’s
underpayments were the result of negligence and therefore do not
address whether the underpayments were also attributable to
substantial understatements of tax, we need not consider whether
Bales is substantial authority for purposes of sec.
6662(d)(2)(B)(i).
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States Tax Court, adopting the opinion of Special Trial Judge
Dinan. Second, and more importantly, petitioner admits that he
did not read the entire case, nor did he understand it. Instead,
he relied on the interpretation provided by Hoyt. We have
already found that petitioner’s reliance on Hoyt and his
organization was unreasonable. Likewise, accepting Hoyt’s
assurances that Bales was a wholesale affirmation of the
legitimacy of his organization was also unreasonable.
Petitioner also argues that, because this Court was unable
to uncover the fraud or deception by Hoyt in Bales, petitioner,
as an individual taxpayer, an “unsophisticated investor”, and a
person of “modest income”, was in no position to evaluate the
legitimacy of his investment or the tax benefits claimed with
respect thereto. As previously noted by this Court:
This argument employs the Bales case as a red herring:
The Bales case involved different investors, different
partnerships, different taxable years, and different
issues. Furthermore, adopting petitioners’ position
would imply that taxpayers should have been given carte
blanche to invest in partnerships promoted by Mr. Hoyt,
merely because Mr. Hoyt had previously engaged in
activities which withstood one type of challenge by the
Commissioner, no matter how illegitimate the
partnerships had become or how unreasonable the
taxpayers were in making investments therein and
claiming the tax benefits that Mr. Hoyt promised would
ensue.
Hansen v. Commissioner, T.C. Memo. 2004-269; see also Mortensen
v. Commissioner, 440 F.3d at 390-391; Van Scoten v. Commissioner,
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439 F.3d at 1254-1256; Sanders v. Commissioner, T.C. Memo. 2005-
163. Petitioner’s reliance on Bales was unreasonable.
On the basis of the above, we conclude that petitioner did
not have reasonable cause for his underpayments of tax.
2. Judicial Estoppel
In general terms, petitioner asks the Court to “apply the
doctrine of judicial estoppel to facts Respondent has asserted in
previous litigation.” Petitioner does not elaborate.
Presumably, petitioner is arguing that because the U.S.
Government successfully prosecuted Hoyt for fraud, respondent is
somehow judicially estopped from asserting an accuracy-related
penalty against petitioner.
The doctrine of judicial estoppel prevents a party from
asserting a claim in a legal proceeding that is inconsistent with
a position successfully taken by that party in a previous
proceeding. New Hampshire v. Maine, 532 U.S. 742, 749 (2001).
Among the requirements for judicial estoppel to be invoked, a
party’s current litigating position must be “clearly
inconsistent” with a prior litigating position. Id. at 750-751.
Respondent’s position in asserting an accuracy-related
penalty against petitioner is in no manner inconsistent with the
position taken by the United States in the criminal conviction of
Hoyt. See, e.g., Goldman v. Commissioner, 39 F.3d at 408
(taxpayer-appellants’ argument that an investment partnership
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“constituted a fraud on the IRS, as found by a civil jury * * *
and by the tax court * * * cannot justify appellants’ own failure
to exercise reasonable care in claiming the losses derived from
their investment”); see also Mortensen v. Commissioner, 440 F.3d
375 (6th Cir. 2006); Van Scoten v. Commissioner, 439 F.3d 1243
(10th Cir. 2006); Hansen v. Commissioner, supra. Other than his
vague assertions, petitioner has failed to identify any clear
inconsistencies between respondent’s current position and his
position in any previous litigation. We conclude that there are
no grounds for judicial estoppel in the present case.
3. Fairness Considerations
Petitioner argues that the application of accuracy-related
penalties would be unfair or unjust because such an application
does not comport with the underlying purpose of the penalties.
Petitioner states:
Here, the problem was not Petitioner’s disregard of the
tax laws, but was Jay Hoyt’s fraud and deception.
Petitioner did not engage in noncompliant behavior,
instead, he was the victim of a complex fraud that it
took Respondent years to unravel completely.
Petitioner made a good faith effort to comply with
the tax laws and punishing him by imposing penalties
does not encourage voluntary compliance, but instead
has the opposite effect of the appearance of unfairness
by punishing the victim. Indeed, penalties are
improper for any investor in the Hoyt partnerships on a
policy basis alone. [Fn. ref. omitted.]
We are mindful of the fact that Hoyt was convicted for his
fraudulent actions. We also recognize that petitioner remitted
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the bulk of his refunds to the Hoyt organization. However, this
does not alter our conclusion that petitioner was negligent with
respect to entering into the investment, and he was negligent
with respect to the positions taken on his returns. Despite
Hoyt’s actions, the positions taken on the 1994 and 1995 returns,
signed by petitioner, were ultimately the positions of
petitioner.
G. Conclusion
Petitioner’s underpayments of tax for 1994 and 1995 were
the result of petitioner’s negligence, and portions of those
underpayments were attributable to gross valuation misstatements.
Petitioner did not have reasonable cause for the underpayments.
Likewise, petitioner’s arguments regarding judicial estoppel and
fairness do not absolve him from liability for the accuracy-
related penalties. Therefore, we hold that petitioner is liable
for 40-percent accuracy-related penalties under section 6662(h)
on his underpayments attributable to gross valuation
misstatments, so long as the total of those underpayments exceeds
$5,000. On his underpayments not subject to penalties under
section 6662(h), we hold that petitioner is liable for 20-percent
accuracy-related penalties under section 6662(a) and (b)(1).
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To reflect the foregoing and the concessions of the parties,
Decision will be entered
under Rule 155.