UNITED STATES TAX COURT

47

REC0EED

SENICE

CAL

T. JUDGE

T.C. Memo. 2004-275

UNITED STATES TAX COURT

RONALD F. AND CYNTHIA G. VAN SCOTEN, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No.

24946-96.

Filed December 6,

2004.

Wendy S. Pearson, Terri A. Merriam, and Jennifer A. Gellner,

for petitioners.

Nhi T. Luu-Sanders and Alan E. Staines, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

GOLDBERG, Special Trial Judge:

Respondent determined that

petitioners are liable for a section 6662(a) accuracy-related

penalty of $2,872 for the taxable year 1991.

Unless otherwise

indicated,.section references are to the Internal Revenue Code in

SERVED DEC

6 2004

- 2 effect for the year in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure.

The sole issue before this Court is whether petitioners are

liable for the section 6662(a) accuracy-related penalty for

negligence or disregard of rules or regulations in the year in

issue.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

The first, second, third, and fourth stipulations of facts and

the attached exhibits are incorporated herein by this reference.

Petitioners resided in Sandy, Utah, on the date the petition was

filed in this case.

I.

Walter J. Hoyt III and- the Hoyt Partnerships

The accuracy-related penalty at issue in this case arises

from adjustments of partnership items on petitioners' 1991

Federal income tax return.

The adjustments are the result of

petitioners' involvement in a partnership organized and promoted

by Walter J. Hoyt III

(Mr. Hoyt).

Mr. Hoyt's father was a prominent breeder of Shorthorn

cattle, one of the threé major breeds of cattle in the United

States.

In order to expand his business and attract investors,

Mr. Hoyt's father had started organizing and promoting cattle

breeding partnerships by the late 1960s.

Before and after his

father's death in early 1972, Mr. Hoyt and other members of the

- 3 Hoyt family were extensively involved in organizing and operating

numerous cattle breeding partnerships.

From about 1971 through

1998, Mr. Hoyt organized, promoted to thousands of investors, and

operated as a general partner more than 100 cattle breeding

partnerships.

Mr. Hoyt also organized and operated sheep

breeding partnerships in essentially the same fashion as the

cattle breeding partnerships

(collectively the investor

partnerships or Hoyt partnerships).

Each of the investor

partnerships was marketed and promoted in the same manner.

Beginning in 1983, and·until removed by this Court due to a

criminal conv.iction, Mr. Hoyt was the tax matters partner of each

of the investor partnerships that are subject to the provisions

of the T.ax Equity & Fiscal Responsibility Act of 1982, Pub. L.

97-248,

96 Stat. 324.

As the general partner managing each

partnership, Mr. Hoyt was responsible for and directed the

preparation of the tax returns of each partnership, and he

042

typically signed and filed each return.

Mr. Hoyt also operated

tax return preparation companies, variously called "Tax Office of

W.J. Hoyt Sons",

"Agri-Tax", and "Laguna Tax Service", that

prepared most of the investors' individual tax returns during the

years of their investments.

Petitioners' 1991 return was

prepared in this manner and was signed by Mr. Hoyt.

From

approximately 1980 through 1997, Mr. Hoyt was a licensed enrolled

agent, and as such he represented many of the investor-partners

- 4 before the Internal Revenue Service (IRS) until he was

disenrolled as an enrolled agent in 1998.

Beginning in February 1993, respondent generally froze and

stopped issuing income tax refunds to partners in the investor

partnerships.

The IRS issued prefiling notices to the investor-

partners advising them that, starting with the 1992 taxable year,

the IRS would disallow the tax benefits that the partners claimed

on their individual returns from the investor partnerships, and

the IRS would not issue any tax refunds these partners might

claim attributable to such partnership tax benefits.

Also beginning in 1993, an increasing number of investorpartners were becoming disgruntled with Mr. Hoyt and the Hoyt

organization.

Many partners stopped making their partnership

payments and withdrew from their partnerships, due in part to

respondent's tax enforcement.

Mr. Hoyt urged the partners to

support and remain loyal to the organization in challenging the

IRS's actions.

The Hoyt organization warned that partners who

stopped making their partnership payments and withdrew from their

partnerships would be reported to the IRS as having substantial

debt relief income, and that they would have to deal with the IRS

on their own.

On June 5,

1997, a bankruptcy court entered an order for

relief, in effect finding that W.J. Hoyt Sons Management Company

and W.J. Hoyt Sons MLP were both bankrupt.

In these bankruptcy

- 5 cases, the U.S. trustee moved in 1997 to have the bankruptcy

court substantively consolidate all assets and liabilities of

almost all Hoyt organization entities and all of the investor

partnerships.

On November 13, 1998, the bankruptcy court entered

its Judgment for Substantive Consolidation, consolidating all the

above-mentioned entities for bankruptcy purposes.

The trustee

then sold off what livestock the Hoyt organization owned or

managed on behalf of the investor partnerships.

Mr. Hoyt and others were indicted for certain Federal crimes

and a trial was conducted in the U.S. District Court for the

District of Oregon.

The District Court described Mr. Hoyt's

actions as "the most egregious white collar crime committed in

the history of the State of Oregon."

Mr. Hoyt was found guilty

on all counts, and as part of his sentence in the criminal case

he was required to pay restitution in the amount of $102 million.

This amount represented the total amount that the United States

042

determined, using Hoyt organization records, was paid to the Hoyt

organization from 1982 through 1998 by investor-partners in

various investor partnerships.

II.

Petitioners and Their Investment

Petitioner husband (Mr. Van Scoten) has an associate's

degree, and petitioner wife (Ms. Van Scoten) completed 1 year of

a college education.

During the year in issue, Mr. Van Scoten

- 6 worked as an equipment salesman, and Ms. Van Scoten was a

respiratory therapist.¹

Mr. Van Scoten's father, Edward Van Scoten, has a bachelor's

degree.

He served in the Air Force for approximately 21 years,

after which time he taught at a community college and worked for

an electronics corporation.

He also had limited experience with

dairy farms--he spent his childhood living on or near dairy

farms, and as a teenager and for 1 year, amidst his Air Force

career, he worked on a dairy farm.

Edward Van Scoten invested in a.Hoyt partnership in December

1983.

He first learned about the Hoyt organization from his

nephew, who had already invested in a Hoyt partnership.

In

making his own investment, Edward Van Scoten relied upon

information obtained from his nephew and from the Hoyt

organization.

He did not seek outside advice, such as advice

from an attorney or accountant.

After making his investment,

Edward Van Scoten spent one summer working on a Hoyt ranch, where

he drove a truck hauling hay bales.

He also attended monthly

Hoyt partner meetings over a period of several years starting in

the early 1990s.

Petitioners first learned of the Hoyt partnership

investments from Mr. Van Scoten's father in 1988.

Mr. Van Scoten

knew that his father "had been in it for quite a number of years,

10n the 1990 and 1991 Federal income tax returns signed by

Ms. Van Scoten, both state that she was a receptionist.

didn't appear to have a problem with or any issues about it, so

my wife and I had talked about it and about two years later we

decided that we would invest."

During the time between 1988 and

petitioners' investment in early 1991, Mr. Van Scoten spoke to

his father about the Hoyt partnerships on a regular basis.

His

father told him that

the partnership involved cattle; in particular, what he

called "Borrow-A-Bull." That entailed investing money into

the partnership, buying what I presumed was a percentage of

a group of cattle, and from there, after a number of years

or after the initial investment, then we would receive·a

return on our investment.

Mr. Van Scoten's father also told him t.hat he had seen cattle and

"numerous trucks with the Walter J. Hoyt logo and insignia" on

them.

Mr. Van Scoten trusted his father's advice to invest in a

Hoyt partnership because his father had attended partnership

meetings and had seen Hoyt cattle and trucks.2

When giving his

son advice concerning the investment, Edward Van .Scoten relied

partially on the information he had received from the Hoyt

organization, and also answered "yes" to his son's inquiry "does

this makes sense".

Petitioners first invested in a Hoyt partnership in January

1991.3

At the time that petitioners invested in the partnership,

2While the record is clear that Ms. Van Scoten was an

investor in the Hoyt partnership, because she did not testify at

trial there is no evidence in the record with respect to her

understanding of the investment or her decision to invest.

3Although Mr. Van Scoten testified at trial that "I believe

(continued...)

- 8 Mr. Van Scoten had no investment experience.

Although Mr. Van

Scoten had lived on a family farm for approximately 2 years,

neither petitioner had experience in cattle ranching.

Because he

trusted his father's advice, Mr. Van Scoten did not personally

investigate the partnership.

While Mr. Van Scoten relied on his

father's advice concerning the Hoyt investment, he did not review

his father's partnership documents, and he was unaware in which

partnership his father had invested.

At the time that petitioners initially made their

investment, Mr. Van Scoten believed that the investment would

produce a profit and provide retirement income.

Mr. Van Scoten

understood that the investment generally required petitioners to

remit 75 percent of the Federal income tax refunds that they

received and that petitioners were to retain the remaining 25

percent.

Before investing in the Hoyt partnerships, petitioners

did not consult with anyone other than members of the Hoyt

organization and investors in Hoyt partnerships--for example,

they did not consult with cattle ranchers, independent investment

consultants, or independent tax advisers--concerning either the

partnerships or the tax claims made by the partnerships.

Prior to investing, petitioners received promotional

materials prepared by the Hoyt organization.

Petitioners relied

3(...continued)

the first year we invested" was 1990, the documentary evidence

shows that the investment was in fact made in January 1991.

9 _

on these promotional materials which, in general, purported to

provide rationales for why the partnerships were good investments

and why the purported tax savings were legitimate.

One document

on which petitioners relied, entitled "Hoyt and Sons -- The 1,000

lb. Tax Shelter", provided information concerning the Hoyt

investment partnerships and how they purportedly would provide

profits to investors over time.

The document emphasized that the

primary return on an investment in a Hoyt partnership would be

from tax savings, but that the U.S. Congress had enacted the tax

laws to encourage investment in partnerships such as those

promoted by Mr. Hoyt.

The document stated that an "investment in

cattle [is arranged] so the cash required to keep it going is

only about seventy five percent" of an investor's tax savings,

while the other twenty-five percent of the tax savings is "a

thirty percent return on investment."

This arrangement

purportedly provided protection to investors:

"If the cows do

die and the sky falls in, you have still made a return on the

investment, and no matter what happens you are always better off

than if you paid taxes."

After an explanation of the tax

benefits, the document asked:

"Now, can you feel good about not

paying taxes, and feeling like you were not, somehow, abusing the

system, or doing something illegal?"

A section of the "1,000 lb. Tax Shelter" document that was

devoted to a discussion of audits by the IRS,

stated that the

partnerships would be "branded an 'abuse' by the Internal Revenue

- 10 Service and will be subject to automatic" and "constant audit".

Statements in the document compared the IRS to children, stating

that IRS employees did not have the "proper experience and

training" and "working knowledge of concepts required by the

Internal Revenue Code" to evaluate the partnerships.

In a

section of the document titled "Tax Aspects", the following

"warning" was given:

Out here, tax accountants don't read brands, and our cowboys

don't read tax law.

If you don't have a tax man who knows

you well enough to give you specific personal advice as to

whether or not you belong in the cattle business, stay out.

The cattle business today cannot be separated from tax law

any more than cattle can be separated from grass and water.

Don't have anything to do with any aspect of the cattle

business without thorough tax advice, and don't waste much

time trying to learn tax law from an Offering Circular.

Despite this warning, the document spent numerous pages

explaining the tax benefits of investing in a Hoyt partnership,

and explaining why investors should trust only Mr. Hoyt's

organization to prepare their individual tax returns:

It is the recommendation of the General Partner, as outlined

in the private placement offering circular, that a

prospective Partner seek independent advice and counsel

concerning this investment. * * * The Limited Partners

should then authorize the Tax Office of W.J. Hoyt Sons to

prepare their personal returns. * * * Then you have an

affiliate of the Partnership preparing all personal and

Partnership returns and controlling all audit activity with

the Internal Revenue Service. * * * Then, all Partners are

able to benefit from the concept of "Circle the Wagons," and

no individual Partner can be isolated and have his tax

losses disallowed because of the incompetence or lack of

knowledge of a tax preparer who is not familiar with the

law, regulations, format, procedures, and operations

concerning the Partnership that are required to protect the

Limited Partners from Internal Revenue audits. * * * If a

Partner needs more or less Partnership loss any year, it i.s

- 11 arranged quickly within the office, without the Partner

having to pay a higher fee while an outside preparer spends

more time to make the arrangements.

Finally, the document warned that there remained a chance that "A

change in tax law 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 back the tax savings, with penalties and

interest."

Prior to petitioners' investment in the partnership, Mr. Van

Scoten also received from the Hoyt organization a copy of this

Court's opinion in Bales v. Commissioner, T.C. Memo. 1989-568.

Mr. Hoyt touted the Bales opinion as proof that the Hoyt

partnerships were legal, and that the IRS was incorrect in

challenging their tax claims.

Mr. Van Scoten believed that the

Bales opinion meant "basically, that a partnership either similar

to ours or like it was--it had gone to court and the Bales had

won the case.

As far as the details about it, I don't know."

On January 7, 1991, petitioners signed a document comprised

of four sections in order to invest in the Hoyt partnership known

as Durham Shorthorn Breed Syndicate 1987-C (DSBS 87-C).

The

first section was titled "Subscription Agreement -- Durham

Shorthorn Breed Syndicate 1987-C J.V. -- Series 'A' Units".

section expressed petitioners'

This

intent to make a capital

contribution to and become a limited partner of DSBS 87-C with

respect to certain "Series 'A' Units".

Included in this section

was a "Power of Attorney" form, which provided in relevant part:

- 12 The UNDERSIGNED hereby constitutes and appoints Walter

J. Hoyt III his/her true and lawful attorney with power and

authority to act in the UNDERSIGNEDS' behalf in the

execution, acknowledging, and filing of the documents as

follows:

1.

The Partnership Certificates for filing, and

2. Any document which may be required to effect the

restructuring, amending, or continuation of the Partnership,

the admission of any substituted or added Partner, or the

dissolution and termination of the Partnership, provided

such restructuring, continuation, admission or dissolution

and termination are in accordance with the terms of the

Partnership Agreement, and

3. Any and all documents required to be executed by a

substituted, substituting or added Partner, to effectuate

the transfer of a Partner's interest in the Partnership, and

4. Any other instrument, application, certificate, or

affidavit which may be required to be filed by the

Partnership under the laws of any State or any Federal, or

local agency or authority, and

5. Any promissory notes, bills-of-sale or other

instruments required for the conduct of the Partnership

business, including an assumption of primary liability form

attached to promissory notes for which the UNDERSIGNED

becomes personally liable for operating deficits of the

Partnership up to a maximum of Five Thousand Dollars

($5,000.00) per SERIES "A" UNIT if needed to meet the

business goals of the partnership.

The second section of the document was a "Partnership Agreement",

purportedly affirming certain "oral Partnership Agreements that

were made on or about" January 7,

1991.

The third section was

titled "Subscription Agreement -- Durham Shorthorn Breed

Syndicate 1987-C J.V. -- Series

'B' Units", and was similar to

the first section, without a power of attorney form.

The fourth

section was titled "Subscription Agreement -- Durham Shorthorn

Breed Syndicate 1987-C J.V. -- Series 'C' Units".

This section

W

- 13 was similar to the first section, and it included a "Debt

Assumption" provision "to memorialize, affirm and set out the

oral Debt Assumption Agreement" along with another power of

attorney form with similar provisions as those detailed above.

Paragraph 5 of the power of attorney form, which differed from

the prior form, provided Mr. Hoyt with the authority to execute:

5. Any promissory notes, bills-of-sale or other

instruments required for the conduct of the Partnership

business, including a certificate of assumption of primary

liability form attached to promissory notes and held by the

lender for which the UNDERSIGNED becomes personally liable

directly to the lender for recourse debt of the Partnership

in order to pay his initial capital contribution to the

partnership.

On July 31, 1991, Mr. Van Scoten signed a document titled

"Subscription Agreement and Signature Page for Limited Partners".

This document contained provisions similar to those in the prior

document, and it included another power of attorney form.

The

document purported to evidence a financial institution's purchase

042

of four "units" of the partnership Hoyt & Sons Ranch Properties,

Ltd., at a cost of $2,000, to be held in trust for the benefit of

Mr. Van Scoten.

When Mr. Van Scoten signed the various

partnership documents and power of attorney forms, he believed

that petitioners would be required to repay the promissory notes

signed on their behalf by Mr. Hoyt.

Petitioners made substantial cash payments to the Hoyt

organization during the years 1991 through 1997.

In a summary of

such payments prepared by petitioners, they estimate that the

- 14 -

total amount of these payments exceeds $40,000.

These payments

included the remittance of their tax refunds, the payment of

quarterly and monthly installments on their promissory notes,

special "assessments" imposed by the partnership, and

contributions to purported individual retirement account plans

maintained by the Hoyt organization.

Petitioners continued

contributing to the partnership even after they stopped receiving

refunds from respondent.

During and after the year in issue,

petitioners received numerous documents purporting to show both

the legitimacy of the Hoyt partnerships and the legality of the

tax claims being made by the Hoyt organization.

The Hoyt

organization also portrayed employees of the IRS as incompetent

and claimed that they were engaging in unjust harassment of Hoyt

investors.

Petitioners trusted these documents and believed and

relied upon what the Hoyt organization told them.

III.

Petitioners' Federal Tax Claims

On June 10, 1991, petitioners filed a joint Federal income

tax return for 1990, on which they reported the following:

Wage income

Interest income

Pension and annuity income

$46,162

29

8,422

Loss from DSBS 87-C

(148,390)

IRA contribution

Adjusted gross income

Tax liability

Overpayment

(2,000)

(95,777)

842

3,771

Upon filing their 1990 return, petitioners also filed a Form

1045, Application for Tentative Refund.

On this form,

- 15 petitioners claimed a net operating loss (NOL) carryback from

1990 in the amount of $102,228.

Petitioners reported the

following after application of the carryback to the respective

taxable years:

AGI on return

Tax liability on return

Corrected tax liability

Overpayment

1987

1988

1989

$49,726

5,949

-05,949

$38,967

3,529

-03,529

$40,889

3,549

-03,549

The 1990 return and the Form 1045 were prepared by individuals

042

affiliated with the Hoyt organization.

The refund and tentative

refunds requested by petitioners with respect to the 1990 return

and the carryback years totaled $16,798.

Petitioners remitted

two payments to the Hoyt organization during 1991 in the form of

two cashier's checks dated May 8,

1991, and August 20,

1991, in

the respective amounts of $7,000 and $9,750.

In January 1992, prior to the time petitioners signed their

1991 return, respondent mailed Hoyt investors, including

petitioners, a letter regarding the application of section 469

(relating to passive activity loss limitations).

That same

month, Mr. Hoyt mailed a letter to investors, including

petitioners,

setting forth arguments that Hoyt investors

materially participated in their investments within the meaning

of section 469.

In this letter, Mr. Hoyt stated that

respondent's assertions in the preceding letter were incorrect,

and that the investors should do what was necessary to

- 16 participate in their investment at least 100 or 500 hours per

year, depending upon the circumstances, in order to meet the

section 469 requirements.

Mr. Hoyt stated that the time

investors spent in recruiting new investors, as well as "reading

and thinking about these letters", would count toward the

material participation hourly requirements.

Finally, in this

letter Mr. Hoyt emphasized that "The position of your partnership

is that it is not a tax shelter", because tax shelters "are never

recognized for Federal income tax purposes."

By letter dated

February 11, 1992, respondent mailed petitioners a notice

stating:

In Mr. Hoyt's letter misleading and/or inaccurate

premises were made which may directly affect you and your

decision-making process in filing your 1991 individual tax

return.

First, a "tax shelter" is not necessarily synonymous

with a "sham" investment.

Low income housing credits, your

personal residence, and real estate rentals are examples of

tax shelters.

It is an oversimplification to state tax

shelters are never recognized for Federal income tax

purposes.

The letter stated that I failed to include number seven

of the regulations which addresses the facts and

circumstances test.

Enclosed is the exact wording of this

test, Regulation 1.469-ST(a)(7), and example #8 which refers

to this regulation. Also enclosed is paragraph (b) that is

refe.rred to in paragraph (a)(7).

Section 1402 noted in

paragraph (b) defines income subject to self-employment tax.

In the past, and currently, Mr. Hoyt has used Revenue

Rulings 56-496, 57-58, and 64-32 as authorities for

investors having met the material participation requirement.

These rulings and the court cases he has cited are prior to

the enactment of section 469 and all refer to section 1402.

Please note in (b)(2) that meeting the material

participation requirement of Section 1402 is specifically

excluded from being taken into account for having met the

material participation requirement of section 469 in using

the facts and circumstances test of (a)(7).

- 17 Whether a person meets the material participation

requirement of section 469 is a factual determination.

The

Reg. 1.469-5T(f)(2)(ii) defines investors' activities that

are not considered in meeting the hourly requirement.

Simply signing a statement or making an election are not a

means in meeting the requirement. Although Section 469 may

not have existed at the time of your initial investment, it

is law that investors have to address in claiming investment

losses today. Contrary to Mr. Hoyt's statement, time spent

reading and thinking about this issue should not be

considered as material participation hours for 1992.

If this letter is somewhat confusing or you are

questioning the accuracy of this letter, I recommend you

consider having an independent accountant or attorney review

this matter with you.

In addition to the above correspondence, petitioners received a

letter dated February 3,

1992 that informed them that respondent

was beginning an examination of DSBS 87-C with respect to its

taxable year ending in 1990.

When petitioners received any

correspondence from respondent, petitioners would mail or fax

copies to the Hoyt organization, but they would take no further

action, and they sought no advice concerning the information that

they were receiving from respondent.

Petitioners filed a joint Federal income tax return for

taxable.year 1991, the year in issue, reporting the following:

Wage income

Interest income

State tax refunds

Loss from DSBS 87-C

Farm income

IRA contribution

Self-employment tax deduction

Adjusted gross income

Tax liability

Overpayment

$51,362

71

1,433

(45,510)

22,199

(2,000)

(240)

27,315

1,798

2,471

- 18 The Schedule K-1, Partner's Share of Income, Credits, Deductions,

Etc., attached to petitioners' return indicates that the DSBS 87C loss comprised of a "nonpassive activity deduction" of $18,810,

and a "special allocation deduction" of $26,700.

The Schedule K-

1 also lists farm income of $22,199 as nonemployee compensation

earned by petitioners, and the schedule lists this amount as a

contribution to the partnership.

A statement attached to the

return indicates that petitioners "contributed $2,000.00 in cash

to the partnership as part of his

[sic] total cash contribution"

and that petitioners "should claim $2,000.00 as an I.R.A.

contribution for 1991" if they qualify.

Another statement,

separately signed by petitioners, indicates that petitioners

materially participated in partnership-related activities--on the

blank line following "The numbers [sic] of hours we spent working

in our business activity in 1991 was", petitioners filled in "all

that was needed to be done."

The 1991 return was prepared by one

of Mr. Hoyt's tax preparation services and was signed by Mr.

Hoyt.

Mr. Hoyt signed the return on April 10, 1992, and

petitioners signed the return on April 14, 1992.

Petitioners remitted two payments to the Hoyt organization

during 1992, one in the form of a cashier's check dated June 15,

1992,

in the amount of $3,000, and a second payment in December

1992 in the amount of $1,250.

Upon signing the returns and forms prepared by the Hoyt

organization, Mr. Van Scoten did not know how the Hoyt-related

- 19 items were derived; he knew only that Mr. Hoyt or a member of his

organization had entered the items on the returns, and he assumed

the items were therefore correct.

Mr. Van Scoten did not

question any of the amounts shown on the return, and petitioners

did not have the returns reviewed by an accountant or anyone else

outside the Hoyt organization prior to signing them.

Respondent issued a Notice of Final Partnership

Administrative Adjustment (FPAA) to petitioners with respect to

042

DSBS 87-C that reflected the disallowance of various deductions

claimed on the partnership return for its taxable year ending in

1991.

Because a timely petition to this Court was not filed in

response to the FPAA issued for DSBS 87-C, respondent made a

computational adjustment assessment against petitioners with

respect to the FPAA.

The computational adjustments changed

petitioners' claimed DSBS 87-C loss of $45,510 to income of

$4,998, disallowed the partnership-related IRA contribution

deduction of $2,000, and made computational adjustments to

petitioners'

itemized deductions and self-employment tax

deduction based on the above two changes.4

These changes

increased petitioners' tax liability to $16,479, an increase of

$14,681 above petitioners' reported tax liability of $1,798.

In

the notice of deficiency underlying this case, respondent

4The amount of the farm income reported by petitioners on

their 1991 return was not changed by respondent pursuant to the

computational adjustment assessment, presumably because the farm

income was not a partnership item.

- 20 determined that petitioners are liable for the section 6662(a)

accuracy-related penalty for negligence or disregard of rules or

regulations with respect to $14,359 of the underpayment resulting

from the DSBS 87-C computational adjustment.

OPINION

I.

Evidentiary Issues

As a preliminary matter, we address evidentiary issues

raised by the parties in the stipulations of facts.

The parties

reserved objections to a number of the exhibits and paragraphs

contained in the stipulations, all on the grounds of relevancy.

Federal Rule of Evidence 4025 provides the general rule that all

relevant evidence is admissible, while evidence which is not

relevant is not admissible.

Federal Rule of Evidence 401

provides that "'Relevant evidence' means evidence having any

tendency to make the existence of any fact that is of consequence

to the determination of the action more probable or less probable

than it would be without the evidence."

While certain of the

exhibits and stipulated facts are given little to no weight in

our finding of ultimate facts in this case, we hold that the

exhibits and stipulated facts meet the threshold definition of

"relevant evidence" under Federal Rule of Evidence 401, and that

the exhibits and stipulated facts therefore are admissible under

Federal Rule of Evidence 402.

Accordingly, to the extent that

SThe Federal Rules of Evidence are applicable in this Court

pursuant to sec. 7453 and Rule 143(a).

- 21 the Court did not overrule the relevancy objections at trial, we

do so here.

II.

The Section 6662(a) Accuracy-Related Penalty

Section 6662(a) imposes an addition to tax of 20 percent on

the portion of an underpayment attributable to any one of various

factors, one of which is "negligence or disregard of rules or

regulations".

Sec. 6662(a) and (b).

"Negligence" includes any

failure to make a reasonable attempt to comply with the

provisions of the Internal Revenue Code, and "disregard of rules

or regulations" includes any careless, reckless, or intentional

disregard.

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.'"

947

(1985)

Neely v. Commissioner, 85 T.C. 934,

(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.

1266, 1271

168

(1964)); see Anderson v. Commissioner,

62 F.3d

(10th Cir. 1995), affg. T.C. Memo. 1993-607.

Negligence is determined by testing a taxpayer's conduct against

- 22 that of a reasonable, prudent person.

supra at 1272-1273.

Anderson v. Commissioner,

Courts generally look both to the underlying

investment and to the taxpayer's position taken on the return in

evaluating whether a taxpayer was negligent.

Commissioner, 243 F.3d 1212, 1221

Id.; Keeler v.

(10th Cir. 2001), affg. Leema

Enters., Inc. v. Commissioner, T.C. Memo. 1999-18; 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 the investment is required.

Roberson

v. Commissioner, T.C. Memo. 1996-335, affd. without published

opinion 142 F.3d 435 (6th Cir. 1998)

Commissioner,

94 T.C. 637, 652-653

(citing LaVerne v.

(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); Horn v. Commissioner, 90 T.C. 908, 942

(1988)).

The Commissioner's decision to impose the negligence penalty

is presumptively correct.6

Commissioner, supra at 1271.

Rule 142(a); Anderson v.

A taxpayer has the burden of

proving that respondent's determination is erroneous and that he

6While sec. 7491 shifts the burden of production and/or

burden of proof to the Commissioner in certain circumstances,

this section is not applicable in this case because respondent's

examination of petitioners' return 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.

- 23 did what a reasonably prudent person would have done under the

circumstances.

III.

Bixby v. Commissioner, 58 T.C. 757, 791

(1972).

Application of the Negligence Standard

Although petitioners had no background in cattle ranching,

and petitioners did not consult any independent investment

advisers, petitioners made the decision to invest in a cattle

ranching activity as a means to provide for their retirement.

As

part of their initial investment in the Hoyt partnerships,

petitioners provided Mr. Hoyt with the authority to sign

promissory notes on their behalf.

The power of attorney forms

which petitioners signed granted Mr. Hoyt the authority to incur

personal debts on petitioners' behalf, debt that Mr. Van Scoten

believed petitioners would be required to repay in the event

something went wrong with the partnership.

In addition to the

promissory notes, the power of attorney forms granted Mr. Hoyt

the power to control numerous aspects of petitioners'

without prior consultation with petitioners.

investment

Nevertheless,

petitioners placed their trust entirely with the Hoyt

organization, and they did not investigate the legitimacy of the

partnerships with anyone not employed by or invested in the Hoyt

organization.

We conclude that petitioners were negligent in

signing the power of attorney forms and in entering into the

investment.

Furthermore, we note that we do not accept Mr. Van

Scoten's testimony that he did not intend to invest in a tax

shelter, and that he "never intended not to pay" his taxes.

The

- 24 promotional materials received by petitioners specifically called

the Hoyt investment a "tax shelter" and specifically stated that

the primary return.on any investment would be from tax savings.

In the years preceding their investment, 1987 through 1989,

petitioners reported adjusted gross income (AGI) averaging

approximately $43,000 each year.

In each of these years,

petitioners paid Federal income taxes in an amount averaging

approximately $4,300.

After making their investment in DSBS 87-C

in January 1991, petitioners filed a 1990 return on which they

claimed a deduction for a partnership loss of $148,390,

reducing

their 1990 tax liability on $46,162 of wage income to only $842.

Petitioners then filed the Form 1045 on which they used the

partnership loss to reduce their tax liability to zero in -each of

1987, 1988, and 1989.

Finally, for the year in issue,

1991,

petitioners claimed an additional partnership loss deduction of

$45,510, resulting in a tax liability of $1,798.

While this loss

was partially offset by the farm income reported on the return,

petitioners' tax liability was nevertheless less than half of

petitioners' average tax liability before application of the

carryback in the years prior to their investment.

Petitioners claimed the.tax benefits from the partnership

losses based solely on the advice that they received from the

promoters of the investment and from other Hoyt investors.

Furthermore, the promotional materials that petitioners received

had clearly indicated that there were substantial tax risks in

- 25 making an investment.

Nevertheless, petitioners did not

investigate the tax claims being made by the Hoyt organization

with anyone who was not involved with the organization.

When it came time to prepare petitioners' tax returns and

claim the losses being reported by the Hoyt partnerships,

petitioners relied on the very people who were receiving the bulk

of the tax savings generated by the claims.

Thus, the same

individuals who sold petitioners an interest in the Hoyt

partnerships and who ran the purported ranching operations also

prepared the partnerships' tax returns, prepared petitioners' tax

returns, and received from petitioners most of the tax savings

that resulted from the positions taken on petitioners'

returns.

When petitioners filed their 1991 return, Mr. Van Scoten did not

know, and there is no evidence that Ms. Van Scoten knew, how the

loss or other amounts were derived; he knew only that the Hoyt

organization had reported the amounts on petitioners'

tax return.

042

Petitioners claimed the loss despite the fact that respondent had

warned petitioners, as well Mr. Van Scoten's father, that there

were potential problems with the tax claims being made on both

the partnership returns and on petitioners'

returns.

Prior to

signing their 1991 return, petitioners had received at least two

separate letters from respondent alerting petitioners to

suspected problems or alerting petitioners to reviews that had

been commenced with respect to their partnership.

Despite these

letters, petitioners did not further investigate the partnership

- 26 losses, such as by consulting an independent tax adviser, before

claiming the losses as deductions on their 1991 return.

Instead,

petitioners essentially ignored the letters, merely sending

copies of them to the Hoyt organization as petitioners had been

instructed to do.

Finally, petitioners' actions with respect to the 1991

return reflect a nonchalant attitude with respect thereto, rather

than a reasonable attempt to ascertain their proper tax

liability.

For example, on the statement attached to

petitioners' return regarding material participation, petitioners

merely stated that they worked "all that was needed to be done",

rather than specifying an accurate number of hours.

When

questioned at trial concerning a.partnership-related item

appearing on the return, Mr. Van Scoten testified twice that he

"probably looked at it and did not pay any attention to" the

amount appearing on the return.

Petitioner further testified

that, in reviewing the 1991 return, "like most naive people, I'd

look for the smiley face at the end, not the numbers that got to

it."

Upon the basis of the record before the Court, we conclude

that petitioners were negligent in 1991 in deducting the $45,510

partnership loss from DSBS 87-C.

IV.

Alleged Defenses to the Accuracy-Related Penalty

Section 6664(c)(1)

provides that the section 6662(a)

accuracy-related penalty is not imposed "with respect to any

- 27 portion of an underpayment if it is shown that there was a

reasonable cause for such portion and that the taxpayer acted in

good faith with respect to such portion."

"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."

Tax Regs.

Sec. 1.6664-4(b) (1), Income

The extent of the taxpayer's effort to ascertain his

proper tax liability is generally the most important factor.

A.

Id.

Reliance on the Hoyt Organization and Edward Van Scoten

Petitioners first argue. that they should escape the

negligence penalty because they relied in good faith on various

individuals with respect to the Hoyt investment:

Mr. Hoyt and

other members of the Hoyt organization, tax professionals hired

by the Hoyt organization, and Mr. Van Scoten's father, Edward Van

Scoten.

Good faith reliance on professional advice concerning tax

laws may be a defense to the negligence penalties.

v. Boyle, 469 U.S. 241, 250-251

4(b) (1),

Income Tax Regs.

United States

(1985); see also sec. 1.6664-

However,

"Reliance on professional

advice, standing alone, is not an absolute defense to negligence,

but rather a factor to be considered".

89 T.C. 849, 888

Freytag v. Commissioner,

(1987), affd. 904 F.2d 1011

affd. 501 U.S. 868

(1991).

(5th Cir. 1990),

In order to be considered as such,

the reliance must be reasonable.

Id.

To be objectively

reasonable, the advice generally must be from competent and

- 28 independent parties unburdened with an inherent conflict of

interest, not from the promoters of the investment. 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); Edwards v. Commissioner,

T.C. Memo. 2002-169.

It is clear in this case that petitioners' reliance on the

Hoyt organization to prepare their tax returns was not

objectively reasonable.

We note that petitioners did not receive

any specific advice concerning the deduction of the partnership

loss--they simply accepted whatever numbers were placed on the

return by the Hoyt organization and signed the returns as they

were presented to them.

Petitioners' reliance on the Hoyt

organization to prepare the returns was not objectively

reasonable because Mr. Hoyt and his organization created and

promoted the partnership, they completed petitioners' tax return,

and they received the bulk of the tax benefits from doing so.

For petitioners to. trust Mr. Hoyt or members of his organization

to prepare their return under these circumstances was inherently

unreasonable.

In addition to members of the Hoyt organization itself,

petitioners argue that they relied on tax professionals hired by

the Hoyt organization.

Petitioners, however, have only

established that they believed that the Hoyt organization had

consulted with tax professionals.

Petitioners have not

- 29 established in what manner they personally relied upon any such

professionals, or even the details of what advice the

professionals provided that would be applicable to petitioners'

situation with respect to the year in issue.

Furthermore,

because all of these individuals were affiliated with the Hoyt

organization, it would have been objectively unreasonable for

petitioners to rely upon them in claiming the tax benefits

advertised by that very organization.

We reach a similar conclusion with respect to petitioners'

reliance on Mr. Van Scoten's father, Edward Van Scoten.

While

Mr. Van Scoten trusted Edward Van Scoten because of their

relationship, Edward Van Scoten lacked the expertise necessary to

provide objectively reasonable advice concerning an investment in

a Hoyt partnership.

Although he had experience working on dairy

farms, this experience was not directly transferable to a

purportedly vast cattle ranching operation with a complex

financial and ownership structure.

Furthermore, Edward Van

Scoten's information pertaining to the tax benefits of an

investment in the Hoyt organization was derived from the same

source as Mr. Van Scoten's information--from the promotional

materials and newsletters issued by the Hoyt organization.

Ultimately, petitioners'

reliance on Mr. Van Scoten's father for

advice concerning the Hoyt partnership investment does not

absolve petitioner from the negligence penalty.

- 30 B.

Deception and Fraud by Mr. Hoyt

Petitioners next argue that they should not be liable for

the negligence -penalty because they were defrauded and otherwise

deceived by Mr. Hoyt with respect to their investment in the Hoyt

partnerships.

In this regard, petitioners first argue that the

doctrine of judicial estoppel bars application of the negligence

penalty because the U.S. Government successfully prosecuted Mr.

Hoyt for, in general terms, defrauding petitioners.

Judicial estoppel is a doctrine that prevents parties in

subsequent judicial proceedings from asserting positions

contradictory to those they previously have affirmatively

persuaded a court to accept.

C.I.T. Constr.,

United States ex rel. Am. Bank v.

Inc., 944 F.2d 253, 258-259 (5th Cir. 1991);

Edwards v. Aetna Life Ins. Co., 690 F.2d 595, 598-599

1982).

(6th Cir.

While this Court has accepted the doctrine of judicial

estoppel, see Huddleston v. Commissioner, 100 T.C. 17, 28-29

(1993), the Court of Appeals for the Tenth Circuit, to which

appeal lies in this case, has expressly rejected the doctrine.

United States v. 162 MegaMania Gambling Devices, 231 F.3d 713,

726 (10th Cir. 2000).

Consequently, the doctrine of judicial

estoppel is not applicable in this case.

Commissioner, 54 T.C. 742, 757

(1970)

See Golsen v.

(holding that this Court

must "follow a Court of Appeals decision which is squarely in

point where appeal from our decision lies to that Court of

Appeals and to that court alone").

- 31 Despite the inapplicability of the judicial estoppel

doctrine in this case, we note that respondent's position herein

is in no manner contradictory to the position taken by the United

States in the criminal conviction of Mr. Hoyt.

Goldman v. Commissioner, 39 F.3d at 408

See, e.g.,

(taxpayer-appellants'

argument that an investment partnership "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").

To

the contrary, this Court has sustained a finding of negligence

with respect to investors who had been victims of deception by

tax shelter promoters.

For example, in Klieger v. Commissioner,

T.C. Memo. 1992-734, this Court held that taxpayers in a

situation similar to that of petitioners were negligent.

In

Klieger, we addressed taxpayers' involvement in certain

investments that were sham transactions that lacked economic

substance:

Petitioners are taxpayers of modest means who were

euchred by Graham, a typical shifty promoter.

Graham sold

petitione'rs worthless investments by giving spurious tax

advice that induced them to reduce their withholding and

turn their excess pay over to Graham as initial payments to

acquire interests in "investment programs" that did not

produce any economic return and apparently never had any

prospects of doing so. Graham purported to fulfill his

prophecies about the tax treatment of the Programs by

preparing petitioners' tax returns and claiming deductions

and credits that have been disallowed in full, with

resulting deficiencies * * *.

* * * * * * *

- 32 When a tax shelter is a sham devoid of economic

substance and a taxpayer relies solely on the tax shelter

promoter to prepare his income tax return or advise him how

to prepare the return with respect to the items attributable

to the shelter that the promoter has sold him, it will be

difficult for the taxpayer to carry his burden of proving

that he acted reasonably or prudently. Although a tax

shelter participant, as a taxpayer, has a duty to use

reasonable care in reporting his tax liability, the promoter

who prepares the participant's tax return can be expected to

report large tax deductions and credits to show a relatively

low amount of tax due, and thereby fulfill the prophecies

incorporated in his sales pitch. * * *

In a vein similar to their judicial estoppel argument,

petitioners further argue that Mr. Hoyt's deception resulted in

an "honest mistake of fact" by petitioners when they entered into

their investment.

More specifically, petitioners assert that

they had insufficient information concerning the losses and that

"all tangible evidence available to the Hoyt partners supported

Jay Hoyt's statements."

Reasonable cause and good faith under section 6664(c)(1) 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

indicated by reliance on facts that, unknown to the taxpayer, are

incorrect."

Id.

For the reasons discussed above in applying the negligence

standard, whether or, not petitioners had a "mistake of fact" does

not alter our conclusion that petitioners' actions in relation to

- 33 their investment and the tax claims were objectively

unreasonable.

Furthermore, and again for the reasons discussed

above, petitioners' failure to investigate further--beyond what

was made available to them by Mr. Hoyt and his organization--was

also not an objectively reasonable course of action.

C.

Petitioners' Investigation

Petitioners further argue that they had reasonable cause for

the underpayment because they made a reasonable investigation

into the partnership, taking into account the level of their

sophistication.

Petitioners assert.that this investigation

yielded no indication of wrongdoing by Mr. Hoyt, and petitioners

further assert that an average taxpayer would have been unable to

uncover Mr. Hoyt's fraud.

As we have held, petitioners'

investigation into the partnership went no further than members

of the Hoyt organization and Mr. Van Scoten's father, who was

another Hoyt investor and who in turn was relying on the Hoyt

organization.

Relying on these individuals as a source of

objective information concerning the partnerships was not

reasonable.

Furthermore, petitioners were negligent in not

further investigating the partnership and/or seeking independent

advice concerning it.

- 34 D.

The Bales Opinion

Petitioners next argue that they had reasonable cause for

the underpayment because of this Court's opinion in Bales v.

Commissioner, T.C. Memo. 1989-568.7

Bales involved deficiencies

asserted against various investors in several different cattle

partnerships marketed by Mr. Hoyt.

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."

The

Bales case involved different investors, different partnerships,

different taxable years, and different issues than those

underlying the present case.

First, petitioners argue they relied on Bales in claiming

the deduction for the partnership loss.

We find that petitioners

have not established that they relied on Bales in this manner.

While petitioners received the opinion, there is no evidence that

they, without any background in law or accounting, personally

relied upon the opinion in claiming the relevant partnership

loss.

To the contrary, Mr. Van Scoten testified at trial that he

'Petitioners also argue that the Bales opinion provided

"substantial authority for the positions taken on petitioners'

1991 income tax return." There is no explicit "substantial

authority" exception to the sec. 6662(a) accuracy-related penalty

for negligence.

Hillman v. Commissioner, T.C. Memo. 1999-255

n.14 (citing Wheeler v. Commissioner, T.C. Memo. 1999-56).

While

petitioners refer to the "reasonable basis" exception to the

negligence penalty, set forth in sec. 1.6662-3(b)(3), Income Tax

Regs., they do not specifically argue that the exception applies

in this case.

Nevertheless, we note that the record does not

establish that petitioners had a reasonable basis for claiming

the partnership loss at issue in this case.

- 35 did not know any details concerning the opinion, and, when

questioned about a letter from the Hoyt organization regarding

another case in this Court, he further testified that he "didn't

care about" the portions of the letter pertaining to the "Tax

Court writing stuff".

In short, the record shows that if

petitioners relied on Bales to any degree, they relied only on

the interpretation of Bales provided by Mr. Hoyt and members of

his organization, who repeatedly claimed that Bales was proof

that the partnerships and the tax positions were legitimate.

We

have already found that petitioners' reliance on Mr. Hoyt and his

organization was objectively unreasonable and, as such, not a

defense to the negligence penalty.

Accepting Mr. Hoyt's

.assurances that Bales was a wholesale affirmation of his

partnerships and his tax claims was no less unreasonable.

Second, petitioners argue that, because this Court was

unable to uncover the fraud o·r deception by Mr. Hoyt in Bales,

petitioners as individual taxpayers were in no position to

evaluate the legitimacy of their partnership or the tax benefits

claimed with respect thereto.

case as a red herring:

This argument employs the Bales

Bales 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

- 36 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.

E.

Fairness Considerations

Petitioners' final arguments concerning application of the

accuracy-related penalty are in essence arguments that imposition

of the penalty would be unfair or unjust in this case.

Petitioners argue that "The application of penalties in the

present case does not comport with the underlying purpose of

penalties."

To this effect, petitioners argue that, in this

case,

The problem was not Petitioners' disregard of the tax laws,

but was Jay Hoyt's fraud and deception.

Petitioners did not

engage in noncompliant behavior, instead [they) were the

victims of a complex fraud that it took Respondent years to

completely unravel.

Petitioner Ron Van Scoten 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].

We are mindful of the fact that petitioners were victims of Mr.

Hoyt's fraudulent actions.

Petitioners ultimately lost the bulk

of the tax savings that they received, which they had remitted to

Mr. Hoyt as part of their investment.

Nevertheless, petitioners

believed that this money was being used for their own personal

benefit--at the time that they claimed the tax savings, they

believed that they would eventually benefit from them.

Mr.

- 37 Hoyt's conduct does not alter our conclusion that petitioners

were negligent with respect to entering the Hoyt investment, and

that they were negligent with respect to the position that they

took on their 1991 tax return.

Despite Mr. Hoyt's actions, the

positions taken on the 1991 return signed by petitioners were

ultimately the positions of petitioners, not of Mr. Hoyt.

V.

Conclusion

Upon the basis of the record before the Court, we conclude

that.petitioners'

actions in relation to the Hoyt investment

constituted a lack of due care and a failure to do what

reasonable or ordinarily prudent persons.would do under the

circumstances.

First, petitioners entered into an investment, in

which they gave Mr. Hoyt authority to incur personal debts on

their behalf and control petitioners' interest in their

partnership, without investigating the legitimacy of the

partnerships beyond the advice of Mr. Van Scoten's father.

042

Second, and foremost, petitioners trusted individuals who told

them that they effectively could escape paying Federal income

taxes for a number of years--petitioners reported a combined tax

liability of $2,640 on $106,.046 of wage, interest, and pension

income over 2 years, and reported zero tax liability on $129,582

of AGI for the prior 3 years--based solely upon the tax advice of

the individuals promoting the tax shelter.

Our conclusion is

reinforced by the fact that petitioners received warnings from

respondent, warnings that petitioners chose to ignore.

We find

t

- 38 that petitioners were negligent with respect to entering the Hoyt

investment, and that they were negligent with respect to claiming

the DSBS 87-C loss on their return.

To reflect the foregoing,

Decision will be entered

for respondent.