UNITED STATES TAX COURT
Agency decision
Ask Donna
What actually matters in this document.
Text
T.C. Memo. 1996-398
UNITED STATES TAX COURT
BRUCE AND LOIS ZENKEL, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 12091-89, 19760-89,
24512-89, 10147-91.
Filed August 27, 1996.
Stuart A. Smith and David H. Schnabel, for petitioners in
docket Nos. 12091-89, 24512-89, and 10147-91.
Stuart A. Smith, David H. Schnabel, and Richard J. Walsh,
for petitioner in docket No. 19760-89.
Mitchell Hausman, Gail A. Campbell, and Frances Ferrito
Regan, for respondent in docket No. 12091-89.
Cases of the following petitioners are consolidated for
opinion: Bruce and Lois Zenkel, docket No. 12091-89; Robert G.
Blount, docket No. 19760-89; Morton and Carol David, docket No.
24512-89; and Ira and Helen Selvin, docket No. 10147-91. The
cases were tried and briefed separately.
1
- 2 Gail A. Campbell and Frances Ferrito Regan, for respondent
in docket No. 19760-89.
Jennifer J. Kohler and Frances Ferrito Regan, for respondent
in docket No. 24512-89.
Wendy Sands and Frances Ferrito Regan, for respondent in
docket No. 10147-91.
CONTENTS
Page
MEMORANDUM FINDINGS OF FACT AND OPINION.......................3
OPINION OF THE SPECIAL TRIAL JUDGE............................3
FINDINGS OF FACT..............................................6
A. The Plastics Recycling Transactions......................6
B. The Partnerships.........................................9
C. Richard Roberts.........................................12
D. Stuart Becker and Steven Leicht.........................13
E. Petitioners and Their Introduction to the Partnership
Transactions............................................17
1. Bruce and Lois Zenkel...............................17
2. Robert G. Blount....................................19
3. Morton and Carol David..............................22
4. Ira and Helen Selvin................................24
OPINION......................................................26
A. Statute of Limitations..................................29
B. Section 6653(a)--Negligence.............................31
1.
The So-Called Oil Crisis...........................33
2.
Petitioners' Purported Reliance on Ta7
Advisers...........................................37
a. The Circumstances Under Which a Taxpayer May
Avoid Liability Under Section 6653(a)(1) and
(2) Because of Reasonable Reliance on
Competent and Fully Informed Professional
Advice.........................................40
b. Becker.........................................41
c. Steele and Sprague.............................48
3.
The Private Offering Memoranda.....................51
4.
Miscellaneous......................................55
5.
Conclusion as to Negligence........................62
C. Section 6659--Valuation Overstatement...................62
1.
The Grounds for Petitioners' Underpayments.........64
2.
Concession of the Deficiency.......................69
3.
Section 6659(e)....................................73
- 3 D. Petitioners' Motions For Leave To File Motion For
Decision Ordering Relief From the Negligence Penalty
and the Penalty Rate of Interest and To File Supporting
Memorandum of Law.......................................77
MEMORANDUM FINDINGS OF FACT AND OPINION
DAWSON, Judge:
These cases were assigned to Special Trial
Judge Norman H. Wolfe pursuant to the provisions of section
7443A(b)(4) and Rules 180, 181, and 183.
They were tried and
briefed separately but consolidated for purposes of opinion.
All
section references are to the Internal Revenue Code in effect for
the tax years in issue, unless otherwise indicated.
All Rule
references are to the Tax Court Rules of Practice and Procedure.
The Court agrees with and adopts the opinion of the Special Trial
Judge, which is set forth below.
OPINION OF THE SPECIAL TRIAL JUDGE
WOLFE, Special Trial Judge:
Plastics Recycling group of cases.
These cases are part of the
For a detailed discussion of
the transactions involved in the Plastics Recycling cases, see
Provizer v. Commissioner, T.C. Memo. 1992-177, affd. without
published opinion 996 F.2d 1216 (6th Cir. 1993).
The facts of
the underlying transactions and the Sentinel EPE recyclers in
these cases are substantially identical to those in the Provizer
case.
In notices of deficiency, respondent determined the
following deficiencies in and additions to petitioners' Federal
income taxes:
Penalty
Additions to Tax
Docket No.
Petitioner
6653(a)(2)
Sec. 6659
12091-89
---
Year
Deficiency
1979
$26,330.001
2
--
1980
483.001
--
--
1982
72,349.00
2
$3,617.00
Robert G. Blount
15,798.75
1981
52,662.49
2
2,633.12
Morton and Carol David
15,407.004
1982
51,356.00
2
2,569.00
Ira and Helen Selvin
13,388.00
1981
44,626.00
2
2,231.00
Bruce and Lois Zenkel
$ 7,899.004
Sec. 6621(c)
Sec. 6653(a)(1)
Sec.
-21,705.004
3
19760-89
3
24512-89
3
10147-91
3
1
The deficiencies in docket No. 12091-89 for taxable years 1979 and 1980 result from disallowance of investment tax
credit carrybacks and business energy credit carrybacks from taxable year 1982.
2
Sec. 6621(c) was repealed by sec. 7721(b) of the Omnibus Budget Reconciliation Act of 1989 (OBRA 89), Pub. L. 101239, 103 Stat. 2106, 2399, effective for tax returns due after Dec. 31, 1989, OBRA 89 sec. 7721(d), 103 Stat. 2400. The
repeal does not affect the instant cases. The annual rate of interest under sec. 6621(c) for interest accruing after Dec.
31, 1984, equals 120 percent of the interest payable under sec. 6601 with respect to any substantial underpayment
attributable to tax-motivated transactions.
3
50 percent of the interest payable with respect to the portion of the underpayment attributable to negligence.
4
In the alternative to the addition to tax under sec. 6659, respondent also determined that petitioners'
underpayments were subject to the addition to tax under sec. 6661.
- 5 The parties in each of these consolidated cases filed a
Stipulation of Settled Issues concerning the adjustments relating
to their participation in the Plastics Recycling Program.
Although there are insubstantial differences in the language
used, such as singular terminology versus plural terminology, the
stipulations are substantively identical.
The stipulations in
each of these consolidated cases provide, in part:
1. Petitioners are not entitled to any deductions,
losses, investment credits, business energy investment
credits or any other tax benefits claimed on their tax
returns as a result of their participation in the
Plastics Recycling Program.
2. The underpayments in income tax attributable to
petitioners' participation in the Plastics Recycling
Program are substantial underpayments attributable to
tax-motivated transactions, subject to the increased
rate of interest established under I.R.C. §6621(c),
formerly §6621(d).
3. This stipulation resolves all issues that relate to
the items claimed on petitioners' tax returns resulting
from their participation in the Plastics Recycling
Program, except for the petitioners' potential
liability for additions to the tax for valuation
overstatements under I.R.C. §6659 and for negligence
under the applicable provisions of §6653(a).
Long after the trials in these cases, petitioners in docket
Nos. 10147-91 (Selvin), 24512-89 (David), and 19760-89 (Blount)
each filed a Motion For Leave to File Motion for Decision
Ordering Relief From the Negligence Penalty and the Penalty Rate
of Interest and to File Supporting Memorandum of Law under Rule
50.
These motions were filed with attached exhibits on September
22, 1995, October 2, 1995, and November 30, 1995, respectively.
- 6 On those same dates, each petitioner who filed a motion for leave
also lodged with the Court a motion for decision ordering relief
from the additions to tax for negligence and the increased rate
of interest, with attachments, and a memorandum in support of
such motion.
Subsequently, respondent filed objections, with
attachments, and memoranda in support thereof.
For reasons
discussed in more detail at the end of this opinion, and also in
Farrell v. Commissioner, T.C. Memo. 1996-295, petitioners'
motions shall be denied.
The issues remaining in these consolidated cases are:
(1)
Whether the assessment in docket No. 24512-89 (David) is barred
by the statute of limitations; (2) whether petitioners are liable
for additions to tax under section 6653(a)(1) and (2) for
negligence; and (3) whether petitioners are liable for additions
to tax under section 6659 for underpayments of tax attributable
to valuation overstatement.
FINDINGS OF FACT
Some of the facts have been stipulated in each case and are
so found.
The stipulated facts and attached exhibits are
incorporated in the respective cases by this reference.
A.
The Plastics Recycling Transactions
These cases concern petitioners' investments in four limited
partnerships that leased Sentinel expanded polyethylene (EPE)
recyclers:
Phoenix Recycling Group (Phoenix), Scarborough
Leasing Associates (Scarborough), SAB Resource Reclamation
- 7 Associates (SAB Reclamation), and SAB Resource Recycling
Associates (SAB Recycling).
Petitioners Zenkel are limited
partners in SAB Reclamation; petitioner Blount is a limited
partner in Phoenix; petitioners David are limited partners in SAB
Recycling; and petitioners Selvin are limited partners in
Scarborough.
For convenience we refer to these partnerships
collectively as the Partnerships.
The transactions involving the Sentinel EPE Recyclers leased
by the Partnerships are substantially identical to those in the
Clearwater Group limited partnership (Clearwater), the
partnership considered in Provizer v. Commissioner, T.C. Memo.
1992-177.
Petitioners have stipulated substantially the same
facts concerning the underlying transactions as we found in the
Provizer case.
In the Provizer case, Packaging Industries, Inc. (PI),
manufactured and sold six Sentinel EPE recyclers to ECI Corp. for
$981,000 each.
ECI Corp., in turn, resold the recyclers to F & G
Corp. for $1,162,666 each.
F & G Corp. then leased the recyclers
to Clearwater, which licensed the recyclers to FMEC Corp., which
sublicensed them back to PI.
The sales of the recyclers from PI
to ECI Corp. were financed with nonrecourse notes.
Approximately
7 percent of the sales price of the recyclers sold by ECI Corp.
to F & G Corp. was paid in cash with the remainder financed
through notes.
These notes provided that 10 percent of the notes
- 8 were recourse but that the recourse portion of the notes was only
due after the nonrecourse portion, 90 percent, was paid in full.
All of the monthly payments required among the entities in
the above transactions offset each other.
were done simultaneously.
These transactions
Although the recyclers were sold and
leased for the above amounts under the structure of simultaneous
transactions, the fair market value of a Sentinel EPE recycler in
1981 and 1982 was not in excess of $50,000.
PI allegedly sublicensed the recyclers to entities that
would use them to recycle plastic scrap.
The sublicense
agreements provided that the end-users would transfer to PI 100
percent of the recycled scrap in exchange for a payment from FMEC
Corp. based on the quality and amount of recycled scrap.
Like Clearwater, each of the Partnerships leased Sentinel
EPE recyclers from F & G Corp. and licensed those recyclers to
FMEC Corp.
The transactions of the Partnerships differ from the
underlying transactions in the Provizer case in the following
respects:
(1) The entity that leased the machines from F & G
Corp. and licensed them to FMEC Corp., and (2) the number of
recyclers the Partnerships were organized to lease and license.
Phoenix, Scarborough, and SAB Recycling each was to lease and
license seven Sentinel EPE recyclers.
SAB Reclamation was to
lease and license eight recyclers, according to its offering
memorandum, but the SAB Reclamation partnership tax return for
1982 indicates that it leased and licensed only four recyclers.
- 9 For convenience, we refer to the series of transactions
among PI, ECI Corp., F & G Corp., each of the Partnerships, FMEC
Corp., and PI as the Partnership transactions.
In addition to
the Partnership transactions, a number of other limited
partnerships entered into transactions similar to the Partnership
transactions, also involving Sentinel EPE recyclers and Sentinel
expanded polystyrene (EPS) recyclers.
We refer to these
collectively as the Plastics Recycling transactions.
B.
The Partnerships
Phoenix and Scarborough are New York limited partnerships
that were formed in late 1981.
Richard Roberts (Roberts).
The general partner of Phoenix is
He and Samuel L. Winer (Winer) are
the general partners of Scarborough.
Winer is also the general
partner of Clearwater, the partnership considered in the Provizer
case.
See Provizer v. Commissioner, supra.
SAB Reclamation and SAB Recycling are New York limited
partnerships that were organized and promoted in 1982 by Stuart
Becker (Becker), a certified public accountant (C.P.A.) and the
founder and principal owner of Stuart Becker & Co., P.C. (Becker
Co.), an accounting firm that specialized in tax matters.
Becker
organized a total of six recycling partnerships (the SAB
Recycling Partnerships).
Two of the SAB Recycling Partnerships
closed in late 1981, two closed in early 1982 (SAB Reclamation
and SAB Recycling), and two more closed in late 1982.
- 10 The general partner of each of the SAB Recycling
Partnerships, including SAB Reclamation and SAB Recycling, is SAB
Management Ltd. (SAB Management).
SAB Management is wholly owned
by Scanbo Management Ltd. (Scanbo), which is wholly owned by
Becker.
Scanbo is an acronym for three of Becker's children:
Scott, Andy, and Bonnie.
The officers and directors of SAB
Management and Scanbo are as follows:
(1) Becker, president and
director; (2) Noel Tucker (Tucker), vice president, treasurer,
and director; and (3) Steven Leicht (Leicht), vice president,
secretary, and director.
During the years in issue, Tucker and
Leicht also worked at Becker Co.
Tucker was vice president.
Each owned between 5 and 7 percent of the stock of Becker Co.
SAB Management did not engage in any business before becoming
involved with the SAB Recycling Partnerships.
With respect to each of the Partnerships, a private
placement memorandum was distributed to potential limited
partners.
Reports by F & G Corp.'s evaluators, Dr. Stanley M.
Ulanoff (Ulanoff), a marketing consultant, and Dr. Samuel Z.
Burstein (Burstein), a mathematics professor, were appended to
the offering memoranda.
Ulanoff owns a 1.27-percent interest in
Plymouth Equipment Associates and a 4.37-percent interest in
Taylor Recycling Associates, partnerships that leased Sentinel
recyclers.
Burstein owns a 2.605-percent interest in Empire
Associates and a 5.82-percent interest in Jefferson Recycling
Associates, also partnerships that leased Sentinel recyclers.
- 11 Burstein also was a client and business associate of Elliot I.
Miller (Miller), the corporate counsel to PI.
The offering memoranda for Phoenix, Scarborough, SAB
Reclamation, and SAB Recycling state that the general partner
will receive fees from those partnerships in the respective
amounts of $40,000, $73,000, $110,000 and $97,375.
SAB
Management received fees of approximately $500,000 as the general
partner of the SAB Recycling Partnerships.
In addition, Becker
Co. prepared the partnership returns and Forms K-1 for all of the
SAB Recycling Partnerships and received fees for those services.
The offering memoranda also allocate a percentage of the
proceeds from each offering--7.5 percent in the case of SAB
Reclamation and SAB Recycling and 10 percent in the case of
Phoenix and Scarborough--to the payment of sales commissions and
offeree representative fees.
In addition, the offering memoranda
provide that the respective general partners "may retain as
additional compensation all amounts not paid as sales commissions
or offeree representative fees."
However, neither SAB Management
nor Becker retained or received any sales commissions or offeree
representative fees.
Instead, after the closing of each SAB
Recycling Partnership, Becker rebated to each investor whose
investment was not subject to a sales commission or offeree
representative fee an amount equal to 7.5 percent of such
investor's original investment.
- 12 The offering memoranda list significant business and tax
risk factors associated with investments in the Partnerships.
Specifically, the offering memoranda state:
(1) There is a
substantial likelihood of audit by the Internal Revenue Service
(IRS) and the purchase price paid by F & G Corp. to ECI Corp.
probably will be challenged as being in excess of fair market
value; (2) the Partnerships have no prior operating history; (3)
the general partner has no prior experience in marketing
recycling or similar equipment; (4) the limited partners have no
control over the conduct of the Partnerships' business; (5) there
is no established market for the Sentinel EPE recyclers; (6)
there are no assurances that market prices for virgin resin will
remain at their current costs per pound or that the recycled
pellets will be as marketable as virgin pellets; and (7) certain
potential conflicts of interest exist.
C.
Richard Roberts
Roberts is a businessman and the general partner in a number
of limited partnerships that leased and licensed Sentinel EPE
recyclers, including Phoenix and Scarborough.
He also is a
9-percent shareholder in F & G Corp., the corporation that leased
the recyclers to Phoenix and Scarborough.
From 1982 through
1985, Roberts maintained the following office address with
Raymond Grant (Grant), the sole owner and president of ECI Corp.:
Grant/Roberts
Investment Banking
Tax Sheltered Investments
- 13 745 Fifth Avenue, Suite 410
New York, New York 10022
Grant was instrumental in the hiring of Ulanoff as an evaluator
of the Plastics Recycling transactions; the two had met on a
cruise.
Roberts and Grant together have been general partners in
other investments.
Prior to the Partnership transactions, Roberts and Grant
were clients of the accounting firm H. W. Freedman & Co.
(Freedman & Co.).
Harris W. Freedman (Freedman), the named
partner in Freedman & Co., was the president and chairman of the
board of F & G Corp.
recycler.
He also owned 94 percent of a Sentinel EPE
Freedman & Co. prepared the partnership returns for
ECI Corp., F & G Corp., Phoenix, and Scarborough.
provided tax services to John D. Bambara (Bambara).
It also
Bambara is
the 100-percent owner of FMEC Corp., as well as its president,
treasurer, clerk, and director.
He, his wife, and daughter also
owned directly or indirectly 100 percent of the stock of PI.
D.
Stuart Becker and Steven Leicht
Becker does not have an engineering background, and he is
not an expert in plastics materials or plastics recycling.
He
received a B.S. degree in accounting from New York University in
1964 and an M.B.A. in taxation from New York University School of
Business Administration in 1973.
He passed the certified public
accountancy test in 1967 and was the winner of the gold medal,
awarded to the person achieving the highest score on the
- 14 examination for that year.
Since early 1966, Becker has
practiced as a C.P.A. exclusively in the tax area.
From 1964
until 1972 he worked for the accounting firm of Touche, Ross &
Co., and in 1972 he joined the accounting firm of Richard A.
Eisner & Co. as the partner in charge of the tax department.
In
1977, Becker founded Becker Co.
Becker had considerable experience involving tax shelter
transactions before he organized the SAB Recycling Partnerships.
He prepared opinions regarding tax shelters' economic and tax
projections, advised individuals and companies with respect to
investments in tax shelters, lectured extensively about tax
shelter investments generally, and lectured and published with
respect to leveraged tax shelters.
Becker described a leveraged
tax shelter as "a transaction where [the ratio of] the effective
[tax] writeoff, which includes the value of the tax credit, * * *
[to the amount invested] exceeds one to one."
specialized in tax-advantaged investments.
Becker Co.
From 1980 to 1982,
approximately 60 percent of the work done by Becker Co. involved
tax sheltered and private investments.
Becker has owned minority
interests in general partners of numerous limited partnerships.
Prior to organizing the SAB Recycling Partnerships, Becker owned
5 percent of the general partner of partnerships involved in
approximately 14 transactions concerning river transportation
(such as barges, tow boats, and grain elevators).
- 15 Although investment counseling was related to his firm's
line of business, Becker did not consider himself in the business
of providing investment advice.
Becker did not normally hire
other professionals for consultation or advice.
In circumstances
where he believed there was a need for outside advice, he would
so advise the client.
Between 30 and 40 of Becker's clients
invested in the Plastics Recycling partnerships.
Becker learned of the Plastics Recycling transactions when a
prospective client presented him with an offering memorandum
concerning the transactions in August or September 1981.
Becker
reviewed the offering memorandum and spoke to Miller, one of the
key figures in the transactions and an acquaintance of Becker's.
Miller was a shareholder of F & G Corp. and, as noted, the
corporate counsel to PI.
Grant's clients.
He also represented Grant and some of
Thereafter, Becker recommended the investment
to the prospective client.
Although the prospective client did
not invest in the Plastics Recycling transactions, Becker became
interested in the proposal and organized the SAB Recycling
Partnerships in order to make similar investments in Sentinel EPE
recyclers conveniently available to appropriate clients.
In organizing the SAB Recycling Partnerships, Becker was not
allowed to change the format of the transactions or the purchase,
lease, or licensing prices of the Sentinel EPE recyclers.
He was
allowed only to conduct a limited investigation of the proposed
investments and choose whether or not to organize similar
- 16 partnerships.
Becker relied heavily upon the offering materials
and discussions with persons involved in the matter to evaluate
the Plastics Recycling transactions.
He and two other members of
Becker Co., Leicht and Tucker, investigated PI and visited its
plant in Hyannis, Massachusetts, where they saw the Sentinel EPE
recyclers.
Tucker did not testify at any of the trials.
During his investigation of the Plastics Recycling
transactions, Becker did not hire any plastics, engineering, or
technical experts, or recommend that his clients do so.
Becker
discussed the transactions with Michael Canno (Canno) of the
Equitable Bag Co., a manufacturer of paper and plastic bags.
Canno never saw the recyclers or the pellets and never wrote any
reports assessing the equipment or the pellets.
In addition,
Becker retained a law firm, Rabin & Silverman, to assist him in
organizing the SAB Recycling Partnerships.
See Spears v.
Commissioner, T.C. Memo. 1996-341, to the effect that in
employing the law firm, Becker particularly sought to protect
himself against liability.
Leicht and Tucker also familiarized themselves with the
Plastics Recycling transactions.
Leicht has a B.A. degree in
finance and accounting from Penn State University, a J.D. from
SUNY Buffalo, and an LL.M. in taxation from New York University
School of Law.
Leicht ran a mathematical check on the numbers
contained in the offering materials for Becker, but he did not
test the underlying assumptions upon which they were based.
He
- 17 also visited PI in Hyannis and met with Miller and other insiders
to the transactions.
Leicht never communicated an opinion as to
the value of the recyclers other than what was presented in the
offering memoranda.
He has no education or expertise in plastics
materials or plastics recycling.
E. Petitioners and Their Introduction to the Partnership
Transactions
Petitioners in these cases under consideration do not have
any education or work experience in plastics recycling or plastic
materials.
They did not independently investigate the Sentinel
EPE recyclers or see a Sentinel EPE recycler or any other type of
plastics recycler prior to participating in the recycling
ventures.
1.
Bruce and Lois Zenkel
Petitioners Bruce and Lois Zenkel (the Zenkels) resided in
Scarsdale, New York, when their petition was filed.
Bruce Zenkel
(Mr. Zenkel) graduated from the University of Michigan and took
some post-graduate courses at the University of Pennsylvania.
Mr. Zenkel did not testify at trial.
Lois Zenkel (Mrs. Zenkel)
attended Connecticut College and in 1975 received a degree from
Manhattanville College.
During the years in issue, Mrs. Zenkel
was a freelance photographer, and Mr. Zenkel was an investment
banker.
On their joint 1982 Federal income tax return, the
Zenkels reported gross income from wages, interest, dividends,
- 18 State and local tax refunds, capital gains, and other sources in
excess of $300,000.
In 1982, Mrs. Zenkel acquired a 9-percent limited
partnership interest in SAB Reclamation for a gross investment of
$50,000, without taking into consideration any sales commission
rebate or advance royalty distribution.
Based on Mrs. Zenkel's
interest in SAB Reclamation, on their 1982 Federal income tax
return the Zenkels claimed an operating loss in the amount of
$40,100 and investment tax and business energy credits totaling
$83,712.
Their total credits claimed, $85,547, were subject to a
limitation of $62,841.
The Zenkels carried back the unused
portion of the credits to 1979 and 1980.
Respondent disallowed
the Zenkels' claimed operating loss and credits related to Mrs.
Zenkel's investment in SAB Reclamation.
The Zenkels learned of the Plastics Recycling transactions
and SAB Reclamation from Robert Steele (Steele), an accountant
with Becker Co.
At the time, Becker Co. prepared the Zenkels'
Federal and State income tax returns.
Mr. Zenkel had earlier met
Steele and Becker on separate occasions during the mid-1970's.
Mr. Zenkel initially met Becker in connection with some
investment offerings with which Mr. Zenkel was involved.
After
Mrs. Zenkel also met Steele, the couple hired Becker Co. to
handle their tax and related accounting needs.
Steele provided Mrs. Zenkel with a copy of the SAB
Reclamation offering memorandum.
Mrs. Zenkel looked it over and
- 19 discussed the investment with Mr. Zenkel.
She did not know
whether Becker or Steele had any experience, education, or
background in plastics recycling.
Steele about the investment.
The Zenkels each talked to
Mr. Zenkel called Becker directly
and asked him a large number of questions about the Plastics
Recycling transactions.
Becker answered his questions and
related the particulars of his investigation to Mr. Zenkel.
The
Zenkels had extensive investment experience prior to investing in
SAB Reclamation.
Mrs. Zenkel considered Mr. Zenkel, who had
professional experience in the syndication business, to be
sophisticated in financial matters.
2.
Robert G. Blount
Petitioner Robert G. Blount (Blount) resided in
Southhampton, New York, when his petition was filed.
He received
an undergraduate degree in accounting from Babson College in 1960
and joined the accounting firm of Arthur Andersen & Co.
(Andersen) that same year.
Blount became a C.P.A. in 1965 and in
1970 he became a partner at Andersen.
In 1973 he left Andersen
and became the chief financial officer of a small company and in
1974 he joined American Home Products (AHP), a major
pharmaceutical manufacturer, as its treasurer and vice president
of finance, subsequently advancing to positions of greater
responsibility with AHP.
On his 1981 Federal income tax return,
Blount reported gross income from wages in excess of $332,000.
- 20 Blount acquired a 2.605-percent interest in Phoenix for a
gross investment of $25,000 in 1981, without taking into
consideration any sales commission rebate or advance royalty
distribution.
As a result of his investment in Phoenix, on his
1981 Federal income tax return Blount claimed an operating loss
in the amount of $20,520 and investment tax and business energy
credits totaling $42,402.
Respondent disallowed Blount's claimed
operating loss and credits related to his investment in Phoenix.
Blount learned of the Plastics Recycling transactions and
Phoenix in 1981 from William Sprague (Sprague), a former
colleague at Andersen who had been introduced to the transactions
by Leicht.
Sprague joined Andersen in 1935, became a C.P.A. in
1938 (receiving the silver medal for the second highest grade on
the examination), and had been a partner at Andersen for
approximately 20 years when he retired in 1973.
His work at
Andersen was primarily in the area of auditing and administrative
functions within the firm.
Sprague knew Leicht because the
latter also worked for Andersen, specifically from 1974 through
1980, and the two occasionally had lunch together.
Leicht was
working at Becker Co. in late 1981 when he suggested to Sprague
that he look at some of the potential investments that passed
through Becker Co.
Sprague was familiar with Becker Co., and he
knew Becker personally since both had been involved with the New
York State Society of C.P.A.'s.
- 21 Leicht gave Sprague a copy of the Phoenix offering
memorandum, and he reviewed it over a couple of days.
Sprague
was a complete stranger to the idea of plastics recycling and was
incapable of evaluating the technical or engineering details
associated with the investment.
Thereafter, he discussed the
investment with Leicht, and Leicht described his visits to PI.
Becker stated that he too discussed the investment with Sprague
and disclosed the extent of his investigation; Sprague, however,
could not recall their conversation.
Sprague did not otherwise
investigate the Plastics Recycling transactions; he relied
exclusively on the offering materials and Becker Co.
During this time, Sprague saw Blount on business occasions
and also lunched with him about once a month.
At one such lunch,
the two were discussing investment opportunities when Blount
mentioned that he was going to receive additional compensation
income.
Sprague suggested the Plastics Recycling transactions as
a potential investment and in general terms recounted the
information he had received from Leicht.
He explained that as a
service to clients, Becker Co. screens such investments--not to
guarantee them--but to determine generally if the proposed
investments are something their clients should look into.
Sprague suggested that Blount contact Leicht or Becker, but
Blount never spoke to either of them.
Blount simply reviewed the
offering memorandum for a few hours and gave it to his tax
preparer, Marilyn Gowin (Gowin).
Gowin reviewed all supporting
- 22 documents for any transactions appearing on Blount's tax returns.
Blount considered Phoenix to be a high-risk investment.
3.
Morton and Carol David
Petitioners Morton and Carol David (the Davids) resided in
New York, New York, when their petition was filed.
Morton David
(David) received a B.A. degree from City College of New York in
1956 and a J.D. from Harvard Law School in 1961.
From 1961
through 1963, David was an assistant to the special trial counsel
of the American Stock Exchange.
He then practiced corporate law
at the law firm of Cooper, Ostrand, Devarco & Ackerman from 1963
until 1967.
David has not practiced law since then.
Instead,
David has engaged in the business of workouts and turnarounds of
technology companies, including a small cable television company,
a burglar alarm company, a military contracting company, an
electronics company, and a computer company.
On their joint 1982
Federal income tax return, the Davids reported gross income from
wages, interest, dividends, State and local tax refunds, and
capital gains in excess of $750,000.
David acquired a 2.538461-percent interest in SAB Recycling
for a gross investment of $25,000 in 1982, without taking into
consideration any sales commission rebate or advance royalty
distribution.
As a result of his interest in SAB Recycling, on
their joint 1982 Federal income tax return the Davids claimed an
operating loss in the amount of $19,871 and investment tax and
business energy credits totaling $41,320.
Respondent disallowed
- 23 the Davids' claimed operating loss and credits related to SAB
Recycling.
David learned of the Plastics Recycling transactions and SAB
Recycling from Becker in late 1981 or 1982.
He first met Becker
sometime in 1963 when David was general counsel for Perfect Photo
Co. (PPC) and Becker did tax work for PPC on behalf of Touche,
Ross & Co.
From 1968 until 1984, Becker provided David with
personal tax advice and performed tax accounting work for
companies that David controlled.
David spent 4 to 6 hours
reviewing the offering memorandum for SAB Recycling and
thereafter he discussed the investment with Becker.
Becker
described his investigation of the Plastics Recycling transaction
to David in detail.
David has no education or experience in plastics materials
or plastics recycling, and he knew that Becker was not an expert
in the plastics industry.
He did not discuss the investment with
anyone who was knowledgeable or expert in the plastics industry.
He never viewed a recycler or independently investigated PI.
David did not investigate whether there was a market for recycled
pellets or independently verify any of the representations in the
offering memorandum.
He simply reviewed the SAB Recycling
offering memorandum and discussed the proposed investment with
Becker.
- 24 4.
Ira and Helen Selvin
Petitioners Ira and Helen Selvin (the Selvins) resided in
Roslyn Estates, New York, when their petition was filed.
Ira
Selvin (Selvin) received a B.S. degree from New York University
School of Commerce.
Excluding his active service in the U.S.
Army during World Wars I and II, Selvin has practiced accounting
for his entire career until he retired in approximately 1980.
He
was a sole practitioner for 30-35 years and serviced many clients
in the garment industry.
Selvin eventually turned his practice
over to the accounting firm of Cooper, Selvin & Strasburg.
Although it maintained an office for him, Selvin never actively
worked for that firm.
On their joint 1981 Federal income tax
return, the Selvins reported gross income from interest,
dividends, capital gains, pensions or annuities, and other
sources in excess of $172,000.
In 1981 Selvin acquired an interest in Scarborough as a
nominee on behalf of himself and other members of his accounting
firm (hereinafter "the Selvin group").
The Selvin group invested
$180,000 for an 18.27-percent interest in Scarborough.
The
amount of Selvin's share in Scarborough is not entirely clear
from the record in docket No. 10147-91.
Selvin stated that he
invested $30,000 in Scarborough, which is the equivalent of a
3.05-percent interest (30,000/180,000 = 16.67 percent; .1667 x
.1827 = 3.05 percent).
However, the Selvins claimed $44,626 of
- 25 investment tax and business energy credits using a reported basis
in qualifying property of $223,126.
That amount is 15 percent of
the total basis owned by the Selvin group (223,126/1,487,504 =
.15), which is the equivalent of an investment of only $27,000
(180,000 x .15 = $27,000) and a total interest in Scarborough of
2.74 percent (.18277 x .15 = .0274).
Relying on the documentary
evidence, we find that the Selvins paid $27,000 for their
partnership interest in Scarborough.
As reported on Selvin's 1981 Form K-1 from Scarborough, the
Selvin group's share of Scarborough's operating loss equaled
$142,821, and its share of Scarborough's basis in the recyclers
was $1,487,504.
The Selvins did not claim any portion of the
operating loss on their joint 1981 Federal income tax return but,
as noted, they did claim investment tax and business energy
credits totaling $44,626.
Respondent disallowed these claimed
credits.
Selvin learned of the Plastics Recycling transactions and
Scarborough from Becker.
He first met Becker on a trip to Israel
in approximately 1968 and the two have been friendly ever since.
Selvin has never referred a client to Becker, although on one
occasion Becker referred a client to Selvin.
a copy of the Scarborough offering memorandum.
Becker gave Selvin
Selvin spent
several hours reviewing the offering memorandum and discussed it
with Becker.
Becker answered Selvin's questions and explained
- 26 the full extent of his investigation, such as his visit to PI,
speaking with Canno, and his research of trade journals to
confirm the price of plastic pellets.
Becker never represented
that he was an expert in plastics materials or plastics
recycling.
Selvin did not do any independent investigation of
the Sentinel EPE recyclers or plastics recycling in general.
He
invested in Scarborough based solely on his review of the
offering materials and his discussions with Becker.
After the 1981 SAB Recycling Partnerships closed, Becker
paid Selvin's accounting firm to send an accountant to PI to
confirm, by serial number, that as of December 31, 1981, the
equipment that was leased to the 1981 SAB Recycling Partnerships
was indeed available for use.
Becker arranged for this
verification, independent of PI, because he understood that the
investment tax and business energy credits would not be available
if the qualifying property was not available for use.
OPINION
We have decided more than 30 of the Plastics Recycling group
of cases.2
The majority of these cases, like the consolidated
Provizer v. Commissioner, T.C. Memo. 1992-177, affd.
without published opinion 996 F.2d 1216 (6th Cir. 1993),
concerned the substance of the partnership transaction and also
the additions to tax.
The following cases concerned the addition to tax for
negligence, inter alia: Estate of Busch v. Commissioner, T.C.
Memo. 1996-342; Spears v. Commissioner, T.C. Memo. 1996-341;
Stone v. Commissioner, T.C. Memo. 1996-230; Reimann v.
(continued...)
2
- 27 cases herein, raised issues regarding additions to tax for
negligence and valuation overstatement.
We have found the
taxpayers liable for such additions to tax in all but one of the
opinions to date on these issues, although procedural rulings
have involved many more favorable results for taxpayers.3
(...continued)
Commissioner, T.C. Memo. 1996-84; Bennett v. Commissioner, T.C.
Memo. 1996-14; Atkind v. Commissioner, T.C. Memo. 1995-582;
Triemstra v. Commissioner, T.C. Memo. 1995-581; Pace v.
Commissioner, T.C. Memo. 1995-580; Dworkin v. Commissioner, T.C.
Memo. 1995-533; Wilson v Commissioner, T.C. Memo. 1995-525;
Avellini v. Commissioner, T.C. Memo. 1995-489; Paulson v.
Commissioner, T.C. Memo. 1995-387; Zidanich v. Commissioner, T.C.
Memo. 1995-382; Ramesh v. Commissioner, T.C. Memo. 1995-346;
Reister v. Commissioner, T.C. Memo. 1995-305; Fralich v.
Commissioner, T.C. Memo. 1995-257; Shapiro v. Commissioner, T.C.
Memo. 1995-224; Pierce v. Commissioner, T.C. Memo. 1995-223; Fine
v. Commissioner, T.C. Memo. 1995-222; Pearlman v. Commissioner,
T.C. Memo. 1995-182; Kott v. Commissioner, T.C. Memo. 1995-181;
Eisenberg v. Commissioner, T.C. Memo. 1995-180.
Greene v. Commissioner, 88 T.C. 376 (1987), concerned the
applicability of the safe-harbor leasing provisions of sec.
168(f)(8). Trost v. Commissioner, 95 T.C. 560 (1990), concerned
a jurisdictional issue.
Farrell v. Commissioner, T.C. Memo. 1996-295; Baratelli v.
Commissioner, T.C. Memo. 1994-484; Estate of Satin v.
Commissioner, T.C. Memo. 1994-435; Fisher v. Commissioner, T.C.
Memo. 1994-434; Foam Recycling Associates v. Commissioner, T.C.
Memo. 1992-645; Madison Recycling Associates v. Commissioner,
T.C. Memo. 1992-605, concerned other issues.
2
In Zidanich v. Commissioner, T.C. Memo. 1995-382, we
held the taxpayers liable for the sec. 6659 addition to tax, but
not liable for the negligence additions to tax under sec.
6653(a). As indicated in our opinion, the Zidanich case, and the
Steinberg case consolidated with it for opinion, involved
exceptional circumstances.
In Estate of Satin v. Commissioner, supra, and Fisher v.
Commissioner, supra, after the decision in Provizer v.
Commissioner, supra, the taxpayers were allowed to elect to
accept a beneficial settlement because of exceptional
(continued...)
3
- 28 In Provizer v. Commissioner, T.C. Memo. 1992-177, a test
case for the Plastics Recycling group of cases, this Court (1)
found that each Sentinel EPE recycler had a fair market value not
in excess of $50,000, (2) held that the transaction, which is
almost identical to the Partnership transactions in these
consolidated cases, was a sham because it lacked economic
substance and a business purpose, (3) upheld the section 6659
addition to tax for valuation overstatement since the
underpayment of taxes was directly related to the overstatement
of the value of the Sentinel EPE recyclers, and (4) held that
losses and credits claimed with respect to Clearwater were
attributable to tax-motivated transactions within the meaning of
section 6621(c).
In reaching the conclusion that the transaction
lacked economic substance and a business purpose, this Court
relied heavily upon the overvaluation of the Sentinel EPE
recyclers.
Although petitioners have not agreed to be bound by the
Provizer opinion, they have stipulated that the investments in
the Sentinel EPE recyclers in these cases are similar to the
investment described in Provizer v. Commissioner, supra.
The
(...continued)
circumstances. In Farrell v. Commissioner, supra, we rejected
taxpayers' claim to a similar belated settlement arrangement
since the circumstances were different and taxpayers previously
had rejected settlement and elected to litigate the case. See
also Baratelli v. Commissioner, supra.
3
- 29 underlying transactions in these consolidated cases, and the
Sentinel EPE recyclers considered in these cases, are the same
type of transaction and same type of machines considered in
Provizer v. Commissioner, supra.
Based on the entire records in these cases, including the
extensive stipulations, testimony of respondent's experts, and
petitioners' testimony, we hold that each of the Partnership
transactions herein was a sham and lacked economic substance.
In
reaching this conclusion, we rely heavily upon the overvaluation
of the Sentinel EPE recyclers.
Respondent is sustained on the
question of the underlying deficiencies.
We note that
petitioners have explicitly conceded this issue in the respective
stipulations of settled issues filed shortly before trial.
The
record plainly supports respondent's determination regardless of
such concessions.
For a detailed discussion of the facts and the
applicable law in a substantially identical case, see Provizer v.
Commissioner, supra.
A.
Statute of Limitations
In their petition, the Davids alleged that the notice of
deficiency in docket No. 24512-89 was not issued within the
statutory limitations period.
abandoned.
This issue appears to have been
The Stipulation of Settled Issues in docket No.
24512-89 indicates that the only issues remaining for decision in
that case are the potential liability of the Davids for additions
- 30 to tax under sections 6653(a) and 6659.
None of the trial
memoranda or briefs in docket No. 24512-89 address this issue.
Regardless of whether the issue was abandoned, the record in
docket No. 24512-89 shows that the notice of deficiency in that
case was issued within the statutory limitations period.
In
general, section 6501(a) requires assessment of tax to be made
within 3 years after a return is filed, whether the return was
filed on or after the date prescribed.
Section 6501(b)(1)
provides that if a return is filed before the due date, for
purposes of section 6501, the return shall be considered filed on
the due date.
Section 6501(c)(4) provides that if, before the
expiration of the time to assess the tax under section 6501(a),
the parties consent in writing to extend the time for the
assessment of the tax, the tax may be assessed at any time before
the end of the period agreed upon.
The Davids' joint 1982 Federal income tax return was due on
April 15, 1983, and was filed on or before that date.
Therefore,
the 3-year period of limitations under section 6501(a) initially
was set to expire on April 15, 1986.
However, the Davids and
respondent executed three consecutive Forms 872, Consent to
Extend the Time to Assess Tax.
The first of these Forms 872 was
fully executed on March 21, 1986, prior to expiration of the
normal 3-year period of limitations, and the last of these Forms
872 extended the period of limitations to December 31, 1989.
The
- 31 notice of deficiency was mailed on July 21, 1989, well before the
expiration of the extended limitations period.
The Davids have
presented no evidence that the Forms 872 were not properly
executed.
Accordingly, the notice of deficiency in docket No.
24512-89 was issued within the statutory limitations period, as
extended by the parties, and the assessment in docket No. 2451289 is not barred by the statute of limitations.
We note that in their respective petitions, the Selvins and
the Zenkels also claimed that the notices of deficiency issued in
their cases were barred by the statute of limitations.
However,
the Selvins conceded the issue at a call of the calendar on
March 21, 1994, and the Zenkels conceded the issue in the
stipulation of facts filed in their case.
Blount never raised a
statute of limitations issue.
B.
Section 6653(a)--Negligence
Respondent determined that petitioners are liable for
additions to tax for negligence under section 6653(a)(1) and (2).
Petitioners have the burden of proving that respondent's
determinations of these additions to tax are erroneous.
Rule
142(a); Luman v. Commissioner, 79 T.C. 846, 860-861 (1982).
Section 6653(a)(1) imposes an addition to tax equal to 5
percent of the underpayment if any part of an underpayment of tax
is due to negligence or intentional disregard of rules or
regulations.
Section 6653(a)(2) imposes an addition to tax equal
- 32 to 50 percent of the interest payable with respect to the portion
of the underpayment attributable to negligence or intentional
disregard of rules or regulations.
Negligence is defined as the failure to exercise the due
care that a reasonable and ordinarily prudent person would employ
under the circumstances.
(1985).
Neely v. Commissioner, 85 T.C. 934, 947
The question is whether a particular taxpayer's actions
in connection with the transactions were reasonable in light of
his experience and the nature of the investment or business.
See
Henry Schwartz Corp. v. Commissioner, 60 T.C. 728, 740 (1973).
When considering the negligence addition to tax, we evaluate the
particular facts of each case, judging the relative
sophistication of the taxpayers, as well as the manner in which
they approached their investment.
Memo. 1996-46.
McPike v. Commissioner, T.C.
Compare, e.g., Spears v. Commissioner, T.C. Memo.
1996-341, with Zidanich v. Commissioner, T.C. Memo. 1995-382.
When petitioners invested in the partnerships, they had no
education or experience in plastics materials or plastics
recycling, nor had any of them seen a Sentinel EPE recycler.
In
each of these consolidated cases, petitioners maintain that they
were reasonable in claiming deductions and investment credits
with respect to their investments in the Partnerships.
In
support of such contentions, petitioners argue, in general terms:
(1) That claiming the deductions and credits with respect to the
- 33 Partnerships was reasonable in light of the so-called oil crisis
during the years in issue; and (2) that they reasonably relied
upon the offering materials and a qualified adviser.
1.
The So-Called Oil Crisis
Petitioners argue that they reasonably expected to make an
economic profit from the Partnership transactions because plastic
is an oil derivative and the United States was experiencing a socalled oil crisis during the years 1981 and 1982.
Petitioners' contention that they reasonably expected an
economic profit from the Partnership transactions is
unconvincing.
Petitioners did not give due consideration to the
caveats and warnings contained in the offering memoranda, nor
seriously investigate or educate themselves in the Plastics
Recycling transactions.
Moreover, testimony by one of
respondent's experts establishes that the oil pricing changes
during the late 1970's and early 1980's did not justify
petitioners' claiming excessive investment credits and purported
losses based on vastly exaggerated valuations of recycling
machinery.
Petitioners' claim that they reasonably expected an economic
profit from the Partnership transactions is undermined by their
indifference to the warnings in the offering memoranda and their
lack of knowledge regarding the transactions in general,
notwithstanding the so-called oil crisis.
Mrs. Zenkel did not
- 34 know how many recyclers SAB Reclamation leased or who
manufactured the recyclers.
Blount had no idea who the general
partner of Phoenix was, how a Sentinel EPE recycler worked, the
value placed on the recyclers, how many recyclers Phoenix leased,
or how he was going to make a profit from his investment.
David
did not know how many recyclers SAB Recycling purchased or the
price of each machine.
Selvin knew nothing about resin prices,
was not aware of any companies that would be suitable end-users,
and did not know whether Scarborough had any assets, or how the
venture was to work.
Petitioners failed to explain how the so-called oil crisis,
or the media coverage of it, provided a reasonable basis for them
to invest in the Partnerships and claim the associated tax
deductions and credits.
The offering materials warned that there
could be no assurances that prices for new resin pellets would
remain at their then current level.
One of respondent's experts,
Steven Grossman, explained that the price of plastics materials
is not directly proportional to the price of oil.
In his report,
he stated that less than 10 percent of crude oil is utilized for
making plastics materials, and that studies have shown that "a
300% increase in crude oil prices results in only a 30 to 40%
increase in the cost of plastics products."
Moreover, during
1980 and 1981, in addition to the media coverage of the so-called
oil crisis, there was "extensive continuing press coverage of
- 35 questionable tax shelter plans."
Zmuda v. Commissioner, 731 F.2d
1417, 1422 (9th Cir. 1984), affg. 79 T.C. 714 (1982).
Petitioners' reliance on Krause v. Commissioner, 99 T.C. 132
(1992), affd. sub nom. Hildebrand v. Commissioner, 28 F.3d 1024
(10th Cir. 1994) and Rousseau v. United States, 71A AFTR 2d 934294, 91-1 USTC par. 50,252 (E.D. La. 1991), is misplaced.
The
facts in Krause v. Commissioner, supra, are distinctly different
from the facts of these cases.
In the Krause case, the taxpayers
invested in limited partnerships whose investment objectives
concerned enhanced oil recovery (EOR) technology.
The Krause
opinion states that during the late 1970's and early 1980's, the
Federal Government adopted specific programs to aid research and
development of EOR technology.
In holding that the taxpayers in
the Krause case were not liable for the negligence additions to
tax, this Court noted that one of the Government's expert
witnesses acknowledged that "investors may have been
significantly and reasonably influenced by the energy price
hysteria that existed in the late 1970's and early 1980's to
invest in EOR technology."
Id. at 177.
In the present cases,
however, as explained by respondent's expert Steven Grossman, the
price of plastics materials was not directly proportional to the
price of oil, and there is no persuasive evidence that the socalled oil crisis had a substantial bearing on petitioners'
decisions to invest.
While EOR was, according to our Krause
- 36 opinion, in the forefront of national policy and the media during
the late 1970's and 1980's, there is no showing in these records
that the so-called energy crisis would provide a reasonable basis
for petitioners' investing in recycling of polyethylene,
particularly in the machinery here in question.
Moreover, the taxpayers in the Krause opinion were
experienced in or investigated the oil industry and EOR
technology specifically.
One of the taxpayers in the Krause case
undertook significant investigation of the proposed investment
including researching EOR technology.
The other taxpayer was a
geological and mining engineer whose work included research of
oil recovery methods and who hired an independent geologic
engineer to review the offering materials.
Id. at 166.
In the
present cases, petitioners were not experienced or educated in
plastics recycling or plastics materials.
They did not
independently investigate the Sentinel recyclers or hire an
expert in plastics to evaluate the Partnership transactions.
In Rousseau v. United States, supra, the property underlying
the investment, ethanol producing equipment, was widely
considered at that time to be a viable fuel alternative to oil,
and its potential for profit was apparent.
In addition, the
taxpayer therein conducted an independent investigation of the
investment and researched the market for the sale of ethanol in
the United States.
In contrast, as we noted in distinguishing
- 37 the Krause case, there is no showing in these records that the
so-called oil crisis would provide a reasonable basis for
petitioners' investing in the polyethylene recyclers here in
question.
As noted above, petitioners did not independently
investigate the Sentinel EPE recyclers or hire an expert in
plastics to evaluate the Partnership transactions.
The facts of
petitioners' cases are distinctly different from the Rousseau
case.
Accordingly, we do not consider petitioners' arguments
with respect to the Krause and Rousseau cases applicable.
2.
Petitioners' Purported Reliance on Tax Advisers
Petitioners also maintain that they reasonably relied upon
the advice of a qualified adviser.
The Zenkels discussed the
investment with Steele and Becker; Blount discussed it with
Sprague; and the Davids and the Selvins discussed it with Becker.
The concept of negligence and the argument of reliance on an
expert are highly fact intensive.
Petitioners in these cases are
very well educated professionals whose intellect and business
sophistication are reflected in their financial and business
success.
Blount is a C.P.A. and business executive with 13 years
of accounting experience with Arthur Andersen, 3 of those as a
partner, and employment with American Home Products, a major
pharmaceutical company, initially as vice president of finance
and treasurer in 1974, and subsequently in positions of greater
responsibility.
David was a corporate attorney before engaging
- 38 in workouts and turnarounds of technology companies.
Selvin is a
C.P.A. who ran his own accounting firm for 30 to 35 years in New
York City.
In respect of these accomplishments and their obvious
financial prowess, petitioners Blount, David, and Selvin do not
pretend to be unsophisticated investors.
Mrs. Zenkel, on the other hand, claims that she is an
unsophisticated investor.
Her claim is without merit.
In her
SAB Reclamation subscription agreement, Mrs. Zenkel expressly
represented and warranted that she had the experience and
expertise in financial and business affairs necessary to evaluate
the merits and risks of investing in SAB Reclamation.
Moreover,
her decision to invest in SAB Reclamation was made with the
assistance of Mr. Zenkel, an investment banker with experience in
the syndication business.
Although Mr. Zenkel did not testify at
the trial4, the record shows that he discussed SAB Reclamation
with his wife, Steele, and Becker.
Becker testified that Mr.
Zenkel "called me directly regarding the program.
He had a large
Mr. and Mrs. Zenkel both benefited from the tax
deductions and credits from SAB Reclamation on their joint 1982
Federal Income tax return, and together they petitioned this
Court in docket No. 12091-89. The testimony of Mrs. Zenkel and
Becker shows that Mr. Zenkel was heavily involved in the decision
to invest in SAB Reclamation, and his failure to testify does not
further his wife's claim that she was an unsophisticated
investor. See Bresler v. Commissioner, 65 T.C. 182, 188 (1975);
Pollack v. Commissioner, 47 T.C. 92, 108 (1966), affd. 392 F.2d
409 (5th Cir. 1968); Wichita Terminal Elevator Co. v.
Commissioner, 6 T.C. 1158, 1165 (1946), affd. 162 F.2d 513 (10th
Cir. 1947).
4
- 39 number of questions which I answered for him, and apparently
based on that he made his decision to invest."
(Emphasis added.)
The Zenkels are not unsophisticated investors.
On their 1982
return, they reported dividend income in the amount of $146,644
and net long-term capital gains in the amount of $155,144.
Petitioners assert that they relied upon one or more members
of the accounting firm of Becker Co., and in particular on its
founder and principal owner Stuart Becker, to investigate the tax
law and the underlying business circumstances of a proposed
investment.
In the Blount case, petitioner placed reliance on
this firm only indirectly or secondhand, through Sprague.
Becker, who is experienced in tax matters, explains that he made
an investigation within the limits of his resources and abilities
and fully disclosed what he had done.
The question here is
whether petitioners actually and reasonably relied on the
accountant with respect to valuation problems requiring expertise
in engineering and plastics technology or whether the accountant
gave the tax advice and facilitated the transaction, but did not
make a full and independent investigation of the relevant
business and technology, and did clearly inform his clients of
the limits of his knowledge and investigation of the transaction.
For reasons set forth below, we believe the latter statement more
accurately describes what happened here.
a. The Circumstances Under Which a Taxpayer
May Avoid Liability Under Section 6653(a)(1)
- 40 and (2) Because of Reasonable Reliance on
Competent and Fully Informed Professional
Advice
A taxpayer may avoid liability for the additions to tax
under section 6653(a)(1) and (2) if he or she reasonably relied
on competent professional advice.
United States v. Boyle, 469
U.S. 241, 250-251 (1985); Freytag v. Commissioner, 89 T.C. 849,
888 (1987), affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S.
868 (1991).
Reliance on professional advice, standing alone, is
not an absolute defense to negligence, but rather a factor to be
considered.
For reliance on professional advice to excuse a
taxpayer from the negligence additions to tax, the taxpayer must
show that such professional had the expertise and knowledge of
the pertinent facts to provide informed advice on the subject
matter.
David v. Commissioner, 43 F.3d
788, 789-790 (2d Cir.
1995), affg. T.C. Memo. 1993-621; Goldman v. Commissioner, 39
F.3d 402 (2d Cir. 1994), affg. T.C. Memo. 1993-480; Freytag v.
Commissioner, supra; Sacks v. Commissioner, T.C. Memo. 1994-217,
affd. 82 F.3d 918 (9th Cir. 1996); Kozlowski v. Commissioner,
T.C. Memo. 1993-430, affd. without published opinion 70 F.3d 1279
(9th Cir. 1995); see also Stone v. Commissioner, T.C. Memo. 1996230; Reimann v. Commissioner, T.C. Memo. 1996-84.
Reliance on representations by insiders, promoters, or
offering materials has been held an inadequate defense to
negligence.
Goldman v. Commissioner, supra; Pasternak v.
- 41 Commissioner, 990 F.2d 893 (6th Cir. 1993), affg. Donahue v.
Commissioner, T.C. Memo. 1991-181; LaVerne v. Commissioner, 94
T.C. 637, 652-653 (1990), affd. without published opinion 956
F.2d 274 (9th Cir. 1992), affd. without published opinion sub
nom. Cowles v. Commissioner, 949 F.2d 401 (10th Cir. 1991);
Marine v. Commissioner, 92 T.C. 958, 992-993 (1989), affd.
without published opinion 921 F.2d 280 (9th Cir. 1991); McCrary
v. Commissioner, 92 T.C. 827, 850 (1989); Rybak v. Commissioner,
91 T.C. 524, 565 (1988).
Pleas of reliance have been rejected
when neither the taxpayer nor the advisers purportedly relied
upon by the taxpayer knew anything about the nontax business
aspects of the contemplated venture.
David v. Commissioner,
supra; Goldman v. Commissioner, supra; Freytag v. Commissioner,
supra; Beck v. Commissioner, 85 T.C. 557 (1985); Lax v.
Commissioner, T.C. Memo. 1994-329, affd. without published
opinion 72 F.3d 123 (3d Cir. 1995); Sacks v. Commissioner, supra;
Steerman v. Commissioner, T.C. Memo. 1993-447; Rogers v.
Commissioner, T.C. Memo. 1990-619; see also the Plastics
Recycling cases cited, supra note 2.
b.
Becker
Becker had no education, special qualifications, or
professional skills in plastics engineering, plastics recycling,
or plastics materials.
In evaluating the Plastics Recycling
transactions and organizing the SAB Recycling Partnerships,
- 42 Becker supposedly relied upon:
(1) The offering materials; (2) a
tour of the PI facility in Hyannis; (3) discussions with insiders
to the transactions; (4) Canno; and (5) his investigation of the
reputation and background of PI and persons involved in the
transactions.
Despite his lack of knowledge regarding the product, the
target market, and the technical aspects at the heart of the
Plastics Recycling transactions, Becker did not hire an expert in
plastics materials or plastics recycling, or recommend that his
clients do so.
The only independent person having any connection
with the plastics industry with whom Becker spoke was Canno.
A
client of Becker Co., Canno was a part owner and the production
manager of Equitable Bag Co., a manufacturer of paper and plastic
bags.
Becker spoke to Canno about the recyclers and PI, but did
not hire or pay him for any advice.
Canno did not visit PI's
plant in Hyannis, see or test a Sentinel EPE recycler, or see or
test any of the output from a Sentinel EPE recycler or the
recycled resin pellets after they were further processed by PI.
According to Becker, Canno endorsed the Partnership transactions
after reviewing the offering materials.
Asked at trial if Canno
had done any type of comparables analysis, Becker replied, "I
don't know what Mr. Canno did."
Becker visited the PI plant in Hyannis, toured the facility,
viewed a Sentinel EPE recycler in operation, and saw products
- 43 that were produced from recycled plastic.
He claims that during
his visit he was told that the recycler was unique and that it
was the only machine of its type.
In fact, the Sentinel EPE
recycler was not unique; instead, several machines capable of
densifying low density materials already were on the market.
Other plastics recycling machines available during 1981 ranged in
price from $20,000 to $200,000, including the Foremost
Densilator, Nelmor/Weiss Densification System (Regenolux), BussCondux Plastcompactor, and Cumberland Granulator.
See Provizer
v. Commissioner, T.C. Memo. 1992-177.
Becker was also told that PI had put an enormous amount of
research and development--10 to 12 years' worth--into the
creation and production of the Sentinel EPE recycler.
When he
asked to see the cost records for some kind of independent
verification, however, his request was denied.
Becker was
informed that such information was proprietary and secret, and
that he would just have to take PI's representations as true.
Although PI claimed that all of its information was a trade
secret, and that it never obtained patents on any of its
machines, PI had in fact obtained numerous patents prior to the
recycling transactions and had also applied for a trademark for
the Sentinel recyclers.
Becker decided to accept PI's
representations after speaking with Miller (the corporate counsel
to PI), Canno (who had never been to PI's plant or seen a
- 44 Sentinel EPE recycler), and a surrogate judge from Rhode Island
who did business in the Boston-Cape Cod area (and who had no
expertise in engineering or plastics materials).
Becker
testified that he was allowed to see PI's internal accounting
controls regarding the allocation of royalty payments and PI's
recordkeeping system in general.
In Provizer v. Commissioner,
supra, this Court found that "PI had no cost accounting system or
records."
Becker confirmed at trial that he relied on the offering
materials and discussions with PI personnel to establish the
value and purported uniqueness of the recyclers.
Becker
testified that he relied upon the reports of Ulanoff and Burstein
contained in the offering materials, despite the fact that:
(1)
Ulanoff's report did not contain any hard data to support his
opinion; (2) Ulanoff was not an economics or plastics expert; (3)
Becker did not know whether Burstein was an engineer; and (4)
Burstein was a client of Miller's and was not an independent
expert.
In addition, Ulanoff and Burstein each owned an interest
in more than one partnership that owned Sentinel recyclers as
part of the Plastics Recycling program.
Becker explained at trial that in the course of his practice
when evaluating prospective investments for clients, he focuses
on the economics of the transaction and investigates whether
there is a need or market for the product or service.
With
- 45 respect to the Partnership transactions, the records indicate
that Becker overlooked several red flags regarding the economic
viability and market for the Sentinel EPE recyclers.
The
offering memoranda for the Partnership transactions warned that
there was no established market for the Sentinel EPE recyclers.
Becker never saw any marketing plans for selling the pellets or
leasing the recyclers.
He accepted representations by PI
personnel that they would be marketing the recyclers to clients
and that there was a sufficient base of end-users for the
machines, yet he never saw PI's client list.
At the time of the
closing of the Partnerships, Becker did not know who the endusers were or whether there were any end-users actually committed
to the transaction.
Becker purportedly checked the price of the pellets by
reading trade journals of the plastics industry.
However, he did
not use those same journals to investigate the recyclers'
purported value or to see whether there were any advertisements
for comparable machines.
The record in these cases does not
indicate that any of petitioners or their advisers other than
Becker asked to see those journals for their own examination.
In
concluding that the Partnerships would be economically
profitable, Becker made two assumptions that he concedes were
unsupported by any hard data:
(1) That there was a market for
the pellets; and (2) that market demand for them would increase.
- 46 Becker also had a financial interest in SAB Reclamation and
SAB Recovery.
He received fees in excess of $500,000 with
respect to the SAB Recycling Partnerships, more than $200,000 of
which was derived from SAB Reclamation and SAB Recycling.
Becker
also received fees from individual investors for investment
advice.
In addition, Becker Co. received fees from the SAB
Recycling Partnerships for preparing their partnership returns.
As Becker himself testified, petitioners could not have read the
offering materials and been ignorant of the financial benefits
accruing to him.
We find that petitioners' purported reliance on Becker was
not reasonable, not in good faith, nor based upon full
disclosure.
Becker's expertise was in taxation, not plastics
materials or plastics recycling, and his investigation and
analysis of the Plastics Recycling transactions reflected this
circumstance.
Selvin and David knew Becker was not expert in
plastics materials or plastics recycling, and the Zenkels and
Blount had no reason to believe otherwise.
Becker testified that
he was very careful not to mislead any of his clients regarding
the particulars of his investigation.
As he put it:
"I don't
recall saying to a client I did due diligence * * * [Rather,] I
told [my clients] precisely what I had done to investigate or
analyze the transaction.
I didn't just say I did due diligence,
- 47 and leave it open for them to define what I might or might not
have done."
The purported value of the Sentinel EPE recycler generated
the deductions and credits in these cases, and that circumstance
was reflected in the offering memoranda.
Certainly Becker
recognized the nature of the tax benefits and, given their
education and business experience, petitioners should have
recognized it as well.
Yet neither petitioners nor Becker
verified the purported value of the Sentinel EPE recycler.
Becker confirmed at trial that he relied on PI for the value of
the Sentinel EPE recyclers.
Investors as sophisticated as
petitioners either learned or should have learned the source and
shortcomings of Becker's valuation information when he reported
to them and "precisely" disclosed "what [he] had done to
investigate or analyze the transaction."
Accordingly, we hold
that petitioners did not reasonably or in good faith rely on
Becker as an expert or a qualified professional working in the
area of his expertise to establish the fair market value of the
Sentinel EPE recycler and the economic viability of the
Partnership transactions.
Becker never assumed such
responsibility, and he fully described the particulars of his
investigation, taking care not to mischaracterize it as "due
diligence."
- 48 In the end, Becker and petitioners relied on PI personnel
for the value of the Sentinel EPE recyclers and the economic
viability of the Partnership transactions.
See Vojticek v.
Commissioner, T.C. Memo. 1995-444, to the effect that advice from
such persons "is better classified as sales promotion."
Becker
did not have any education, special qualifications, or
professional skills in plastics materials or plastics recycling.
A taxpayer may rely upon his adviser's expertise (in these cases,
accounting and tax advice), but it is not reasonable or prudent
to rely upon a tax adviser regarding matters outside of his field
of expertise or with respect to facts that he does not verify.
See David v. Commissioner, 43 F.3d at 789-790; Goldman v.
Commissioner, 39 F.3d at 408; Skeen v. Commissioner, 864 F.2d 93
(9th Cir. 1989), affg. Patin v. Commissioner, 88 T.C. 1086
(1987); Lax v. Commissioner, T.C. Memo. 1994-329; Sacks v.
Commissioner, T.C. Memo. 1994-217; Rogers v. Commissioner, T.C.
Memo. 1990-619; see also Estate of Busch v. Commissioner, T.C.
Memo. 1996-342, Spears v. Commissioner, T.C. Memo. 1996-341, with
respect to Becker's advice in Plastics Recycling cases.
c.
Steele and Sprague
Petitioners Zenkel and Blount purport to have relied on
advisers other than or in addition to Becker.
The only person
with whom Blount discussed the Plastics Recycling transactions
was Sprague, who in turn had spoken with Becker and Leicht.
- 49 Blount also gave a copy of the offering memorandum to his tax
return preparer, Gowin.
Mr. Zenkel spoke to Becker; both he and
Mrs. Zenkel spoke to Steele.
Blount learned about the Plastics Recycling transactions
from Sprague.
Sprague suggested the Plastics Recycling
transactions to Blount as an investment option after Blount
mentioned that he was going to receive additional compensation
income.
Sprague recalled introducing the investment to Blount in
the following manner:
"[I]f you're looking for investments, you
might contact Stephen Leicht or Stuart Becker, because I * * *
understand that they, as a service to clients, do screen numerous
such investments, not to guarantee them but to just generally
determine if they believe they would be suitable for referring *
* * to their clients to take a look at."
(Emphasis added.)
Sprague then went on to describe the Plastics Recycling
information he had received from Leicht and Becker "in a general
way."
Blount never spoke to Becker or Leicht.
He simply reviewed
the offering memorandum, spoke with Sprague, and furnished the
offering memorandum to his tax return preparer.
Sprague is not
an expert in plastics materials or plastics recycling and could
not evaluate the technical or engineering details of the Phoenix
transaction.
He testified that in 1981 he "was a complete
stranger to this notion of reprocessing plastics and recycling."
- 50 Sprague's investigation of Phoenix consisted of reading the
offering memorandum and talking to Leicht and Becker.
Blount has
not shown that his tax return preparer, Gowin, possessed the
requisite expertise in recycling or the plastics industry to have
enabled her properly to evaluate the merits of the Phoenix
transaction.
In light of the foregoing, Blount will not be
relieved of the negligence additions to tax based upon his
purported reliance on Sprague and Gowin.
Mr. and Mrs. Zenkel each discussed the investment with
Steele.
Neither Steele nor Mr. Zenkel testified in docket No.
12091-89.
Mrs. Zenkel could not recall the content of her
conversations with Steele; she remembered only that he told her
that the investment had tax benefits and that he responded
positively when she asked him if SAB Reclamation was a worthwhile
investment.
Mrs. Zenkel testified that she did not know that
Becker Co. was involved in tax-oriented investments, whether
Steele had any background in plastics materials or plastics
recycling, whether Becker or Steele investigated PI, whether they
investigated and/or compared the recycler with any similar
products, whether they investigated end-users, or whether either
of them checked with independent plastics experts as to the value
of the recycler.
Mrs. Zenkel testified that if she had known any
of the particulars of Becker's and Steele's investigation, she
has since forgotten them.
The record in docket No. 12091-89 does
- 51 not establish that the Zenkels' purported reliance on Steele was
reasonable, in good faith, or based upon full disclosure.
3.
The Private Offering Memoranda
In addition to purportedly relying on Becker, Steele, and/or
Sprague, petitioners maintain that they reasonably relied upon
the offering memoranda and the tax opinion letter appended
thereto.
However, petitioners' testimony and actions indicate
that they did not thoroughly review or study all of the
information set out in the offering memoranda and that they
ultimately did not place a great deal of reliance, if any, on the
representations therein.
The offering memoranda included numerous caveats and
warnings with respect to the Partnerships, including:
(1) The
substantial likelihood of audit by the IRS and a likely challenge
of the purported value of the recyclers; (2) the general
partners' lack of experience in marketing recycling or similar
equipment; (3) the lack of an established market for the
recyclers; and (4) uncertainties regarding the market prices for
virgin resin and the possibility that recycled pellets would not
be as marketable as virgin pellets.
In addition, the offering
memoranda noted a number of conflicts of interest, including
Miller's interest in F & G Corp. and his representation of
Burstein, PI, and Grant, who was the sole shareholder of ECI
Corp.
A careful consideration of the materials in the respective
- 52 offering memoranda in these cases, especially the discussions of
high writeoffs and risk of audit, should have alerted a prudent
and reasonable investor to the questionable nature of the
promised deductions and credits.
See Collins v. Commissioner,
857 F.2d 1383, 1386 (9th Cir. 1988), affg. Dister v.
Commissioner, T.C. Memo. 1987-217; Sacks v. Commissioner, T.C.
Memo. 1994-217.
In each case, the projected tax benefits in the respective
offering memoranda exceeded petitioners' respective investments.
According to the offering memoranda, for each $50,000 investor,
the projected first-year tax benefits were investment tax credits
in excess of $82,500 plus deductions in excess of $39,000.
Specifically, the projected investment tax credits and deductions
for the Partnerships in the first year of the investment for each
$50,000 investor were as follows:
$82,639 and $39,323 for
Scarborough in 1981; $84,813 and $40,671 for Phoenix in 1981;
$82,639 and $40,037 for SAB Recycling in 1982; and $83,712 and
$40,234 for SAB Reclamation in 1982.
For Mrs. Zenkel's gross $50,000 investment, the Zenkel's
claimed an operating loss in the amount of $40,100 and investment
tax and business energy credits in the amount of $83,712.
As a
result of his gross $25,000 investment, Blount claimed a $20,520
operating loss and $42,402 in investment tax and business energy
credits.
For their gross $25,000 investment, the Davids claimed
- 53 an operating loss in the amount of $19,871 and investment tax and
business energy credits totaling $41,320.
For their $27,000
investment, the Selvins claimed investment tax and business
energy credits in the amount of $44,626.
The direct reductions in petitioners' Federal income tax,
from the investment tax credits alone, ranged from 149 percent to
170 percent of their cash investments, without consideration of
any rebated commissions or advance royalty payments.
Therefore,
after adjustments of withholding, estimated tax, or final
payment, like the taxpayers in Provizer v. Commissioner, T.C.
Memo. 1992-177, "except for a few weeks at the beginning,
petitioners never had any money in the * * * [Partnership
transactions]."
In view of the disproportionately large tax
benefits claimed on petitioners' 1981 and 1982 Federal income tax
returns, relative to the dollar amounts invested, further
investigation of the Partnership transactions clearly was
required.
A reasonably prudent person would have asked a
qualified independent tax adviser if this windfall were not too
good to be true.
McCrary v. Commissioner, 92 T.C. at 850.
A
reasonably prudent person would not conclude without substantial
investigation that the Government was providing tax benefits so
disproportionate to the taxpayers' investment of their own
capital.
- 54 Petitioners' reliance upon the Court of Appeals for the
Ninth Circuit's partial reversal of our decision in Osterhout v.
Commissioner, T.C. Memo. 1993-251, affd. in part and revd. in
part without published opinion sub nom. Balboa Energy Fund 1981
v. Commissioner, 85 F.3d 634 (9th Cir. 1996), is misplaced.
In
Osterhout, we found that certain oil and gas partnerships were
not engaged in a trade or business and sustained respondent's
imposition of the negligence additions to tax with respect to one
of the partners therein.5
The Court of Appeals for the Ninth
Circuit reversed our imposition of the negligence additions to
tax.
Petitioners point out that the taxpayer in that case relied
in part upon a tax opinion contained in the offering materials.
However, the offering memoranda for the Partnerships herein
warned prospective investors that the accompanying tax opinion
letters were not in final form, and were prepared for the general
partner, and that prospective investors should consult their own
professional advisers with respect to the tax benefits and tax
risks associated with the respective Partnerships.
The tax
opinion letters accompanying the SAB Reclamation and SAB
Osterhout v. Commissioner, T.C. Memo. 1993-251, affd.
in part and revd. in part without published opinion sub nom.
Balboa Energy Fund 1981 v. Commissioner, 85 F.3d 634 (9th Cir.
1996), involved a group of consolidated cases. The parties
therein agreed to be bound by the Court's opinion regarding the
application of the additions to tax under sec. 6653(a), inter
alia. Accordingly, although the Court's analysis focused on one
taxpayer, the additions to tax were sustained with respect to all
of the taxpayers.
5
- 55 Recycling offering memoranda were addressed solely to the general
partner and began with the following disclaimer:
This opinion is provided to you for your individual
guidance. We expect that prospective investors will
rely upon their own professional advisors with respect
to all tax issues arising in connection with an
investment in the Partnership and the operations
thereof. We recognize that you intend to include this
letter with your offering materials and we have
consented to that with the understanding that the
purpose in distributing it is to assist your offerees'
and their tax advisors in making their own analysis and
not to permit any prospective investor to rely upon our
advice in this matter. [Emphasis added.]
A similar disclaimer appears in the tax opinion letter
accompanying the Scarborough offering memorandum.
(The copy of
the Phoenix offering memorandum submitted into the record of
docket No. 19760-89 is missing page 1 of the tax opinion letter,
the page that contains the opening disclaimer).
Accordingly, the
tax opinion letters expressly indicate that prospective investors
such as petitioners were not to rely upon the tax opinion
letters.
See Collins v. Commissioner, 857 F.2d at 1386.
The
limited, technical opinion of tax counsel expressed in these
letters was not designed as advice upon which taxpayers might
rely and the opinion of counsel itself so states.
4.
Miscellaneous
The parties in these consolidated cases stipulated that the
fair market value of a Sentinel EPE recycler in 1981 and 1982 was
not in excess of $50,000.
Notwithstanding this concession,
petitioners contend that they were reasonable in claiming credits
- 56 on their Federal income tax returns based upon each recycler
having a value of $1,162,666.
In support of this position,
petitioners submitted into evidence preliminary reports prepared
for respondent by Ernest D. Carmagnola (Carmagnola), the
president of Professional Plastic Associates.
Carmagnola had
been retained by the IRS in 1984 to evaluate the Sentinel EPE and
EPS recyclers in light of what he described as "the fantastic
values placed on the [recyclers] by the owners."
Based on
limited information available to him at that time, Carmagnola
preliminarily estimated that the value of the Sentinel EPE
recycler was $250,000.
However, after additional information
became available to him, Carmagnola concluded in a signed
affidavit, dated March 16, 1993, that the machines actually had a
fair market value of not more than $50,000 each in the fall of
1981 and 1982.
We accord no weight to the Carmagnola reports submitted by
petitioners.
The projected valuations therein were based on
inadequate information, research, and investigation, and were
subsequently rejected and discredited by their author.
In one
preliminary report, Carmagnola states that he has "a serious
concern of actual profit" from a Sentinel EPE recycler and that
to determine whether the machines actually could be profitable,
he required additional information from PI.
Carmagnola also
indicates that in preparing the report, he did not have
- 57 information available concerning research and development costs
of the machines and that he estimated those costs in his
valuations of the machines.
Respondent rejected the Carmagnola reports and considered
them unsatisfactory for any purpose; and there is no indication
in the records that respondent used them as a basis for any
determinations in the notices of deficiency.
Even so,
petitioners' counsel obtained copies of these reports and urge
that they support the reasonableness of the values reported on
petitioners' returns.
Not surprisingly, petitioners' counsel did
not call Carmagnola to testify in these cases, but preferred
instead to rely solely upon his preliminary, ill-founded
valuation estimates.
Carmagnola has not been called to testify
in any of the Plastics Recycling cases before us.
The Carmagnola
reports were a part of the record considered by this Court and
reviewed by the Court of Appeals for the Sixth Circuit in the
Provizer case, where we held the taxpayers negligent.
Consistent
therewith, we find in these cases, as we have found previously,
that the reports prepared by Carmagnola are unreliable and of no
consequence.
Petitioners are not relieved of the negligence
additions to tax based on the preliminary reports prepared by
Carmagnola.
Petitioners rely on Reile v. Commissioner, T.C. Memo. 1992488, Davis v. Commissioner, T.C. Memo. 1989-607, and Mollen v.
- 58 United States, 72 AFTR 2d 93-6443, 93-2 USTC par. 50,585 (D.
Ariz. 1993).
This Court declined to sustain the negligence
additions to tax in the Reile and Davis cases for reasons
In the Davis case, the taxpayers
inapposite to the facts herein.
reasonably relied upon a "trusted and long-term adviser" who was
independent of the investment venture, and the offering materials
reviewed by the taxpayers did not reflect that the principals in
the venture lacked experience in the pertinent line of business.
In the Reile case, the taxpayers, a married couple, had only one
year of college between them and characterized themselves as
financial "dummies."
In contrast to those cases, petitioners
herein are well educated, sophisticated, and successful
professional and business people.
Their reliance on Becker,
Steele, and/or Sprague with respect to the essential valuation
issue and the economic viability and bona fides of the
Partnership transactions was misplaced and inconsistent with
Becker's disclosure of the limitations of his investigation.
Although Blount did not talk to Becker, Sprague related to Blount
the particulars of Becker's investigation.
In addition, the
offering memoranda disclosed that the Partnerships had no prior
operating history and that the general partner had no prior
experience in marketing recycling or similar equipment.
Accordingly, petitioners' reliance on the Reile and Davis cases
is misplaced.
- 59 In Mollen, the taxpayer was a medical doctor who specialized
in diabetes and who, on behalf of the Arizona Medical
Association, led a continuing medical education (CME)
accreditation program for local hospitals.
The underlying tax
matter involved the taxpayer's investment in Diabetics CME Group,
Ltd., a limited partnership that invested in the production,
marketing, and distribution of medical educational video tapes.
The District Court found that the taxpayer's personal expertise
and insight in the underlying investment gave him reason to
believe it would be economically profitable.
Although the
taxpayer was not experienced in business or tax matters, he did
consult with an accountant and a tax lawyer regarding those
matters.
Moreover, the District Court noted that the propriety
of the taxpayer's disallowed deduction therein was "reasonably
debatable."
Id.
Neither petitioners nor Becker had any formal education,
expertise, or experience in plastics materials or plastics
recycling.
None of them had any personal insight or industry
know-how in plastics recycling that would reasonably lead them to
believe that the Plastics Recycling transactions would be
economically profitable.
Becker and petitioners relied upon
representations by insiders to the Plastics Recycling
transactions, and neither he nor petitioners hired any
independent experts in the field of plastic materials or plastics
- 60 recycling.
Becker purportedly discussed the transactions with
Canno, who apparently was familiar with the plastics industry,
but Canno was not hired by Becker to investigate PI and the
Sentinel EPE recycler, never saw a Sentinel EPE recycler, and
never prepared any kind of formal, written analysis of the
venture.
Accordingly, we consider petitioners' arguments with
respect to the Mollen case inapplicable under the circumstances
of these cases.
Petitioners also rely on two recent decisions by the Court
of Appeals for the Fifth Circuit that reversed this Court's
imposition of the negligence additions to tax in non-plastics
recycling cases:
Durrett v. Commissioner, 71 F.3d 515 (5th Cir.
1996), affg. in part and revg. in part T.C. Memo. 1994-179; and
Chamberlain v. Commissioner, 66 F.3d 729 (5th Cir. 1995), affg.
in part and revg. in part T.C. Memo. 1994-228.
The taxpayers in
the Durrett and Chamberlain cases were among thousands who
invested in the First Western tax shelter program involving
alleged straddle transactions of forward contracts.
In the
Durrett and Chamberlain cases, the Court of Appeals for the Fifth
Circuit concluded that the taxpayers reasonably relied upon
professional advice concerning tax matters.
In other First
Western cases, however, the Courts of Appeals have affirmed
decisions of the Tax Court imposing negligence additions to tax.
See Chakales v. Commissioner, T.C. Memo. 1994-408 (reliance on
- 61 long-term adviser who was a tax attorney and accountant, and who
in turn relied on a promoter of the venture, held unreasonable),
affd. 79 F.3d 726 (8th Cir. 1996); Kozlowski v. Commissioner,
T.C. Memo. 1993-430 (reliance on adviser held unreasonable absent
a showing that the adviser understood the transaction and was
qualified to give an opinion whether it was bona fide), affd.
without published opinion 70 F.3d 1279 (9th Cir. 1995); Freytag
v. Commissioner, 89 T.C. 849 (1987) (reliance on tax advice given
by attorneys and C.P.A.'s held unreasonable absent a showing that
the taxpayers consulted any experts regarding the bona fides of
the transactions), affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501
U.S. 868 (1991).
Here we have found that none of the advisers
consulted by petitioners possessed sufficient knowledge of the
plastics recycling business to render a competent opinion.
This
factor has been deemed relevant by the Court of Appeals for the
Second Circuit, the Court to which appeal in these cases lie.
See David v. Commissioner, 43 F.3d at 789-790 (taxpayers'
reliance on expert advice not reasonable where expert lacks
knowledge of business in which taxpayers invested); Goldman v.
Commissioner, 39 F.3d at 408 (same).
Accordingly, we will not
relieve petitioners of the negligence additions to tax on the
basis of petitioners' reliance on the Court of Appeals' decisions
in the Durrett and Chamberlain cases.
- 62 5.
Conclusion as to Negligence
Under the circumstances of these cases, petitioners failed
to exercise due care in claiming large deductions and tax credits
with respect to the Partnerships on their respective Federal
income tax returns.
Petitioners did not reasonably rely upon the
offering memoranda, or on Becker, Steele, and/or Sprague, and
they did not in good faith investigate the underlying viability,
financial structure, and economics of the Partnership
transactions herein.
We are unconvinced by the claims of these
highly sophisticated, able, and successful business people that
they reasonably failed to inquire about their investments and
simply relied on the offering circulars and on Steele, Sprague,
and ultimately Becker, despite warnings in the offering circulars
and explanations by Becker about the limitations of his
investigation.
In each case, these taxpayers knew or should have
known better.
We hold, upon consideration of the entire records,
that petitioners are liable for the negligence additions to tax
under the provisions of section 6653(a)(1) and (2) for the
taxable years at issue.
C.
Respondent is sustained on this issue.
Section 6659--Valuation Overstatement
Respondent determined that petitioners are each liable for
the section 6659 addition to tax on the portion of their
respective underpayments attributable to valuation overstatement.
- 63 Petitioners have the burden of proving that respondent's
determinations of these section 6659 additions to tax are
erroneous.
Rule 142(a); Luman v. Commissioner, 79 T.C. at 860-
861.
A graduated addition to tax is imposed when an individual
has an underpayment of tax that equals or exceeds $1,000 and "is
attributable to" a valuation overstatement.
Sec. 6659(a), (d).
A valuation overstatement exists if the fair market value (or
adjusted basis) of property claimed on a return equals or exceeds
150 percent of the amount determined to be the correct amount.
Sec. 6659(c).
If the claimed valuation exceeds 250 percent of
the correct value, the addition is equal to 30 percent of the
underpayment.
Sec. 6659(b).
Petitioners claimed tax benefits, including an investment
tax credit and a business energy credit, based on purported
values of $1,162,666 for each Sentinel EPE recycler.
Petitioners
concede that the fair market value of a Sentinel EPE recycler in
1981 and 1982 was not in excess of $50,000.
Therefore, if
disallowance of petitioners' claimed tax benefits is attributable
to such valuation overstatements, petitioners are liable for the
section 6659 addition to tax at the rate of 30 percent of the
underpayment of tax attributable to the tax benefits claimed with
respect to the Partnerships.
- 64 Petitioners argue that section 6659 does not apply in their
cases for the following reasons:
(1) Disallowance of the claimed
tax benefits was attributable to other than a valuation
overstatement; (2) petitioners' concessions of the claimed tax
benefits precludes imposition of the section 6659 additions to
tax; and (3) respondent erroneously failed to waive the section
6659 addition to tax.
We reject each of these arguments in these
cases for reasons set forth below.
1.
The Grounds for Petitioners' Underpayments
Section 6659 does not apply to underpayments of tax that are
not "attributable to" valuation overstatements.
See McCrary v.
Commissioner, 92 T.C. 827 (1989); Todd v. Commissioner, 89 T.C.
912 (1987), affd. 862 F.2d 540 (5th Cir. 1988).
To the extent
taxpayers claim tax benefits that are disallowed on grounds
separate and independent from alleged valuation overstatements,
the resulting underpayments of tax are not regarded as
attributable to valuation overstatements.
Krause v.
Commissioner, 99 T.C. 132, 178 (1992) (citing Todd v.
Commissioner, supra), affd. sub nom. Hildebrand v. Commissioner,
28 F.3d 1024 (10th Cir. 1994).
However, when valuation is an
integral factor in disallowing deductions and credits, section
6659 is applicable.
See Illes v. Commissioner, 982 F.2d 163, 167
(6th Cir. 1992), affg. T.C. Memo. 1991-449; Gilman v.
- 65 Commissioner, 933 F.2d 143, 151 (2d Cir. 1991) (section 6659
addition to tax applies if a finding of lack of economic
substance is "due in part" to a valuation overstatement), affg.
T.C. Memo. 1989-684; Masters v. Commissioner, T.C. Memo. 1994197, affd. without published opinion 70 F.3d 1262 (4th Cir.
1995); Harness v. Commissioner, T.C. Memo. 1991-321.
Petitioners argue that the disallowance of the claimed tax
benefits was not "attributable to" a valuation overstatement.
According to petitioners, the tax benefits were disallowed
because the Partnership transactions lacked economic substance,
not because of any valuation overstatements.
It follows,
petitioners reason, that because the "attributable to" language
of section 6659 requires a direct causative relationship between
a valuation overstatement and an underpayment in tax, section
6659 cannot apply to their deficiencies.
Petitioners cite in
support of this argument, Todd v. Commissioner, supra; Heasley v.
Commissioner, 902 F.2d 380 (5th Cir. 1990), revg. T.C. Memo.
1988-408; Gainer v. Commissioner, 893 F.2d 225 (9th Cir. 1990),
affg. T.C. Memo. 1988-416; McCrary v. Commissioner, supra.
Petitioners' argument rests on the mistaken premise that our
holding herein that the Partnership transactions lacked economic
substance was separate and independent from the overvaluation of
the Sentinel EPE recyclers.
To the contrary, in holding that the
- 66 Partnership transactions lacked economic substance, we relied
heavily upon the overvaluation of the recyclers.
Overvaluation
of the recyclers was an integral factor in regard to:
(1) The
disallowed tax credits and other benefits in these cases; (2) the
underpayments of tax; and (3) our finding that the Partnership
transactions lacked economic substance.
Petitioners argue that in Provizer v. Commissioner, T.C.
Memo. 1992-177, we found that the Clearwater transaction lacked
economic substance for reasons independent of the valuation
reported in that case.
According to petitioners, the purported
value of the recyclers in the Clearwater transaction was
predicated upon a projected stream of royalty income, and this
Court merely rejected the taxpayers' valuation method.
Petitioners misread and distort our Provizer opinion.
In the
Provizer case, overvaluation of the Sentinel EPE recyclers,
irrespective of the technique employed by the taxpayers in their
efforts to justify the overvaluation, was the dominant factor
that led us to hold that the Clearwater transaction lacked
economic substance.
Likewise, overvaluation of the Sentinel EPE
recyclers in these cases is the ground for our holding herein
that the Partnership transactions lacked economic substance.
Moreover, a virtually identical argument was recently
rejected in Gilman v. Commissioner, supra, by the Court of
- 67 Appeals for the Second Circuit, the Court to which appeal in
these cases lie.
See Golsen v. Commissioner, 54 T.C. 742, 756-
758 (1970), affd. 445 F.2d 985 (10th Cir. 1971).
In the Gilman
case, the taxpayers engaged in a computer equipment sale and
leaseback transaction that this Court held was a sham transaction
lacking economic substance.
The taxpayers therein, citing Todd
v. Commissioner, supra, and Heasley v. Commissioner, supra,
argued that their underpayment of taxes derived from
nonrecognition of the transaction for lack of economic substance,
independent of any overvaluation.
The Court of Appeals for the
Second Circuit sustained imposition of the section 6659 addition
to tax because overvaluation of the computer equipment
contributed directly to this Court's earlier conclusion that the
transaction lacked economic substance and was a sham.
Commissioner, supra at 151.
Gilman v.
In addition, the Court of Appeals
for the Second Circuit agreed with this Court and with the Court
of Appeals for the Eighth Circuit that "'when an underpayment
stems from disallowed * * * investment credits due to lack of
economic substance, the deficiency is * * * subject to the
penalty under section 6659.'"
Gilman v. Commissioner, supra at
151 (quoting Massengill v. Commissioner, 876 F.2d 616, 619-620
(8th Cir. 1989), affg. T.C. Memo. 1988-427); see also Rybak v.
Commissioner, 91 T.C. 524, 566-567 (1988); Zirker v.
- 68 Commissioner, 87 T.C. 970, 978-979 (1986); Donahue v.
Commissioner, T.C. Memo. 1991-181, affd. without published
opinion 959 F.2d 234 (6th Cir. 1992), affd. sub nom. Pasternak v.
Commissioner, 990 F.2d 893 (6th Cir. 1993).
Petitioners' reliance on Gainer v. Commissioner, supra, Todd
v. Commissioner, 862 F.2d 540 (5th Cir. 1988), and McCrary v.
Commissioner, supra, is misplaced.
In those cases, in contrast
to the consolidated cases herein, it was found that a valuation
overstatement did not contribute to an underpayment of taxes.
In
the Todd and Gainer cases, the underpayments were due exclusively
to the fact that the property in each case had not been placed in
service.
In the McCrary case, the underpayments were deemed to
result from a concession that the agreement at issue was a
license and not a lease.
Although property was overvalued in
each of those cases, the overvaluations were not the ground on
which the taxpayers' liability was sustained.
In contrast, "a
different situation exists where a valuation overstatement * * *
is an integral part of or is inseparable from the ground found
for disallowance of an item."
at 859.
McCrary v. Commissioner, 92 T.C.
Each of these consolidated cases presents just such a
"different situation":
overvaluation of the recyclers was
integral to and inseparable from petitioners' claimed tax
- 69 benefits and our holding that the Partnership transactions lacked
economic substance.6
2.
Concession of the Deficiency
Petitioners argue that their concessions of the deficiencies
preclude imposition of the section 6659 additions to tax.
Petitioners contend that their concessions render any inquiry
into the grounds for such deficiencies moot.
Absent such
inquiry, petitioners argue that it cannot be known if their
underpayments were attributable to a valuation overstatement or
other discrepancy.
Without a finding that a valuation
overstatement contributed to an underpayment, according to
petitioners, section 6659 cannot apply.
In support of this line
of reasoning, petitioners rely heavily upon Heasley v.
Commissioner, 902 F.2d 380 (5th Cir. 1990), and McCrary v.
Commissioner, supra.
To the extent that Heasley v. Commissioner, 902 F.2d
380 (5th Cir. 1990), revg. T.C. Memo. 1988-408, merely represents
an application of Todd v. Commissioner, 89 T.C. 912 (1987), affd.
862 F.2d 540 (5th Cir. 1988), we consider it distinguishable. To
the extent that the reversal in the Heasley case is based on a
concept that where an underpayment derives from the disallowance
of a transaction for lack of economic substance, the underpayment
cannot be attributable to an overvaluation, this Court and the
Court of Appeals for the Second Circuit have disagreed. See
Gilman v. Commissioner, 933 F.2d 143, 151 (2d Cir. 1991): "The
lack of economic substance was due in part to the overvaluation,
and thus the underpayment was attributable to the valuation
overstatement."
6
- 70 Petitioners' open-ended concessions do not obviate our
finding that the Partnership transactions lacked economic
substance due to overvaluation of the recyclers.
This is not a
situation where we have "to decide difficult valuation questions
for no reason other than the application of penalties."
McCrary v. Commissioner, supra at 854 n. 14.
See
The value of the
Sentinel EPE recycler was established in Provizer v.
Commissioner, T.C. Memo. 1992-177, and stipulated by the parties.
As a consequence of the inflated value assigned to the recyclers
by the Partnerships, petitioners claimed deductions and credits
that resulted in underpayments of tax, and we held that the
Partnership transactions lacked economic substance.
Regardless
of petitioners' concessions, in these cases the underpayments of
tax were attributable to the valuation overstatements.
Moreover, concession of the investment tax credit in and of
itself does not relieve taxpayers of liability for the section
6659 addition to tax.
See Dybsand v. Commissioner, T.C. Memo.
1994-56; Chiechi v. Commissioner, T.C. Memo. 1993-630.
Instead,
the ground upon which the investment tax credit is disallowed or
conceded is significant.
Even in situations in which there are
arguably two grounds to support a deficiency and one supports a
section 6659 addition to tax and the other does not, the taxpayer
may still be liable for the addition to tax.
Gainer v.
- 71 Commissioner, 893 F.2d at 228; Irom v. Commissioner, 866 F.2d
545, 547 (2d Cir. 1989), vacating in part T.C. Memo. 1988-211;
Harness v. Commissioner, T.C. Memo. 1991-321.
In the present cases, no argument was made and no evidence
was presented to the Court to prove that disallowance and
concession of the investment tax credits related to anything
other than a valuation overstatement.
To the contrary,
petitioners each stipulated substantially the same facts
concerning the Partnership transactions as we found in Provizer
v. Commissioner, supra.
In the Provizer case, we held that the
taxpayers were liable for the section 6659 addition to tax
because the underpayment of taxes was directly related to the
overvaluation of the Sentinel EPE recyclers.
The overvaluation
of the recyclers, exceeding 2325 percent, was an integral part of
our findings in Provizer that the transaction was a sham and
lacked economic substance.
Similarly, the records in these cases
plainly show that the overvaluation of the recyclers is integral
to and is the core of our holding that the underlying
transactions here were shams and lacked economic substance.
Petitioners' reliance on McCrary v. Commissioner, supra, is
misplaced.
In that case, the taxpayers conceded disentitlement
to their claimed tax benefits, and the section 6659 additions to
tax were held inapplicable.
However, the concessions of the
- 72 claimed tax benefits, in and of themselves, did not preclude
imposition of the section 6659 additions to tax.
In McCrary v.
Commissioner, supra, the section 6659 addition to tax was
disallowed because the agreement at issue was conceded to be a
license and not a lease.
In contrast, the records in
petitioners' cases plainly show that petitioners' underpayments
were attributable to overvaluation of the Sentinel EPE recyclers.
We hold that petitioners' reliance on McCrary v. Commissioner,
supra, is inappropriate.7
We held in Provizer v. Commissioner, supra, that each
Sentinel EPE recycler had a fair market value not in excess of
$50,000.
Our finding in the Provizer case that the Sentinel EPE
recyclers had been overvalued was integral to and inseparable
from our holding of a lack of economic substance.
Petitioners
stipulated that the Partnership transactions were similar to the
Clearwater transaction described in the Provizer case, and that
the fair market value of a Sentinel EPE recycler in 1981 and 1982
was not in excess of $50,000.
Given those concessions, and the
Petitioners' citation of Heasley v. Commissioner,
supra, in support of the concession argument is also
inappropriate. That case was not decided by the Court of Appeals
for the Fifth Circuit on the basis of a concession. Moreover,
see supra note 6, to the effect that the Court of Appeals for the
Second Circuit and this Court have not followed the Heasley
opinion with respect to the application of sec. 6659.
7
- 73 fact that the records here plainly show that the overvaluation of
the recyclers was the underlying reason for disallowance of the
claimed tax benefits, we conclude that the deficiencies were
attributable to overvaluation of the Sentinel EPE recyclers.
3.
Section 6659(e)
Petitioners argue that respondent erroneously failed to
waive the section 6659 additions to tax.
Section 6659(e)
authorizes respondent to waive all or part of the addition to tax
for valuation overstatements if taxpayers establish that there
was a reasonable basis for the adjusted bases or valuations
claimed on the returns and that such claims were made in good
faith.
Respondent's refusal to waive a section 6659 addition to
tax is reviewable by this Court for abuse of discretion.
v. Commissioner, 99 T.C. at 179.
Krause
Abuse of discretion has been
found in situations where respondent's refusal to exercise her
discretion is arbitrary, capricious, or unreasonable.
See
Mailman v. Commissioner, 91 T.C. 1079 (1988); Estate of Gardner
v. Commissioner, 82 T.C. 989 (1984); Haught v. Commissioner, T.C.
Memo. 1993-58.
We note initially that petitioners did not
request respondent to waive the section 6659 additions to tax
until many months after the trials of the these cases.
We are
reluctant to find that respondent abused her discretion in cases
in which she was not timely requested to exercise it and where
- 74 there is no direct evidence of any abuse of administrative
discretion.
Haught v. Commissioner, supra; cf. Wynn v.
Commissioner, T.C. Memo. 1995-609; Klieger v. Commissioner, T.C.
Memo. 1992-734.
However, we do not decide this issue solely on petitioners'
failure timely to request waivers but, instead, we have
considered the issue on its merits.
Petitioners urge that they relied on the respective offering
materials and Becker, Steele, and/or Sprague in deciding on the
valuation claimed on their tax returns.
Petitioners contend that
such reliance was reasonable, and, therefore, respondent should
have waived the section 6659 additions to tax.
However, as we
explained above in finding petitioners liable for the negligence
additions to tax, petitioners' purported reliance on the offering
materials and their advisers was not reasonable.
The offering materials for the Partnerships contained
numerous warnings and caveats, including the likelihood that the
value placed on the recyclers would be challenged by the IRS as
being in excess of fair market value.
Further, petitioners'
testimony raises doubts as to the extent to which they reviewed
the offering memoranda or sought to resolve the numerous issues
raised in the memoranda.
- 75 Sprague and Becker readily admitted that they possessed no
special qualifications or professional skills in the recycling or
plastics industries.
Steele did not testify, and there is no
showing in the records that he possessed any education or
experience in plastics materials or plastics recycling.
Neither
Becker, Steele, nor Sprague ever hired or consulted any plastics
engineering or technical experts with respect to the Plastics
Recycling transactions.
Becker spoke with his client Canno, who
apparently had some knowledge of the plastics industry, but the
substance of Canno's purported comments is doubtful and he had
only minimal information about the transaction.
At trial Becker
confirmed that in the end he relied exclusively on PI, its
personnel, and the offering materials as to the value and
purported uniqueness of the machines.
Sprague relied on Becker,
and Steele assisted Becker.
In support of their contention that they acted reasonably,
petitioners cite Mauerman v. Commissioner, 22 F.3d 1001 (10th
Cir. 1994), revg. T.C. Memo. 1993-23.
However, the facts in the
Mauerman case are distinctly different from the facts of these
cases.
In Mauerman, Court of Appeals for the Tenth Circuit held
that the Commissioner had abused her discretion by not waiving a
section 6661 addition to tax.
Like section 6659, a section 6661
addition to tax may be waived by the Commissioner if the taxpayer
- 76 demonstrates that there was reasonable cause for his underpayment
and that he acted in good faith.
Sec. 6661(c).
The taxpayer in
Mauerman relied upon independent attorneys and accountants for
advice as to whether payments were properly deductible or
capitalized.
The advice relied upon by the taxpayer in Mauerman
was within the scope of the advisers' expertise, the
interpretation of the tax laws as applied to undisputed facts.
In these cases, particularly with respect to valuation,
petitioners relied upon advice that was outside the scope of
expertise and experience of their advisers.
Consequently, we
consider petitioners' reliance on the Mauerman case inapplicable.
We hold that petitioners did not have a reasonable basis for
the adjusted bases or valuations claimed on their tax returns
with respect to their investments in the Partnerships.
In these
cases, respondent properly could find that petitioners'
respective reliance on the offering materials, Becker, Steele,
and/or Sprague was unreasonable.
The records in these cases do
not establish an abuse of discretion on the part of respondent
but support respondent's position.
We hold that respondent's
refusal to waive the section 6659 addition to tax is not an abuse
of discretion.
Petitioners are liable for the respective section
6659 additions to tax at the rate of 30 percent of the
- 77 underpayments of tax attributable to the disallowed tax benefits.
Respondent is sustained on this issue.
D. Petitioners' Motions For Leave To File Motion For Decision
Ordering Relief From the Negligence Penalty and the Penalty Rate
of Interest and To File Supporting Memorandum of Law
Long after the trials of these cases, petitioners in docket
Nos. 19760-89, 24512-89, and 10147-91 each filed a Motion For
Leave To File Motion for Decision Ordering Relief From the
Negligence Penalty and the Penalty Rate of Interest and To File
Supporting Memorandum of Law under Rule 50.
In addition, they
lodged with the Court motions for decision ordering relief from
the additions to tax for negligence and from the increased rate
of interest, with attachments, and memoranda in support of such
motions.
Respondent filed objections, with attachments, and
memoranda in support thereof and petitioners thereafter filed
reply memoranda.
Petitioners argue that they should be afforded
the same settlement that was reached between other taxpayers and
the IRS in Miller v. Commissioner, docket Nos. 10382-86 and
10383-86.
See Farrell v. Commissioner, T.C. Memo. 1996-295,
denying a similar motion based in part on analogous
circumstances.
Counsel for petitioners seek to raise a new issue long after
the trials in these cases.
require new trials.
Resolution of such issue might well
Such further trials "would be contrary to
- 78 the established policy of this Court to try all issues raised in
a case in one proceeding and to avoid piecemeal and protracted
litigation."
Markwardt v. Commissioner, 64 T.C. 989, 998 (1975);
see also Robin Haft Trust v. Commissioner, 62 T.C. 145, 147
(1974).
Consequently, under the circumstances here, at this late
date in the litigation proceedings, long after the trials and
briefing and after the issuance of numerous opinions on issues
and facts closely analogous to those in these cases, petitioners'
motions for leave are not well founded.
Farrell v. Commissioner,
supra.
Even if petitioners' motions for leave were granted, the
arguments set forth in each of petitioners' motions for decision
and attached memoranda, lodged with this Court, are without merit
and such motions would be denied.
Therefore, and for reasons set
forth in more detail below, petitioners' motions for leave shall
be denied.
Some of our discussion of background circumstances
underlying petitioners' motions is drawn from documents submitted
by the parties and findings of this Court in two earlier
decisions.
Such matters are not disputed by the parties.
See
Estate of Satin v. Commissioner, T.C. Memo. 1994-435; Fisher v.
Commissioner, T.C. Memo. 1994-434.
The Estate of Satin and
Fisher cases involved Stipulation of Settlement agreements
- 79 (piggyback agreements) made available to taxpayers in the
Plastics Recycling project, whereby taxpayers could agree to be
bound by the results of three test cases:
the two Miller cases.
the Provizer case and
We held in the Estate of Satin and Fisher
cases that the terms of the piggyback agreement bound the parties
to the results in all three lead cases, not just the Provizer
case.
Petitioners assert that the piggyback agreement was
extended to them, but they do not claim to have accepted the
offer, so they effectively rejected it.
We discuss the
background matters, apparently not disputed by the parties, for
the sake of completeness.
As we have noted, granting
petitioners' motion for leave would require further proceedings.
On or about February 1988, a settlement offer (the Plastics
Recycling project settlement offer or the offer) was made
available by respondent in all docketed Plastics Recycling cases,
and subsequently in all nondocketed cases.
Commissioner, T.C. Memo. 1994-484.8
Baratelli v.
Pursuant to the offer,
taxpayers had 30 days to accept the following terms:
Although the records do not include a settlement offer
to petitioners, petitioners have attached to their motions for
decision a copy of a settlement offer to another taxpayer with
respect to a plastics recycling case, and respondent has not
disputed the accuracy of the statement of the plastics recycling
settlement offer.
8
- 80 (1) Allowance of a deduction for 50 percent of the amount of the
cash investment in the venture in the year(s) of investment to
the extent of loss claimed; (2) Government concession of the
substantial understatement of tax penalties under section 6661
and the negligence additions to tax under section 6653(a)(1) and
(2); (3) taxpayer concession of the section 6659 addition to tax
for valuation overstatement and the increased rate of interest
under section 6621; and (4) execution of a closing agreement
(Form 906) stating the settlement and resolving the entire matter
for all years.
Petitioners assert that the Plastics Recycling
project settlement offer was extended to them, but they do not
claim to have accepted the offer timely, so they effectively
rejected it.
In December 1988, the Miller cases were disposed of by
settlement agreement between the taxpayers and respondent.9
This
Court entered decisions based upon those settlements on December
22, 1988.
The settlement provided that the taxpayers in the
Miller cases were liable for the addition to tax under section
6659 for valuation overstatement, but not for the additions to
tax under sections 6661 and 6653(a).
The increased interest
Although it is not otherwise a part of the record in
these cases, respondent attached copies of the Miller closing
agreement and disclosure waiver to her objections to petitioners'
motion for leave, and petitioners do not dispute the accuracy of
the document.
9
- 81 under section 6621(c), premised solely upon Miller's interest in
the recyclers for the taxable years at issue, was not applicable
because Miller made payments prior to December 31, 1984, so no
interest accrued after that time.
Respondent did not notify
petitioners or any other taxpayers of the disposition of the
Miller cases.
Estate of Satin v. Commissioner, T.C. Memo. 1994-
435; Fisher v. Commissioner, T.C. Memo. 1994-434.
Petitioners argue that they are similarly situated to the
taxpayer in the Miller cases, and that in accordance with the
principle of "equality" they are therefore entitled to the same
settlement agreement executed by respondent and Miller in those
cases.
In effect, petitioners seek to resurrect the piggyback
agreement offer and the settlement offer that they previously
failed to accept.
Petitioners contend that under the principle of "equality,"
the Commissioner has a duty of consistency toward similarly
situated taxpayers and cannot tax one and not tax another without
some rational basis for the difference.
United States v. Kaiser,
363 U.S. 299, 308 (1960) (Frankfurther, J., concurring opinion);
see Baker v. United States, 748 F.2d 1465 (11th Cir. 1984), affg.
575 F.Supp. 508 (N.D. Ga. 1983); Farmers' & Merchants' Bank v.
United States, 476 F.2d 406 (4th Cir. 1973).
According to
petitioners, the principle of equality precludes the Commissioner
- 82 from making arbitrary distinctions between like cases.
See Baker
v. Commissioner, 787 F.2d 637, 643 (D.C. Cir. 1986), vacating 83
T.C. 822 (1984).
The different tax treatment accorded petitioners and Miller
was not arbitrary or irrational.
While petitioners and Miller
both invested in the Plastics Recycling project, their actions
with respect to such investments provide a rational basis for
treating them differently.
Specifically, Miller foreclosed any
potential liability for increased interest in his cases by making
payment of the tax prior to December 31, 1984; no interest
accrued after that date.
In contrast, petitioners made no such
payment, and they conceded that the increased rate of interest
under section 6621(c) applies in their cases.
Liability for the
increased rate of interest is the principal difference between
the settlement in the Miller cases, which petitioners declined
when they failed to accept the piggyback agreement offer, and the
settlement offer that petitioners also failed to accept.
Petitioners argue that section 6621(c) must have been an
issue in the Miller cases since each of the decisions in Miller
recites "That there is no increased interest due from the
petitioner[s] for the taxable years [at issue] under the
provisions of IRC section 6621(c)."
According to petitioners,
"Surely, if the Millers were not otherwise subject to the penalty
- 83 interest provisions because of the particular timing of their tax
payments, there would have been no need for the Court to include
such a recital in its decisions."
This argument by petitioners
is entirely conjectural and is not supported by the documentation
on which counsel relies.
In fact, the recital that no increased
interest under section 6621(c) was due in the Miller cases was an
express term of the settlement documents in those cases and
apparently included in the decisions for completeness and
accuracy.
There is nothing on the record in the present cases,
or in the Court's opinions in Estate of Satin v. Commissioner,
supra, or Fisher v. Commissioner, supra, or in any of the
material submitted to us in these cases that would indicate that
the Millers were "otherwise subject to the penalty interest
provisions".
Petitioners' argument is based on a false premise.
We find that petitioners and Miller were treated equally to
the extent they were similarly situated, and differently to the
extent they were not.
Miller foreclosed the applicability of the
section 6621(c) increased rate of interest in his cases, while
petitioners concede it applies in their cases.
Petitioners
failed to accept a piggyback settlement offer that would have
entitled them to the settlement reached in the Miller cases, and
also did not enter into a settlement offer made to them prior to
trial of a test case.
In contrast, Miller negotiated and
- 84 accepted an offer that was essentially the same as the Plastics
Recycling project settlement offer that petitioners failed to
accept prior to trial.
Petitioners' motions are not supported by
the principle of equality on which they rely.
Cf. Baratelli v.
Commissioner, T.C. Memo. 1994-484.
To reflect the foregoing,
Appropriate orders will be
issued denying petitioners'
motions, and decisions will be
entered under Rule 155.
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.