Harold Chakales v. CIR ( 1996 )

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No. 95-1742
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Harold Chakales; *
Linda Carol Chakales, *
Appellants, *
*
v. * Appeal from the United States
* Tax Court.
Commissioner of Internal *
Revenue, *
Appellee. * [PUBLISHED]
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Submitted: December 13, 1995
Filed: March 27, 1996
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Before, BOWMAN and LOKEN, Circuit Judges, and SCHWARZER* District
Judge.
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SCHWARZER, District Judge.
Taxpayers Harold and Linda Carol Chakales (“Chakales”) appeal
from a decision of the United States Tax Court upholding the
assessment of penalty interest by the Commissioner of Internal
Revenue. Harold Chakales and Linda Carol Chakales v. Commissioner,
*The HONORABLE WILLIAM W SCHWARZER, Senior United States
District Judge for the Northern District of California,
sitting by designation.
68 T.C.M. 479 (1994). We have jurisdiction under 26 U.S.C.
§ 7482(a) and affirm.
BACKGROUND
Chakales was among several thousand taxpayers who participated
in a program operated by First Western Government Securities
(“First Western”) involving straddle transactions of forward
contracts to buy and sell securities issued by the Government
National Mortgage Association and the Federal Home Loan Mortgage
Corporation. The Commissioner’s disallowance of the participants’
resulting tax losses on the ground that the program was a sham was
upheld in Freytag v. Commissioner, 904 F.2d 1011, 1015-17 (5th Cir.
1990), aff’d on other grounds, 501 U.S. 868 (1991). As summarized
by the Fifth Circuit in that case:
First Western’s absolute authority over the pricing and
timing of the transactions that occurred in the self-
contained market of its own making enabled it to achieve
the tax losses desired by its investors with uncanny
accuracy. The Tax Court’s recognition that First
Western’s program made available to its investors an
essentially risk-free opportunity to purchase tax
deductions cannot be labeled clearly erroneous.
Id. at 1016 (citation omitted).
Chakales does not contest the disallowance of the losses,
conceding that Freytag controls the treatment of his transactions.
He contends, however, that the Tax Court erred in upholding the
Commissioner’s assessment of penalties. The Commissioner
determined that Chakales was liable for a penalty under 26 U.S.C.
§ 6653(a) for negligent underpayment of the tax. In addition,
before the Tax Court, the Commissioner contended that an additional
interest penalty was due under 26 U.S.C. § 6621(c) for a
substantial underpayment of tax due to a tax-motivated transaction.
The Tax Court upheld both assessments.
THE SECTION 6621(c) PENALTY
Section 6621(c) provides for an interest rate of 120 percent
on any “substantial underpayment attributable to any tax motivated
transactions” (i.e., in excess of $1,000), and states in relevant
part: “[T]he term ‘tax motivated transaction’ means . . . any sham
or fraudulent transaction.” 26 U.S.C. § 6621(c)(3)(A)(v). The Tax
Court, basing its determination on the Fifth Circuit’s holding in
Freytag that these transactions were shams, sustained the
assessment of the penalty.1 68 T.C.M. at 482. It rejected
Chakales’s argument that the penalty cannot be assessed in the
absence of a finding that the taxpayer lacked a profit motive. It
went on, however, to find that Chakales in fact lacked a profit
motive.
We review the Tax Court’s legal conclusions de novo but accept
its findings of fact unless clearly erroneous. Chase v.
Commissioner, 926 F.2d 737, 740 (8th Cir. 1991). “‘A finding is
“clearly erroneous” when although there is evidence to support it,
1
The Commissioner assessed section 6621(c) penalty interest
in Freytag. The Tax Court upheld the assessment on the ground
that the transactions were a sham. Freytag v. Commissioner, 89
T.C. 849, 886-87 (1987). The court of appeals did not address
the issue in its opinion.
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the reviewing court on the entire evidence is left with the
definite and firm conviction that a mistake has been committed.’”
Id. (quoting United States v. United States Gypsum Co., 333 U.S.
364, 395 (1948)).
Under the plain language of the statute, a tax motivated
transaction “means . . . [inter alia] any sham . . . transaction.”
26 U.S.C. § 6621(c)(3)(A)(v)(emphasis added). The Commissioner has
authority, therefore, to assess the penalty simply upon a finding
that a transaction was a sham. See Howard v. Commissioner, 931
F.2d 578, 582 (9th Cir. 1991) (affirming a penalty under section
6621(c)(3)(A)(v) where the Tax Court found the underlying
transaction “to be a sham.”). Chakales contends that the
taxpayer’s state of mind is always relevant in the determination of
whether a transaction was tax motivated. He relies principally on
Heasley v. Commissioner, 902 F.2d 380 (5th Cir. 1990). However,
Heasley did not arise under the “sham transaction” provision of
section 6621. In that case the penalty was assessed under the
catch-all provision of section 6621(c)(3)(B) and an IRS regulation
defining a “tax motivated” transaction as one “not engaged in for
profit.” Id. at 385; 26 C.F.R. § 301.6621-2T, Q-4, A-4 (2).
Heasley had invested -- and lost -- a substantial sum in a scheme
represented by his investment adviser as expected to produce future
profits. The court of appeals held that the tax court had erred in
solely considering that the plan had generated only tax deductions
and credits but no profits. It held that “the tax court also
should have considered the Heasleys’ intent when determining
whether the Heasleys did not engage in the transaction for profit.”
Id. at 386. Heasley, therefore, does not address the issue in this
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case nor do the other decisions cited by Chakales. Section
6621(c)(3)(A)(v) by its terms authorizes the assessment of a
penalty against a taxpayer participating in any sham transaction.
Chakales does not dispute the Commissioner’s disallowance of the
losses based on the characterization of the transactions as sham.
There is no basis for reading a separate state of mind requirement
into the application of the sham test for purposes of section
6621(c)(3)(A)(v).
Chakales argues further that “[b]ecause this penalty applies
at the investor level, that is the place to examine the
‘motivation.’ A defrauded investor is not subject to a penalty
because he was unsophisticated enough to be victimized.”
Appellant’s Brief at 47. We need not decide the appropriate
application of section 6621(c)(3)(A)(v) to the case of an innocent
victim of a fraudulent scheme who entered it in good faith for
profit. This is not such a case. The Tax Court made specific
findings rejecting Chakales’ assertion of a profit motive. It
found that he was aware of “[t]he raison d’etre of the
program . . . to convert ordinary income into long-term capital
gains and defer the payment of taxes.” 68 T.C.M. at 483. It found
that Chakales had no understanding of the transactions, that he did
not follow his account with First Western but submitted a request
for a tax loss to First Western and had no taxes withheld from his
substantial income from wages,2 and that he could not explain how
2
Chakales’ explanation for the lack of withholding on his
annual wages in the two years at issue ($300,000 and $400,000,
respectively) was that “[h]e borrowed from his firm throughout
the year and bonused an appropriate amount at year end, basing
his withholding on December 30 or December 31 on the totality of
facts then known.” Appellant’s Brief at 37.
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he expected to make a profit by requesting a loss in one year and
an offsetting gain in the next. After reviewing Chakales’ course
of conduct with respect to his investment, the court found that
“[t]he only rational explanation for any of this is that petitioner
entered into these transactions with the primary, if not sole,
objective of obtaining the tax loss.” Id. at 484. That finding is
not clearly erroneous. See Lukens v. Commissioner, 945 F.2d 92,
99-100 (5th Cir. 1991).
THE SECTION 6653 PENALTY
Section 6653 provides that “[i]f any part of any underpayment
. . . is due to negligence . . . there shall be added to the tax an
amount equal to 5 percent of the underpayment.”3 26 U.S.C. §
6653(a)(1). “[T]he determination of a negligence penalty is
presumptively correct, and the taxpayer bears the burden of proving
that it was improperly imposed.” Chase, 926 F.2d at 740; see also
Freytag, 904 F.2d at 1017. Thus the burden is on the taxpayer to
prove that he did not fail to exercise due care or do what a
reasonable and prudent person would do under similar circumstances.
Goldman v. Commissioner, 39 F.3d 402, 407 (2nd Cir. 1994). “In
addition, because the tax court’s decision involved a factual
determination, it will not be disturbed on appeal unless clearly
3
For the taxable year 1981, section 6653(a)(2) provided an
addition to tax in the amount of 50 percent of the interest
payable with respect to the portion of the underpayment
attributable to negligence.
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erroneous.” Chase, 926 F.2d at 740.
The Tax Court found Chakales to have admitted that he did not
understand these transactions which involved forward contracts to
purchase and sell millions of dollars of securities, with ratios of
tax losses to payments from 8:1 to 16:1. 68 T.C.M. at 483. Given
these facts, Chakales “could not merely rely on the documents
supplied by First Western, and further investigation was clearly
mandated. If there had been any serious examination of the program
‘[n]o reasonable person would have expected * * * [the] scheme to
work.’” 68 T.C.M. at 483 (quoting Freytag, 89 T.C. at
889)(internal quotation omitted).
Chakales contends, however, that he reasonably relied on the
advice of experts, to wit, Charles Frederick Marshall and George
Plastiras. Marshall was a broker employed by a securities firm.
He introduced Chakales to the First Western program, presenting him
with the documents which Chakales later completed and sent to First
Western. Chakales knew that Marshall received a commission from
First Western for selling the program to him. With respect to
Marshall, the Tax Court held that reliance on “the promoter’s
statements concerning the bona fides of these transactions . . .
‘is not the type of activity which will overcome the addition to
tax for negligence.’” 68 T.C.M. at 483 (quoting Rybak v.
Commissioner, 91 T.C. 524, 565 (1988)). See Goldman, 39 F.3d at
408 (reliance on advice from person who signed the limited
partnership agreement at issue as the partnership’s sales
representative was unreasonable).
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Plastiras was an experienced tax attorney and accountant who
had represented Chakales since 1964 in various business and estate
matters, including their tax aspects. At Chakales’ request,
Plastiras met with him and Marshall late one afternoon to discuss
the First Western program, including the risks involved and whether
it had economic reality. He testified that he received First
Western’s materials, had lawyers in his firm research them and
arrive at their own opinion, and received from one of his partners
a hand-written office memorandum respecting the securities aspect
of the investment. Plastiras made no investigation of First
Western; as he put it, “I am just totally unaware about First
Western. Forgive me.”
Chakales’ testimony described the advice he received from
Plastiras as follows:
Q. [D]id you retain his firm to render those opinions or
that advice?
A. Yes.
Q. And what did he tell you the advice of his firm was?
A. That it sounded like this was a very legitimate firm,
and that there was an opportunity to make some money.
Q. And what did he tell you about the tax opinion that
[Marshall gave to you]? . . .
A. He thought that the tax opinion from Arthur Andersen
was reasonable.
Q. The tax opinion from Arthur Andersen?
A. Well, whatever it was. I am not sure. That he
thought that this was a reasonable investment, as a taxpayer.
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Q. Did he give you an opinion about the tax treatment of
the transactions?
A. What do you mean by tax -- an opinion as to tax
treatment?
Q. You gave him three documents . . .
A. One was . . . a legal opinion from a law firm.
Q. What was the legal opinion from the law firm about?
A. Maybe that was the tax - - that was about the
securities, I thought. I may be a little confused.
Q. And what did he tell you about that legal opinion
from the law firm?
A. That he didn’t know the law firm, and that his law
firm looked over it and thought that it was reasonable . . .
[and that it] [c]oncurred with their opinion.
(Joint Appendix 182-84.)
The relevant testimony of Plastiras was as follows:
Q. And what did you advise him or did you give him any
advice as to whether or not this transaction had economic
substance in reality? . . .
A. Yes. In our judgment, it had economic risk, and that
he could lose considerable amount of money. I was very much
concerned more about the loss of money than the gain. I
didn’t want him to lose any money.
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(Joint Appendix 161-62.)4
The Tax Court found that Chakales did not hire Plastiras to
investigate First Western, that when Plastiras’ partner raised
concerns they were not followed up, and that Plastiras, like
Chakales, simply relied on Marshall. 68 T.C.M. at 483.
In United States v. Boyle, 469 U.S. 241, 251 (1985), the
Supreme Court laid down the controlling principle:
When an accountant or attorney advises a taxpayer on a
matter of tax law, . . . it is reasonable for the
taxpayer to rely on that advice. Most taxpayers are not
competent to discern error in the substantive advice of
an accountant or attorney. To require the taxpayer to
challenge the attorney, to seek a “second opinion,” or to
try to monitor counsel on the provisions of the Code
himself would nullify the very purpose of seeking the
advice of a presumed expert in the first place.
The underlying premise is that a taxpayer may reasonably rely on
advice when that advice involves the application of the attorney’s
or accountant’s relevant expertise. That is not what occurred in
this case. The “advice” Plastiras gave, on which Chakales now
claims to have relied, was little more than a generalized statement
that he could lose money on the transaction. Chakales himself was
vague at best about just what “advice” he had received from
Plastiras. See Howard, 931 F.2d at 582 (“Where no reliable
evidence exists in the record suggesting the nature of any advice
4
Plastiras did not prepare Chakales’ tax returns, and there
is no evidence that Chakales received or relied on advice from
his tax accountants in claiming the disallowed losses.
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given, a finding of negligence is not erroneous.”). There is,
moreover, no evidence that Plastiras researched the tax aspects of
the transaction, much less that he investigated First Western or
the manner in which the program operated. See Leonhart v.
Commissioner, 414 F.2d 749, 750 (4th Cir. 1969)(“[T]o escape the
penalty [on the ground of good faith reliance on the advice of an
accountant] taxpayers must be able to show that the accountant
reached his decisions independently after being fully apprised of
the circumstances of the transactions.”) Cf. Chamberlain v.
Commissioner, 66 F.3d 729, 733 (5th Cir. 1995)(reversing penalty
assessment where “[t]he [tax] expert advised that there was ‘a good
faith, supportable position’ concerning the deductibility of the
loss.”), reh’g denied.
The Tax Court’s factual findings are not clearly erroneous and
its conclusion that Chakales failed to carry his burden of proving
that he exercised due care was not error.
Affirmed.
A true copy.
Attest:
CLERK, U.S. COURT OF APPEALS, EIGHTH CIRCUIT.
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