Bass v. Comm'r ( 2007 )

T.C. Memo. 2007-361
UNITED STATES TAX COURT
WILLIAM R. AND BETTY O. BASS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 19207-06. Filed December 5, 2007.
William R. and Betty O. Bass, pro se.
James H. Brunson III, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
COHEN, Judge: In an “affected items” notice of deficiency
sent June 19, 2006, respondent determined that petitioners are
liable for additions to tax for 1982 as follows:
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Additions to Tax
Year Sec. 6653(a)(1) Sec. 6653(a)(2) Sec. 6661
1982 $351 * $1,755
* 50 percent of the interest on $7,020.
The notice also included a statement that interest would accrue
and be assessed at 120 percent of the underpayment rate in
accordance with section 6621(c). The additions to tax resulted
from a final partnership proceeding involving a jojoba plant
venture known as Cal-Neva Partners (Cal-Neva). Unless otherwise
indicated, all section references are to the Internal Revenue
Code in effect for the year in issue, and all Rule references are
to the Tax Court Rules of Practice and Procedure.
FINDINGS OF FACT
Petitioners resided in Georgia at the time that they filed
their petition. In 1982, William R. Bass (petitioner) was
employed by Lockheed Corp. as an accountant, and Betty O. Bass
was employed by the Institute of Basic Youth Conflict as a
typist.
On or about December 23, 1982, petitioners paid $5,000 for a
limited partnership interest in Cal-Neva. The $5,000 was paid in
reliance on representations by two persons associated with Cal-
Neva whom petitioner met during a business trip to Nevada.
Petitioner did not consult any independent persons regarding the
viability of the jojoba plant venture or the claimed tax
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consequences related to the venture, and he relied solely on
promoters who had no known experience in jojoba plant farming.
Petitioner prepared a joint 1982 Form 1040, U.S. Individual
Income Tax Return. As a result of losses claimed, petitioners
requested a refund of $3,742.07, which had been paid by
withholding and estimated tax payments. On Schedule C, Profit or
(Loss) From Business or Profession, petitioner reported his
business as Bass Enterprises, with gross receipts of $444.30 and
a net loss of $25,827.79. Among the items shown as constituting
the loss was a “Write-off of Farming Venture $13,150".
Petitioner did not have a Schedule K-1, Partner’s Share of
Income, Credits, Deductions, etc., from Cal-Neva when he filed
the 1982 return. The amount that petitioner deducted on
Schedule C was his estimate of the amount to be claimed based on
his conversations with the promoters of Cal-Neva at the time that
he paid the $5,000.
On February 11, 1987, a Notice of Final Partnership
Administrative Adjustment was sent to petitioners as a partner in
Cal-Neva. In the notice, research and development expenses of
$193,150 and amortization of organizational costs of $42 were
disallowed to Cal-Neva. A petition on behalf of Cal-Neva was
filed by Yolanda J. Benham (Benham), tax matters partner, as
docket No. 6594-87. On October 18, 1993, the parties in docket
No. 6594-87 filed a Stipulation to be Bound setting forth their
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agreement that the outcome of the Cal-Neva case was to be
determined in accordance with the outcome of Utah Jojoba I
Research v. Commissioner, docket No. 7619-90. On January 5,
1998, the Court’s opinion in Utah Jojoba I Research v.
Commissioner, T.C. Memo. 1998-6 (Utah Jojoba I Research), was
filed, and, pursuant to that opinion, a decision sustaining
respondent’s adjustments was entered on January 8, 1998, in that
case.
At the time the decision in Utah Jojoba I Research became
final, the tax matters partner in the Cal-Neva case, Benham,
could not be located. Ultimately, respondent filed a Motion for
Entry of Decision in accordance with the Stipulation to be Bound.
By order dated February 1, 2005, the partners of Cal-Neva were
directed to show cause why respondent’s Motion for Entry of
Decision should not be granted. No response to the Court’s order
was received. Decision in the Cal-Neva case, docket No. 6594-87,
was entered April 11, 2005. A copy of the decision was served on
petitioner. The decision in docket No. 6594-87 became final
July 11, 2005. The notice in the instant case was sent June 19,
2006, within 1 year of finality of the partnership proceeding.
The additions to tax in issue here were based on $7,020, which
the Internal Revenue Service (IRS) determined to be the
deficiency in income tax attributable to the Cal-Neva deductions
claimed by petitioners on Schedule C of their 1982 return.
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Because miscellaneous deductions were not identified on
Schedule C as attributable to Cal-Neva or to some other activity
on the part of petitioners, the IRS estimated disallowed amounts
as 50 percent of the miscellaneous expenses shown on Schedule C.
Thus, the adjustment on which the additions to tax were
calculated totaled $14,783.69, including the $13,150 attributable
to Cal-Neva.
OPINION
Petitioners contend that they were not negligent and that
the additions to tax are inappropriate in this case. They also
assert that the tax on which the additions to tax are computed
was overstated because of the manner in which the disallowed
expenses attributable to Cal-Neva were determined, because items
above and beyond $13,150 were not related to Cal-Neva but to
other activities in which petitioner engaged. We accept
petitioner’s testimony in this regard. Our findings, however,
are otherwise sparse. Petitioner provided no details concerning
the partnership. His testimony at trial as to the extent of his
investigation of Cal-Neva consisted of the following:
I don’t recall exactly how the investment
possibility came into being. I don’t know whether it
was a phone call, letter, or what, but anyway, we were
contacted regarding the investment.
Since I grew up on a farm, I thought that it had
some potential. I combined a trip to Nevada to meet
with them with a trip by my employer, and I did meet
with them. They seemed to be honest people. He had
been in the airline industry, and she had worked as an
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attorney. I don’t know whether exactly she was a
practicing attorney or what.
But they seemed to be people that understood
enough about the investment, and that it was viable,
and so I know at some point, having some knowledge of
taxes on some of the past investments, I thought it
would be a viable investment.
So I did enter into the investment, and paid the
$5,000 initial investment amount, and the rest was
financed, and interest payments were made for several
years, five or six years, and ultimately the
partnership went under.
Of course, if I had known that at the beginning, I
definitely would not have been involved in it,
especially since it looks like it was creating a
problem from the standpoint of taxability. But at the
time, it seemed to me that it was not an unusual
investment to make.
And so after doing the limited amount of checking
that I was able to do without spending days and days, I
guess, in the area where they resided. I think it was
during that time that they subsequently moved to
Hawaii.
So my investigating from a due diligence to me was
sufficient to let me know that it was a viable
investment and it would stand up from a tax standpoint,
and so that’s basically my statement and my testimony
in that regard.
In other reported cases, notably the opinion in Utah
Jojoba I Research, the programs concerning Jojoba plants are
described in detail. As summarized in Lopez v. Commissioner,
T.C. Memo. 2001-278, affd. 92 Fed. Appx. 571 (9th Cir. 2004):
In the decided case, this Court held that the
partnerships did not directly or indirectly engage in
research or experimentation and that the partnerships
lacked a realistic prospect of entering into a trade or
business. In upholding respondent’s disallowance of
research and experimental expenditures, the Court found
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that the agreements between the partnerships and the
proposed research and development contractor, U.S. Agri
Research & Development Corp. (U.S. Agri), had been
designed and entered into solely to provide a mechanism
to disguise the capital contributions of limited
partners as currently deductible expenditures. The
Court stated that the activities of the partnerships
were “another example of efforts by promoters and
investors in the early 1980's to reduce the cost of
commencing and engaging in the farming of jojoba by
claiming, inaccurately, that capital expenditures in
jojoba plantations might be treated as research or
experimental expenditures for purposes of claiming
deductions under section 174.” * * * [Fn. ref.
omitted.]
More details concerning the partnerships and the investors are
found in the records and in the opinions in other cases in which
we have sustained additions to tax arising out of investments in
the jojoba plant partnerships. As the Court stated in Kellen v.
Commissioner, T.C. Memo. 2002-19:
We have decided many jojoba cases involving
additions to tax for negligence and substantial
understatement of tax liability. 15/ We have found the
taxpayers liable for additions to tax for negligence in
all of those cases; likewise, we have found the
taxpayers liable for the addition to tax for
substantial understatement of tax liability in all of
those cases that have presented that issue.
__________________
15/ See, e.g., Lopez v. Commissioner, T.C. Memo.
2001-278; Christensen v. Commissioner, T.C. Memo. 2001-
185; Serfustini v. Commissioner, T.C. Memo. 2001-183;
Carmena v. Commissioner, T.C. Memo. 2001-177; Nilsen v.
Commissioner, T.C. Memo. 2001-163; Ruggiero v.
Commissioner, T.C. Memo. 2001-162; Robnett v.
Commissioner, T.C. Memo. 2001-17; Harvey v.
Commissioner, T.C. Memo. 2001-16; Hunt v. Commissioner,
T.C. Memo. 2001-15; Fawson v. Commissioner, T.C. Memo.
2000-195; Downs v. Commissioner, T.C. Memo. 2000-155;
Glassley v. Commissioner, T.C. Memo. 1996-206;
Stankevich v. Commissioner, T.C. Memo. 1992-458.
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In Lopez v. Commissioner, supra, as in this case, the
partnership in which the taxpayers invested had signed a
Stipulation to be Bound by the outcome of Utah Jojoba I Research.
Petitioners have not shown any facts that would distinguish this
case from the others involving jojoba plant ventures.
Section 6653(a)(1) imposes an addition to tax in an amount
equal to 5 percent of the underpayment of tax if any part of the
underpayment is due to negligence or intentional disregard of
rules or regulations. Section 6653(a)(2) imposes another
addition to tax in an amount equal to 50 percent of the interest
due on 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
exercise under like circumstances. See Anderson v. Commissioner,
62 F.3d 1266, 1271 (10th Cir. 1995), affg. T.C. Memo. 1993-607;
Neely v. Commissioner, 85 T.C. 934, 947 (1985). The focus of
inquiry is the reasonableness of the taxpayer’s actions in light
of the taxpayer’s experience and the nature of the investment.
See Henry Schwartz Corp. v. Commissioner, 60 T.C. 728, 740
(1973); see also Sacks v. Commissioner, 82 F.3d 918, 920 (9th
Cir. 1996) (whether a taxpayer is negligent in claiming a tax
deduction “depends upon both the legitimacy of the underlying
investment, and due care in the claiming of the deduction.”),
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affg. T.C. Memo. 1994-217; Turner v. Commissioner, T.C. Memo.
1995-363. In this regard, the determination of negligence is
highly factual.
In his testimony quoted above, petitioner indicated that he
spent very little time investigating the viability of an
investment in jojoba farming or the likely tax treatment of that
investment, relying on his experience in similar investments. He
offered in evidence at trial tax returns from earlier years on
which he had deducted various partnership losses. Among the
papers that he presented, however, was a decision where this
Court determined that he owed a deficiency and a negligence
addition to tax for 1981. Petitioner’s experience is not
persuasive evidence that he was qualified to assess the viability
and the proper treatment of the Cal-Neva partnership, relying
solely on the promoters. Based on the limited effort described
by petitioner and consistent with all opinions in similar cases,
we conclude that petitioners failed to exercise reasonable care
and are liable for the additions to tax for negligence.
Section 6661(a), as amended by the Omnibus Budget
Reconciliation Act of 1986, Pub. L. 99-509, sec. 8002, 100 Stat.
1951, provides for an addition to tax of 25 percent of the amount
of any underpayment attributable to a substantial understatement
of income tax for the taxable year. A substantial understatement
of income tax exists if the amount of the understatement exceeds
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the greater of 10 percent of the tax required to be shown on the
return, or $5,000. Sec. 6661(b)(1)(A). Generally, the amount of
an understatement is reduced by the portion of the understatement
that the taxpayer shows is attributable to either (1) the tax
treatment of any item for which there was substantial authority,
or (2) the tax treatment of any items with respect to which the
relevant facts were adequately disclosed on the return. Sec.
6661(b)(2)(B). If an understatement is attributable to a tax
shelter item, however, different standards apply. First, in
addition to showing the existence of substantial authority, a
taxpayer must show that he reasonably believed that the tax
treatment claimed was more likely than not proper. Sec.
6661(b)(2)(C)(i)(II). Second, disclosure, whether or not
otherwise adequate, will not reduce the amount of the
understatement. Sec. 6661(b)(2)(C)(i)(I).
Substantial authority exists when “the weight of the
authorities supporting the treatment is substantial in relation
to the weight of authorities supporting contrary positions.”
Sec. 1.6661-3(b)(1), Income Tax Regs. Petitioner has failed to
show that substantial authority existed for the tax treatment of
the Cal-Neva loss on his 1982 return.
Petitioner has not satisfied any of the conditions for
avoiding application of the section 6661 addition to tax. His
inclusion of the loss on Schedule C without identification of the
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Cal-Neva partnership does not constitute adequate disclosure.
Accepting his testimony and concluding that the correct amount of
the underpayment should have been calculated based on $13,150 in
disallowed losses rather than $14,783.69, the underpayment would
still be substantial for purposes of section 6661.
Petitioners have made several arguments that we address
briefly. First, in their answering brief, petitioners argue for
the first time that the notice in this case was sent after the
expiration of the period of limitations. In this context,
however, the period of limitations was suspended during the time
that the partnership action was pending and for 1 year
thereafter. Sec. 6229(d). The decision in the partnership
action did not become final until the expiration of the time for
filing a notice of appeal, which was 90 days after entry of the
decision. Secs. 7481(a)(1), 7483. Thus, the notice in this case
was sent approximately 3 weeks before the expiration of the
period of limitations.
Second, petitioners argue that the underpayment should be
further reduced by allowance of $5,000 as their out-of-pocket
expenses in relation to the Cal-Neva investment. There is no
authority, however, that would allow them to deduct their out-of-
pocket amounts in the year of the investments. See, e.g., Marine
v. Commissioner, 92 T.C. 958, 974-980 (1989), affd. without
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published opinion 921 F.2d 280 (9th Cir. 1991); Viehweg v.
Commissioner, 90 T.C. 1248, 1253-1255 (1988).
Third, following up on an inquiry made by the Court to
respondent’s counsel at the time of trial, petitioners assert
that section 7491(c) should impose on respondent the burden of
production with respect to the additions to tax in this case.
That section applies to examinations commenced after July 22,
1998. Internal Revenue Service Restructuring and Reform Act of
1998, Pub. L. 105-206, sec. 3001(c), 112 Stat. 685, 727.
Respondent contends that the affected items in this case are
merely a continuation of the proceeding commenced with respect to
the partnership long before the effective date of section
7491(c). Under the circumstances of this case, it is arguable
that an examination of petitioners’ return commenced after that
effective date, because, due to petitioners’ failure to attach a
Schedule K-1, the disallowed deductions were determined only
after examining petitioners’ Schedule C. This is not the normal
proceeding in which adjustments based on the partnership
proceeding and Schedules K-1 are automatically made and assessed
with respect to the individual partners. We offer no opinion,
however, about whether the determination of additions to tax as
affected items resulting from a partnership examination is a
separate examination for purposes of the effective date of
section 7491, and we need not decide whether the circumstances of
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this case would lead to the conclusion that examination of
petitioners’ Schedule C was a separate examination. The record
in this case supports the application of the additions to tax
without regard to the burden of production. If the burden of
production were on respondent, it would be satisfied in this case
by the tax return, petitioner’s testimony, and other evidence in
the record.
Petitioners also ask that we reduce the amount of tax that
was assessed after the partnership-level proceedings became
final, which is not a part of the determination in the statutory
notice in this case. That assessment was a computational
adjustment that the Commissioner is permitted to assess against
the partner without issuing a notice of deficiency. Secs. 6225,
6230(a)(1); N.C.F. Energy Partners v. Commissioner, 89 T.C. 741,
744 (1987); Maxwell v. Commissioner, 87 T.C. 783, 792 n.7 (1986).
We have no jurisdiction in this case over that computational
adjustment. For purposes of the additions to tax, however, we
are satisfied by the evidence in this case that the correct
amount of the underpayment is less than the amount assessed and
that the correct amount should be used in computing the additions
to tax. That amount will be computed by determining the tax
based on disallowance of the sum of $13,150.
Finally, petitioners assert that the investment in Cal-Neva
was not a “tax-motivated transaction” for purposes of section
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6621(c). The increased rate of interest under section 6621(c) is
120 percent of the statutory rate imposed on underpayments under
section 6601 if the underpayment exceeds $1,000 and is
attributable to a tax-motivated transaction (as defined in
section 6621(c)(3)). The increased interest is effective only
with respect to interest accruing after December 31, 1984,
notwithstanding that the transaction was entered into before that
date. Solowiejczyk v. Commissioner, 85 T.C. 552 (1985), affd.
per curiam without published opinion 795 F.2d 1005 (2d Cir.
1986).
This Court generally does not have jurisdiction to review
assessment of section 6621(c) tax-motivated interest in affected
item proceedings, even though the tax-motivated interest is an
affected item that requires a partner-level determination. See
White v. Commissioner, 95 T.C. 209 (1990); Korchak v.
Commissioner, T.C. Memo. 2005-244; see also Ertz v. Commissioner,
T.C. Memo. 2007-15. A narrow exception to this rule applies if a
taxpayer has paid the assessed tax-motivated interest and
subsequently invokes the overpayment jurisdiction of this Court
under section 6512(b). See Barton v. Commissioner, 97 T.C. 548
(1991). Petitioners do not claim that they have paid the
interest.
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Petitioners nevertheless argue that this Court has
jurisdiction to review interest assessments under section
6621(c)(4). Section 6621(c)(4) provides as follows:
(4) Jurisdiction of Tax Court.–-In the case of any
proceeding in the Tax Court for a redetermination of a
deficiency, the Tax Court shall also have jurisdiction
to determine the portion (if any) of such deficiency
which is a substantial underpayment attributable to tax
motivated transactions.
Respondent presumably determined that the underlying deficiency
in this case was a substantial underpayment attributable to a
tax-motivated transaction. As explained above, this Court does
not have jurisdiction to review the underlying deficiency.
Because the underlying deficiency is not before this Court,
section 6621(c)(4) cannot confer jurisdiction to determine what
portion of such underlying deficiency is attributable to a tax-
motivated transaction. Although each addition to tax at issue in
this case is a “deficiency” within the meaning of section
6621(c)(4), section 6621(c)(2) excludes additions to tax from the
definition of “substantial underpayment attributable to tax
motivated transactions”, thereby precluding review under section
6621(c)(4). White v. Commissioner, supra at 216; see Robnett v.
Commissioner, T.C. Memo. 2001-17; Hunt v. Commissioner, T.C.
Memo. 2001-15 (both involving jojoba venture partnerships).
We have considered the other arguments of the parties, and
they are either irrelevant to our decision or lacking in merit.
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To take account of the necessary recomputation of the additions
to tax,
Decision will be entered
under Rule 155.