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JEFFREY I. AND ROBERTA H. STONE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent; JOSEPH AND MARY COTE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentStone v. CommissionerDocket Nos. 11776-88, 322-91
United States Tax Court T.C. Memo 1996-230; 1996 Tax Ct. Memo LEXIS 250; 71 T.C.M. (CCH) 3020;May 22, 1996, Filed*250 Decisions will be entered under Rule 155.
Bernard S. Mark and Richard S. Kestenbaum, for petitioners.Lawrence L. Davidow andFrances Ferrito Regan , for respondent in docket No. 11776-88.Barry J. Laterman , for respondent in docket No. 322-91.DAWSON, WOLFEWOLFEMEMORANDUM 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. WOLFE,Special Trial Judge : These cases are part of the Plastics Recycling group of cases. For a detailed discussion of the transactions involved*251 in the Plastics Recycling cases, seeProvizer v. Commissioner , T.C. Memo. 1992-177996 F.2d 1216">996 F.2d 1216 (6th Cir. 1993). The underlying transactions in these cases are substantially identical to the transaction considered in theProvizer case.In a notice of deficiency, respondent determined a deficiency in the 1981 joint Federal income taxes of petitioners Stone in the amount of $ 52,576 and additions to tax for that year in the amount of $ 15,773 under
section 6659 for valuation overstatement, in the amount of $ 2,629 undersection 6653(a)(1) for negligence, and undersection 6653(a)(2) in an amount equal to 50 percent of the interest due on the underpayment attributable to negligence. In another notice of deficiency, respondent determined deficiencies in the 1980 and 1981 joint Federal income taxes of petitioners Cote in the respective amounts of $ 16,941 and $ 100,472. *252Additions to Tax Year Sec. 6651 Sec. 6653(a)(1) Sec. 6653(a)(2) Sec. 6659 1980 $ 847 1981 $ 3,619 5,024 $ 30,141 Respondent also determined in each case that interest on deficiencies accruing after December 31, 1984, would be calculated at 120 percent of the statutory rate under
section 6621(c) .Stipulations of Settled Issues pertaining to petitioners' respective participation in the Plastics Recycling Program, and filed in each of these consolidated cases, provide in part that:
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. *253 § 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, with the exception of 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) .Accordingly, the only issues remaining in these consolidated cases are: (1) Whether petitioners are liable for additions to tax under
section 6653(a)(1) andsection 6653(a)(2) for negligence; and (2) whether petitioners are liable for additions to tax undersection 6659 for underpayments of tax attributable to valuation overstatements.FINDINGS OF FACT
Some of the facts have been stipulated and are so *254 found. The stipulated facts and attached exhibits are incorporated by this reference. Petitioners Stone resided in Framingham, Massachusetts, when their petition was filed. Petitioners Cote resided in Huntington, New York, when their petition was filed.
During 1981, petitioner Jeffrey Stone (Stone) was the sole owner of an electronics distributor, Stone Component Sales Corp., for which he worked as a manufacturers' representative. His spouse, Roberta, was not employed outside the home. On their 1981 Federal income tax return, petitioners Stone reported gross income from wages, interest, and dividends in excess of $ 250,000. Consequently, in the absence of significant deductions or credits, they were subject to payment of Federal income taxes in substantial amounts for taxable year 1981.
Petitioner Joseph Cote (Cote) was a corporate bond trader for Merrill Lynch, Pierce, Fenner & Smith, Inc. (Merrill Lynch), during 1981. His wife, Mary, was not employed outside the home. On their 1981 Federal income tax return, petitioners Cote reported gross income from wages, interest, and dividends in excess of $ 320,000. Consequently, in the absence of significant deductions or credits, they were*255 subject to payment of Federal income taxes in substantial amounts for taxable year 1981.
Stone is a limited partner in Northeast Resource Recovery Associates (Northeast) and Cote is a limited partner in Hyannis Recycling Associates (Hyannis). For convenience, we refer to these two partnerships collectively as the Partnerships.
Petitioners have stipulated that 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">T.C. Memo. 1992-177Provizer 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*256 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 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. These transactions were done simultaneously. 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 herein was formed to lease Sentinel EPE recyclers from F & G Corp. and license those recyclers to FMEC Corp. *258 The transactions *257 of the Partnerships differ from the underlying transaction 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.; (2) in the Northeast transaction, seven, rather than six, machines were sold, leased, licensed, and sublicensed; and (3) in the Hyannis transaction, F & G purchased the recyclers for $ 1,066,667 each. *259 be challenged as being in excess of fair market value; (2) that the Partnerships have no prior operating history; (3) that the general partners have no prior experience in marketing recycling or similar equipment; (4) that the limited partners have no control over the conduct of the Partnerships' business; (5) that there is no established market for the Sentinel EPE recyclers; (6) that 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) that certain potential conflicts of interest exist.During 1981, Stone acquired a 2.60525-percent interest in Northeast for his investment of $ 25,000. As a result of the passthrough from Northeast, on their 1981 Federal income tax return the Stones deducted an operating loss in the amount of $ 20,340 and claimed investment tax and business energy credits totaling $ 42,406. The underlying deficiency in the Stone case results from respondent's disallowance of the Stones' claimed operating losses and credits related to Northeast.
Stone learned about the Sentinel EPE recyclers and Northeast from Donald F. Tomasetti (Tomasetti), an accountant married to a cousin of his. The two have known each other on a personal level since the 1960's. Tomasetti has a B.B.A. in accounting from the University*262 of Massachusetts. He worked at Peat, Marwick, Mitchell for 13 years (5-1/2 as an auditor and 7-1/2 as a tax specialist). In 1975 he established his own full service accounting practice, Romito & Tomasetti. Two or 3 years later, Stone Component Sales Corp. became a client of Romito & Tomasetti, with Tomasetti acting as the principal adviser to both the corporation and Stone individually. Tomasetti has no expertise in plastics.
Tomasetti learned about the Sentinel EPE recyclers from John Frabotta (Frabotta) and Dick Omohundro (Omohundro). *263 and since 1988 he has worked for a registered investment adviser, Prospect Street Investment Management, another fund for which Tomasetti is the auditor. Frabotta is not an expert in plastics or plastics recycling.
Frabotta learned about the Sentinel EPE recyclers from Cote, who in turn had learned about them from an accounting firm, Finkle & Co. Finkle & Co. performed accounting functions for Northeast or its general partner, Richard Roberts (Roberts), in 1983. *264 During Tomasetti's tour at PI, there was an inquiry about the cost of the Sentinel EPE recycler but PI representatives declined to discuss that subject because, as Tomasetti understood it, the machine was proprietary in nature and had not been patented. (Although PI claimed that its information was a trade secret and that it never obtained patents on its machines, in fact, PI had obtained numerous patents prior to the Partnership transactions and had also applied for a trademark for the Sentinel EPE recyclers). PI indicated that there was no other comparable machine on the market and Tomasetti made no independent inquiries or investigation regarding the uniqueness or value of the recycler. Tomasetti read the reports of Ulanoff and Burstein, but did not fully understand them and did not attach much weight to them. No other members of Tomasetti's accounting firm performed any due diligence or investigation of the Partnership transactions. An attorney representing one of Tomasetti's client's supposedly did speak with some acquaintances at PI.
Tomasetti did not attempt to market the Partnership transactions himself. He thought they were very aggressive. He fully expected an IRS challenge*265 "because of the obvious tax benefits in excess of the investment that were being achieved in the first year". Tomasetti understood that the tax benefits stemmed from the purported value of the Sentinel EPE recyclers, and he did not believe it was prudent to invest in the partnerships while relying upon the value of the recyclers as represented in the offering materials. Tomasetti believed that before investing, an interested party should have a strong inclination that the Partnership transactions were economically viable. Tomasetti thought that a substantial value for the recyclers might be established in the future if the machines performed well.
Frabotta understood that Omohundro questioned a few Boston area law firms about PI and was told nothing that gave him concern. Frabotta did not pursue an independent investigation of the value of the Sentinel EPE recycler, nor did he ask anyone else to investigate it. Frabotta discussed the value of the recycler with Tomasetti and Omohundro only in passing. Frabotta did not verify the price of resin; he did not inquire whether there were other comparable machines on the market; and he did not ask anyone about the market for the Sentinel*266 EPE recycler.
Stone reviewed the Northeast offering memorandum and spoke with Tomasetti about the visit to Hyannis. Stone knew that Tomasetti had no expertise in plastics, and Tomasetti never told Stone that he had consulted with, or intended to consult, anyone who was not associated with PI or the Partnerships. Stone knew that Tomasetti was unsure about the value of the Sentinel EPE recycler, but the value of the machine did not concern Stone. He also knew that Tomasetti received a commission for sales of partnership interests. Stone did not investigate the existence of competing suppliers or manufacturers, or the existence of a market for the recyclers. Except for two or three discussions with Tomasetti, Stone did not independently, or through any third parties, investigate PI or the plastics recycling industry.
Cote spoke with people at Merrill Lynch about leasing transactions in general, recycling, and speculation about the price of oil. He did not supply anyone with the Hyannis offering memorandum or pay for an evaluation of Hyannis, nor did anyone prepare any kind of report for him. Cote and Frabotta understood from a client, Global Marine, Inc., an offshore drilling company, *267 that there was speculation that the price of oil could rise. Cote spoke to a representative of Finkle & Co. about Hyannis' tax benefits. He was aware that Burstein had a potential conflict of interest, that there was no established market for the recyclers, and that Finkle & Co. received a sales commission on his investment in the Partnerships. Cote also knew that Frabotta and Omohundro were not plastics recycling experts. Cote knew of Tomasetti because he was Omohundro's accountant, but Cote never had any direct conversations with Tomasetti.
None of petitioners have any education or work experience in plastics recycling or plastics 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.
OPINION
We have decided more than two dozen of the Plastics Recycling group of cases. *268 The majority of these cases, like the consolidated 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 issued to date.
Provizer v. Commissioner , T.C. Memo. 1992-177section 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 the Clearwater partnership were attributable to tax-motivated*269 transactions within the meaning ofsection 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 inProvizer v. Commissioner ,supra .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*270 have explicitly conceded this issue in their respective stipulations of fact and stipulations of settled issues filed shortly before trial. The record plainly supports respondent's determinations in these cases 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 .Issue 1. Section 6653(a) NegligenceIn notices of deficiency, respondent determined that petitioners were liable for additions to tax for negligence under
section 6653(a) for 1980 and 6653(a)(1) and (2) for 1981. Each of petitioners has 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">79 T.C. 846Section 6653(a) for 1980 andsection 6653(a)(1) for 1981 impose 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. In cases involving negligence for 1981, an additional amount is added to the tax undersection 6653(a)(2) ; such amount*271 is equal to 50 percent of the interest payable with respect to the portion of the underpayment attributable to negligence. Negligence is defined as the failure to exercise the due care that a reasonable and ordinarily prudent person would employ under the circumstances.Neely v. Commissioner , 85 T.C. 934">85 T.C. 934Henry Schwartz Corp. v. Commissioner , 60 T.C. 728">60 T.C. 728Petitioners in these consolidated cases contend that they were reasonable in claiming deductions and credits with respect to the Partnerships. Petitioners each allege that they reasonably relied upon the advice of qualified advisers, and that they reasonably expected an economic profit in light of the so-called oil crisis in the United States during 1981. In each case, petitioners' investigation of the Partnership transactions and the Sentinel EPE recyclers was essentially limited to conversations with Tomasetti, Frabotta, or Omohundro, in addition to a review of*272 the respective offering memoranda. Petitioners argue that such investigation insulates them from the negligence additions to tax.
Under some circumstances a taxpayer may avoid liability for the additions to tax under
section 6653(a) if reasonable reliance on a competent professional adviser is shown.Freytag v. Commissioner , 89 T.C. 849">89 T.C. 849904 F.2d 1011">904 F.2d 1011 (5th Cir. 1990), affd.501 U.S. 868">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.Id. In order for reliance on professional advice to excuse a taxpayer from the negligence additions to tax, the reliance must be reasonable, in good faith, and based upon full disclosure.Id. ; seeWeis v. Commissioner , 94 T.C. 473">94 T.C. 473Ewing v. Commissioner , 91 T.C. 396">91 T.C. 396940 F.2d 1534">940 F.2d 1534 (9th Cir. 1991);Pritchett v. Commissioner , 63 T.C. 149">63 T.C. 149Reliance on representations*273 by insiders, promoters, or offering materials has been held an inadequate defense to negligence.
LaVerne v. Commissioner , 94 T.C. 637">94 T.C. 637956 F.2d 274">956 F.2d 274 (9th Cir. 1992), affd. without published opinion sub nom.Cowles v. Commissioner , 949 F.2d 401">949 F.2d 401Marine v. Commissioner , 92 T.C. 958">92 T.C. 958921 F.2d 280">921 F.2d 280 (9th Cir. 1991);McCrary v. Commissioner , 92 T.C. 827">92 T.C. 827Rybak v. Commissioner , 91 T.C. 524">91 T.C. 524Beck v. Commissioner , 85 T.C. 557">85 T.C. 557Flowers v. Commissioner , 80 T.C. 914">80 T.C. 914Steerman v. Commissioner , T.C. Memo 1993-447">T.C. Memo. 1993-447Based upon our review of the entire records in*274 these cases, we hold that Stone's purported reliance on Tomasetti, and Cote's purported reliance on Frabotta and Omohundro, and through them Tomasetti, was not reasonable, not in good faith, nor based upon full disclosure. Neither petitioners, nor their supposed advisers, nor anyone affiliated with them had any education or work experience in plastics materials or plastics recycling. Neither petitioners nor their supposed advisers consulted any independent experts or conducted anything approaching a meaningful investigation. In addition, it is clear that Tomasetti had serious concerns regarding the recycler's purported value, and nothing in the records indicates that his concerns were not communicated to petitioners.
Frabotta's purported investigation entailed speaking to a client contact at Global Marine about the price of oil, a review of the offering memorandum, and a visit to Hyannis with Tomasetti and Omohundro. Tomasetti became involved at the behest of Frabotta and Omohundro; they paid him to review the offering materials and visit PI with them. Omohundro did not testify at the trial; aside from visiting the PI plant in Hyannis, he purportedly phoned some legal contacts in*275 Boston who knew of no reason to be concerned about PI. As for Finkle & Co., nothing in the records indicates that they performed any due diligence, and in 1983 they were providing services to either Northeast or Roberts. See
supra note 7. Consequently, we must consider this accounting firm part of the offering or promoting group.None of petitioners' supposed advisers had any background in plastics or plastics recycling to help them analyze or assess the recyclers, and the only persons they spoke to were insiders of the Partnerships or PI personnel. Neither Tomasetti nor Frabotta made any inquiries regarding the value of the machine or sought any independent investigation or third party appraisal. The PI personnel, insiders, and promoters they spoke to in Hyannis were the ones petitioners ultimately relied upon for the value of the Sentinel EPE recycler and the economic viability of the Partnership transactions. See
Vojticek v. Commissioner , T.C. Memo. 1995-444Tomasetti understood that the tax benefits were generated by the purported value of the recyclers *276 and thought that "nobody should go into this deal at all based on the valuations established." He did not market the Partnerships; in his view the deal "was very aggressive" and "sure to be challenged" by the IRS. He knew that the recyclers were insured for only a "nominal amount" in relation to their purported value. (The parties have stipulated that the recyclers had a manufacturing cost of only $ 18,000 each.) Consequently, Tomasetti believed their purported value could only be supported by the success of the Partnerships, i.e., as a function of market demand, and that an investor should therefore have "a strong inclination that this was a viable economic deal." Both Tomasetti and Frabotta testified that they believed the purported value of the Sentinel EPE recycler was supported by the economic projections in the offering materials.
Neither Tomasetti nor Frabotta, nor anyone associated with them investigated the merits of those projections. Frabotta did not investigate the market for the Sentinel EPE recycler or inquire as to whether the recycler had any competition. Tomasetti made no independent inquiries or investigation of the recycler or any of the individuals involved. He*277 thought that there was a ready market for the recyclers. As he put it, "I did some due diligence to the extent that I was asked to accompany these individuals to Hyannis, but it wasn't my objective to go down and to try and shake this out, and spend six months of my life trying to learn about the industry".
The offering materials clearly stated that there was no established market for leasing or operating the recyclers. Information published prior to the Plastics Recycling transactions indicated that 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), Buss-Condux Plastcompactor, and Cumberland Granulator. See
Provizer v. Commissioner , T.C. Memo. 1992-177Petitioners have failed to show that Tomasetti, Frabotta, Omohundro, or Finkle & Co. was qualified to evaluate the Sentinel EPE recyclers and the Partnership transactions. Tomasetti was skeptical of the recycler's inflated value, and he communicated the results of his investigation *278 and review to his clients. Frabotta's and Tomasetti's testimony that they believed the purported value of the recycler was supported by the economic projections in the offering materials is without merit and not credible. Petitioners knew that Tomasetti and Frabotta had no education or expertise in plastics or plastics recycling, and there is no reason to doubt that Tomasetti's reservations and disclaimers were communicated to petitioners. A taxpayer may rely upon his adviser's expertise (in these cases, accounting, financial planning, and tax advice), but it is not reasonable or prudent to rely upon an adviser regarding matters outside of his field of expertise or with respect to facts which he does not verify. See
Skeen v. Commissioner , 864 F.2d 93 (9th Cir. 1989)Patin v. Commissioner , 88 T.C. 1086 (1987)Lax v. Commissioner , T.C. Memo. 1994-32972 F.3d 123">72 F.3d 123 (3d Cir. 1995). Because of the technical nature of these investment ventures, it was unreasonable for petitioners to rely on Tomasetti, Frabotta, or Omohundro.Moreover, *279 a careful consideration of the materials in the respective offering memoranda, especially the discussions in the prospectuses 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">857 F.2d 1383Dister v. Commissioner , T.C. Memo 1987-217">T.C. Memo. 1987-217On their face, the Partnership transactions should have raised serious questions in the minds of ordinarily prudent investors. According to the Northeast and Hyannis offering memoranda, the projected benefits for taxable year 1981 were, for each $ 50,000 investor, investment tax credits of $ 84,813 and $ 79,200, respectively, plus deductions of $ 40,174 and $ 42,491, respectively, all in the initial year of investment.
Provizer v. Commissioner ,supra McCrary v. Commissioner , 92 T.C. 827">92 T.C. 827The Stones placed into the record of their case several documents, ostensibly submitted as evidence that they monitored their investments in Northeast. These included unaudited financial statements of Northeast prepared by nonindependent accountants from 1981 to 1985, Forms K-1 from 1984 and 1986, a 1983 report prepared by Finkle & Co. describing the accounting procedures and controls for the recycling operations at PI, and a 1983 update from PI noting that "market prices for polyethylene resin have remained relatively low * * * [and] the Sentinel recyclers * * * have not been profitable." Stone did not testify or otherwise indicate that he ever examined these documents. *282 He spoke to Roberts once about the performance of the Northeast partnership and learned that it was experiencing difficulty placing the machines. We decline to infer from these documents that he actively monitored his investment in Northeast.
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 on their Federal income tax returns based upon each recycler's having a value of $ 1,066,666 in the Hyannis partnership and $ 1,162,666 in the Northeast partnership. *283 250,000. 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, *285 research, and investigation, and were subsequently rejected and discredited by their author. Respondent likewise rejected the 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 *284 the values reported on petitioners' returns. Not surprisingly, petitioners did not call Carmagnola to testify in these cases, 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' reliance on
Mollen v. United States , 72 AFTR 2d 93-6443, 93-2Mollen 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 which 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*286 debatable." SeeZfass v. Commissioner , T.C. Memo 1996-167">T.C. Memo. 1996-167The records in these cases show that none of petitioners or their supposed advisers had any formal education, expertise, or experience in plastics 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 Partnership transactions would be economically profitable. The extent of Tomasetti's, Frabotta's, and Omohundro's "investigation" was a tour of PI's plant in Hyannis and a discussion with PI personnel and insiders to the Partnership transactions. No independent experts in the field of plastics or plastics recycling were consulted by any of petitioners or their advisers. The facts of these cases are distinctly different from those in the
Mollen case. Thus, we consider petitioners' arguments with respect to theMollen case inapplicable under the circumstances of these cases.Petitioner's arguments are not supported by the Ninth Circuit Court of Appeals' partial reversal of our decision in
Osterhout v. Commissioner , T.C. Memo 1993-251">T.C. Memo. 1993-251Balboa Energy Fund 1981 v. Commissioner ,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. Balboa Energy Fund 1981, petitioners argue that their reliance upon the offering materials concerning their investments in Northeast and Hyannis was reasonable and therefore sufficient to overcome the additions to tax for negligence. The Court of Appeals for the Ninth Circuit's opinion is unpublished, however. Moreover, the prefaces to the offering memoranda for Northeast and Hyannis warned prospective investors that the tax opinion letter was not in final form, and was prepared for the general partner, and that prospective investors should consult their own professional*288 advisers with respect to the tax benefits and tax risks associated with the Partnership. The tax opinion letter was addressed solely to the general partner and contained the following opening 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 their 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 thatthe purpose in distributing it is to assist your offerees' tax advisors in making their own analysis and not to permit any prospective investor to rely upon our advice in this matter . [Emphasis added.]Petitioners also argue, in general terms, that they were reasonable in claiming the deductions and credits related to the Partnerships because of rising oil prices in the United States in 1981. In support of this argument, petitioners testified that the conventional wisdom at the time was that oil prices would rise; petitioners also placed into the record several articles from Modern Plastics and an energy projections report from the U.S. Department of Energy (DOE), all published in the years 1980 and 1981. Petitioners also cite
Krause v. Commissioner , 99 T.C. 132">99 T.C. 132Hildebrand v. Commissioner , 28 F.3d 1024">28 F.3d 1024Rousseau v. United States , 91-1 USTC par. 50,252 (E.D. La. 1991).The articles from Modern Plastics and the report by the DOE speculated on the price of oil, among other matters. The preface to the DOE report cautioned about "the tremendous uncertainties underlying energy projections" and warned "that [their] projections do not constitute any sort of blueprint for the future." Reflective of such uncertainties, an April 1980 article in Modern Plastics contemplated resin price hikes, while a May 1981 article predicted a leveling off of prices, market disruptions, and an industrywide shakeout. Petitioners do not purport to have read, or in any way relied upon, the DOE report or the Modern Plastics articles, and have not otherwise explained the connection between these speculative materials and their investments in the Partnerships. Indeed, while Cote testified that he saw a correlation between resin pellets, an oil-based product, and the price of oil, he could not "recall ever making a direct connection between those two". Petitioners' vague, general*291 claims concerning the so-called oil crisis are without merit.
Petitioners' reliance on
Krause v. Commissioner ,supra Krause case are distinctly different from the facts of these cases. In theKrause case, the taxpayers invested in limited partnerships whose investment objectives concerned enhanced oil recovery (EOR) technology. TheKrause 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.Id. at 135-136Krause 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 177Krause 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 theKrause 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 166Krause case are inapplicable here.Petitioners' reliance on
Rousseau v. United States ,supra Rousseau , 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 theKrause 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. 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 theRousseau case. *294 Accordingly, we do not find petitioners' arguments with respect to theRousseau case applicable.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. We hold that petitioners did not reasonably rely upon Tomasetti, Frabotta, or Omohundro and the offering memoranda, or in good faith investigate the underlying viability, financial structure, and economics of the Partnership transactions herein. It is clear from Tomasetti's testimony that he was concerned with the inflated values placed on the recyclers, that he communicated his concerns to his clients, and that all petitioners were made aware of his views with respect to the Plastics Recycling deal. 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) for 1980 andsection 6653(a)(1) and(2) for 1981. Respondent is sustained on this issue.Issue 2. Section 6659 Valuation OverstatementRespondent determined that petitioners were each liable for the
section 6659 addition to*295 tax on the portion of their respective underpayments attributable to valuation overstatement. Petitioners have the burden of proving that respondent's determinations of thesesection 6659 additions to tax are erroneous. Rule 142(a);Luman v. Commissioner , 79 T.C. 846">79 T.C. 846A 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 each claimed an investment tax credit and a business energy credit based on the following purported values for each Sentinel EPE recycler: $ 1,162,666 in the Northeast transaction and $ 1,066,666 in the Hyannis transaction. Petitioners each concede that the fair market value of each recycler was not in excess of $ 50,000. Therefore, if disallowance*296 of petitioners' claimed credits is attributable to the valuation overstatements, petitioners are liable for the
section 6659 addition to tax at the rate of 30 percent of the respective underpayments of tax attributable to the credits claimed with respect to the Partnerships.Section 6659 does not apply to underpayments of tax that are not "attributable to" valuation overstatements. SeeMcCrary v. Commissioner , 92 T.C. 827">92 T.C. 827Todd v. Commissioner , 89 T.C. 912 (1987)862 F.2d 540">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">99 T.C. 132Todd v. Commissioner ,supra Hildebrand v. Commissioner , 28 F.3d 1024 (10th Cir. 1994)section 6659 is applicable. SeeIlles v. Commissioner , 982 F.2d 163">982 F.2d 163T.C. Memo. 1991-449 ;Gilman v. Commissioner , 933 F.2d 143">933 F.2d 143section 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">T.C. Memo. 1989-684 ;Masters v. Commissioner , T.C. Memo. 1994-19770 F.3d 1262">70 F.3d 1262 (4th Cir. 1995);Harness v. Commissioner , T.C. Memo. 1991-321In the respective stipulations of settled issues, petitioners concede that they "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." In
Todd v. Commissioner ,supra McCrary v. Commissioner ,supra section 6659 , even though the subject property was overvalued, because the related deductions and credits had been conceded or denied in their entirety on other*298 grounds. InTodd , we found that an underpayment was not attributable to a valuation overstatement because property was not placed in service during the years in issue. InMcCrary , we found the taxpayers were not liable for thesection 6659 addition to tax when, prior to the trial of the case, the taxpayers conceded that they were not entitled to the investment tax credit because the agreement in question was a license and not a lease. In both cases, the underpayment was attributable to something other than a valuation overstatement.This Court has held that concession of the investment tax credit in and of itself does not relieve taxpayers of liability for the
section 6659 addition to tax.Dybsand v. Commissioner , T.C. Memo 1994-56">T.C. Memo. 1994-56Chiechi v. Commissioner , T.C. Memo 1993-630">T.C. Memo. 1993-630Chiechi v. Commissioner ,supra .section 6659 addition to tax and the other does not, the taxpayer may *299 still be liable for the addition to tax.Gainer v. Commissioner , 893 F.2d 225">893 F.2d 225T.C. Memo 1988-416">T.C. Memo. 1988-416 ;Irom v. Commissioner , 866 F.2d 545">866 F.2d 545T.C. Memo 1988-211">T.C. Memo. 1988-211 ;Harness v. Commissioner ,supra .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 stipulated substantially the same facts concerning the underlying transactions as we found in
Provizer v. Commissioner , T.C. Memo. 1992-177Provizer case, we held that the taxpayers were liable for thesection 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 inProvizer that the transaction was a sham and lacked*300 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.Consistent with our findings in
Provizer , petitioners respectively stipulated that the Northeast and Hyannis transactions had no net equity value, that the sole activity of the Northeast and Hyannis partnerships lacked any potential for profit, and that the Northeast and Hyannis partnership transactions therefore lacked economic substance. When a transaction lacks economic substance,section 6659 will apply because the correct basis is zero, and any basis claimed in excess of that is a valuation overstatement.Gilman v. Commissioner ,supra Rybak v. Commissioner , 91 T.C. 524">91 T.C. 524Zirker v. Commissioner , 87 T.C. 970">87 T.C. 970Donahue v. Commissioner , T.C. Memo. 1991-181959 F.2d 234">959 F.2d 234 (6th Cir. 1992), affd. sub nom.Pasternak v. Commissioner , 990 F.2d 893">990 F.2d 893We held in
Provizer v. Commissioner ,supra Provizer case that the Sentinel EPE recyclers had been overvalued was integral to and inseparable from our finding of a lack of economic substance. Petitioners conceded that the Northeast and Hyannis transactions were similar to the Clearwater transaction described inProvizer v. Commissioner ,supra Finally, we consider petitioners' express arguments as to waiver of the*302 addition to tax under
section 6659 . On brief, petitioners each contested imposition of thesection 6659 addition to tax on the grounds that respondent erroneously failed to waive the addition to tax.Section 6659(e) authorizes respondent to waive all or part of the addition to tax for valuation overstatement 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 asection 6659 addition to tax is reviewable by this Court for abuse of discretion.Krause v. Commissioner , 99 T.C. at 179Petitioners urge that they relied on the offering memoranda and, in varying degrees, Tomasetti, Frabotta, and Omohundro in deciding on the valuation claimed on their tax returns. Petitioners each contend that such reliance was reasonable and, therefore, respondent should have waived the
section 6659 addition to tax. Petitioners citeKrause v. Commissioner ,supra Mauerman v. Commissioner , 22 F.3d 1001">22 F.3d 1001T.C. Memo 1993-23">T.C. Memo. 1993-23 ;*303 andRousseau v. United States , 71A AFTR 2d 93-4294, 91-1We have found that petitioners' purported reliance on Tomasetti, Frabotta, and Omohundro, in addition to the offering memoranda, was not reasonable. None of petitioners, their supposed advisers, nor anyone affiliated with them was educated or experienced in plastics or plastics recycling. The evaluators whose reports were appended to each of the offering memoranda each owned interests in partnerships which leased Sentinel EPE recyclers. The offering memoranda contained numerous caveats, including the following: NO OFFEREE SHOULD CONSIDER THE CONTENTS OF THIS MEMORANDUM *** AS *** EXPERT ADVICE. *** EACH OFFEREE SHOULD CONSULT HIS OWN PROFESSIONAL ADVISERS. Petitioners did not see a Sentinel EPE recycler prior to investing in Northeast or Hyannis, nor did they independently investigate the recyclers. They only went so far as to have an accountant and two bond dealers, all lacking any training or experience in plastics or recycling, look at the machines and the factory which produced them. In effect, petitioners went so far as to find*304 out whether some sort of machine existed and not much farther.
Petitioners' reliance on
Krause v. Commissioner ,supra Rousseau v. United States ,supra Mauerman v. Commissioner ,supra Krause andRousseau cases, thesection 6659 addition to tax was disallowed in light of the respective holdings that the taxpayers in each case had a reasonable basis for the valuations claimed on the tax returns or had reasonable cause for the understatements on the returns and were not subject to negligence additions to tax. In contrast, we have held that petitioners herein did not act reasonably in claiming deductions and investment tax credits related to the Partnerships, that the errors on petitioners' tax returns were caused by the excessive valuations of the underlying machinery in the Partnership transactions, that petitioners lacked reasonable cause for such overvaluation, and that each petitioner is therefore liable for the negligence additions to tax undersection 6653(a) . Accordingly, petitioners' *305 reliance on theKrause andRousseau cases is misplaced.In
Mauerman , the Tenth Circuit Court of Appeals held that the Commissioner had abused her discretion for not waiving asection 6661 addition to tax. Likesection 6659 , asection 6661 addition to tax may be waived by the Commissioner if the taxpayer demonstrates that there was reasonable cause for his underpayment and that he acted in good faith.Sec. 6661(c) . The taxpayer inMauerman relied upon independent attorneys and accountants for advice as to whether payments were properly deductible or capitalized. The advice relied upon by the taxpayer inMauerman 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 supposed advisers. Consequently, we consider petitioners' reliance on theMauerman case inapplicable.We hold that petitioners did not have a reasonable basis for the adjusted bases or valuations reflected on their tax returns with respect to their investments in Northeast and Hyannis. *306 In these cases respondent properly could find that petitioners' reliance on Tomasetti, Frabotta, and Omohundro, in addition to the offering materials, 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 thesection 6659 addition to tax at the rate of 30 percent of the underpayment of tax attributable to the disallowed tax benefits. Respondent is sustained on this issue.Decisions will be entered under Rule 155 .Footnotes
1. All section references are to the Internal Revenue Code in effect for the years in issue, unless otherwise indicated. All Rule references are to the Tax Court Rules of Practice and Procedure.↩
2. The deficiency in the Cote case for taxable year 1980 is solely attributable to respondent's disallowance of an investment credit carryback from taxable year 1981.↩
1. For 1980, the addition to tax is under
sec. 6653(a)↩ .2. 50 percent of the interest payable with respect to the portion of the underpayment attributable to negligence.↩
3. As the Hyannis transaction was initially structured, Hyannis purchased the recyclers from ECI Corp. and leased them to FMEC. This transaction was restructured to take advantage of the safe-harbor leasing rules of the Economic Recovery Tax Act of 1981 (ERTA), Pub. L. 97-34, 95 Stat. 172. As in all subsequent Plastics Recycling programs, F & G Corp. was interposed between ECI and the primary leasing partnership (in this case Hyannis).↩
4. There is no explanation in the record as to why the six recyclers were sold to F & G Corp. for $ 6,400,000 in the Hyannis transaction but later sold for $ 6,975,996 in subsequent Plastics Recycling transactions. We note that the Hyannis partnership initially closed at the lower price prior to the enactment of the safe-harbor legislation, and subsequently the arrangement was modified in an attempt to take advantage of those rules by inserting F & G Corp. into the transaction.↩
5. The parties stipulated that Cote owned a 3.094-percent interest in Hyannis. However, Cote's 1981 Form K-1, Partner's Share of Income, Credits, Deductions, etc., attached to the Hyannis partnership return, indicates that he acquired a 6.187-percent interest in Hyannis. The reason for this discrepancy is not explained in the record.↩
6. Omohundro did not testify at the trial.↩
7. In 1983 Finkle & Co. prepared a report on the polyethylene operations at Hyannis. Roberts forwarded this report to limited partners in the Plastics Recycling transactions. In a cover letter, Roberts refers to Finkle & Co. as "our accounting firm". It is not clear whether Finkle & Co. prepared the report for Northeast or Roberts' consulting firm.↩
8.
Provizer v. Commissioner , T.C. Memo 1992-177">T.C. Memo. 1992-177Reimann v. Commissioner , T.C. Memo. 1996-84Bennett v. Commissioner , T.C. Memo. 1996-14Atkind v. Commissioner , T.C. Memo. 1995-582Triemstra v. Commissioner , T.C. Memo. 1995-581Pace v. Commissioner , T.C. Memo. 1995-580Dworkin v. Commissioner , T.C. Memo. 1995-533Wilson v. Commissioner , T.C. Memo. 1995-525Avellini v. Commissioner , T.C. Memo. 1995-489Paulson v. Commissioner , T.C. Memo. 1995-387Zidanich v. Commissioner , T.C. Memo 1995-382">T.C. Memo. 1995-382Ramesh v. Commissioner , T.C. Memo 1995-346">T.C. Memo. 1995-346Reister v. Commissioner , T.C. Memo 1995-305">T.C. Memo. 1995-305Fralich v. Commissioner , T.C. Memo. 1995-257Shapiro v. Commissioner , T.C. Memo. 1995-224Pierce v. Commissioner , T.C. Memo. 1995-223Fine v. Commissioner , T.C. Memo. 1995-222Pearlman v. Commissioner , T.C. Memo. 1995-182Kott v. Commissioner , T.C. Memo. 1995-181Eisenberg v. Commissioner , T.C. Memo 1995-180">T.C. Memo. 1995-180Baratelli v. Commissioner , T.C. Memo. 1994-484Estate of Satin v. Commissioner , T.C. Memo. 1994-435Fisher v. Commissioner , T.C. Memo 1994-434">T.C. Memo. 1994-434Foam Recycling Associates v. Commissioner , T.C. Memo 1992-645">T.C. Memo. 1992-645Madison Recycling Associates v. Commissioner , T.C. Memo. 1992-605↩9. In
Zidanich v. Commissioner , T.C. Memo. 1995-382section 6659 addition to tax, but not liable for the negligence additions to tax undersection 6653(a) . As indicated in our opinion, theZidanich case, and theSteinberg↩ case consolidated with it for opinion, involved exceptional circumstances.10. In both cases the parties stipulated that the offering memoranda projected tax benefits of $ 86,328 in investment tax credits and $ 39,399 in deductions. There is no explanation for this discrepancy in the record.↩
11. The Hyannis partnership involved 6 machines on which the partnership set a value of $ 6,400,000. The Northeast partnership involved 7 machines on which the partnership set a value of $ 8,138,667.↩
12. In one preliminary report, Carmagnola states that he has "a serious concern of actual
profit-level↩ " of 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 information available concerning research and development costs of the machines and that he estimated those costs in his valuations of the machines.13. Carmagnola has not been called to testify in any of the Plastics Recycling cases before us.↩
14.
Osterhout v. Commissioner , T.C. Memo. 1993-251sec. 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 parties.
Document Info
Docket Number： Docket Nos. 11776-88, 322-91
Judges： DAWSON,WOLFE
Filed Date： 5/22/1996
Precedential Status： Non-Precedential
Modified Date： 4/17/2021