F I L E D
United States Court of Appeals
Tenth Circuit
UNITED STATES COURT OF APPEALS
JAN 13 1999
FOR THE TENTH CIRCUIT
PATRICK FISHER
Clerk
GILMORE & WILSON
CONSTRUCTION COMPANY AND
SUBSIDIARY, No. 97-9024
Appeal from U.S. Tax Court
Petitioner-Appellant, (T.C. No. 19780-89)
v.
COMMISSIONER OF INTERNAL
REVENUE,
Respondent-Appellee.
_____________________________
JERRY L. WILSON,
Petitioner-Appellant,
No. 97-9026
v. Appeal from U.S. Tax Court
(T.C. No. 27225-89)
COMMISSIONER OF INTERNAL
REVENUE,
Respondent-Appellee.
_____________________________
CHARLES T. GILMORE and No. 97-9027
BETTYE GILMORE, Appeal from U.S. Tax Court
(T.C. No. 27132-89)
Petitioners-Appellants,
v.
COMMISSIONER OF INTERNAL
REVENUE,
Respondent-Appellee.
ORDER AND JUDGMENT *
Before BRORBY , BRISCOE , and LUCERO , Circuit Judges.
After examining the briefs and appellate record, this panel has determined
unanimously to grant the parties’ request for a decision on the briefs without oral
argument. See Fed. R. App. P. 34(f); 10th Cir. R. 34.1(G). These cases are
therefore ordered submitted without oral argument.
These three appeals challenge the Tax Court’s affirmance of the
Commissioner’s imposition of penalties and interest due to the taxpayers-
appellants’ negligent underpayment of taxes owed for various tax years from 1979
to 1983. See Estate of Hogard v. Commissioner , 73 T.C.M. (CCH) 2552, 1997
*
This order and judgment is not binding precedent, except under the
doctrines of law of the case, res judicata, and collateral estoppel. The court
generally disfavors the citation of orders and judgments; nevertheless, an order
and judgment may be cited under the terms and conditions of 10th Cir. R. 36.3.
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WL 160769 (1997). 1
We have jurisdiction pursuant to 26 U.S.C. § 7482(a) and
affirm.
I.
These cases are part of what the Commissioner refers to as the “plastics
recycling” group of cases, which involve limited partnership tax shelters that
claimed tax benefits relating to machines designed to recycle plastic scrap. A
detailed discussion of the transactions involved in the plastics recycling cases is
contained in Provizer v. Commissioner , 63 T.C.M. (CCH) 2531, 1992 WL 56983
(1992), aff’d , No. 92-1827, 1993 WL 245799 (6th Cir. 1993). In affirming the
Tax Court’s decision in Provizer , the Sixth Circuit briefly summarized the
circular transactions involved as follows:
In 1981, a corporation called Packaging Industries, Inc.
manufactured and sold six Sentinel EPE Recyclers to ECI
Corporation for $5,886,000 ($981,000 each) which in turn resold the
recyclers to F & G Corporation for $6,976,000 ($1,162,666 each).
F & G leased the recyclers to a limited partnership called Clearwater
Group, and Clearwater then licensed the recyclers to FMEC
Corporation, which sublicensed them back to Packaging Industries.
These transactions were structured in such a way that all of the
payments between the entities offset each other. Packaging
Industries then allegedly sublicensed the recyclers to entities who
would use them to recycle plastic scrap.
1
The Tax Court consolidated the cases of the Hogard estate and appellants.
The Hogard estate did not appeal. Although appellants each filed separate briefs,
they raise the same issues, and with only minor variations in facts, the briefs are
virtually identical. We therefore have combined the three appeals for disposition.
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Provizer , 1993 WL 245799 at **1.
The underlying transactions in these cases are essentially identical to those
in Provizer except that the limited partnership involved was Southeast Recycling
Associates rather than the Clearwater Group. 2
The taxpayers-appellants here--
Charles and Bettye Gilmore, Jerry Wilson, and Gilmore & Wilson Construction
Company (G&W), a company owned and managed by Charles Gilmore and
Wilson (collectively, “taxpayers”)--each invested $25,000 in Southeast in 1982.
The tax effects of these investments were as follows: In 1982, the Gilmores
claimed investment tax credits of $43,042, and carried back credits of $21,176 to
1979, $18,479 to 1980, and $6,332 to 1981. On Wilson’s 1982 return, he claimed
investment tax credits of $43,042. He also carried back credits of $13,054 to
1979 and $881 to 1980. G&W claimed a tax loss on its 1983 return of $20,452
and carried back tax credits of $4,472 to 1980 and $10,514 to 1981. All told, on
the total $75,000 invested, taxpayers took tax credits of $160,992 and losses of
$20,452; they did not report any income from their investments in Southeast.
The Tax Court in Provizer determined that the transactions involving the
Sentinel recyclers were tax shams lacking economic substance and business
2
There apparently were a number of different limited partnerships formed to
play roles similar to those of Clearwater and Southeast in other series of
transactions, thus creating more opportunities for investors. Taxpayers invested
in Southeast because Clearwater had already been fully subscribed.
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purpose. See Provizer , 1992 WL 56983, at 17-23. The court’s determination was
due in large part to its finding that the recyclers’ fair market value, an amount
critical to the size of any tax benefits, was no more than $50,000 each, rather than
the $1,162,666 on which the tax benefits were based. See id. at 15. As a result of
the decision in Provizer , the Commissioner determined deficiencies, additions to
tax and increased tax pursuant to I.R.C. §§ 6659, 6621(c) and 6653 with respect
to the taxpayers’ claimed tax benefits relating to their investments in Southeast.
Taxpayers each filed separate suits in the Tax Court challenging the
Commissioner’s determinations. Taxpayers eventually stipulated substantially to
the facts found in Provizer and, as a result, further stipulated that
1. [Taxpayers] are not entitled to any deductions, losses, investment
credits, business energy credits or any other tax benefits claimed on
their tax returns for the taxable years in issue as a result of their
participation in the Plastics Recycling Program.
2. The underpayments in income tax attributable to the investment
credit and business energy investment credit claimed with respect to
[taxpayers’] participation in the Plastics Recycling Program are
subject to the addition to tax for valuation overstatements determined
under I.R.C. section 6659 using an applicable percentage of 30
percent.
3. The underpayments in income tax attributable to [taxpayers’]
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. section 6621(c)
as set forth in the notice of deficiency.
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Estate of Hogard , 1997 WL 160769, at 9. The only remaining issue was whether
taxpayers were liable for the additions to tax for negligence under § 6653 for the
years in question.
Section 6653, as applicable to the period in question, provides for
imposition of an addition to tax of five percent of the underpayment if any part of
the underpayment is due to negligence or intentional disregard of rules or
regulations. 3
“For purposes of section 6653, ‘negligence’ is lack of due care or
failure to do what a reasonable and prudent person would do under similar
circumstances.” Anderson v. Commissioner , 62 F.3d 1266, 1271 (10th Cir. 1995).
Because the Commissioner did not assert that their tax treatment of their
investments would have been improper had Southeast’s business not been a sham,
taxpayers’ negligence, if any, must have been due to their failure to discover that
the recycler transactions were a sham. See id. Because the Commissioner’s
determination of negligence is presumed to be correct, taxpayers have the burden
of proving they were not negligent. See id. Following consolidation of the cases
and a trial, the Tax Court concluded that taxpayers had failed to meet their
burden. Its findings in this regard may be summarized as follows.
3
Beginning in 1981, § 6653 also provided for an additional interest penalty
for negligent underpayment.
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Charles Gilmore and Wilson organized G&W in 1966. Bill Stewart, a
certified public accountant, provided tax and accounting advice to Gilmore,
Wilson and G&W from at least 1966 to the time of trial. In 1982, Stewart learned
about the Southeast and related plastics recycling limited partnerships and
obtained an offering memorandum. The offering memorandum noted a variety of
business and tax risks associated with investing in the partnership including (1) a
substantial likelihood of an audit by the Commissioner that would include a
challenge to the value of the recyclers as being in excess of fair market value; (2)
Southeast’s lack of an operating history; (3) the general partner’s lack of
experience with recycling or similar equipment; (4) the absence of an established
market for the recyclers; (5) no assurances as to the marketability or market price
for recycled materials; and (6) the existence of potential conflicts of interest. The
offering memorandum included favorable marketing, technical and tax opinions
from people with experience in the relevant fields. 4
Stewart traveled to Packaging Industries’ plant in Hyannis, Massachusetts,
observed a demonstration of the recyclers, and listened to a presentation about
them. Stewart did not have any knowledge or experience in plastics recycling,
4
The Tax Court also noted that the individuals providing these opinions had
ownership interests in various related plastics recycling limited partnerships, but
it does not appear that this information was disclosed in the offering
memorandum.
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machinery or materials, and he relied on this presentation and the opinions
contained in the offering memorandum for technical expertise in concluding that
the operations looked viable. Stewart was informed that he would be entitled to a
commission if any of his clients invested in Southeast.
Stewart advised Gilmore and Wilson about investing in Southeast,
indicating that the business appeared to be viable and discussing the tax benefits.
He told Gilmore and Wilson that he planned to invest in one of the partnerships,
and he eventually did. Gilmore and Wilson read parts of the offering
memorandum but did not seek further information about the investment, recyclers
or transactions before deciding to invest in Southeast.
The Tax Court concluded that taxpayers’ underpayment of tax was due to
their negligent failure to adequately investigate the validity of the transactions.
This determination was based primarily on its conclusion that their reliance on
Stewart was unreasonable. The court noted that despite the offering
memorandum’s description of various business and tax risks and Stewart’s lack of
knowledge regarding the technical aspects of the business, he did not contact any
experts in plastics recycling or recommend that taxpayers do so. He did not
investigate the value placed on the recycler, although, the court found, an
adequate investigation would have disclosed the availability of other recyclers on
the market ranging in price from $20,000 to $200,000. It concluded that Stewart,
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in effect, simply relied on the representations made by Southeast’s promoters and
promotional materials. Because the investment was outside his area of
expertise--financial planning and tax advice--the court found that reliance on his
advice was unreasonable. The court also found Stewart’s advice suspect because
he would receive a commission from taxpayers’ investments and therefore was
not an independent advisor.
The court also found that because the front page of the offering
memorandum contained a statement regarding the risks of the investment and
Gilmore and Wilson admitted they reviewed the memorandum to some extent,
they were negligent for failing to heed the warnings and further investigate. The
memorandum explained that it was likely the Commissioner would challenge the
validity of the transactions and the values placed on the recyclers. The court also
found that in light of Gilmore and Wilson’s successful business backgrounds--i.e.,
their profitable construction business and real estate investments--they knew or
should have known that the value of the recyclers were overstated. Further, the
court found
it more likely than not that they were so interested in the expected
tax benefits that would result from the investment that they failed to
investigate and seek advice on the underlying transactions that were
to generate those tax benefits. Our conclusion on this point is
supported by the fact that the Gilmores’ and Wilson’s investments in
Southeast, which were not consistent with their prior investment
histories, occurred in a year that capital transactions were expected
to, and did, generate large capital gains.
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Estate of Hogard , 1997 WL 160769, at 15. Finally, the court found that while it
had “severe reservations” about the validity of taxpayers’ claims that they
expected to make a profit on the investment, their profit motives, even if true,
would not be dispositive because it would not excuse them from claiming benefits
to which they clearly were not entitled. The court therefore concluded that
taxpayers did not meet their burden of showing that they were not negligent in
failing to discover that the recycler transactions were a sham, and it upheld the
imposition of the negligence penalties. Taxpayers appeal.
II.
The historical facts in this case are largely undisputed. In similar
circumstances involving a challenge to negligence penalties, we have explained
our standard of review as follows:
We review Tax Court decisions “in the same manner and to the
same extent as decisions of the district courts in civil actions tried
without a jury.” I.R.C. § 7482(a)(1). We review the Tax Court’s
factual findings under the clearly erroneous standard and review its
legal conclusions de novo. Worden v. Commissioner , 2 F.3d 359,
361 (10th Cir. 1993). We review mixed questions of law and fact
either under the clearly erroneous standard or de novo, depending on
whether the mixed question is primarily factual or legal. Armstrong
v. Commissioner , 15 F.3d 970, 973 (10th Cir. 1994). Here, the
underlying facts . . . are, for the most part, undisputed. The parties
primarily dispute the conclusions the Tax Court drew from the facts.
Where, as here, “‘the sole issue is whether the law applied to the
facts satisfied the statutory standard,’” we review the Tax Court’s
application of the law to the facts de novo, since we “‘are equally as
able as the tax court to draw conclusions from the undisputed facts
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presented.’” See National Collegiate Athletic Ass’n v.
Commissioner , 914 F.2d 1417, 1420 (10th Cir.1990) (citations
omitted). See also First Nat’l Bank v. Commissioner , 921 F.2d
1081, 1086 (10th Cir.1990) (findings of ultimate fact derived from
applying legal principles to subsidiary facts are subject to de novo
review).
Anderson , 62 F.3d at 1270 (footnote omitted). We note that this standard seems
to differ from the one used by other circuits in analyzing a challenge to a
negligence penalty. Other circuits appear to apply a clearly erroneous standard of
review to the ultimate question of negligence regardless of whether the underlying
facts are disputed. See, e.g. , Sacks v. Commissioner , 82 F.3d 918, 920 (9th Cir.
1996); Durrett v. Commissioner , 71 F.3d 515, 517 (5th Cir. 1996); Goldman v.
Commissioner , 39 F.3d 402, 406 (2d Cir. 1994); Illes v. Commissioner , 982 F.2d
163, 166 (6th Cir. 1992). Although in his response briefs, the Commissioner
notes that the general rule is that a finding of negligence under § 6653 is
reviewed for clear error, he does acknowledge the above holding from Anderson .
The Commissioner does not argue that Anderson is wrong or ask that it be
overruled, which would require en banc consideration, see Starzynski v. Sequoia
Forest Indus. , 72 F.3d 816, 819 (10th Cir. 1995). We therefore apply the de novo
standard required by Anderson to the generally undisputed facts in this case.
Taxpayers first argue that the Tax Court misinterpreted the burden of proof
and the effect of the presumption that the Commissioner’s determination of
negligence is correct. They acknowledge that they have the burden of proving
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that they were not negligent. They contend, however, that because they put on
evidence indicating that they were not negligent, the presumption disappeared,
and the Commissioner was obligated to present evidence showing that a
reasonable investor in 1982 would have discovered that the Southeast transactions
were a sham. Because they contend that the Commissioner failed to do so, they
argue that the Tax Court effectively upheld the Commissioner’s decision by
relying improperly on the presumption.
The cases on which taxpayers rely involve situations in which the matters at
issue were questions of historical fact on which the taxpayers presented evidence
in their favor but which the Commissioner failed to rebut with any evidence of his
own. See Moretti v. Commissioner , 77 F.3d 637, 643-44 (2d Cir. 1996); Estate of
DeNiro v. Commissioner , 795 F.2d 582, 584-85 (6th Cir. 1986); Demkowicz v.
Commissioner , 551 F.2d 929, 931-32 (3d Cir. 1977). The courts thus held that it
was improper for the Tax Court to have concluded that the taxpayers failed to
overcome the presumption in light of the uncontradicted, competent and relevant
evidence they presented. That is not the situation the Tax Court faced here. The
evidence introduced, both at trial and through stipulation, presents a close
question regarding whether taxpayers were negligent. We see no indication in the
Tax Court’s decision that it relied on any presumption. It simply evaluated the
evidence and concluded that taxpayers had not met their burden. We thus
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conclude the court did not err procedurally in its assessment of the evidence and
turn to its substantive determination that taxpayers were negligent.
Whether taxpayers were negligent depends on whether they exercised due
care and performed a reasonable investigation into the validity of the recycler
transactions before investing in Southeast. See Anderson , 62 F.3d at 1271. They
contend that they exercised due care by relying on the reasonable investigation
performed by Stewart, and alternatively, because even if Stewart’s investigation
was not reasonable, they were not negligent in relying on his advice.
Moderate-income investors, such as taxpayers here, do not have to
investigate their investments themselves, but may rely on the appropriate advice
of financial advisors and accountants. See Anderson , 62 F.3d at 1271; Mauerman
v. Commissioner , 22 F.3d 1001, 1006 (10th Cir. 1994); Heasley v. Commissioner ,
902 F.2d 380, 383 (5th Cir. 1990). Reliance on such advisors, however, must be
objectively reasonable and justifiable; that is, the advice must fall at least
generally within the advisors’ areas of expertise, and the advisors must be
independent of the investment. See, e.g. , United States v. Boyle , 469 U.S. 241,
251 (1985) (noting taxpayer’s reliance on advice of accountant or attorney on
matter of tax law reasonable, as “[m]ost taxpayers are not competent to discern
error in the substantive advice of an accountant or attorney”); Freytag v.
Commissioner , 904 F.2d 1011, 1016 (5th Cir. 1990) (finding reliance on advice of
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lawyers, accountants, and financial consultants referred to as “finders”
unreasonable where finders had no expertise in financial aspects of investments
involved); Goldman , 39 F.3d at 408 (finding taxpayers’ reliance on accountant
who was also sales representative for investment unreasonable because of
inherent conflict of interest); Pasternak v. Commissioner , 990 F.2d 893, 903 (6th
Cir. 1993) (finding reliance on promoters or their agents unreasonable, as
“[a]dvice of such persons can hardly be described as that of ‘independent
professionals’”). The relative sophistication of the taxpayers is also a
consideration in determining whether their reliance was reasonable. See, e.g.,
Heasley , 902 F.2d at 384.
Had Stewart performed a reasonable investigation, taxpayers would have
been able to rely on his advice. But we agree with the Tax Court that he did not.
To his credit, he did visit the plant where the recyclers were manufactured and
observed a several minute demonstration of a prototype. In this respect, he did
more than the negligent taxpayer in Anderson , who failed to verify the existence
of the cargo containers he was supposedly purchasing. See Anderson , 62 F.3d at
1272-73. Yet beyond that, as the Tax Court found, Stewart did virtually nothing
more than rely on the representations of the promoters and offering materials.
Critically, the offering memorandum warned that the Commissioner would likely
challenge the value placed on the recyclers in the transactions, which lacked any
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market controls. Even though the tax benefits were directly tied to this value,
Stewart did nothing to determine whether it was reasonable. Additionally,
although Stewart testified that he expected the investments to return a profit, he
did nothing to investigate the likelihood of a profit despite the offering
memorandum’s warnings regarding Southeast’s lack of an operating history and
absence of an established market for recyclers and recycled materials. Taxpayers
therefore cannot rely on Stewart’s investigation to show they exercised due care
before investing in Southeast.
Alternatively, taxpayers argue that regardless of whether Stewart in fact
performed a reasonable investigation here, they were entitled to rely on his advice
regarding the investment in Southeast and the economic validity of the
transactions because he was their long-time, trusted advisor. Considering their
relatively modest investments of $25,000 each, taxpayers contend they should not
be expected to have extensively or independently investigated the validity of the
Southeast transactions. In support of this position, they point to the Fifth
Circuit’s concern that “[i]f we require moderate-income investors to
independently investigate their investments, the start-up investigation costs may
prevent them from investing at all. If the costs do not prohibit entry, these
investors still may not invest because the investigation costs may far exceed their
potential profit.” Heasley , 902 F.2d at 383-84. Further, they contend that the Tax
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Court’s conclusion that their reliance on Stewart’s advice was unreasonable
because he was advising on matters outside his area of expertise is inconsistent
with the law of this circuit, because in Anderson , we held that “one does not have
to be an expert in an industry before he can invest in the industry himself or
recommend an investment to another.” 62 F.3d at 1271.
We agree with taxpayers that, to the extent the Tax Court found their
reliance on Stewart’s advice unreasonable because he was not an expert in the
plastics recycling industry, that finding is inconsistent with Anderson . 5 And we
also agree that taxpayers generally need not monitor the efforts of their advisors
5
The statement in Anderson that advisors do not have to be experts in
particular industries was in response to the Commissioner’s argument that
reliance on the advisor in that case was unreasonable because the advisor lacked
knowledge and experience in the particular industry in which the investment was
made. The Tax Court here cited cases from the Second Circuit consistent with the
argument we rejected in Anderson . See David v. Commissioner , 43 F.3d 788,
789-90 (2d Cir. 1995); Goldman , 39 F.3d at 408.
We also reject another of the reasons the Tax Court gave for finding
taxpayers’ reliance on Stewart’s advice to be unreasonable--the fact that he was
entitled to receive compensation from Southeast for taxpayers’ investments, thus
making his advice not independent. We agree with taxpayers that this fact does
not make their reliance on that advice per se unreasonable. Taxpayers had long
relied on Stewart for tax and accounting advice, and he had a good reputation in
the community. Moreover, he was not affiliated with Southeast or any of the
other recycling partnerships other than through his personal investment in one of
them. As we found in Anderson in similar circumstances, 62 F.3d at 1271, the
mere fact that Stewart received compensation for taxpayers’ reliance on his
advice does not turn him into a promoter whose advice cannot be considered
independent.
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when their advisors are acting within their areas of expertise. But we disagree
that Anderson supports taxpayers’ reliance on Stewart here. The advisor in
Anderson was the taxpayer’s investment advisor, and he advised the taxpayer
regarding the soundness of his investment. See 62 F.3d at 1268. In contrast,
Stewart was not the taxpayers’ investment advisor, but their tax accountant who
had also provided some accounting advice. There is no indication in the record
that he had previously provided taxpayers advice on investments generally or
investments designed to shelter income from taxes, nor that he had experience and
knowledge in such areas as assessing the economic substance of tax shelters.
Southeast’s offering memorandum advertised tax credits of $77,000 and
deductions of $38,940, all in the first year of an investment of $50,000. It
explained the circularity of the sale, leasing and licensing transactions that
involved virtually no net cash outlays by any of the parties to the transactions.
The memorandum was replete with warnings regarding the risks involved.
Anyone reading the offering memorandum would be placed on guard that the deal
might just be too good to be true.
The due care that taxpayers were obliged to exercise here was not to inquire
into the reasonableness of the tax aspects of the investment per se, but to inquire
into the economic substance of the investment. As we noted, the red flags raised
by the offering memorandum were obvious to anyone--especially college-
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educated, successful businessmen like Gilmore and Wilson. In this regard,
Stewart’s position as their tax advisor did not sufficiently differentiate him from
Gilmore and Wilson on a knowledge and experience basis such that taxpayers
could rely on his advice without further inquiry. See Leuhsler v. Commissioner ,
963 F.2d 907, 910 (6th Cir. 1992) (finding taxpayer’s reliance on advisors, who
were fellow accountants, lacking knowledge and experience significantly greater
than taxpayer’s unreasonable); Illes , 982 F.2d at 166 (noting importance of
taxpayer’s education and business experience in determining whether reliance on
advisor reasonable); Heasley , 902 F.2d at 383-84. Thus, Stewart’s lack of
experience in the plastics recycling industry, the Tax Court’s reason for finding
his advice suspect, is not itself dispositive. But that fact combines with his
general lack of knowledge and experience in the area of inquiry to convince us
that taxpayers’ reliance on Stewart’s advice merely because of his position as
their long-time tax advisor was not justified in this situation. 6
6
We also disagree with taxpayers’ contention that an investigation into the
economic substance of the transactions would have been prohibitively expensive.
One of the critical risks identified by the offering memorandum was the possible
overvaluation of the recyclers, and a reasonable investigation here could have
checked into the value placed on them without undue cost. Taxpayers have
stipulated that trade publications at the time advertised other plastics recyclers for
less than one-fifth the cost.
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As we noted, Gilmore and Wilson were successful businessmen. Prior to
investing in Southeast, they had only conservatively invested in stocks and real
estate. In 1982, the year they invested in Southeast, their adjusted gross income
more than doubled over prior years due to their disposal of a capital asset.
Southeast’s offering memorandum advertised tax benefits that allowed them to
recoup more than their total investment in the first year. Though not all
comparable investments may be too good to be true, such lucrative benefits must
place any potential investor on guard. We conclude that taxpayers were not
adequately on guard and did not undertake a reasonable investigation before
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investing in what turned out to be a tax sham. The Commissioner correctly
assessed the negligence penalties.
AFFIRMED.
Entered for the Court
Wade Brorby
Circuit Judge
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