T.C. Memo. 1995-580
UNITED STATES TAX COURT
ANTHONY J. AND CLAIRE L. PACE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
ESTATE OF EDGAR P. BERRY, DECEASED, DOROTHY M. BERRY, EXECUTRIX
AND DOROTHY M. BERRY, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 14454-85, 3918-90. Filed December 6, 1995.
James J. Mahon, for petitioners.
Barry J. Laterman, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
DAWSON, Judge: These consolidated cases were assigned to
Special Trial Judge Norman H. Wolfe pursuant to the provisions of
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section 7443A(b)(4) and Rules 180, 181, and 183.1 The Court
agrees with and adopts the opinion of the Special Trial Judge,
which is set forth below.
OPINION OF THE SPECIAL TRIAL JUDGE
WOLFE, Special Trial Judge: These cases are part of the
Plastics Recycling group of cases. For a detailed discussion of
the transactions involved in the Plastics Recycling cases, see
Provizer v. Commissioner, T.C. Memo. 1992-177, affd. without
published opinion 996 F.2d 1216 (6th Cir. 1993). The facts of
the underlying transaction in these cases are substantially
identical to those in the Provizer case.
In a notice of deficiency dated April 13, 1985, respondent
determined a deficiency in the 1981 joint Federal income tax of
petitioners Pace in the amount of $52,211. Respondent also
determined that interest on deficiencies accruing after December
31, 1984, should be calculated at 120 percent of the statutory
rate under section 6621(c).2 On January 10, 1994, respondent
1
All section references are to the Internal Revenue Code, in
effect for the year in issue, unless otherwise indicated. All
Rule references are to the Tax Court Rules of Practice and
Procedure.
2
The notice of deficiency refers to sec. 6621(d). This
section was redesignated as sec. 6621(c) by sec. 1511(c)(1)(A) of
the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085, 2744
and repealed by sec. 7721(b) of the Omnibus Budget Reconciliation
Act of 1989 (OBRA 89), Pub. L. 101-239, 103 Stat. 2106, 2399,
effective for tax returns due after Dec. 31, 1989, OBRA 89 sec.
7721(d), 103 Stat. 2400. The repeal does not affect the instant
case. For simplicity, we will refer to this section as sec.
(continued...)
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filed an amendment to answer and asserted additions to tax for
1981 in the amount of $2,611 under section 6653(a)(1) for
negligence and under section 6653(a)(2) in an amount equal to 50
percent of the interest due on the underpayment attributable to
negligence. Respondent also claimed therein that petitioners had
an underpayment of tax on their 1981 return attributable to a
valuation overstatement and asserted an addition to tax under
section 6659 in an amount equal to 30 percent of the underpayment
attributable to valuation overstatement.
In a notice of deficiency dated December 14, 1989,
respondent determined a deficiency in the 1981 joint Federal
income tax of petitioners Berry in the amount of $29,978 and
additions to tax for that year in the amount of $11,881 under
section 6659 for valuation overstatement, in the amount of $2,489
under section 6653(a)(1) for negligence, and under section
6653(a)(2) in an amount equal to 50 percent of the interest due
on the underpayment attributable to negligence. On March 14,
1994, respondent filed an amendment to answer and asserted that
interest on deficiencies accruing after December 31, 1984, should
be calculated at 120 percent of the statutory rate under section
6621(c).
2
(...continued)
6621(c). The annual rate of interest under sec. 6621(c) for
interest accruing after Dec. 31, 1984, equals 120 percent of the
interest payable under sec. 6601 with respect to any substantial
underpayment attributable to tax-motivated transactions.
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On March 23, 1994, the parties in these cases each filed a
Stipulation of Settled Issues. In each Stipulation of Settled
Issues, the parties agreed that petitioners were not entitled to
any deductions, investment tax 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.
The issues for decision are: (1) Whether petitioners are
liable for additions to tax for negligence or intentional
disregard of rules or regulations under section 6653(a)(1) and
(2); (2) whether petitioners are liable for the addition to tax
under section 6659 for an underpayment of tax attributable to
valuation overstatement; and (3) whether petitioners are liable
for increased interest under section 6621(c).
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulated facts and attached exhibits are incorporated by
this reference. Petitioners Anthony J. and Claire L. Pace
(petitioners Pace) resided in Lloyd Harbor, New Jersey, when
their petition was filed. Petitioners Edgar P. and Dorothy M.
Berry (petitioners Berry) resided in New York, New York, when
their petition was filed.
During 1981, Anthony J. Pace (petitioner Pace) was an
institutional salesman at Bear Stearns & Co., one of the largest
securities brokerage and investment banking organizations in the
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country. His spouse, petitioner Claire L. Pace, was not employed
outside the home during 1981. Petitioner Edgar P. Berry was a
surgeon during 1981. His spouse, petitioner Dorothy M. Berry
(petitioner Berry), was employed at Edgar Berry's professional
corporation (Edgar P. Berry, MD PC) and also served as president
of the auxiliary chapter of the American Medical Association
during 1981.
On their 1981 Federal income tax return, petitioners Pace
reported gross income from wages, interest, dividends, and
farming in the amount of $306,597, less $3,000 in capital losses,
and $53,792 in losses from partnerships, trusts, etc., including
losses here in issue. Petitioners Berry reported on their 1981
Federal income tax return gross income from wages, interest,
dividends, and other sources in the amount of $206,038, less
$34,637 in losses from rents, partnerships, trusts, etc.,
including losses here in issue. Consequently, in the absence of
significant deductions or credits, petitioners in each case were
subject to payment of Federal income taxes in substantial amounts
for taxable year 1981.
During the summer of 1981, petitioners Pace and Berry each
acquired a 3.094-percent limited partnership interest in Hyannis
Recycling Associates (Hyannis) for an investment of $25,000 each.
As a result of the passthrough from Hyannis, on their respective
1981 Federal income tax returns petitioners each deducted an
operating loss in the amount of $20,327 and claimed investment
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tax and business energy credits totaling $39,604. The underlying
deficiencies in these cases result from respondent's disallowance
of petitioners' claimed operating losses and credits related to
Hyannis for taxable year 1981.
The underlying transaction in these cases was found by this
Court to be the initial Plastics Recycling transaction in
Provizer v. Commissioner, T.C. Memo. 1992-177, and may be
summarized as follows. In 1981, Packaging Industries, Inc. (PI),
manufactured and sold six Sentinel expanded polyethylene (EPE)
recyclers to ECI Corp. for $5,400,000 ($900,000 each), of which
$340,000 was paid in cash. ECI Corp., in turn, resold the
recyclers to the Hyannis limited partnership for $6,400,000
($1,066,666 each), of which $440,000 was paid in cash. Hyannis
then leased the recyclers to FMEC Corp., which subleased them
back to PI. All of the monthly payments for nonrecourse notes,
leases, and licenses, which were required among the entities in
the above transactions, offset each other. These transactions
were accomplished simultaneously.
After the Hyannis offering closed, the safe-harbor leasing
rules were enacted as part of the Economic Recovery Tax Act of
1981 (ERTA), Pub. L. 97-34, 95 Stat. 172. The underlying
transaction was restructured in a manner designed to take
advantage of the safe-harbor provisions. F & G Corp. became the
safe-harbor lessor and was interposed between ECI Corp. and the
primary leasing partnership, in this case Hyannis. Subsequent
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Plastics Recycling programs were structured in a similar manner
to take advantage of the new statutory safe-harbor opportunities.
See Provizer v. Commissioner, T.C. Memo. 1992-177. We refer to
the transactions herein collectively as the Hyannis transaction.
In the Provizer case, we considered such a restructured
Plastics Recycling transaction, the Clearwater transaction. In
the Clearwater transaction, PI sold six 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 them to FMEC
Corp., which sublicensed them to PI. The transaction involved
herein differed from the Clearwater transaction in the following
respects: (1) F & G Corp. purchased the recyclers for
$6,400,000, rather than the $6,975,996 paid in Clearwater, and
(2) Hyannis, rather than Clearwater, leased the recyclers from F
& G Corp. and then licensed them to FMEC Corp.3 In all other
material respects the transactions are substantively identical.
Hyannis is thus like Clearwater, occupying the same link in the
transactional chain. In addition, the Sentinel EPE recyclers
considered in these cases are the same type of machine considered
3
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 the same number of identical machines 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 was modified in an attempt to take advantage of
those rules by inserting F & G Corp. in the transaction.
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in Provizer. The fair market value of a Sentinel EPE recycler in
1981 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.
Petitioners Pace and Berry each learned of the Hyannis
transaction from Lawrence Greenstein (Greenstein). Greenstein is
a certified public accountant (C.P.A.). Greenstein had been
certified just 2 years earlier, in 1979, the same year he joined
and became a partner at his father's firm, Greenstein & Co., PC.
Greenstein's client services included accounting, tax
preparation, and investment analysis. The latter entailed
checking figures and determining whether an investment was suited
to a client's economic outlook and station in life. When
reviewing an investment involving high technology or other field
outside his expertise, Greenstein relied upon the representations
and due diligence of the dealer or promoter of the investment.
Greenstein learned about Hyannis from a client. The client
had heard about Hyannis from a member of the New York Stock
Exchange, Cowen & Co., Inc. (CCI). Greenstein spoke about
Hyannis with representatives of CCI, in particular Peter Zuck
(Zuck). It was Greenstein's understanding that Zuck was in
charge of marketing the Hyannis investment at CCI. After
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reviewing the Hyannis offering memorandum, Greenstein's primary
concern was whether the machines worked. He expressed this
concern to Zuck and was told that a group of investors would be
touring the Hyannis plant and viewing the recyclers. Greenstein
then introduced the Hyannis investment to petitioners Pace and
Berry. Petitioners Pace and Berry were each given a copy of the
Hyannis offering memorandum. Petitioner Pace wanted verification
of the existence of the Sentinel EPE recycler, so Greenstein
decided to visit the manufacturing plant in Hyannis.
On July 19th, 1981, Greenstein visited the Hyannis plant
with Zuck, a handful of other potential investors, and the
general partner of Hyannis, Richard Roberts. Greenstein and the
other visitors were required to sign nondisclosure agreements
before being allowed entry into the plant. Greenstein and the
others viewed five to six Sentinel EPE recyclers in operation at
the plant. The group also had lunch during the visit. Upon his
return from the plant, Greenstein told petitioners Pace and Berry
about the visit and recommended the investment. Greenstein was
never offered, nor did he receive, compensation from CCI.
Greenstein does not have any formal training or work
experience related to plastics recycling or plastics materials;
he is not an engineer. Greenstein is an environmental
enthusiast, but he is not knowledgeable with respect to recycling
or other environmental technology.
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Petitioners Berry usually sought professional advice before
making investments. Their advisers in 1981 were Greenstein and
his father, Charles Greenstein. The Greensteins provided
accounting services to petitioners Berry, prepared their tax
returns, and gave them investment advice from time to time.
Petitioners Berry learned of the Hyannis investment from
Greenstein and were provided a copy of the Hyannis offering
memorandum. Petitioners Berry owned property near Hyannis and
while there during the summer they visited a PI office. They
also looked at the manufacturing plant, but they did not go
inside or view a recycler. Petitioners Berry decided to invest
in Hyannis after Greenstein gave them a favorable report of his
visit to the plant. Petitioner Dorothy Berry provided the money
for this investment.
Petitioners Berry have no education or work experience in
plastics recycling or plastics materials. Petitioners Berry were
aware of Greenstein's background and knew that he was not an
expert in plastics recycling or plastics materials. Petitioners
Berry never saw a Sentinel EPE recycler or visited any end-user
locations.
Petitioners Pace also employed Greenstein and his father for
accounting services. Greenstein introduced the Hyannis
investment to petitioners Pace and provided them with a copy of
the offering memorandum. Petitioner Pace wanted verification
that the plant and machines existed before he would invest.
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Greenstein visited the plant and reported to petitioners Pace
that Hyannis was a legitimate business. Greenstein recommended
the investment for its front-end tax benefits and potential
residual values. At that time, petitioners Pace decided to go
ahead with the investment.
Petitioners Pace have no education or work experience in
plastics recycling or plastics materials. Petitioners Pace were
aware of Greenstein's background and knew that he was not an
expert in plastics recycling or plastics materials. There is
nothing in the record indicating that petitioners Pace ever saw a
Sentinel EPE recycler or visited any end-user locations.
OPINION
In Provizer v. Commissioner, T.C. Memo. 1992-177, a test
case involving the Clearwater transaction and another tier
partnership, this Court (1) found that each Sentinel EPE recycler
had a fair market value not in excess of $50,000, (2) held that
the Clearwater transaction was a sham because it lacked economic
substance and a business purpose, (3) upheld the section 6659
addition to tax for valuation overstatement since the
underpayment of taxes was directly related to the overstatement
of the value of the Sentinel EPE recyclers, and (4) held that
losses and credits claimed with respect to Clearwater were
attributable to tax-motivated transactions within the meaning of
section 6621(c). In reaching the conclusion that the Clearwater
transaction lacked economic substance and a business purpose,
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this Court relied heavily upon the overvaluation of the Sentinel
EPE recyclers.
The underlying transaction in these cases (the Hyannis
transaction) is in all material respects identical to the
transaction considered in the Provizer case. The Sentinel EPE
recyclers considered in these cases are the same type of machines
considered in the Provizer case.
Based on the entire records in these cases, including the
extensive stipulations, testimony of respondent's experts, and
petitioners' testimony, we hold that the Hyannis transaction was
a sham and lacked economic substance. In reaching this
conclusion, we rely heavily upon the overvaluation of the
Sentinel EPE recyclers. Respondent is sustained on the question
of the underlying deficiencies. We note that petitioners have
explicitly conceded this issue in their respective Stipulations
of Settled Issues filed shortly before trial. The record plainly
supports respondent's determinations 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. Sec. 6653(a) Negligence
In a notice of deficiency, respondent determined that
petitioners Berry were liable for the negligence additions to tax
under section 6653(a)(1) and (2) for 1981. Petitioners have the
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burden of proving that respondent's determination is erroneous.
Rule 142(a); Luman v. Commissioner, 79 T.C. 846, 860-861 (1982).
In an amendment to answer, respondent asserted that
petitioners Pace were liable for the negligence additions to tax
under section 6653(a)(1) and (2). Because these additions to tax
were raised for the first time in respondent's amendment to
answer, respondent bears the burden of proof on this issue. Rule
142(a); Vecchio v. Commissioner, 103 T.C. 170, 196 (1994).
Section 6653(a)(1) imposes an addition to tax equal to 5
percent of the underpayment if any part of an underpayment of tax
is due to negligence or intentional disregard of rules or
regulations. In cases involving negligence, an additional amount
is added to the tax under section 6653(a)(2); such amount 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, 947
(1985). The question is whether a particular taxpayer's actions
in connection with the transactions were reasonable in light of
his experience and the nature of the investment or business. See
Henry Schwartz Corp. v. Commissioner, 60 T.C. 728, 740 (1973).
When petitioners claimed the disallowed deductions and tax
credits, they had no knowledge of the plastics or recycling
industries. Petitioners contend that they reasonably relied on
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the advice and due diligence of their accountant Greenstein, and
to some extent upon the representations in the Hyannis offering
memorandum.
Under some circumstances a taxpayer may avoid liability for
the additions to tax under section 6653(a)(1) and (2) if
reasonable reliance on a competent professional adviser is shown.
Freytag v. Commissioner, 89 T.C. 849, 888 (1987), affd. 904 F.2d
1011 (5th Cir. 1990), affd. 501 U.S. 868 (1991). Reliance on
professional advice, standing alone, is not an absolute defense
to negligence, but rather a factor to be considered. 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.;
see Weis v. Commissioner, 94 T.C. 473, 487 (1990); Ewing v.
Commissioner, 91 T.C. 396, 423-424 (1988), affd. without
published opinion 940 F.2d 1534 (9th Cir. 1991); Pritchett v.
Commissioner, 63 T.C. 149, 174-175 (1974).
Reliance on representations by insiders, promoters, or
offering materials has been held an inadequate defense to
negligence. LaVerne v. Commissioner, 94 T.C. 637, 652-653
(1990), affd. without published opinion 956 F.2d 274 (9th Cir.
1992), affd. without published opinion sub nom. Cowles v.
Commissioner, 949 F.2d 401 (10th Cir. 1991); Marine v.
Commissioner, 92 T.C. 958, 992-993 (1989), affd. without
published opinion 921 F.2d 280 (9th Cir. 1991); McCrary v.
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Commissioner, 92 T.C. 827, 850 (1989); Rybak v. Commissioner, 91
T.C. 524, 565 (1988). We have rejected pleas of reliance when
neither the taxpayer nor the advisers purportedly relied upon by
the taxpayer knew anything about the nontax business aspects of
the contemplated venture. Beck v. Commissioner, 85 T.C. 557
(1985); Flowers v. Commissioner, 80 T.C. 914 (1983); Steerman v.
Commissioner, T.C. Memo. 1993-447.
These cases do not present a situation such as that found in
Heasley v. Commissioner, 902 F.2d 380, 385 (5th Cir. 1990), revg.
T.C. Memo. 1988-408, where the Fifth Circuit Court of Appeals
held that taxpayers, who were unsophisticated investors not
educated beyond high school, were not liable for the negligence
additions to tax. The facts in the present cases are
distinguishable. Petitioners herein are all well-educated. The
late Edgar Berry was a surgeon in 1981 and his wife, petitioner
Dorothy Berry, graduated from Radcliffe College. Petitioner Pace
graduated from St. Bonaventure in 1958. He has been working in
the brokerage business since the late 1960's and during 1981 he
was a highly compensated institutional salesman at Bear Stearns &
Co. Petitioners Pace reported income or losses from nine
different partnerships on their 1981 Federal income tax return,
while petitioners Berry reported income or losses from four
different partnerships, estates or trusts, or small business
corporations. Accordingly, the record indicates that unlike the
taxpayers in Heasley, petitioners in these cases were not
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uneducated, unsophisticated investors in 1981. Not only were
petitioners well-educated and financially successful in their
professions and businesses, but also they were accustomed to
considering tax-oriented investments, since they had made such
investments in the past.
In evaluating the Hyannis transaction, petitioners purport
to have relied on Greenstein and to some extent the offering
memorandum. With respect to petitioners Berry, they did little
beyond discussing the Hyannis transaction with Greenstein. While
on vacation near Hyannis during the summer of 1981, they visited
the plant site but did not enter it. When asked at trial whether
she had read the offering memorandum, petitioner Berry testified,
"I leafed through it," and "I don't know whether you would call
it reading it." Petitioner Berry testified that she did not have
any idea of the value of the recyclers. When asked if their
value was important to her, she replied, "I guess I didn't think
much about that." Petitioner Berry testified that she and her
husband basically relied on Greenstein.
As for petitioners Pace, Anthony Pace was familiar with
offering memoranda from his work at Bear Stearns & Co. He stated
that he "relied on the offering memorandum" in evaluating
Hyannis, yet when asked at trial how much time he spent reviewing
it, he too replied, "I leafed through it." Petitioner Pace
testified that his first impression of Hyannis was "it sounds
awfully good, sounds too good in a sense." Nonetheless, all that
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concerned petitioner Pace was whether the plant and recyclers
actually existed. He had recently read about some executives of
"Wall Street companies" who had invested in an oil and gas
venture which turned out to be nothing more than wooden pipes
painted different colors, and he did not want to blunder into an
investment in a nonexistent physical plant. Greenstein's
facilities tour verified the existence of the plant and
recyclers. With the existence of PI and the recyclers confirmed,
petitioner Pace thought he had no reason to believe Hyannis was
not a "bona fide deal" and went forth with the investment.
Petitioners' alleged reliance on Greenstein does not satisfy
the requirement that it be reasonable, in good faith, and based
upon full disclosure. The purported values of the Sentinel EPE
recyclers generated the deductions and credits in these cases.
Yet the purported value of the Sentinel EPE recyclers is the very
thing that petitioners and Greenstein did not verify. A taxpayer
may rely upon his adviser's expertise (in these cases accounting
and tax advice), but it is not reasonable or prudent to rely upon
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), affg. without
published opinion Patin v. Commissioner, 88 T.C. 1086 (1987); Lax
v. Commissioner, T.C. Memo. 1994-329.
Greenstein had just 2 years' experience as a C.P.A. He was
not an engineer and had no education or work experience in
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plastics materials or plastics recycling. Greenstein relied upon
CCI and the offering materials for the value of the Sentinel EPE
recyclers. Greenstein testified that he assumed that CCI had
"done all of the due diligence that was necessary", and that the
representations in the offering materials were therefore
reliable. Nevertheless, petitioners claim that they relied on
Greenstein regarding the value of the recyclers and the economic
viability of the Plastics Recycling transactions. In these
cases, recyclers purportedly worth $1,066,666 each were being
sold, resold, leased, and subleased. Petitioners were not
reasonable in relying upon Greenstein in claiming the deductions
and credits related to their investments in Hyannis. In 1981 he
was a relatively inexperienced C.P.A. who had no knowledge of the
industry in which petitioners were considering investing. On
behalf of his clients, Greenstein accepted the selling broker's
offer of a plane trip to Hyannis, took the guided tour of the PI
plant to ascertain that there really were recycling machines, and
returned to tell his clients that if everything were exactly as
represented in the seller's offering circular, there were good
tax benefits up front so the deal was attractive. He did not
obtain full disclosure of the Hyannis transaction, or raise any
question concerning any aspect of the offering circular.
Moreover, on its face, the Hyannis transaction should have
raised serious questions in the minds of ordinarily prudent
investors. According to the offering memorandum, the projected
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benefits for each $50,000 invested were investment tax credits in
1981 of $79,200 plus deductions in 1981 of $42,491. On their
1981 tax returns, petitioners each indicated ownership of
investment credit property valued at $198,016 as a result of
their participation in the Hyannis deal. In the first year of
the investment alone, petitioners each claimed an operating loss
in the amount of $20,327 and investment tax and business energy
credits related to Hyannis totaling $39,604, while petitioners'
each invested only $25,000 in Hyannis. The direct reductions in
petitioners' respective Federal income tax, from just the tax
credits, equaled 158 percent of their cash investment.
Therefore, like the taxpayers in Provizer v. Commissioner, T.C.
Memo. 1992-177, "except for a few weeks at the beginning,
petitioners never had any money in the [Hyannis] deal." A
reasonably prudent person would not conclude without substantial
investigation that the Government was providing massive tax
benefits to taxpayers in these circumstances. McCrary v.
Commissioner, 92 T.C. 827, 850 (1989).
We think petitioners Pace and Berry failed to exercise due
care in claiming large deductions and tax credits with respect to
Hyannis on their respective 1981 Federal income tax returns.
They did not reasonably rely upon Greenstein and the offering
memorandum, or in good faith investigate the underlying
viability, financial structure, and economics of the Hyannis
transaction. We hold, upon consideration of the entire records,
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that petitioners are liable for the negligence additions to tax
under the provisions of section 6653(a)(1) and (2) for 1981.
Respondent is sustained on this issue.
Issue 2. Sec. 6659 Valuation Overstatement
In a notice of deficiency, respondent determined that
petitioners Berry are liable for the section 6659 addition to tax
for valuation overstatement on the portion of their 1981
underpayment attributable to the investment tax and business
energy credits claimed with respect to Hyannis. Petitioners
Berry have the burden of proving that respondent's determination
is erroneous. Rule 142(a); Luman v. Commissioner, 79 T.C. 846,
860-861 (1982). In the case of petitioners Pace, respondent
asserted an addition to tax under section 6659 in an amendment to
answer. Because it was raised for the first time in her
amendment to answer, respondent bears the burden of proof on this
issue. Rule 142(a); Vecchio v. Commissioner, 103 T.C. 170, 196
(1994).
A graduated addition to tax is imposed when an individual
has an underpayment of tax that equals or exceeds $1,000 and "is
attributable to" a valuation overstatement. Sec. 6659(a), (d).
A valuation overstatement exists if the fair market value (or
adjusted basis) of property claimed on a return equals or exceeds
150 percent of the amount determined to be the correct amount.
Sec. 6659(c). If the claimed valuation exceeds 250 percent of
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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 purported values of $1,066,666
for each Sentinel EPE recycler. Petitioners stipulated that the
fair market value of each recycler was not in excess of $50,000.
Therefore, if disallowance of petitioners' claimed credits is
attributable to the valuation overstatement, petitioners are
liable for the section 6659 addition to tax at the rate of 30
percent of the underpayment of tax attributable to the credits
claimed with respect to Hyannis.
Section 6659 does not apply to underpayments of tax that are
not "attributable to" valuation overstatements. See McCrary v.
Commissioner, supra; Todd v. Commissioner, 89 T.C. 912 (1987),
affd. 862 F.2d 540 (5th Cir. 1988). To the extent taxpayers
claim tax benefits that are disallowed on grounds separate and
independent from alleged valuation overstatements, the resulting
underpayments of tax are not regarded as attributable to
valuation overstatements. Krause v. Commissioner, 99 T.C. 132,
178 (1992) (citing Todd v. Commissioner, supra), affd. sub nom.
Hildebrand v. Commissioner, 28 F.3d 1024 (10th Cir. 1994).
However, when valuation is an integral factor in disallowing
deductions and credits, section 6659 is applicable. See Illes v.
Commissioner, 982 F.2d 163, 167 (6th Cir. 1992), affg. T.C. Memo.
1991-449; Gilman v. Commissioner, 933 F.2d 143, 151 (2d Cir.
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1991), affg. T.C. Memo. 1989-684; Masters v. Commissioner, T.C.
Memo. 1994-197; Harness v. Commissioner, T.C. Memo. 1991-321.
In their respective Stipulation of Settled Issues,
petitioners each conceded that they "are not entitled to any
deductions, 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, and McCrary v.
Commissioner, supra, we denied application of 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 grounds. In Todd, we found that an
underpayment was not attributable to a valuation overstatement
because property was not placed in service during the years in
issue. In McCrary, we found the taxpayers were not liable for
the section 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.
A concession of the investment tax credit in and of itself
does not relieve taxpayers of liability for the section 6659
addition to tax. See Dybsand v. Commissioner, T.C. Memo. 1994-
56; Chiechi v. Commissioner, T.C. Memo. 1993-630. Instead, what
is significant is the ground upon which the investment tax credit
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is disallowed or conceded. See Irom v. Commissioner, 866 F.2d
545, 547 (2d Cir. 1989), vacating in part and remanding T.C.
Memo. 1988-211; Harness v. Commissioner, supra.
In petitioners' cases, no arguments were 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 valuation overstatements. To the contrary,
petitioners stipulated substantially the same facts concerning
the underlying transactions as we found in Provizer v.
Commissioner, supra. In the Provizer case, we held that the
taxpayers were liable for the section 6659 addition to tax
because the underpayment of taxes was directly related to the
overvaluation of the Sentinel EPE recyclers. The overvaluation
of the recyclers, exceeding 2325 percent, was an integral part of
our findings in Provizer that the transaction was a sham and
lacked economic substance. Similarly, the records in these cases
plainly show that the overvaluation of the recyclers is integral
to and is the core of our holding that the underlying transaction
in these cases was a sham and 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, 566-567 (1988); Zirker
v. Commissioner, 87 T.C. 970, 978-979 (1986); Donahue v.
Commissioner, T.C. Memo. 1991-181, affd. without published
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opinion 959 F.2d 234 (6th Cir. 1992), affd. sub nom. Pasternak v.
Commissioner, 990 F.2d 893 (6th Cir. 1993).
We held in Provizer v. Commissioner, T.C. Memo. 1992-177,
that each Sentinel EPE recycler had a fair market value not in
excess of $50,000. Our finding in the Provizer case that the
Sentinel EPE recyclers had been overvalued was integral to and
inseparable from our finding of a lack of economic substance.
Petitioners stipulated substantially the same facts regarding the
Hyannis transaction as we found with respect to the Clearwater
transaction described in the Provizer case, and that the
recyclers each had a fair market value not in excess of $50,000.
Given those stipulations, and the fact that the records here
plainly show that the overvaluation of the recyclers was the
primary reason for the respective disallowances of the claimed
tax benefits, and the fact that no argument was made and no
evidence was presented to the Court to prove that the
disallowances and concessions of the investment tax credits
related to anything other than a valuation overstatement, we
conclude that the respective deficiencies caused by the
disallowances of the claimed tax benefits were attributable to
overvaluation of the Sentinel EPE recyclers.
Finally, we consider the express arguments of petitioners as
to waiver of the section 6659 additions to tax. On brief,
petitioners each contested imposition of the section 6659
addition to tax on the grounds that respondent erroneously failed
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to waive the addition. Section 6659(e) authorizes respondent to
waive all or part of the addition to tax for valuation
overstatements if taxpayers establish that there was a reasonable
basis for the adjusted bases or valuations claimed on the returns
and that such claims were made in good faith. Respondent's
refusal to waive a section 6659 addition to tax is reviewable by
this Court for abuse of discretion. Krause v. Commissioner,
supra at 179.
Petitioners urged that they relied on Greenstein, and to
some extent upon the representations and evaluations contained in
the offering memorandum, in deciding on the valuation claimed on
their tax returns. Petitioners contend that such reliance was
reasonable, and, therefore, respondent should have waived the
section 6659 addition to tax.
We have found that petitioners' purported reliance on
Greenstein and the offering memorandum was not reasonable. At
the time of the investment, petitioners knew that Greenstein was
not an engineer and had no education or experience in plastics
materials or plastics recycling. He made a very limited
investigation about the recyclers, and there is no evidence or
indication that petitioners were willing to finance a more
thorough inquiry. Nevertheless, petitioners relied exclusively
on Greenstein for the underlying viability, financial structure,
and economics of the Hyannis transaction. The investment credits
were directly dependent upon the value of the recyclers, and the
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offering memorandum warned that the Internal Revenue Service
would likely challenge their purported value. Yet the record
indicates that petitioners' sought no verification of the value
of the recyclers; their only concern was whether the recyclers
actually existed.
Petitioners did not have a reasonable basis for the adjusted
bases or valuations claimed on their 1981 returns with respect to
their investments in Hyannis. Accordingly, in these cases
respondent could find that petitioners' purported reliance on
Greenstein and the promotional materials was unreasonable. The
records here 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 additions to tax
is not an abuse of discretion. Petitioners are liable for the
respective section 6659 additions to tax at the rate of 30
percent of the underpayment of tax attributable to the disallowed
credits for 1981. Respondent is sustained on this issue.
Issue 3. Sec. 6621(c) Tax-Motivated Transactions
With respect to petitioners Pace, respondent determined that
interest on deficiencies accruing after December 31, 1984, would
be calculated under section 6621(c). Petitioners Pace have the
burden of proving that respondent's determination is erroneous.
Rule 142(a); Luman v. Commissioner, 79 T.C. 846 (1982). With
respect to petitioners Berry, respondent asserted the section
6621(c) interest calculation in an amendment to answer. Because
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it was raised for the first time in an amendment to answer,
respondent bears the burden of proof. Rule 142(a); Vecchio v.
Commissioner, 103 T.C. 170 (1994).
The annual rate of interest under section 6621(c) equals 120
percent of the interest payable under section 6601 with respect
to any substantial underpayment attributable to tax-motivated
transactions. An underpayment is substantial if it exceeds
$1,000. Sec. 6621(c)(2).
The term "tax motivated transaction" includes "any sham or
fraudulent transaction." Sec. 6621(c)(3)(A)(v). Transactions
devoid of economic substance are sham transactions for purposes
of section 6621(c)(3)(A)(v). Friendship Dairies, Inc. v.
Commissioner, 90 T.C. 1054, 1068 (1988); Cherin v. Commissioner,
89 T.C. 986, 1000 (1987). We have found that the Hyannis
transaction was a sham transaction lacking economic substance.
Therefore, by definition the Hyannis transaction is tax-motivated
under section 6621(c)(3)(A)(v). Moreover, the term "tax
motivated transaction" includes any section 6659(c) valuation
overstatement. Sec. 6621(c)(3)(A)(i). In 1981, petitioners
claimed a value for the recyclers in excess of 150 percent of the
true value of the recyclers. Therefore, petitioners had a
valuation overstatement as defined in section 6659(c).
For section 6621(c) interest to apply, the underpayment of
taxes must be "attributable to" a tax-motivated transaction.
Where a valuation overstatement or other category of tax-
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motivated transaction is an integral part of, or inseparable
from, the ground for disallowance of an item, section 6621(c)
increased interest applies. See McCrary v. Commissioner, 92 T.C.
at 859. Petitioners stipulated substantially the same facts
regarding the underlying transaction in these cases as we found
in Provizer v. Commissioner, T.C. Memo. 1992-177, where we held
that the taxpayers were liable for the section 6659 addition to
tax because the underpayment of taxes was directly related to the
overvaluation of the Sentinel EPE recyclers. In the present
cases we have likewise found that overvaluation of the recyclers
was an integral part of the ground for disallowance of the items
related to Hyannis. Accordingly, respondent's determination as
to the applicable interest rate for deficiencies attributable to
tax-motivated transactions is sustained, and the increased rate
of interest applies for the taxable year in issue.
To reflect the foregoing,
Decision will be entered
under Rule 155.