T.C. Memo. 1995-605
UNITED STATES TAX COURT
UNITED CIRCUITS, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 20548-94. Filed December 26, 1995.
Gino Pulito, for petitioner.
John E. Budde, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
COHEN, Judge: Respondent determined deficiencies of $68,587
and $33,638 in petitioner's 1989 and 1990 Federal income taxes,
respectively, and accuracy related penalties of $9,386 and $55
under section 6662(a) for 1989 and 1990, respectively. Unless
otherwise indicated, all section references are to the Internal
Revenue Code in effect for the years in issue, and all Rule
references are to the Tax Court Rules of Practice and Procedure.
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After concessions by the parties, the only issues remaining
for decision are whether petitioner is liable for the 1989 and
1990 accuracy related penalties for negligence and for a
substantial understatement of income tax.
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulated
facts are incorporated in our findings by this reference.
Petitioner had its principal place of business in Ohio at the
time the petition was filed. During the years in issue,
petitioner was in the business of manufacturing circuit boards.
United Circuits, Inc. (UCI), was owned by Frank Schubert
(Schubert) and Gary Jump (Jump). Schubert, the president of UCI,
was primarily responsible for overseeing the manufacturing
process and ensuring that the waste produced from the
manufacturing process was in compliance with Environmental
Protection Agency standards. Schubert's education and prior work
experience were in engineering.
Jump was the vice president and general manager of UCI.
Jump had various responsibilities that included reviewing UCI
financial information, making decisions about equipment
purchases, and working with Schubert on manufacturing matters.
Jump received a degree in marketing.
UCI employed Davidson Audit Company (DAC) to perform
accounting functions and to prepare UCI's financial statements
and tax returns. Eleanor Northcutt (Northcutt), an employee of
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DAC, was responsible for the UCI account. Northcutt had been
employed by DAC since 1965 and had handled the UCI account since
UCI began business. Northcutt was a high school and a business
school graduate. She took 32 to 48 hours of continuing education
courses a year that were offered by the International Society of
Public Accountants. Northcutt did not have a public accountant
license. When Northcutt was presented with an accounting issue
about which she was uncertain, she would research the issue
herself and then make a decision as to how she felt the issue
should be treated.
Every month, Jump took UCI ledgers and invoices to
Northcutt. Northcutt would have her clerk prepare monthly
financial statements for UCI based on the ledgers and invoices.
Northcutt reviewed the monthly financial statements after the
clerk completed them and before they were given to UCI.
Because the manufacturing processes used by UCI corroded its
equipment, periodic replacement of the equipment was necessary.
Prior to the years in issue, UCI purchased equipment outright and
depreciated it for tax purposes.
During 1988, Jump was contacted by Equitable Lomas Leasing
Corp. (Lomas), a company that offered leases on equipment that
Jump was interested in purchasing. Lomas told Jump that there
were tax advantages of leasing the equipment instead of
purchasing it. Lomas advised Jump that, if the equipment lease
were for a duration of at least 1 year, the lease would be
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"legitimate". Jump contacted Northcutt about the equipment
acquisitions, and they discussed the possibility of leasing the
equipment. Jump specifically asked whether a 1-year lease was a
"legitimate" lease. Northcutt researched the issue of lease
duration and told Jump that 1-year leases would not be a problem
as long as they had monthly payments and they were set up as
leases or intended as leases.
During 1989 and 1990, UCI acquired the equipment and made
payments as follows:
Asset 1989 Payments 1990 Payments
Voss level machine $ 38,750 $11,250
Drill 66,840 12,368
Etcher 26,220 26,221
Filter press 9,295
Air compressor 7,086
Total $141,105 $56,925
The document that conveyed the Voss level machine equipment
to UCI consisted of a typed payment schedule on a form that had
the preprinted words "Purchase Order" on the top of the form.
The words "Lease Payments as Follows" were typed below "Purchase
Order". The agreement required four payments of $5,000 and eight
payments of $3,750, for a total of $50,000, with a $1.00 buy out
option. The agreement did not contain a provision for the return
of the equipment to the lessor. The invoice was signed by Jump
and dated April 28, 1989.
The drill was conveyed on a Lomas form titled "Master
Equipment Lease Agreement". The agreement consisted of a deposit
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and advance payment of $32,736.16, followed by eight monthly
payments of $5,684.04, for a total of $78,208, with a $1,000 buy
out option at the end of the 8 months. UCI exercised the buy out
option. The lease was signed by Schubert and dated June 27,
1989.
UCI was sent an invoice for the etcher by the supplier. The
terms were 50 percent down and 50 percent net 30 days after
shipment. UCI paid with two $26,220.50 checks dated November 9,
1989, and June 21, 1990, for a total of $52,441. The invoices
did not contain a provision for the return of the equipment to
the lessor or a buy out option. The checks were signed by Jump,
and the invoice was dated October 17, 1989.
The filter press was acquired on a series of invoices from
Jim's Plating Supply, Inc. There were a total of seven monthly
invoices, each one requesting a payment of $1,168.13. The
invoices did not contain a buy out option or a provision to
return the equipment to the lessor. The invoices were dated June
through December 1989.
The air compressor was acquired on a Compu Rent lease
agreement that required an advance payment of $1,574.60 and 10
monthly payments of $787.30. The agreement did not contain a buy
out provision. The agreement was signed by Jump and dated
May 15, 1990.
UCI recorded the payments for the equipment under "Lease
Expense" on its ledgers. The useful life of the equipment
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acquired as described above was substantially greater than the
duration of the purported leases.
Northcutt's clerk prepared UCI's 1989 and 1990 tax returns
based on the ledgers and invoices provided by UCI. Northcutt did
not review the purported lease transactions that were entered
into by UCI. Neither Northcutt nor her clerk verified the lease
expenses as part of UCI's return preparation. Petitioner
deducted the payments for the asset acquisitions as "Lease
Expense" on its 1989 and 1990 tax returns in the aggregate
amounts of $141,105 and $56,925, respectively. Northcutt
reviewed and checked the returns before sending them to UCI for
signature. Jump and Schubert each spent 5 to 10 minutes
reviewing the Federal income tax returns after they were received
from Northcutt. Schubert, as president of UCI, signed the
returns in both 1989 and 1990.
OPINION
Respondent determined that the lease expenses claimed by
petitioner were capital expenses and disallowed the deductions.
Petitioner has conceded the $68,587 and $33,638 deficiencies for
1989 and 1990, respectively. Petitioner argues, however, that it
is not liable for the accuracy related penalties because there
was substantial authority for its position on its tax returns and
because petitioner's reliance on its accountant was reasonable
and in good faith. Respondent contends that there is no
substantial authority for petitioner's position on its tax
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returns and that petitioner's accountant was not qualified to
render tax advice. Petitioner bears the burden of proving that
respondent's determination is erroneous. Rule 142(a); INDOPCO,
Inc. v. Commissioner, 503 U.S. 79, 84 (1992); Bixby v.
Commissioner, 58 T.C. 757, 791 (1972).
Section 6662(a) imposes an accuracy related penalty of
20 percent on any portion of an underpayment of tax that is
attributable to items set forth in section 6662(b). Section
6662(b)(2) specifies as one of those items "Any substantial
understatement of income tax." An understatement is substantial
if it exceeds the greater of 10 percent of the tax required to be
shown on the return or $10,000. Sec. 6662(d)(1)(A) and (B). In
calculating understatements under section 6662(b)(2), items for
which there was substantial authority are not to be considered.
Sec. 6662(d)(2)(B)(i). To determine whether the treatment of any
portion of an understatement is supported by substantial
authority, the weight of authorities in support of the taxpayer's
position must be substantial in relation to the weight of
authorities supporting contrary positions. Antonides v.
Commissioner, 91 T.C. 686, 700-704 (1988), affd. 893 F.2d 656
(4th Cir. 1990); sec. 1.6662-4(d)(3), Income Tax Regs.
Petitioner argues that the weight of authorities supports
its position that the equipment was acquired by lease and not
acquired in a disguised sale. Petitioner relies on Revenue
Ruling 55-540, 1955-2 C.B. 39, and Benton v. Commissioner, 197
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F.2d 745 (5th Cir. 1952), revg. a Memorandum Opinion of this
Court dated Sept. 20, 1950, as authorities to support its
position. Petitioner quotes Revenue Ruling 55-540, 1955-2 C.B.
at 41, as follows:
Whether an agreement, which in form is a lease, is in
substance a conditional sales contract depends upon the
intent of the parties as evidenced by the provisions of
the agreement, read in the light of the facts and
circumstances existing at the time the agreement was
executed. In ascertaining such intent no single test,
or any special combination of tests, is absolutely
determinative. No general rule, applicable to all
cases, can be laid down. Each case must be decided in
the light of its particular facts. * * *
Petitioner concludes that, because there is no general rule on
how to treat these arrangements, there is substantial authority
to treat them as petitioner did on its returns. However,
petitioner's recitation of Revenue Ruling 55-540 is incomplete.
The ruling sets forth an "economic" test and continues as
follows:
However, from the decisions cited below, it would
appear that in the absence of compelling persuasive
factors of contrary implication an intent warranting
treatment of a transaction for tax purposes as a
purchase and sale rather than as a lease or rental
agreement may in general be said to exist if, for
example, one or more of the following conditions are
present: [Id. at 41.]
The conditions following in the ruling that would indicate a
sale include facts where: The lessee will acquire title upon the
payment of a stated amount of "rentals", which under the contract
he is required to make; the total amount that the lessee is
required to pay for a relatively short period of use constitutes
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an inordinately large proportion of the total sum required to be
paid to secure the transfer of the title; and the property may be
acquired under a purchase option at a price that is nominal in
relation to the value of the property at the time when the option
may be exercised, as determined at the time of entering into the
original agreement, or at a price that is a relatively small
amount when compared with the total payments that are required to
be made.
The facts in this case fit squarely within the conditions
set forth in the ruling: the terms of the leases were
substantially less than the life of the equipment, and UCI owned
the equipment outright, either after a maximum of 10 payments or
after exercising a nominal buy out option. Rather than
supporting petitioner's position, Revenue Ruling 55-540 is
contrary to petitioner's position.
Petitioner relies on Benton v. Commissioner, supra, to
support deducting all payments under short-term leases. In
Benton, the lease was for the purchase of automobiles to be used
as taxicabs. The 1945 lease required 10 payments of $5,000 with
an option to purchase the automobiles for $35,000 at the end of
the 10 months. The Court of Appeals upheld the leases stating
that, when the intent of the parties to a contract is determined,
it must be determined in light of the facts and circumstances as
they existed at the time the parties entered into the contract.
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At the time the "leases" in dispute here were entered into,
UCI intended to keep the equipment permanently. Northcutt
testified at trial: "United Circuits was buying some equipment
and we [Jump and Northcutt] discussed the possibility of a lease
against depreciating it". (Emphasis added.) The documents
transferring the equipment either had no provision for the return
of the equipment to the "lessors" at the end of the required
payments or the agreements offered a nominal buy out. Taking
into account all of the relevant facts and circumstances,
including the intent of the parties to the agreement at the time
of the agreements, we conclude that agreements have the legal
effect of a contract for sale. Benton is distinguishable and
does not represent authority for petitioner's position.
Petitioner has failed to present any authority that supports
petitioner's position on its tax returns. Under either the
economic test of the revenue ruling or the intent test of Benton
applied to the facts, the transactions were sales and not leases.
Accordingly, petitioner cannot rely on the substantial authority
exception to the substantial understatement penalty to avoid
liability.
Petitioner also argues that it reasonably and in good faith
relied on Northcutt, its accountant, to prepare its returns and,
therefore, it should not be liable for the accuracy related
penalty. The reasonable cause and good faith exception in
section 6664(c) applies to both the substantial understatement
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and negligence penalties in section 6662(a) and (b). Section
1.6664-4, Income Tax Regs., states:
Reasonable cause and good faith exception to section
6662 penalties.--(a) In general. No penalty may be
imposed under section 6662 with respect to an portion
of an underpayment upon a showing by the taxpayer that
there was reasonable cause for, and the taxpayer acted
in good faith with respect to, such portion. * * *
(b) Facts and circumstances taken into account.--
(1) In general. The determination of whether a
taxpayer acted with reasonable cause and in good faith
is made on a case-by-case basis, taking into account
all pertinent facts and circumstances. The most
important factor is the extent of the taxpayer's effort
to assess the taxpayer's proper liability. * * *
Reliance on * * * the advice of a professional (such as
an appraiser, attorney or accountant) does not
necessarily demonstrate reasonable cause and good
faith. Similarly, reasonable cause and good faith is
not necessarily indicated by reliance on facts that,
unknown to the taxpayer, are incorrect. * * *
As a general rule, the responsibility of filing an accurate
return cannot be shifted by the taxpayer to a return preparer.
Metra Chem Corp. v. Commissioner, 88 T.C. 654, 662 (1987).
However, under certain circumstances, the taxpayer has been able
to avoid the imposition of a penalty if there was good faith
reliance by the taxpayer on the advice of a competent adviser.
Jackson v. Commissioner, 86 T.C. 492, 539-540 (1986), affd. 864
F.2d 1521 (10th Cir. 1989). To show good faith reliance on the
advice of a competent adviser, the taxpayer must at least
establish: (1) That he or she provided the return preparer with
complete and accurate information; (2) that an incorrect return
was a result of the preparer's mistakes; and (3) that the
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taxpayer believed in good faith that he was relying on the advice
of a competent return preparer. Metra Chem Corp. v.
Commissioner, supra.
Petitioner relies on section 1.6664-4(b)(2), Example (l),
Income Tax Regs., to establish good faith reliance:
A, an individual calendar year taxpayer, engages B, a
tax professional, to give him advice concerning the
deductibility of certain state and local taxes. A
provides B with full details concerning the taxes at
issue. B advises A that the taxes are fully
deductible. A, in preparing his own tax return, claims
a deduction for the taxes. Under these facts, A is
considered to have demonstrated good faith by seeking
the advice of a tax professional, and to have shown
reasonable cause for any underpayment attributable to
the deduction claimed for the taxes. However, if A had
sought advice from someone that he knew, or should have
known, lacked knowledge in federal income taxation, A
would not be considered to have shown reasonable cause
or to have acted in good faith.
Petitioner argues that it is not liable for the penalty
because the facts in the instant case are the same as the facts
in the example. Petitioner's argument, however, is contradicted
by the evidence. Jump did not provide Northcutt with full
details or complete and accurate information concerning the
transactions in issue. Northcutt testified that she did not see
the agreements for the equipment acquisitions entered into by
UCI.
In addition, Jump relied on Northcutt for “accounting”
advice rather than for “tax” advice. Jump testified:
Q In giving it [the question about the leases] to
her, did you anticipate she would render tax advice?
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A I guess we were looking at it more as
accounting advice than strictly tax advice.
Q So your reliance on Ms. Northcutt for these
lease expenses goes to the question of accounting as
opposed to tax return preparation?
A Having never been involved in an audit or
anything, we're more aware of it now but at the time,
no, we were concerned with accounting and the company.
We really didn't give much thought to being audited or
the IRS. We do now.
Northcutt’s return preparation consisted of transferring the
information in petitioner's ledgers to an income tax form without
verifying the validity of the entries in the ledger. Jump did
not inquire about the tax consequences of the transactions
entered into by petitioners and did not receive advice on the tax
consequences. Jump, by his own admission, did not rely on
Northcutt to render tax advice. Moreover, Jump did not follow
her advice as to the characteristics of a “legitimate” lease,
because two of the five purported leases’ payment terms were for
a duration of less than 1 year. Petitioner has failed to
establish good faith reliance on the advice of a competent tax
adviser.
Respondent also determined that petitioner was liable for an
accuracy related penalty because the understatement was due to
negligence. Petitioner argues that it is not liable for the
negligence penalty because it relied on its accountant. For the
reasons set forth above, we are not persuaded by petitioner's
argument.
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Petitioner has failed to meet its burden of proof to avoid
the accuracy related penalties. Accordingly, respondent's
determination will be sustained.
Decision will be entered
for respondent.