McPike v. Commissioner

T.C. Memo. 1996-46

UNITED STATES TAX COURT

MARVIN W. AND KATHRYN A. MCPIKE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 16752-87. Filed February 12, 1996.

Marvin W. and Kathryn A. McPike, pro se.

Debra Bowe, for respondent.

MEMORANDUM FINDINGS of FACT and OPINION

DAWSON, Judge: This case was assigned to Special Trial

Judge Larry L. Nameroff pursuant to section 7443A(b)(4) and Rules

180, 181, and 183.1 The Court agrees with and adopts the opinion

1
All section references are to the Internal Revenue Code
in effect for the years in issue. All Rule references are to the
Tax Court Rules of Practice and Procedure.
 - 2 -

of the Special Trial Judge, which is set forth below.

OPINION OF THE SPECIAL TRIAL JUDGE

NAMEROFF, Special Trial Judge: Respondent determined

deficiencies, additions to tax, and increased interest as

follows:
Additions to Tax and Increased Interest
Sec. Sec. Sec. Sec. Sec.
Year Deficiency 6653(a)(1) 6653(a)(2) 6651(a)(1) 6661(a) 6621(c)
1 2
1980 $ 8,689 $434.45 --- --- ---
3 2
1981 11,311 565.55 --- ---
3 2
1983 9,258 462.90 --- $2,314.50
3 2
1984 14,139 960.80 $3,534.75 3,534.75
1
The Code section for 1980 is 6653(a).
2
Interest on the entire deficiency to be computed at 120 percent of the standard
underpayment rate.
3
50 percent of the interest due on the deficiency.

Initially, in the notice of deficiency, respondent

determined adjustments to petitioners' income by disallowing

their claims to losses with respect to the Winthrop Trust and

their claims to distributive shares of partnership losses of the

Kathmar Company in which petitioners are the two general

partners, each having a 50-percent interest. In a Stipulation of

Settlement filed with the Court on January 9, 1995, the parties

settled all issues pertaining to the Winthrop Trust.

Specifically, the parties agreed that petitioners are allowed

ordinary losses of $8,506 for 1983 and $6,441 for 1984

attributable to the Winthrop Trust. With respect to the

additions to tax and increased interest the parties agreed as

follows:
* * * * * * *
 - 3 -

4. No amount of the deficiencies in income taxes
resulting from disallowed deductions and credits
attributable to Winthrop Trust due from petitioners for the
1983 and 1984 taxable years are attributable to tax-
motivated transactions for the purpose of computing the
addition to tax payable pursuant to I.R.C. section 6621(c).

5. The addition to tax for negligence pursuant to
I.R.C. sections 6653(a)(1) and (2) shall not be applicable
to the 1983 and 1984 taxable years for any deficiency in
income taxes resulting from disallowed deductions and
credits attributable to Winthrop Trust.

6. The addition to tax for delinquency pursuant to
I.R.C. section 6651 shall be applicable to the 1984 taxable
year for any deficiency in income taxes resulting from
disallowed deductions and credits attributable to Winthrop
Trust.

7. The addition to tax for substantial understatement
of income tax pursuant to I.R.C. section 6661(a) shall not
be applicable to the 1983 and 1984 taxable years for any
deficiency in income taxes resulting from disallowed
deductions and credits attributable to Winthrop Trust.

These concessions should be reflected in the Rule 155

computations.

In the Stipulation of Facts filed with the Court on February

3, 1995, petitioners conceded that all losses, expenses, and

investment tax credits derived from the Kathmar Company as

partners thereof on their Federal income tax returns for 1983 and

1984 are not allowable. Thus, the issues remaining for decision,

pertaining only to the Gold Depository and Loan Company, Inc.

(GD&L) container leasing tax shelter2 through Kathmar Company,

are (1) whether petitioners are liable for the additions to tax

2
A detailed discussion of the container industry and
program, including GD&L, can be found in Weiler v. Commissioner,
T.C. Memo. 1990-562.
 - 4 -

for negligence or intentional disregard of the rules or

regulations; (2) whether petitioners are liable for the 1984

addition to tax under section 6651(a)(1); (3) whether petitioners

are liable for the additions to tax for substantial

understatement of income tax for 1983 and 1984 under section

6661(a); and (4) whether petitioners are liable for an increased

rate of interest on deficiencies attributable to tax motivated

transactions under section 6621(c).

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

The stipulation of facts and exhibits attached thereto are

incorporated herein by this reference. Petitioners resided in

San Bernardino, California, when their petition was filed in this

case.

Marvin McPike (petitioner) is a retired fire fighter. He

was employed for 28 years as a fireman in San Bernardino and 4

years in Colton. He has a high school education. Since

graduating from high school, petitioner received no further

formal education, except for a few courses in fire science.

Petitioner has no previous investment experience other than

investing in his personal residence.

Kathryn McPike (Mrs. McPike) completed the ninth grade in

school. During the years before the Court she was employed as

office manager and general clerk for the United Food and

Commercial Workers Union. Her responsibilities included typing,
 - 5 -

filing, answering telephones, and general office work. She is

now retired. Mrs. McPike has no previous investment experience

other than her personal residence.

Prior to 1982, petitioners either prepared their own tax

returns or hired someone to prepare them. They did not have a

regular return preparer. In 1982, petitioners saw an

advertisement in a local newspaper for tax return preparation by

Daniel Lukensow (Lukensow). According to the advertisement,

Lukensow's background consisted of 7 years as an internal revenue

agent and 8 years of private practice in the areas of tax law,

tax return preparation, and tax audits. Petitioners contacted

Lukensow, made an appointment, and hired him to be their tax

return preparer. They never investigated Lukensow's background.

Lukensow advised petitioners that they could save a

considerable amount of money through investment in tax shelters.

He promoted and sold two different tax shelters, one involving a

computer rental program and the other involving a marine dry

cargo container program. Petitioner discussed these programs

with Lukensow, but Mrs. McPike was not involved. She relied on

petitioner to make the decisions regarding investments.

Petitioner believed that the proposed investments would reduce

their Federal income tax liability, allow them to provide better

financial assistance to their blind son, and generate a pension

after their retirement.

In 1983, petitioners invested in the container leasing
 - 6 -

program promoted by Lukensow and offered by GD&L. Lukensow

provided petitioner with promotional materials for the container

leasing program. These materials included a question and answer

memorandum regarding the program, a favorable letter from an

attorney, and a prospectus of the container leasing program.

Petitioner reviewed and relied on these documents. Although

petitioner did not completely understand the documents, his basic

understanding of these materials was that an investment in the

program would substantially reduce his Federal income tax

liability.

Petitioner relied on the following passages from the

question and answer memorandum:

Q. Aren't container leasing tax shelters an industry-
wide scam?

A. Yes, we too have heard of such schemes. The only
answer to that is that we have been and are now
honorable and legitimate and plan to be around for a
long time. It is not the form of the investment that
is important - it is the expertise that goes into
making it successful. All scams will mimic legitimate
projects and are actually trading on the good name of
the ones that have achieved success.

* * * * * * *
Q. How do we know that your firm can, and will, do
what you say?

A. * * * Our chief counsel, Alex Laurins, is an
attorney, formerly with the IRS and with years of
experience in the tax field. Our staff of attorneys
has reviewed this program at every step and is now
exercising the same meticulous preparatory work on our
forthcoming mining tax shelter. * * *

In addition to this excerpt, petitioner relied on the
 - 7 -

favorable letter from an attorney, Alois E. Lemke. This letter

stated that investors in the container leasing program would be

able to qualify for tax credits and depreciation write-offs.

Petitioners did not contact another attorney, accountant, or any

other individual to verify this information.

Lukensow set up a partnership called Kathmar Company in

which petitioners each held a 50-percent interest. Through

Kathmar, petitioners invested in GD&L's container leasing

program. Petitioners did not understand the nature or purpose of

the partnership, and Lukensow did not explain its function or

operation due to its alleged complexity.

On August 16, 1983, petitioners purchased 20 units3 of

containers for $200,000.4 The terms of the purchase required a

downpayment of $9,900, and GD&L purportedly arranged the

financing for the remaining $190,100, for which petitioner signed

promissory notes. As part of the agreement, petitioners agreed

to appoint GD&L as their non-exclusive agent for the purposes of

leasing the containers. GD&L agreed to act as the leasing agent

for petitioners for 35 months and to use its best efforts to

3
According to the Container Purchase and Lease
Agreement, each unit represented one 40-foot container "valued
at" $4,000 and three 20-foot containers "valued at" $2,000.
4
Most of the documentation contained in the stipulation
of facts reflects only the purchase of 10 units, while the 1983
tax return reflects a total cost of $200,000. Moreover, the
amount of the investment tax credit (ITC) claimed therein,
carried back to 1980 and 1981, and at issue herein, is based upon
a $200,000 alleged cost.
 - 8 -

lease the containers. Pursuant to this agreement, GD&L was to

receive an annual lease management fee of $1 plus 15 percent of

the revenues generated by leasing petitioners' containers.

Petitioner does not recall making any payments on the promissory

notes nor for any management fees.

Petitioners received income and expense statements related

to their container leasing investment. Because petitioners did

not understand the documents, they took them to Lukensow for use

in the preparation of their tax returns.

On the Schedule E attached to their 1983 Federal income tax

return, petitioners reported ordinary losses of $33,758 from

Kathmar. On Form 3468 petitioners computed an ITC in the amount

of $20,000. Petitioners carried this $20,000 credit back to

taxable years 1980 and 1981 for refunds in the amounts of $8,698

and $11,311, respectively.

Based on Lukensow's advice, petitioners filed Form 4868,

Application for Automatic Extension of Time, on April 12, 1985,

for an automatic extension until August 15, 1985, to file their

1984 Federal income tax return. Petitioners gave Lukensow all

their tax papers, and he prepared the Form 4868. On that form,

petitioners estimated their 1984 Federal income tax liability to

be $5,077, of which $4,551 had been withheld by Mrs. McPike's

employer and a life insurance company. Petitioners filed Form

4868 and enclosed a check in the amount of $526. Thereafter,

they sent by certified mail their 1984 Federal income tax return
 - 9 -

to the Internal Revenue Service Center in Fresno, California.

The envelope containing petitioners' 1984 tax return was

postmarked August 13, 1985. The tax return was stamped

"received" by the Internal Revenue Service on August 19, 1985.

On the Schedule E attached to their 1984 Federal income tax

return, petitioners reported ordinary losses of $23,484 related

to the container leasing investment. In the notice of deficiency

respondent disallowed all losses claimed by petitioners regarding

Kathmar for 1983 and 1984, as well as all claimed ITC.

Petitioners are currently part of a pending class action

lawsuit against the promoters of GD&L. The primary claim of the

lawsuit is that the promotion was fraudulent and a sham.

OPINION

Petitioners contend that they reasonably relied on Lukensow

and the promotional materials when they invested in and claimed

deductions and credits attributable to the GD&L container leasing

program. Therefore, they assert that they are not liable for the

additions to tax and increased interest related thereto. To the

contrary, respondent contends that petitioners are liable for the

additions to tax pursuant to section 6653(a)(1) and (2), section

6661(a), and section 6651(a), and the increased interest pursuant

to section 6621(c).

Section 6653(a) Additions to Tax for Negligence

Section 6653(a) for 1980 and section 6653(a)(1) for 1981,

1983, and 1984 impose an addition to tax equal to 5 percent of
 - 10 -

the underpayment of tax if any part of the underpayment is due to

negligence or intentional disregard of the rules or regulations.

Section 6653(a)(2) for 1981, 1983, and 1984 imposes an addition

to tax in the amount of 50 percent of the interest due on the

portion of the underpayment attributable to negligence.

Negligence is defined as the lack of due care or failure to do

what a reasonable and ordinarily prudent person would do under

the circumstances. Neely v. Commissioner, 85 T.C. 934, 937

(1985). Respondent's determination that petitioners were

negligent is presumed correct, and petitioners bear the burden of

proving that they were not negligent. Rule 142(a).

In order to prevail on the negligence issue, petitioners

must prove that their actions in connection with the GD&L

container investment were reasonable in light of their experience

and the nature of the investment. See Henry Schwartz Corp. v.

Commissioner, 60 T.C. 728, 740 (1973). Within this framework,

petitioners may prevail if they reasonably relied on competent

professional advice. Freytag v. Commissioner, 89 T.C. 849, 888

(1987), affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S. 868

(1991). When considering the negligence addition to tax we

evaluate the particular facts of each case, judging the relative

sophistication of the taxpayers, as well as the manner in which

they approached their investment. Maminga v. Commissioner, T.C.

Memo. 1995-361.

Based on this record, we conclude that petitioners' reliance
 - 11 -

on the alleged expertise of Lukensow and the promotional

materials was not reasonable or prudent. Pasternak v.

Commissioner, 990 F.2d 893, 902-903 (6th Cir. 1993), affg.

Donahue v. Commissioner, T.C. Memo. 1991-181; Klieger v.

Commissioner, T.C. Memo. 1992-734. Without any previous

investment experience, petitioners agreed to purchase $200,000

worth of assets and incur debt of $190,100 solely upon the

representations and promotional materials presented by Lukensow,

an individual they discovered in a newspaper advertisement.

Petitioners relied solely on Lukensow's representations as to his

expertise without any further research. They also relied on his

representations and the promotional material as to the legitimacy

of the container investment, without any further investigation,

although Lukensow, as a promoter, earned fees from the sale of

the container leasing program. Petitioners proceeded to invest

cash of nearly $10,000 and purported to incur liability for

approximately $190,100, hoping to save taxes at virtually no

cost to themselves, due to the refunds from the ITC carryback

claims.5

It is clear that petitioners were sheltering income

improperly with large deductions and small cash investments. For

5
Prior to the filing of their 1983 return, petitioners
had undergone an audit of their 1980 and 1981 income tax returns
in connection with an investment in the Universal Life Church and
had been assessed substantial deficiencies, interest, and
additions to tax in connection therewith.
 - 12 -

example, in 1983 they used GD&L losses of $33,758 to offset gross

income of $53,422, and in 1984 they used GD&L losses of $23,484

to offset gross income of $75,664. The substantial losses that

GD&L generated for 2 consecutive years should have concerned even

unsophisticated investors. Although petitioners may not have

fully understood their GD&L investment and may not have known all

the "gremlins" that were present in the investment, it would seem

that they should have inquired. See Maminga v. Commissioner,

T.C. Memo. 1995-361; Sacks v. Commissioner, T.C. Memo. 1994-217.

We have considered Heasley v. Commissioner, 902 F.2d 380

(5th Cir. 1990), revg. T.C. Memo. 1988-408, in our evaluation of

this case. In Heasley, the taxpayers were not educated beyond

high school and had limited investment experience. The taxpayers

in Heasley relied upon the advice of an independent accountant

who apparently did not receive a commission from the sale of the

tax shelter in which the taxpayers invested. Further, the

taxpayers actively monitored their investment and intended to

profit from the investment.

We cannot reach similar conclusions in the instant case.

Although petitioners have educational backgrounds similar to the

taxpayers in Heasley, they did not have an accountant or any

other individual independently review the container investment.

Instead, they relied only on the advice of Lukensow and the

promotional materials. Moreover, petitioners made no effort to

monitor their investment, and they have failed to establish that
 - 13 -

they intended to profit from their investment.6 Thus, we do not

find Heasley controlling in the instant case.

Accordingly, we sustain respondent's determination with

respect to the additions to tax for negligence insofar as it

pertains to the GD&L container leasing investment.7

Section 6651(a)(1) Addition to Tax for Delinquency

Section 6651(a)(1) imposes an addition to tax for failure to

file a tax return or pay any tax by the applicable due date,

unless it is shown that such failure is due to reasonable cause

and not willful neglect. United States v. Boyle, 469 U.S. 241,

246 (1985). Petitioners bear the burden of proving that their

failure to file a timely return was due to reasonable cause and

not willful neglect. Neubecker v. Commissioner, 65 T.C. 577, 586

(1975).

Generally, individuals who compute their taxes on a calendar

year basis must file their Federal income tax return by the 15th

day of April following the close of the taxable year. Sec.

6
There is ample evidence to suggest that petitioners
invested in the container leasing program primarily to reduce
their Federal tax liability. Petitioner's testimony emphasized
his desire to reduce their income tax liability through
investments. In addition, his review of the promotional
materials focused on the tax benefits which could be obtained by
investing in the container program. Although Mrs. McPike
suggested that petitioners had a profit motive, we think that
petitioners invested in the container program for its tax
benefits, and any profit motive was incidental.
7
We emphasize again that, in our judgment, respondent
has conceded there is no negligence with respect to the claimed
losses of the Winthrop Trust, and this should be reflected in the
Rule 155 computations.
 - 14 -

6072(a). Nevertheless, individual taxpayers may obtain an

automatic 4-month extension of time to file their return. Sec.

1.6081-4(a)(1), Income Tax Regs. In order to obtain the

automatic extension, a taxpayer must file a signed Form 4868,

Application for Automatic Extension of Time to File U.S.

Individual Income Tax Return. Sec. 1.6081-4(a)(2), Income Tax

Regs. The application must be filed with the appropriate

internal revenue officer on or before the due date prescribed for

filing the taxpayer's return. Sec. 1.6081-4(a)(3), Income Tax

Regs. Sec. 1.6081-4(a)(4), Income Tax Regs., provides that the

application:

must show the full amount properly estimated as tax for
such taxpayer for such taxable year, and such
application must be accompanied by the full remittance
of the amount properly estimated as tax which is unpaid
as of the date prescribed for the filing of the return.
[Emphasis added.]

Respondent concedes that petitioners' 1984 Federal income

tax return was timely postmarked and therefore timely filed if

the extension request was valid. Sec. 7502(a). However, it is

respondent's position that because petitioners failed to properly

estimate their tax liability, their extension request was

invalid, and the extension received was void ab initio. The

Commissioner may properly void automatic extensions of filing

deadlines previously obtained where the taxpayer's Form 4868 is

invalid because of a failure to estimate properly tax liability.

Crocker v. Commissioner, 92 T.C. 899, 911 (1989). Nevertheless,

the mere fact that petitioners underestimated their income tax
 - 15 -

liability is insufficient to conclude that the estimate was

improper. Id. at 906.

A taxpayer is treated as having "properly estimated" his tax

liability, within the meaning of section 1.6081-4(a)(4), Income

Tax Regs., when he makes a bona fide and reasonable estimate of

his tax liability based on the information available to him at

the time he makes his request for an extension. Crocker v.

Commissioner, supra at 908. Petitioners estimated their tax

liability to be $5,077 at the time they filed their extension

request. Their 1984 Federal income tax return reported an income

tax liability in the same amount. Ultimately, after the issuance

of the notice of deficiency and disallowance of credits and

deductions reported on the 1984 Federal income tax return,

petitioners' true income tax liability was determined to be

$16,510.

Petitioners argue that the Form 4868 was prepared by

Lukensow and that they paid the amount of tax they believed to be

due for 1984. It is the taxpayer's obligation to supply his

accountant with complete and accurate records from which to make

a reasonable estimate of tax liability. Estate of Duttenhofer v.

Commissioner, 49 T.C. 200, 205 (1967), affd. per curiam 410 F.2d

302 (6th Cir. 1969). Petitioners located, gathered, and supplied

all of their 1984 income tax information to Lukensow.

In the previous section of this opinion, we held that

petitioners were negligent in claiming deductions and investment
 - 16 -

tax credits arising out of the GD&L container leasing program

and that they did not reasonably rely upon the advice of a

competent adviser. It follows that petitioners did not make a

bona fide and reasonable estimate of their tax liabilities by

relying on that same adviser, who utilized the GD&L deductions

and credits in estimating their 1984 Federal tax liability for

purposes of obtaining a filing extension. Thus, we conclude that

petitioners did not properly estimate their 1984 tax liability,

the extension request was not valid, and the 1984 return was not

timely filed. Therefore, we hold that petitioners are liable for

the 1984 addition to tax for delinquency under section

6651(a)(1).8

Section 6661(a) Addition to Tax

Section 6661(a) provides for an addition to tax equal to 25

percent of an underpayment attributable to a substantial

understatement of tax. Section 6661(b)(1)(A) defines a

substantial understatement as the greater of 10 percent of the

tax required to be shown or $5,000. The amount of the

understatement may be reduced by an amount for which there was

substantial authority for the treatment adopted by the taxpayers

on their return. Sec. 6661(b)(2)(B)(i). This reduction is not

available in the case of a tax shelter unless, in addition, the

8
This addition to tax applies to the entire deficiency
for 1984, Indeed petitioners have conceded that it applies to
the portion of the deficiency in income taxes resulting from the
disallowance of deductions and credits attributable to the
Winthrop Trust.
 - 17 -

taxpayers reasonably believed that the claimed tax treatment was

"more likely than not" the proper tax treatment. Sec.

6661(b)(2)(C)(i)(II). For this purpose, section

6661(b)(2)(C)(ii) defines a tax shelter as any partnership or

other entity or investment plan or arrangement the principal

purpose of which is the avoidance or evasion of Federal income

tax.

Section 6661(c) authorizes respondent to waive any part of

the addition to tax imposed under section 6661(a) upon a showing

by the taxpayers of reasonable cause for the understatement and

that the taxpayers acted in good faith. The most important

factor in determining whether to grant a waiver is "the extent of

the taxpayer's effort to assess the taxpayers' proper tax

liability under the law." Sec. 1.6661-6(b), Income Tax Regs.;

Mailman v. Commissioner, 91 T.C. 1079, 1083-1084 (1988).

Reliance upon the advice of a professional will not constitute a

showing of reasonable cause and good faith unless, under all the

circumstances, such reliance was reasonable in light of the

taxpayers' experience, knowledge, and education. Sec. 1.6661-

6(b), Income Tax Regs. Thus, if it was reasonable for the

taxpayers to rely on their financial adviser or accountant under

the circumstances, and the taxpayers did so in good faith, then

the Commissioner may waive the penalty. Vorsheck v.

Commissioner, 933 F.2d 757 (9th Cir. 1991), affg. in part and

revg. in part an Oral Opinion of this Court.
 - 18 -

As previously discussed, petitioners' efforts to assess

their proper income tax liability consisted of their reliance

upon the promotional materials and their discussions with

Lukensow. It is clear that they did not make the kind of factual

or legal analysis of the GD&L container leasing program that

would enable them to formulate any reasonable belief one way or

another as to whether the tax treatment they gave to their

claimed deductions and ITC was more likely than not the proper

treatment. Having concluded that petitioners' reliance on

Lukensow and the promotional materials was neither reasonable nor

in good faith, it follows that no reduction of the understatement

is available and that respondent did not abuse her discretion in

declining to waive the addition to tax under section 6661(a).

Accordingly, respondent's determination with respect to this

issue is sustained.

Section 6621(c) Increased Rate of Interest

Section 6621(c) provides for an increased interest rate with

respect to any "substantial underpayment" (greater than $1,000)

in any taxable year "attributable to 1 or more tax motivated

transactions". The increased rate of interest applies as of

December 31, 1984, even though the transaction was entered into

prior to the enactment of the statute. Solowiejczyk v.

Commissioner, 85 T.C. 552 (1985), affd. without published opinion

795 F.2d 1005 (2d Cir. 1986). The term "tax motivated

transaction" includes any "sham or fraudulent transaction". Sec.
 - 19 -

6621(c)(3)(A)(v). The statutory language encompasses

transactions which lack a profit objective and which are without

economic substance. Cherin v. Commissioner, 89 T.C. 986, 1000

(1987).

This Court has previously held that the container leasing

program promoted by GD&L lacked economic substance and was a

factual sham. See Cleland v. Commissioner, T.C. Memo. 1993-589;

Shortal v. Commissioner, T.C. Memo. 1992-560; Weiler v.

Commissioner, T.C. Memo. 1990-562. Petitioners introduced no

evidence that the container leasing program was not an economic

sham. Accordingly, the increased rate of interest applies to the

underpayment attributable to all deductions and credits taken

with respect to the container program.

We have considered all arguments made by the petitioners

and, to the extent not addressed herein, have found them to be

without merit.

In order to reflect our disposition of the disputed issues,

as well as the parties' concessions and stipulations,

Decision will be entered
under Rule 155.