T.C. Memo. 1996-335
UNITED STATES TAX COURT
LAWRENCE R. ROBERSON, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 1595-89. Filed July 24, 1996.
Joseph Falcone, for petitioner.
Timothy S. Murphy, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
VASQUEZ, Judge: Respondent determined deficiencies in
petitioner's Federal income taxes and additions to tax as
follows:
- 2 -
Additions to Tax
Year Deficiency Sec. 6653(a) Sec. 6653(a)(1) Sec. 6653(a)(2) Sec. 6659
1979 $1,476 $74 --- --- $443.00
1980 3,402 170 --- --- 1,021.00
1
1981 3,532 --- $177.00 1,060.00
1
1982 7,975 --- 398.75 1,766.10
1
1983 9,428 --- 471.40 1,677.60
1
1984 2,472 --- 123.60 741.60
1
50 percent of the interest due on the portion of the underpayment
attributable to negligence.
After concessions, the sole issue for decision is whether
petitioner is liable for the applicable additions to tax under
section 6653(a) and under section 6653(a)(1) and (2) in the
years at issue.
All section references are to the Internal Revenue Code as
in effect for the years under consideration. All Rule
references are to the Tax Court Rules of Practice and Procedure.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by this reference. Petitioner resided in
Detroit, Michigan, at the time the petition was filed in this
case.
Petitioner received a bachelor of arts degree from Alabama
A & M University in 1967 and a master's of business
administration (M.B.A.) with concentrations in finance and
management from Indiana University in 1970. After receiving his
M.B.A. degree, petitioner was employed by the Ford Motor Co.,
- 3 -
where he held various positions in the corporate finance area,
including cost analyst, financial analyst, and eventually,
supervisor of profit analysis. In those positions, petitioner's
duties included analyzing the profitability of cars and looking
at the fixed costs to produce a new car. Petitioner left the
Ford Motor Co. in 1983 to start a financial planning firm.
Thereafter, petitioner became a certified financial planner and
has worked in the financial planning and investment advisory
business through the date of trial.
In 1978 or 1979, petitioner became acquainted with Louis
Cunningham, a financial planner and securities broker. Shortly
thereafter, petitioner began to invest in various mutual funds,
stocks, bonds, and variable annuities based on Cunningham's
suggestions and advice. Petitioner believed that all
investments presented to him by Cunningham had been reviewed and
placed on an approved list of investments by Cunningham's
brokerage firm, Mutual Service Corp. (MSC). In 1982, Cunningham
informed petitioner of an investment opportunity in the music
industry, specifically, the purchase of leasehold interests in
master recordings from the Southampton Music Co. (Southampton).
Cunningham earned a commission if petitioner decided to invest
in Southampton, and he encouraged petitioner to do so.
Petitioner could not recall whether Cunningham had indicated to
- 4 -
him that the Southampton investment had been investigated by
MSC, and in fact no such investigation had been done.
At the time he learned of the Southampton investment,
petitioner was not familiar with the music industry or master
recordings. Petitioner claims that he familiarized himself with
the music industry by spending numerous hours at the library
doing research, talking to some musicians from his church,
attending several seminars about investing in the music
industry, and on one or two occasions, speaking on the phone
with someone from Motown Records. There is no indication,
however, that these efforts included an investigation of the
Southampton master recording investment presented to petitioner
by Cunningham.1 When asked at trial what he had learned from
his research, petitioner stated: "I learned that it was an
industry where you could make a lot of money if you got a good
album--a good person that became popular." Petitioner provided
no evidence, however, that he had researched the profitability
1
Petitioner introduced into evidence two brochures he allegedly
received at a seminar on investing in the music industry. One of
the brochures is a quarterly report prepared by another master
recording leasing company, Audio Leasing Corp., and includes
information about the activities of that company as well as news
about the music industry generally. The brochure also emphasizes
the alleged tax incentives in investing in master recording
leases. The second brochure is a glossary of terms used in the
music industry. Neither brochure contains a discussion of the
nontax economic benefits to be expected from a master recording
lease, nor do they discuss the Southampton investment program at
issue in this case.
- 5 -
of a master recording or the likelihood of success of a
recording artist.
In November 1982, Cunningham provided petitioner with a
promotional booklet entitled "Southampton Music Company: 1982-
1983 Program". The promotional booklet emphasizes the tax
benefits of investing in a master recording rather than any
economic benefits that could be expected. The booklet includes
a 36-page tax opinion by Joseph Wetzel, an attorney in Portland,
Oregon. The tax opinion discusses the tax benefits of the
investment and potential tax problems that could be raised by
the Internal Revenue Service and ways to avoid them. The
promotional booklet also contains a chart entitled "Table of
Advance Lease Payments and First Year Tax Benefits" with four
levels of escalating investments with escalating tax benefits.
For example, according to the chart, a cash investment of
$31,000 in a master recording valued at $400,000 would yield in
the first year an investment tax credit of $40,000 and a tax
deduction of $26,000.
Petitioner asked William Parnell, an acquaintance who was a
return preparer and an enrolled agent before the Internal
Revenue Service, to review the Southampton promotional booklet.
According to petitioner,2 Parnell's assessment of the
2
Parnell did not testify in this case.
- 6 -
Southampton investment was that "If they would do everything
that they said in the booklet, it looked okay to him."
Based on his discussions with Cunningham and Parnell, and
on his own research of the music industry, petitioner decided to
invest in Southampton and signed a master recording lease
agreement on December 22, 1982. Petitioner was aware of the tax
benefits expected from the investment. The availability of
those benefits for the 1982 taxable year had an impact on
petitioner's decision to sign the lease agreement prior to the
end of the year. Pursuant to the agreement, petitioner was to
pay Southampton a total of $10,5003 for a one-fourth leasehold
interest in a master recording featuring Ray Pillow, a country-
western singer. The lease was for a term of 5 years and 10
months. Petitioner had not listened to or received a copy of
the Ray Pillow master recording prior to investing in
Southampton.
Petitioner's master recording was to be distributed as a
phonograph album by Indigo Music Co. (Indigo), a distributor
recommended to petitioner by Southampton. Petitioner did not
meet or negotiate with anyone from Indigo prior to investing in
Southampton. Pursuant to his agreements with Indigo and
3
Petitioner paid $8,400 on or about the date the lease was
signed and reported that amount as rental expense on his 1982 tax
return. The remaining $2,100 was paid approximately 1 year
thereafter and reported as rental expense on petitioner's 1983
return.
- 7 -
Southampton, petitioner was to receive royalty payments from
Indigo on album sales, and in turn, petitioner was to make
additional rental payments to Southampton based on a percentage
of net profits earned. There is no evidence in the record that
petitioner has ever received royalty payments from Indigo or
that any additional rental payments have been made to
Southampton.4
Pursuant to the lease agreement, Southampton agreed to pass
to petitioner his one-fourth share of any investment tax credit
generated by the Ray Pillow master recording. On his 1982 tax
return, petitioner reported a tentative regular investment
credit from his Southampton investment of $21,250. This amount
was determined based on a value for the Ray Pillow master
recording reported to petitioner by Southampton of $850,000.5
Petitioner never obtained an independent appraisal of the Ray
Pillow master recording but relied solely on the value reported
to him by Southampton.6 Of the total investment tax credit of
4
On his 1984 tax return, however, petitioner reported $15 in
"Other Income" from his Southampton investment.
5
Petitioner's tentative regular investment tax credit was
determined by multiplying the regular investment tax credit
percentage (10 percent) by petitioner's one-fourth share of the
total value of the master recording reported by Southampton (10
percent x ($850,000 x ¼) = $21,250).
6
Petitioner introduced into evidence two documents that he
received from Southampton purporting to be appraisals of the Ray
Pillow master recording. Petitioner's reliance on these
(continued...)
- 8 -
$21,250, petitioner used $2,776.45 of the credit in 1982,
carried back unused credit in the amounts of $1,476, $3,402, and
$3,532 to 1979, 1980, and 1981, respectively, and carried
forward additional unused credit in the amounts of $3,693 and
$3,191.28 to 1983 and 1984, respectively. Petitioner had
$3,179.27 of unused investment tax credit to carry over into
later years. Additionally, on his 1983 tax return petitioner
deducted $2,750 in distribution costs relating to the
Southampton investment.
Petitioner's 1982 tax return was prepared by an accounting
firm, Chaness and Simon, and signed by a representative of that
firm on April 10, 1983. Petitioner provided the accounting firm
with the Southampton promotional booklet and an investment tax
credit election statement that he had received from Southampton
for use in preparing his 1982 return. Petitioner presumably
provided the same documents to Ramona Henderson, a C.P.A. who
petitioner claims prepared his 1983 tax return after petitioner
provided "receipts and information on all investments to her and
6
(...continued)
documents as independent appraisals or as indications of his
expected economic benefit from the investment is misplaced as the
appraisals were commissioned by and addressed to Southampton and
were furnished to petitioner several months after petitioner made
his investment in Southampton and after his 1982 tax return was
filed.
- 9 -
discussed them all with her".7 There is no evidence in the
record that either return preparer relied on anything other than
the materials provided to petitioner by Southampton or that they
investigated the bona fides of the master recording investment
at the time they completed petitioner's 1982 and 1983 tax
returns.
Subsequent to investing in Southampton, and after his 1982
tax return was filed, petitioner wrote to Indigo requesting a
sample copy of the Ray Pillow album and information about when
he could expect to receive royalty payments from album sales.
Petitioner also wrote to Southampton seeking clarification of
the percentage of profits to be paid to Southampton as
additional rent pursuant to the master recording lease. The
letters from petitioner to Indigo and Southampton do not request
information about the sales potential of the Ray Pillow master
recording. In addition to a copy of the album, petitioner
received correspondence from Southampton explaining the revenue
distribution clause of the lease agreement and two letters sent
by Indigo to all Southampton investors regarding proposed
distribution outlets and marketing techniques. Additionally, in
early 1985, petitioner claims to have learned from Southampton
that other investors had been successfully represented before
7
We note, however, that petitioner's 1983 tax return does not
bear a preparer's signature.
- 10 -
the Internal Revenue Service by an attorney, Mark Vogel.
Although Vogel did not testify in this case, petitioner claims
to have spoken with him and relied on that conversation as
additional support for his belief that the Southampton master
recordings were bona fide investments.
OPINION
Petitioner has conceded that he is liable for the full
amount of the deficiencies determined by respondent relating to
his Southampton master recording investment. The only issue for
consideration is whether petitioner is liable for the additions
to tax for negligence under section 6653(a).
Section 6653(a) for 1979 and 1980 and section 6653(a)(1)
for 1981 through 1984 provide for 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. Section 6653(a)(2) for 1981 through 1984 provides
for an addition to tax of 50 percent of the interest on the
portion of the underpayment attributable to negligence.
Negligence is defined as a lack of due care or a failure to do
what a reasonable and ordinarily prudent person would do under
the circumstances. Neely v. Commissioner, 85 T.C. 934, 947
(1985). Respondent's determination of negligence is presumed to
be correct, and petitioner has the burden of proving that it is
erroneous. Rule 142(a); Bixby v. Commissioner, 58 T.C. 757,
- 11 -
791-792 (1972). The addition to tax for negligence under
section 6653 may be correctly assessed in cases where claimed
deductions are not supported by the facts. Sandvall v.
Commissioner, 898 F.2d 455, 459 (5th Cir. 1990), affg. T.C.
Memo. 1989-56 and T.C. Memo. 1989-189; Marcello v. Commissioner,
380 F.2d 499 (5th Cir. 1967), affg. in part and remanding in
part 43 T.C. 168 (1964).
Petitioner maintains that he acted reasonably and with due
care in claiming deductions and credits with respect to his
investment in Southampton. In support thereof, petitioner
argues that: (1) He relied on promotional materials and
appraisals furnished by Southampton; (2) he relied on his
investment adviser and an enrolled agent who reviewed the
promotional materials; (3) he conducted his own investigation of
the music industry; (4) he monitored his investment through
correspondence with Indigo and Southampton; (5) he relied on
accountants who prepared his 1982 and 1983 tax returns; and (6)
he believed other investors had been successfully represented by
an attorney regarding the propriety of the tax treatment of
their Southampton investments.
Under some circumstances, a taxpayer may avoid liability
for the additions to tax under section 6653(a) if reasonable
reliance on a competent professional adviser is shown. Freytag
v. Commissioner, 89 T.C. 849, 888 (1987), affd. 904 F.2d 1011
- 12 -
(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). Taxpayers
must be able to show that the adviser reached his or her
decisions independently. See Leonhart v. Commissioner, 414 F.2d
749, 750 (4th Cir. 1969), affg. T.C. Memo. 1968-98. 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). Reliance on representations
by insiders, promoters, or offering materials has been held an
inadequate defense to negligence. Illes v. Commissioner, 982
F.2d 163, 166 (6th Cir. 1992), affg. per curiam T.C. Memo. 1991-
449; 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. Commissioner, 92 T.C. 827, 850
- 13 -
(1989); Rybak v. Commissioner, 91 T.C. 524, 565 (1988).
Additionally, when an investment has such obviously suspect tax
claims as to put a reasonable taxpayer under a duty of inquiry,
a good faith investigation of the underlying viability,
financial structure, and economics of the investment is
required. LaVerne v. Commissioner, supra at 652-653; Horn v.
Commissioner, 90 T.C. 908, 942 (1988).
In the instant case, petitioner claims that he relied on
several professional advisers with respect to his investment in
Southampton. Petitioner learned about the Southampton
investment program from Cunningham, a financial adviser who
encouraged petitioner to invest in a master recording lease.
Petitioner was aware, however, that Cunningham received a
commission if petitioner decided to invest in Southampton and
that Cunningham was serving as a salesman rather than an
independent adviser acting solely on petitioner's behalf.
Petitioner also argues that he relied on statements made by
Parnell, an enrolled agent who had reviewed the Southampton
promotional booklet. There is no evidence in the record that
Parnell relied on anything other than the materials furnished by
Southampton or that either Parnell or Cunningham had otherwise
investigated the bona fides of the master recording investment.
Similarly, there has been no showing that the accountants who
prepared petitioner's 1982 and 1983 tax returns evaluated the
- 14 -
merits of the claimed deductions and investment tax credits
rather than simply preparing the tax returns based on
information supplied to petitioner by Southampton. Finally,
petitioner's alleged conversation with Vogel in early 1985
regarding the tax treatment of other Southampton investors
provides no support for petitioner's argument that an adequate
independent investigation of the Southampton program was
performed prior to his investment or that petitioner had an
objective to earn an economic profit at the time the transaction
was entered into.
In light of the suspect tax benefits offered by the
Southampton investment and noting petitioner's education and
work experience in the area of financial and profit analysis, we
do not find petitioner's reliance on his alleged advisers to be
reasonable or in keeping with the standard of an ordinarily
prudent person. We note that none of the advisers purportedly
relied on by petitioner had any special qualifications or
experience in the music industry or with master recording leases
that would reasonably lead them to believe that the Southampton
investment program would be economically profitable. 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. Patin v. Commissioner, 88 T.C. 1086 (1987).
- 15 -
Petitioner also argues that his own investigation of the
music industry constituted sufficient inquiry into the
Southampton investment to preclude imposition of section 6653(a)
negligence additions. Negligence additions may be imposed if a
taxpayer fails to exercise due diligence in an investigation
into the bona fides of an obviously suspect transaction.
Leuhsler v. Commissioner, 963 F.2d 907, 910 (6th Cir. 1992),
affg. T.C. Memo. 1991-179; LaVerne v. Commissioner, supra at
652-653. Petitioner's education and experience as a financial
analyst should be considered in determining whether he was
negligent in failing to conduct a good faith investigation of
the Southampton master recording program. Leuhsler v.
Commissioner, supra; Freytag v. Commissioner, 89 T.C. at 887-
889.
On its face, the Southampton investment should have raised
serious questions in the minds of ordinarily prudent investors.
The fact that Southampton leased petitioner a one-fourth
interest in a master recording purportedly worth $850,000 for a
total of $10,500 which immediately generated an investment tax
credit of $21,250 as well as deductions equal to the amount of
all lease payments made should have prompted petitioner to look
beyond the promotional materials and to investigate the economic
viability of the venture. See Allen v. Commissioner, 925 F.2d
348, 353 (9th Cir. 1991), affg. 92 T.C. 1 (1989) (taxpayers
- 16 -
negligent where tax savings were almost double the amount of
their cash outlay). Petitioner's alleged investigation of the
music industry was superficial at best and does not represent a
due diligence inquiry into the specifics of the Southampton
investment. In addition, petitioner's limited correspondence
with Indigo and Southampton does not demonstrate a concern for
the economic viability of the master recording investment.
There is no evidence that petitioner investigated the bona fides
of the Southampton program or that he was concerned with
anything other than the tax benefits involved. If petitioner
had conducted his own good faith investigation, he would have
discerned strong reasons to conclude that the Southampton
investment program was not bona fide and was designed primarily
for tax-avoidance purposes.
Finally, petitioner's reliance on Heasley v. Commissioner,
902 F.2d 380 (5th Cir. 1990), revg. T.C. Memo. 1988-408, as
authority for his position that his actions were reasonable is
misplaced. The taxpayers in Heasley were uneducated and had
extremely limited investment experience. Moreover, the U.S.
Court of Appeals for the Fifth Circuit indicated that the
taxpayers in Heasley both intended to earn an economic profit on
the investment in issue and actively monitored that investment.
We cannot reach similar conclusions in the present case.
Petitioner herein was highly educated, had worked in the area of
- 17 -
financial and profit analysis, and had previous investment
experience. The evidence in this case is that petitioner
anticipated benefits primarily from tax savings. Petitioner has
failed to provide evidence of serious efforts to monitor the
Southampton investment or reliable evidence of any profit
objective independent of tax savings. We consider petitioner's
argument with respect to the Heasley case inapplicable.
Under the circumstances of this case, we find that
petitioner's actions were not reasonable and prudent and that
the underpayments attributable to the Southampton claims were
due to negligence. Accordingly, the additions to tax under
sections 6653(a) and 6653(a)(1) are sustained in full and the
additions to tax under section 6653(a)(2) are sustained as to
the underpayments due to the Southampton investment.
To reflect the foregoing and the concessions of the
parties,
Decision will be entered
under Rule 155.