Ballantyne v. Commissioner

T.C. Memo. 1996-456

UNITED STATES TAX COURT

DON BALLANTYNE AND SUSANNE C. BALLANTYNE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 13255-94. Filed October 10, 1996.

Kevin M. Bagley, for petitioners.

Jeffrey A. Hatfield and Mary Tseng Klaasen, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

JACOBS, Judge: Respondent determined the following

deficiencies in, and additions to, petitioners' Federal income

taxes:
 -2-

Additions to Tax
Year Deficiency Sec. 6653(a)(1)1 Sec. 6653(a)(2) Sec. 6661
2
1985 $388,937 $19,447 $ 97,235
2
1986 950,703 47,535 237,676
1
The addition to tax for negligence or intentional
disregard of rules or regulations is codified under sec.
6653(a)(1)(A) and (B) for 1986.
2
50 percent of the interest due on the deficiency.

Susanne Ballantyne is a party to this case by virtue of having

filed a joint return for the years under consideration with her

husband, Don. Accordingly, Don Ballantyne hereinafter will be

referred to as petitioner.

Some of the issues raised by the pleadings have been disposed

of by agreement of the parties. The principal unagreed issue

focuses on the transfer of 86 acres of land located in Escondido,

California (the Escondido property), in 1985 from petitioner to

Balmac, Inc. (Balmac), an entity he controlled. Our task is to

determine whether that transfer should be characterized as a sale,

as respondent contends, or a tax-free exchange, as petitioner

urges.1 In the event we determine that the transfer constituted a

sale, then we must determine the amount of gain petitioner must

recognize therefrom. Other unagreed issues are: Whether

petitioners had $40,188 of unreported interest income in 1986;

1
As will be discussed infra, petitioner claims that he
contributed approximately 44.25 acres of the Escondido property
to BTG Corp., a Delaware corporation, in exchange for 1,000
shares of its stock, and that the balance of the acreage was
transferred on petitioner's behalf to Balmac.
 -3-

whether petitioners are entitled to deduct $122,605 in 1986 for

interest petitioner paid to Escondido Property Investment

Corporation; and whether petitioners are liable for additions to

tax under sections 6653(a)(2) and 6653(a)(1)(B) for 1985 and 1986,

respectively, on the portion of the underpayment attributable to

the transfer of the Escondido property to Balmac.

All section references are to the Internal Revenue Code for

the years in issue. 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.

Background

Petitioners resided in San Diego, California, at the time they

filed their petition.

Petitioner completed 2 years of college and thereafter went to

work for a company involved in real estate development. He remained

there for approximately 10 years before going out on his own when

he formed Balmac to engage in the development of real estate.

At all relevant times, (1) petitioner owned all of the stock

of Balmac, and (2) Balmac owned all of the stock of Westland

Holding Corp., which in turn owned all the stock of Westland Title

Co., Inc. (WTC).

In 1978, petitioner purchased approximately 106 acres of
 -4-

unimproved land in Escondido, California, from Balmac (which had

purchased the property in the early 1970's). In connection with

petitioner's purchase of the land, petitioner gave Balmac a note

which was secured by a trust deed on the property. The 106 acres

so acquired by petitioner included the Escondido property. In

1979, title to the Escondido property was transferred to WTC, as

nominee for petitioner, and held for petitioner's benefit under

the terms of Holding Agreement No. 1037 (Holding Agreement).

Petitioner used the name "Don McLane"2 in the Holding Agreement and

was identified as owner of the Escondido property. Petitioner paid

property taxes and other costs associated with the Escondido

property.

The Escondido property was zoned for industrial use. In order

to commercially develop and sell the Escondido property, it had to

be mapped and subdivided into smaller parcels. As developed, the

Escondido property was known as Wine Ridge Industrial Park.

Sale to Balmac

On November 8, 1984, Balmac and petitioner executed a "Real

Estate Purchase Contract and Receipt for Deposit" (the purchase

agreement), providing for the purchase of the Escondido property by

Balmac from petitioner for $7 million. Byron P. Halling (Halling),

2
Petitioner was raised by his aunt and uncle, whose
surname was McLane. Petitioner used his birth surname of
Ballantyne until age 12. He then used his aunt and uncle's
surname for approximately 40 years (until the early 1980's) when
at the urging of his wife and children he resumed using his birth
surname.
 -5-

an attorney, executed the purchase agreement on behalf of

petitioner; petitioner signed the purchase agreement on behalf of

Balmac.

The purchase agreement provided that Balmac would make a $2

million cash down payment; the balance of the purchase price was to

be deferred and evidenced by a 5-year, interest-bearing note.

Closing was to take place by December 31, 1984.

Sometime in early November 1984, Balmac entered into an

agreement with Palomar Systems and Machines, Inc. (Palomar), to

develop and sell to the latter a 10-acre lot in Wine Ridge

Industrial Park.

Closing under the purchase agreement did not occur by December

31, 1984. Rather, on February 6, 1985, Halling and petitioner

executed escrow instructions (escrow No. 10425-04) with WTC with

respect to the contemplated purchase of the Escondido property by

Balmac.

In June 1985, Balmac applied for a loan from First Commercial

Bank of San Diego (the bank) with respect to the development of the

Escondido property. The borrowing was to occur in two stages. The

first of the two stages was to be with respect to the acquisition

of the property; this loan was to be in the amount of $1.1 million.

The second was to be a $3 million development loan. With respect

to the land acquisition loan, the loan application request stated:

The land purchase calls for $2,000,000 cash
down. We will be putting up $950,00, and
would like First Commercial Bank to loan the
 -6-

balance * * * These funds [$1,100,000] will
be used: $1,050,000 for land purchase, and
$50,000 for costs and interest. This land
acquisition loan can be secured by a first [ ]
deed of trust on 86 acres that we are
purchasing for $7,000,000. When the
development loan [$3,000,000] is recorded this
loan will be paid in full.

Petitioner led the bank to believe that Halling was the owner

of the Escondido property.

Both loan requests were approved by the bank. Petitioner

individually guaranteed repayment of the $1.1 million land

acquisition loan. Closing for the acquisition loan (which was

handled by WTC) occurred on July 31, 1985. As of closing, WTC had

received funds totaling $2 million; $1,050,000 from the bank, and

$950,000 from Balmac. WTC issued a check for $1,960,680.25 ($2

million less seller's escrow-related fees and costs) made payable

to itself as petitioner's nominee under the Holding Agreement.

Recorded Documents

On July 31, 1985, the following documents were recorded in

the San Diego County Recorder's Office: (1) A grant deed from WTC,

acting under the Holding Agreement, to Balmac with regard to the

transfer of the Escondido property; (2) a deed of trust encumbering

the Escondido property executed by Balmac in favor of the bank to

secure the $1.1 million land acquisition loan; and (3) a

subordinated purchase money deed of trust executed in favor of WTC

under the Holding Agreement to secure the balance due by Balmac as

evidenced by Balmac's $5 million note.
 -7-

On October 25, 1985, the following documents were recorded in

the San Diego County Recorder's Office: (1) A full reconveyance by

the bank to Balmac of the Escondido property which had previously

been conveyed to the bank to secure Balmac's $1.1 million loan; and

(2) a deed of trust with respect to a portion of the Escondido

property executed by Balmac in favor of the bank to secure Balmac's

note for $3 million covering a portion of the Escondido property.

On February 7, 1986, a partial reconveyance by WTC, as

Trustee, to Balmac with respect to the property securing the deed

of trust that had been recorded on July 31, 1985, was recorded in

the San Diego County Recorder's office. On April 18, 1986: (1) A

full reconveyance by WTC, as Trustee, to Balmac with respect to

the remaining acreage of the Escondido property that had not been

released or sold to Palomar; and (2) a grant deed from Balmac to

Palomar for that portion of the Escondido property that was sold to

Palomar, were recorded in the San Diego County Recorder's office.

Development of Wine Ridge Industrial Park

A total of 44.25 acres of the Escondido property was

developed and sold as lots (including the property sold to

Palomar). All negotiations regarding the sale of these lots were

undertaken by Balmac. All correspondence regarding the

negotiations for the sale, and all documents related to the sale of

these lots were signed by petitioner, as president of Balmac.

Balmac signed the deeds to all sold lots.
 -8-

BTG Corp.

BTG Corp. (BTG) was incorporated in Delaware on September 28,

1981. Prior to July 30, 1985, BTG was a dormant corporation.

BTG had been formed by AMCOR, a California corporation, which

incorporated and sold other corporations primarily to attorneys for

tax planning activities. From 1984 to 1988, AMCOR had only two

employees, Robert Burton (Burton) and Lisa Aspoy. Ms. Aspoy is,

and at all relevant times was, the wife of Mark Schiavenza

(Schiavenza).

Schiavenza is an attorney specializing in the field of

taxation. From October of 1975 to January or February of 1981, he

practiced law with Harry Margolis, whose tax planning strategy

(which involved the circular transfer of funds through the use of

offshore entities, trusts, and shell corporations) has been

repudiated by this Court on numerous occasions. See Marine v.

Commissioner, 92 T.C. 958 (1989), affd. without published opinion

921 F.2d 280 (9th Cir.1991); Erhard v. Commissioner, T.C. Memo.

1991-290, modified T.C. Memo. 1992-376 and T.C. Memo. 1993-25,

affd. 46 F.3d 1470 (9th Cir. 1995); Leonard v. Commissioner, T.C.

Memo. 1985-51, affd. without published opinion sub nom. Robinson v.

Commissioner, 816 F.2d 684 (9th Cir. 1987).

Schiavenza represented various real estate developers and

referred them to AMCOR as clients. Schiavenza also represented

Escondido Property Investment Corp. (EPIC), Oi Weng Co. Ltd., a
 -9-

Hong Kong corporation, and the Marwick Trust, a purported offshore

trust formed in Guernsey, the Channel Islands.

Petitioner was a client of Schiavenza. Upon the advice of

Schiavenza, in October 1985, petitioner entered into a management

contract with AMCOR with respect to BTG.3 In connection with that

arrangement, petitioner agreed to acquire all the stock of BTG in

exchange for a portion of the Escondido property. Corporate

minutes authorizing petitioner's acquisition of the BTG stock were

backdated to July 30, 1985.

Capitalization Agreement

Petitioner's acquisition of BTG stock for property was

memorialized in a Capitalization Agreement that was backdated to

3
During the years 1984 to 1988, AMCOR provided
management services to numerous corporations, including BTG and
EPIC. For an annual fee, AMCOR provided the purchaser with a
domestic corporation and services related to the management of
that corporation, including but not limited to the following:
(1) Supplying individuals to serve as directors, officers, and
bank signatories; (2) supplying a registered agent for the
purpose of accepting service of process on the corporation; (3)
filing annual information reports and payment of any annual fees
to the secretary of state and other authorities of the State of
the corporation's formation; (4) holding annual shareholders'
meetings or preparing consents of shareholders in lieu thereof;
(5) holding directors' meetings; (6) preparing corporate minutes
of stockholders' meetings and meetings of directors; (7)
maintaining corporate bank accounts as required; and (8)
executing documentation prepared by counsel on behalf of the
corporation and administering transactions established by said
documentation.
AMCOR's normal practice was to have its employees serve
as officers and directors for its client corporations.
Occasionally, AMCOR used the employees of the offices of those
attorneys utilizing AMCOR's services to serve as officers and/or
directors of AMCOR's client corporations.
 -10-

July 30, 1985. The agreement was signed by petitioner as

"shareholder" and by Burton on behalf of BTG.

The introductory part of the Capitalization Agreement states

that: (1) Petitioner owns the Escondido property but legal title

to the property is being held by WTC, under Holding Agreement No.

1037 for the benefit of petitioner; (2) Balmac is engaged in

redeveloping and marketing a portion of the Escondido property

(amounting to 44.25 acres) and that it expects that acreage to be

developed and marketed over the course of the next 24 months; and

(3) petitioner wishes to transfer the 44.25 acres to BTG in

exchange for 1,000 shares of BTG stock. The Capitalization

Agreement provides for: (1) An assignment of the 44.25 acres

from petitioner to BTG; (2) petitioner's agreement to execute and

deliver to WTC an assignment of beneficial interest under Holding

Agreement 1037; (3) effective July 30, 1985, BTG will have all

rights of direction and control under Holding Agreement No. 1037;

(4) an agreement by BTG to enter into a joint venture agreement

with Balmac to further develop and sell the 44.25 acres and, in

this regard, (5) an agreement by BTG to instruct WTC to transfer

the entire acreage of the Escondido property to Balmac and to

instruct Balmac to hold the 44.25 acres for benefit of the joint

venture between BTG and Balmac and the balance of the 86 acres for

the benefit of petitioner. The Capitalization Agreement further

states that: (1) The parties understand that it is to their mutual
 -11-

benefit that Balmac acquire title to the entire 86-acre Escondido

property to enable Balmac to conclude arrangements to borrow

$1,100,000 from First Commercial Bank; (2) the parties intend to

effect a section 351 tax free capitalization; and (3) the tax base

on the 44.25 acres is a carryover basis.

The Capitalization Agreement requires Balmac to lend the

proceeds of the $1.1 million land acquisition loan to BTG, which

thereafter is to lend the proceeds to petitioner. Petitioner is

then required to transfer approximately $940,000 to Balmac as a

repayment on his prior indebtedness to Balmac.

The transactions contemplated by the Capitalization Agreement

occurred. Petitioner contributed 44.25 acres of the Escondido

property to BTG in exchange for 1,000 shares of BTG stock. BTG

entered into a joint venture agreement with Balmac and contributed

the 44.25 acres of the Escondido property to the joint venture (the

Wine Ridge Joint Venture). The proceeds of the bank loan were lent

to BTG, which then lent such proceeds to petitioner, who then

transferred the money to Balmac in repayment of his prior purported

debt.

EPIC, Oi Weng, and the Marwick Trust

EPIC was incorporated on March 24, 1986. Oi Weng Co., Ltd.

(Oi Weng), a Hong Kong corporation, was the sole shareholder of

EPIC. Oi Weng was wholly owned by the Marwick Trust. The trustee

of the Marwick Trust was Grange Trustees Ltd., a wholly owned
 -12-

subsidiary of Rea Brothers (Guernsey) Ltd. Petitioner was the

"First Trust Protector" for the Marwick Trust; Susanne Ballantyne

was the successor trust protector.

EPIC was formed at the request of Schiavenza. Schiavenza's

wife (Lisa Aspoy) was the president of EPIC during 1986, 1987, and

1988.

EPIC signed a management agreement with AMCOR, effective March

27, 1986.

On April 15, 1986, petitioner sold his 1,000 shares of BTG

stock to EPIC for $3.6 million on an installment basis. On April

16, 1986, BTG liquidated and distributed all of its assets (a $1.1

million note from petitioner and BTG's interest in the Wine Ridge

Joint Venture) to EPIC.

The $3.6 million purchase price was evidenced by a 20-year

installment note ($3.6 million note). The terms of the $3.6

million note called for the payment of interest at the rate of 9.33

percent per annum, payable semiannually, beginning October 15,

1986. Principal was to be paid in 20 equal installments of

$180,000 per year, beginning April 15, 1987. The $3.6 million note

was secured by an offshore Channel Islands escrow account managed

by Rea Brothers. Funding for the offshore escrow account was to

come from distributions from the Wine Ridge Joint Venture (which

were to be made to EPIC by virtue of EPIC's interest in the joint

venture) and from payments due EPIC from petitioner (with regard to

petitioner's $1.1 million obligation to BTG).
 -13-

OPINION

Positions of the Parties

Petitioners contend that the sale of the Escondido property to

Balmac was a fiction and that it was in essence part of a financing

transaction. They maintain that the $950,000 deposited by Balmac

with WTC was never intended to be for the benefit of petitioner or

distributed to him. According to petitioners, the loan from the

bank (purportedly for the purchase of the Escondido property) was

in reality a loan to the joint venture (which then lent the

proceeds to BTG, which in turn lent the proceeds to petitioner).

Petitioners request that we find, as an ultimate fact, that

petitioner "received no net proceeds from the sale of any portion

of the Escondido property in 1985 or 1986" and that petitioner

"received no compensation or other consideration in exchange for

the $5 million deed of trust."

Petitioners' version of events is that petitioner transferred

44.25 acres of the Escondido property to BTG in exchange for stock

and caused the remaining 41.75 acres to be deeded to Balmac as

nominee for petitioner. Accordingly, petitioners characterized the

transfers as tax-free exchanges under section 351.4 They contend

4
Sec. 351(a) provides:

SEC. 351(a). General Rule.--No gain or loss shall be
recognized if property is transferred to a corporation by
one or more persons solely in exchange for stock or
(continued...)
 -14-

that BTG subsequently contributed the 44.25 acres to the joint

venture. In the alternative, petitioners contend that some or all

of the Escondido property was contributed to Balmac as a capital

contribution (which would also constitute a tax-free exchange).

In contrast, respondent argues that "the purported section 351

exchange asserted by petitioner [is] nothing more than an attempt,

engaged in subsequent to the completion of the Balmac transfer, to

recast the form of the sale transaction to obtain a more favorable

tax consequence." Respondent maintains that the transfer by

petitioner to Balmac of the Escondido property on July 31, 1985,

should be characterized as a sale and that in 1985 petitioner

incurred a long-term capital gain in the amount of $1,648,722 (as

a result of receiving $2 million in cash) and that in 1986

petitioner incurred a long-term capital gain in the amount of

$4,121,930 (as a result of the cancellation of the $5 million

installment note received in connection with the sale).

Balmac Contract

The structure of the transaction in this case is unmistakable.

All the documents and objective evidence support characterizing the

transfer of the Escondido property from petitioner to Balmac as a

sale. The purchase agreement provided for the purchase of the

Escondido property by Balmac from petitioner for $7 million.

4
(...continued)
securities in such corporation and immediately after the
exchange such person or persons are in control (as defined
in section 368(c)) of the corporation.
 -15-

Petitioner, on behalf of Balmac, applied for and obtained a $1.1

million bank loan based on a number of representations that were

consistent with a sale to Balmac. Further, there was a grant deed

and deed of trust which were filed with the San Diego County

Recorder's office. And finally, there was the escrow check for

$1,960,680.25 that was delivered to petitioner's nominee, WTC under

the Holding Agreement, as seller, and a $5 million installment note

that was secured by the recorded deed of trust.

Petitioners did not attempt to show that the sale transaction

to Balmac was the result of mistake, undue influence, fraud, or

duress. Instead, they ask us to disregard the transaction as

nothing but a ruse to obtain the $1.1 million bank loan and want us

to believe that the transaction was as they reported for tax

purposes. We refuse to do so. "[W]hile a taxpayer is free to

organize his affairs as he chooses, nevertheless, once having done

so, he must accept the tax consequences of his choice, whether

contemplated or not * * * and may not enjoy the benefit of some

other route he might have chosen to follow but did not."

Commissioner v. National Alfalfa Dehydrating & Milling Co., 417

U.S. 134, 149 (1974).

Where a taxpayer seeks to disavow what is purported to be a

sale, the burden lies with the taxpayer to prove error in the

Commissioner's determination that the transaction was in fact a

sale. Shannon v. Commissioner, 29 T.C. 702, 718 (1958). Here,

petitioners failed to prove error in respondent's determination.
 -16-

We accept the structure of the transaction as cast by

petitioners. The substance of the transfer of the Escondido

property from petitioner to Balmac comports with the form of a sale

transaction. Consequently, we sustain respondent's determination

that petitioner sold the Escondido property to Balmac.

Having determined that a sale occurred, we turn to the tax

consequences flowing from petitioner's sale to Balmac. The

purchase price for the Escondido property was $7 million. At

closing Balmac paid $2 million in cash and gave a $5 million

installment note. Security for the note was reconveyed to Balmac

in 1986, and there is no evidence that any obligation to pay the

note remained. The reconveyance of the note amounts to a

cancellation of the note. The cancellation requires recognition

of gain of $4,121,930 under section 453B(a) and (f) in 1986.5

5
Sec. 453B(a) provides in part:

SEC. 453B(a). General Rule.--If an installment
obligation is satisfied at other than its face value or
distributed, transmitted, sold, or otherwise disposed
of, gain or loss shall result to the extent of the
difference between the basis of the obligation and--

* * * * * * *

(2) the fair market value of the
obligation at the time of distribution,
transmission, or disposition, in the case of
the distribution, transmission, or
disposition otherwise than by sale or
exchange.

Sec. 453B(f) provides:

(continued...)
 -17-

An installment obligation is canceled when there is "any

cessation of an obligation to pay that would otherwise continue to

exist." Estate of Frane v. Commissioner, 98 T.C. 341, 350 (1992),

revd. in part on other grounds 998 F.2d 567 (8th Cir. 1993). The

fact that cancellation occurred within a short time after the note

was given to petitioner does not preclude or otherwise affect the

application of section 453B. See Utley v. Commissioner, 906 F.2d

1033 (5th Cir. 1990), vacating T.C. Memo. 1988-575.

Claimed BTG Sale

Petitioners claim that the Escondido property was sold to BTG

on July 30, 1985. However, a grant deed conveying the Escondido

property to Balmac was recorded in the San Diego County recorder's

office on July 31, 1985. And petitioner admitted that several of

the documents involved in the claimed section 351 transaction with

BTG--although dated July 30, 1985--were signed sometime after July

31.

5
(...continued)
SEC. 453B(f). Obligation Becomes Unenforceable.--
For purposes of this section, if any installment
obligation is canceled or otherwise becomes
unenforceable--

(1) the obligation shall be treated as
if it were disposed of in a transaction other
than a sale or exchange, and

(2) if the obligor and obligee are
related persons (within the meaning of
section 453(f)(1)), the fair market value of
the obligation shall be treated as not less
than its face amount.
 -18-

The only business conducted by BTG was the receipt of property

in a claimed section 351 transaction and the transfer of property

to the joint venture. The $1.1 million bank loan supposedly made

to the joint venture, lent again to BTG, and then to petitioner, in

our opinion, was simply an attempt to create a basis for interest

deductions for petitioner. Further, petitioner's sale of BTG stock

to EPIC was, in our opinion, done in order to create an increase in

petitioner's basis in the property (from $582,039 to $3.6 million)

prior to the sale of developed lots; and the 20-year, $3.6 million

note petitioner received in exchange for the stock was an attempt

to defer recognition of gain.

Respondent contends that the purported sale of the Escondido

property to BTG and the subsequent sale of the BTG stock to EPIC

were a series of sham transactions devoid of economic substance.

We have defined that which constitutes a sham in substance as "the

expedient of drawing up papers to characterize transactions

contrary to objective economic realities and which have no economic

significance beyond expected tax benefits." Falsetti v.

Commissioner, 85 T.C. 332, 347 (1985).

We find that petitioner's transactions with BTG and the sale

of BTG's stock to EPIC had no economic substance and were intended

only to accomplish tax-motivated objectives. They were sham

transactions, and we will disregard them.
 -19-

Unreported Interest Income

The next issue is whether petitioners had $40,188 of

unreported interest income in 1986. Petitioners presented no

credible evidence to rebut the presumption of correctness afforded

the notice of deficiency. (We were not impressed with the

credibility of petitioner's testimony.) Accordingly, we sustain

respondent's determination that petitioners are liable for

unreported interest income of $40,188 in 1986.

Interest Deduction

The third issue is whether petitioners' deduction of $122,605

in 1986 for interest paid to EPIC should be disallowed. Interest

is not deductible "if the underlying transaction is a sham * * *.

Nor is interest deductible if it is incurred in a transaction 'that

can not with reason be said to have purpose, substance, or utility

apart from their anticipated tax consequences.'" Sheldon v.

Commissioner, 94 T.C. 738, 760 (1990) (citations omitted).

In view of our finding that the sale of the BTG stock to EPIC

was a sham transaction, the interest payments to EPIC are not

deductible.

Negligence

The final issue is whether petitioners are liable for

additions to tax under sections 6653(a)(2) and 6653(a)(1)(B) on the

portion of the underpayment attributable to the transfer of the

Escondido property to Balmac. Petitioners have conceded the

application of all additions to tax raised in respondent's notice
 -20-

of deficiency with respect to all other matters. Petitioners

claim, however, that they were not negligent, that they reasonably

relied on the advice of experts, and that there was substantial

authority for their position.

Sections 6653(a)(2) and 6653(a)(1)(B) impose an addition to

tax of 50 percent of the interest on the portion of an underpayment

of tax attributable to negligence or intentional disregard of rules

or regulations. Negligence is defined as the failure to exercise

the due care that a reasonable, prudent person would exercise under

similar circumstances. Zmuda v. Commissioner, 731 F.2d 1417, 1422

(9th Cir. 1984), affg. 79 T.C. 714 (1982); Neely v. Commissioner,

85 T.C. 934, 947 (1985).

Reliance on professional advice, by itself, is not an absolute

defense to negligence. A taxpayer first must demonstrate that his

reliance was reasonable. Freytag v. Commissioner, 89 T.C. 849, 888

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

(1991). Here, petitioners failed to do so.

Petitioner engaged in sham transactions. Petitioner

participated in the backdating of documents and in highly

questionable transactions. A prudent person would not have

believed that these purported transactions served a purpose other

than tax avoidance.

We conclude that petitioners were negligent and did not

reasonably rely on the advice of experts. Consequently,

petitioners are liable for the additions to tax under sections
 -21-

6653(a)(2) and 6653(a)(1)(B) for 1985 and 1986.

To reflect the foregoing and concessions by the parties,

Decision will be entered

under Rule 155.