T.C. Memo. 1996-546
UNITED STATES TAX COURT
STANLEY AND JEAN COHEN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3956-93. Filed December 18, 1996.
Bernard S. Mark and Richard S. Kestenbaum, for petitioners.
Halvor N. Adams III, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
BEGHE, Judge: Respondent determined deficiencies in, and
additions to, petitioners' Federal income taxes as follows:1
1
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the years at issue, and all
Rule references are to the Tax Court Rules of Practice and
Procedure.
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Additions to Tax
Sec. Sec. Sec. Sec. Sec. Sec.
Year Deficiency 6651(a)(1) 6653(a)(1) 6653(a)(1)(A) 6653(a)(2) 6653(a)(1)(B) 6661
1
1985 $96,919 $19,480 $4,846 -- -- $24,230
2
1986 59,044 14,611 -- $2,952 -- 14,761
3
1987 116,370 29,093 -- 5,819 -- 28,414
1988 25,576 2,558 1,279 -- -- -- 6,394
1
Fifty percent of the interest due on $96,919
2
Fifty percent of the interest due on $59,044.
3
Fifty percent of the interest due on $113,657.
Pursuant to six stipulations of settled issues, the parties
resolved, by mutual concessions, all substantive issues in this
case and agreed that petitioners are liable for deficiencies in
the amounts of $96,919 for 1985, zero for 1986, $92,439 for 1987,
and $12,544 for 1988. The only issues that remain for decision
concern petitioners' liability for additions to tax, based on the
agreed underpayments for 1985, 1987, and 1988, for failure to
file timely returns under section 6651(a)(1), for negligence or
(intentional) disregard of rules or regulations under section
6653(a), and for substantial understatement of tax under section
6661. We hold petitioners liable for each of the additions to
tax.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and attached exhibits are incorporated
by this reference. At the time the petition was filed,
petitioners resided in Great Neck Estates, New York. All
references to petitioner are to petitioner Stanley Cohen.
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For several years petitioner was employed as manager of the
Wall Street office of Loeb Rhodes & Co., a securities brokerage
firm. Subsequently, he was affiliated with Tyz-All Plastics,
Inc., as an employee, officer, director, and shareholder. His
affiliation with this corporation ended in 1986. Prior to and
during the years at issue, petitioner traded securities for his
own account. The parties have stipulated that he did not engage
in these securities transactions as a dealer.2
During the years at issue petitioner held an interest in
several partnerships and S corporations. In 1986 he and two
other individuals incorporated KRS Restaurant Corp. (KRS) for the
purpose of operating a restaurant. Later that year petitioner
and his two associates formed the Carlisle Inn Joint Venture
(CIJV) and Harrisburg Inn Joint Venture (HIJV) to operate two
motels. Acquisition of the motel and restaurant businesses was
financed in part by loans that petitioner and his associates
guaranteed. The Forms 1065 filed by CIJV and HIJV reflect that a
50-percent interest in each joint venture was owned by an S
corporation called KBS Motel Corp. (KBS). The Forms 1120S filed
2
The record contains additional facts concerning
petitioner's background and trading activity that may be relevant
to the reasonableness of petitioner's reliance on his
accountant's substantive tax advice for purposes of sec. 6653(a)
and to the existence of reasonable cause for a waiver under sec.
6661. In view of our disposition of both of these issues,
however, further details would be superfluous, and we have
therefore omitted them.
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by KBS show petitioner and his two associates as equal one-third
shareholders.3 Petitioner actively participated in the
management of each of the entities and signed their tax returns.
Petitioners' Federal income tax returns for the years at
issue were prepared by Edward Leuschner (Leuschner). Leuschner
has been a certified public accountant since 1964. Tax return
preparation constitutes half of his practice. Leuschner prepared
petitioners' returns on the basis of information provided by
petitioner, including Schedules K-1 and worksheets prepared by
petitioner showing the results of his securities transactions
during the year.
Petitioner had net losses from his investments in S
corporations and partnerships for each of the years at issue.
The largest losses for 1987 and 1988 arose from the motel and
restaurant businesses reported on the Schedules K-1 issued by KBS
and KRS. Leuschner advised petitioner that he had sufficient
basis and amount at risk to deduct fully his distributive share
of loss from each of the entities for each year. With respect
to the losses reported by KBS and KRS in particular, Leuschner
3
Whether the tax returns of CIJV, HIJV, and KBS accurately
reflect the actual ownership relationships among these entities
and petitioner is disputed by the parties. Petitioners contend
that the tax returns are inaccurate. Respondent takes the
position that this question is subject to resolution in a TEFRA
partnership-level proceeding and thus not properly before this
Court. There is no dispute, however, that the Schedules K-1 used
to prepare petitioners' returns were based on the ownership
structures reflected on the entities' returns.
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explained to petitioner that the amounts of the loan guarantees
he had furnished in connection with the motel and restaurant
acquisitions were properly credited to his basis and amount at
risk and would absorb the deductions.
For each of the years at issue, petitioner also sustained
net losses from his securities trading. Leuschner advised
petitioner that his securities trading was substantial enough
to constitute a trade or business entitling him to deduct his
trading losses in full on Schedule C. On the basis of similar
advice that he had received from other accountants, in prior
years petitioner had reported his trading losses as ordinary
losses on Schedule C rather than capital losses on Schedule D
depending on the level of his trading activity during the year.
Preparation of petitioners' return for 1985 was delayed by
an Internal Revenue Service audit of one of the entities in which
petitioner held an interest, a limited partnership called
Barrister Equipment Associates (or Trust). It was Leuschner's
practice to advise his clients not to file a return until it
could be filed on the basis of complete and accurate information.
In his opinion, the alternative strategy of filing a timely but
incorrect return and subsequently amending it was unwise, because
it tended to expose the client to a greater risk of audit.
Moreover, he determined from the available information that
petitioners would have no tax liability for 1985 owing to sizable
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current losses and loss carryforwards. He advised petitioner
that since no tax would be due, there would be no financial
disadvantage to filing a late return. Petitioner knew that he
had a duty to file timely returns, but adopted the course of
action that Leuschner recommended. Petitioners requested and
received extensions of the due date for their 1985 return until
October 15, 1986. They did not file their 1985 return until
January 11, 1988.
The returns for 1987 and 1988 were untimely filed for
similar reasons. Not all the information relevant to
petitioners' tax liabilities for these years had been collected
before the prescribed dates for filing. Leuschner informed
petitioner that in view of the "overwhelming" losses passed
through to him from the motel and restaurant businesses, he would
certainly have no tax liability for these years, and hence no
reason to be concerned about meeting the filing deadlines. Once
again petitioner was persuaded by the logic of his accountant's
advice. Petitioners sought and received extensions of the due
date for filing their return for 1987 until October 15, 1988.
They filed the return on December 5, 1989. Petitioners sought
and received extensions of the due date for filing their 1988
return until October 15, 1989. They filed the return on
December 4, 1989.
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The results of petitioner's securities trading for each of
the years at issue were reported on Schedule C using a method
that tracked changes in an aggregate trading account. The ending
balance of this account was reported as "gross receipts" for the
taxable year, while the sum of the initial balance plus losses
incurred during the taxable year was reported as "cost of goods
sold". The Schedule C for each year showed a net loss equal to
the excess of the amount of cost of goods sold and certain
business expenses over gross receipts (gross receipts were not
reported for 1985). No information provided on the returns
identified what "gross receipts" and "cost of goods sold"
represented. The reported amounts, taken from the worksheets
that Leuschner had received from petitioner, overstated the
actual losses by $184,598 for 1985, $76,910 for 1987, and $46,281
for 1988. The Forms 1040 for each year described petitioner's
occupation as "trader" and the Schedules C for 1985 and 1988
further identified the business activity to which the cost items
were attributable using simply the word "trading". The type of
asset traded was not disclosed. In addition, for 1985 and 1987
petitioners reported on Schedule C certain expenses that should
have been reported on Schedule A, and they claimed losses from
partnerships and S corporations in amounts that exceeded
petitioner's basis and amount at risk by $5,444 for 1985,
$154,468 for 1987, and $379,613 for 1988.
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OPINION
Petitioners bear the burden of proving that they are not
liable for additions to tax under sections 6651(a)(1), 6653(a),
and 6661. Rule 142(a).
1. Section 6651(a)(1)
Section 6651(a)(1) imposes an addition to tax for failure to
file an income tax return by the prescribed due date (including
any extensions). The amount of the addition is 5 percent of the
amount of tax required to be shown on the return for each month
that the delinquency continues, up to a maximum of 25 percent.
The addition to tax does not apply when the failure to file was
due to reasonable cause and not due to willful neglect. Sec.
6651(a)(1). To establish reasonable cause a taxpayer must
demonstrate that he exercised ordinary business care and prudence
but was nevertheless unable to file within the prescribed time
period. Sec. 301.6651-1(c), Proced. & Admin. Regs.
Petitioners contend that they exercised ordinary business
care and prudence in relying on the advice of a certified public
accountant that it was more appropriate to file a late return
than to file a timely return on the basis of incomplete and
inaccurate information. They argue that such reliance
constitutes reasonable cause, citing United States v. Boyle, 469
U.S. 241, 251 (1985). We disagree.
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In United States v. Boyle, supra, the Supreme Court
suggested that a taxpayer's reliance on professional advice that
there is no obligation to file would generally establish
reasonable cause for purposes of section 6651. Id. at 250-251.
On the other hand, the Court affirmed that the orderly operation
of our system of self-assessment depends on strict compliance
with known filing obligations. Id. at 249. Leuschner did not
advise petitioner that he need not file a return. Petitioner is
a sophisticated businessman. He exercises responsibility for the
tax compliance of partnerships and S corporations whose business
he manages. He was aware of his obligation to file returns and
of the applicable deadlines. The advice he received from
Leuschner was that failure to comply with filing deadlines would
have no adverse consequences because he would have no tax to pay.
Leuschner also may have explained to petitioner that his
recommendation was based in part on the concern that filing an
amended return would prompt an audit of the return. The argument
that reliance on such advice constitutes reasonable cause for
delinquency has been rejected repeatedly by this Court and
others. Jackson v. Commissioner, 864 F.2d 1521, 1527-1528 (10th
Cir. 1989), affg. 86 T.C. 492, 538-539 (1986); Becker v.
Commissioner, T.C. Memo. 1990-120; Estate of Smith v. United
States, 589 F. Supp. 836, 840 (E.D. La. 1984); cf. Lilley v.
Commissioner, T.C. Memo. 1989-602, affd. without published
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opinion 925 F.2d 417 (3d Cir. 1991). The addition to tax under
section 6651 is accordingly sustained.
2. Section 6653(a)
Section 6653(a) provides for an addition to tax if any part
of an underpayment is due to negligence or (intentional)
disregard of rules or regulations. For taxable years 1985 and
1987 the amount of the addition to tax is 5 percent of the entire
underpayment plus 50 percent of the interest payable with respect
to the portion of the underpayment attributable to negligence.
Sec. 6653(a)(1) and (2) (taxable year 1985); sec. 6653(a)(1)(A)
and (B) (taxable year 1987). For the 1988 taxable year the
addition is equal to 5 percent of the underpayment. Sec.
6653(a)(1). For purposes of section 6653(a), "underpayment" has
the same meaning as "deficiency", as defined in section 6211(a),
except that the amount shown on the return is treated as zero if
the return was filed after the prescribed deadline, including any
extension. Sec. 6653(c)(1). "Negligence" includes any failure
to make a reasonable attempt to comply with provisions of the
Code. Sec. 6653(a)(3); cf. Neely v. Commissioner, 85 T.C. 934,
947 (1985).
Failure to comply with filing deadlines without reasonable
cause within the meaning of section 6651(a)(1) constitutes
negligence. Sullivan v. Commissioner, 985 F.2d 704, 706 (2d Cir.
1993), affg. in part and revg. on another issue T.C. Memo. 1991-
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492; Emmons v. Commissioner, 92 T.C. 342, 349 (1989), affd. on
other grounds 898 F.2d 50 (5th Cir. 1990); Eyefull Inc. v.
Commissioner, T.C. Memo. 1996-238; Ellwest Stereo Theatres v.
Commissioner, T.C. Memo. 1995-610. Petitioners' failure to
comply with filing deadlines created underpayments for each of
the years at issue equal to the amount of tax due. Since they
were unable to show reasonable cause for the delinquencies, it
follows that the underpayment for each year was attributable to
negligence.4
3. Section 6661
Section 6661 imposes an addition to tax equal to 25 percent
of the amount of any underpayment attributable to a substantial
understatement of tax. Sec. 6661(a). An understatement is
substantial if it exceeds the greater of 10 percent of the tax
required to be shown on the return or $5,000. Sec.
6661(b)(1)(A). The understatement is reduced by any portion
attributable to: (1) The tax treatment of an item for which the
taxpayer had substantial authority, or (2) an item with respect
to which the relevant facts affecting the item's tax treatment
are adequately disclosed in the return or in a statement attached
to the return. Sec. 6661(b)(2)(B). Respondent is authorized to
4
Our disposition of the negligence issue obviates the need
to consider petitioners' contention that they were not negligent
with respect to the substantive errors on their tax returns
because they relied reasonably and in good faith on professional
advice.
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waive the addition to tax, in whole or in part, upon a showing
that the taxpayer had reasonable cause for the corresponding
portion of the understatement and acted in good faith. Sec.
6661(c). It is undisputed that petitioners substantially
understated their tax liability for 1985, 1987, and 1988.
Petitioners advance two arguments to contest their liability
under section 6661. First, they argue that the substantial
understatements should be reduced to the extent that they are
attributable to the securities trading losses deducted on
Schedule C, because petitioners disclosed sufficient relevant
facts to enable respondent to identify the potential controversy.
We disagree. Petitioners did not follow the procedures for
making adequate disclosure on Form 8275 or on a statement
attached to the return as provided for in the regulations. See
sec. 1.6661-4(b), Income Tax Regs. The returns themselves
contained no reference to section 6661 or other acknowledgment
that petitioners were taking a potentially controversial
position. They did not explicitly identify petitioners' position
with respect to the losses. Nor could respondent reasonably be
expected to infer that the characterization of losses was at
issue, where the losses were identified only as "cost of goods
sold". The Forms 1040 reflected that petitioner's occupation was
"trader" and the Schedules C for 1985 and 1988 reflected that his
principal business was "trading". When used properly in their
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technical legal sense, these terms denote activities inconsistent
with the use of Schedule C for reporting of losses, see, e.g.,
Kemon v. Commissioner, 16 T.C. 1026, 1032-1033 (1951); Kelly v.
Commissioner, T.C. Memo. 1996-529, and might therefore suggest a
potential controversy. But inasmuch as respondent had no way of
ascertaining whether these terms were being used as legal terms
of art or in some nontechnical sense, these terms could not serve
as a substitute for disclosure of the fact that petitioner was
reporting losses from the sale of property that he had not held
as inventory or primarily for sale to customers. Cf. Lester v.
Commissioner, T.C. Memo. 1995-317. Petitioners did not
adequately disclose any items contributing to the substantial
understatements for the years at issue.
Petitioners' second argument is that respondent should have
waived the additions to tax for substantial understatement
because the errors on their returns (or most of them) were the
result of reasonable and good faith reliance upon the mistaken
judgments of their accountant. See sec. 1.6661-6(b), Income Tax
Regs. Respondent's failure to waive the addition to tax under
section 6661 is reviewable by this Court for abuse of discretion.
Mailman v. Commissioner, 91 T.C. 1079, 1083-1084 (1988). In
order to establish abuse of discretion, the taxpayer must
demonstrate that he specifically requested a waiver or otherwise
presented his claim to respondent at some time during the
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administrative stage of the proceedings so as to afford her the
opportunity to exercise her discretion. McCoy Enterprises v.
Commissioner, 58 F.3d 557, 563 (10th Cir. 1995), affg. T.C. Memo.
1992-693; Estate of Reinke v. Commissioner, 46 F.3d 760, 765 (8th
Cir. 1995), affg. T.C. Memo. 1993-197; Sisson v. Commissioner,
T.C. Memo. 1994-545; Myers v. Commissioner, T.C. Memo. 1994-529;
Klieger v. Commissioner, T.C. Memo. 1992-734.
Petitioners concede that they did not seek a waiver prior
to trial, but contend that there is case authority for the
proposition that respondent should have granted a waiver sua
sponte. On brief they cite Fisher v. Commissioner, 45 F.3d 396
(10th Cir. 1995), revg. and remanding T.C. Memo. 1992-740;
Vorsheck v. Commissioner, 933 F.2d 757 (9th Cir. 1991), affg. in
part and revg. in part an Oral Opinion of this Court; and Daoust
v. Commissioner, T.C. Memo. 1994-203. Petitioners' reliance on
these cases is misplaced. In the Fisher case, the Court of
Appeals found that the Commissioner abused her discretion by
failing to respond to the taxpayer's request for a waiver, not by
refusing to grant a waiver sua sponte. In neither of the other
decisions cited by petitioners is there any indication of whether
an administrative remedy was in fact sought or any discussion of
the need to follow such a procedure as a matter of law.
Petitioners have not proven their entitlement to a waiver. The
addition to tax is accordingly sustained.
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To reflect the foregoing,
Decision will be entered
under Rule 155.