Skyrms v. Commissioner

T.C. Memo. 1997-69

UNITED STATES TAX COURT

DEBORAH K. SKYRMS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 7503-95. Filed February 10, 1997.

Leslie J. Barnett, for petitioner.

Avarian R. McKendrick, for respondent.

MEMORANDUM OPINION

DEAN, Special Trial Judge: This case was heard pursuant to

the provisions of section 7443A(b) of the Code and Rules 180,

181, and 182.1

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

Respondent determined additions to petitioner's Federal

income tax for the years 1979 through 1982 as follows:

Additions to Tax
Year Sec. 6653(a)(1) Sec. 6653(a)(2)1 Sec. 6659
1979 $211 applies $1,266
1980 189 applies 1,137
1981 22 applies 131
1982 221 applies 742

1. Fifty percent of the interest due on the portion of the
underpayment attributable to negligence for the years 1979, 1980,
1981, and 1982.

In a Stipulation of Settled Issues the parties agree that

"all issues that relate to the additions to tax" have been

conceded except liability for the negligence additions to tax for

the taxable years 1979 through 1982 and the applicability of

section 6659 "for the taxable year 1981." The stipulation

limiting the contest of the application of section 6659 to the

1981 year is by way of a handwritten addendum to paragraph 2 of

the stipulation agreement. At trial, respondent's counsel read

into the record the stipulated paragraph with the added language.

Although petitioner's counsel made a correction to the reading of

the paragraph, it was not with respect to the language addressing

the year of the 6659 addition.2

In view of the record, we interpret paragraph 2 of the

stipulation of settled issues as a concession by petitioner of

2
On brief, petitioner addressed the sec. 6659 addition only
as it relates to the year 1981.
 - 3 -

the section 6659 additions to tax for all years at issue except

1981. Thus, the issues remaining for decision are: (1) Whether

the period for assessment of the additions to tax expired prior

to the issuance of the respective notices of deficiency in this

case;3 (2) whether petitioner is liable for the additions to tax

under section 6653(a)(1) and (2) for each of the years 1979,

1980, 1981, and 1982; and (3) whether petitioner is liable for

the addition to tax under section 6659 for the year 1981.

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

The stipulation of settled issues, the stipulation of facts, and

the attached exhibits are incorporated herein by reference.

Petitioner resided in Tampa, Florida, when the petition was filed

in this case.

Background

The parties agree that this case is part of a "tax shelter

project" involving plastics recycling machines and that

petitioner, through a partnership, took deductions and credits

relating to recycling machines.

Petitioner is a 1971 graduate of Florida State University.

From her graduation in 1971 through the year 1980, petitioner was

employed in increasingly more responsible positions by Maas

Brothers Department Store (Maas Bros). Petitioner described Maas

3
At trial, petitioner in an Amendment to Petition raised as
a defense the period of the statute of limitations.
Concurrently, petitioner filed a motion to dismiss that we
recharacterized as a motion for summary judgment and denied.
 - 4 -

Bros as a publicly traded company. By the time she left

employment at Maas Bros, petitioner had become a women's clothing

buyer for the store.

In her position as a buyer, before submitting orders to

manufacturers for clothing, petitioner examined and evaluated the

fabric and style of the clothing, the "selling history" and

history of profitability of the manufacturers based upon Maas

Bros' internal records.

Through management level associates at Maas Bros, petitioner

met Edward P. Russell (Russell) in the year 1977. Petitioner was

"impressed" with Russell and hired him as her tax return

preparer. Petitioner did not investigate Russell's professional

background or credentials, but he had a "good" reputation among

the managers. Russell prepared petitioner's Federal income tax

returns for the years 1977 through 1982.

Assisted by an attorney, petitioner in 1980 started her own

clothing business under the name, Deborah Kent's, Inc.

Petitioner prepared a business plan to submit to a bank in order

to obtain financing for Deborah Kent's, Inc.

In 1982, petitioner had "money in a money market account and

making minimal interest." Russell advised petitioner to reinvest

the money she had in the money market fund. Russell told

petitioner about the Republic Investment Partnership (Republic),

which held a partnership interest in Davenport Recycling

Associates (Davenport), a limited partnership. Russell explained
 - 5 -

to petitioner that the investment involved "the only machine in

the world that could recycle styrofoam". Russell also explained

that there were tax benefits to be derived from the investment.

Petitioner decided to invest in Republic, and on December 8,

1982, she drew a check payable to Republic in the amount of

$7,500 on a checking account in the name of Deborah Kent's, Inc.4

As a result of the $7,500 investment in Republic, petitioner

on her 1982 Federal income tax return deducted a partnership loss

of $5,839 and claimed an investment tax credit of $5,773 that was

limited to her 1982 income tax liability (as reduced by the

partnership loss) of $2,472. The $3,301 balance of the

investment credit along with a business energy credit in the

amount of $5,7735 was carried back to tax years 1979, 1980, and

1981 to generate tax refund claims in the amounts of $4,848,

$3,789, and $437.

4
Petitioner reported on her Federal income tax return
dividend income of only $290 for the year 1982. We therefore
assume that the check drawn to Republic on the corporate checking
account represents either a loan to petitioner or part of the
wages that petitioner reported on the 1982 tax return. The
record reveals no connection between the corporate check and
petitioner's money market fund.
5
Petitioner claimed as her portion of the basis in the
recycling deal $57,727, the claimed investment credit and energy
credit each representing 10 percent of her claimed basis. The
parties have now stipulated that the recycling machine that
generated the partnership deductions and credits in this case was
worth no more than $50,000. The record does not reveal what
percentage petitioner's indirect ownership was in Davenport, the
entity that apparently owned or leased the machine.
 - 6 -

Petitioner's investment in Republic represents almost 40

percent of her reported taxable income for 1982. She did not

have an attorney or accountant examine the investment.

Petitioner relied on Russell's verbal explanation of the

partnership and did not read the offering memorandum. Russell

told her that he had investigated "the partnership", and

petitioner "felt" that he had thoroughly investigated the

investment.

Although she was told in 1985 that "they were having success

in placing these machines," petitioner apparently took no action

to monitor her investment. It was in 1985 that petitioner last

spoke to Russell who filed for bankruptcy under Chapter 7 in that

year.

In January of 1995 petitioner for the first time received

notice that the investment tax credits from Republic were not

proper. On April 7, 1995, she paid the assessed taxes and

interest due as a result of respondent's disallowance of the

Republic deductions and credits.

In notices of deficiency for affected items issued on

February 17, 1995, respondent determined that the underpayments

of taxes for the years 1979 through 1982 are subject to the

negligence additions of section 6653(a)(1) and (2), and that the

tax underpayments are attributable to a valuation overstatement

as described in section 6659.
 - 7 -

Discussion

Statute of Limitations

As a result of the declaration of bankruptcy in 1985 by

Russell, the general and Tax Matters Partner for Republic,

petitioner argues that the additions to tax determined by

respondent became nonpartnership items the period of assessment

for which was 3 years from the filing of her 1979 through 1982

returns. Petitioner contends that the period for assessment of

the additions to tax in this case expired prior to the issuance

of the notice of deficiency. Petitioner bears the ultimate

burden of proof on this issue. Rule 142(a); Adler v.

Commissioner, 85 T.C. 535, 540 (1985).

Petitioner cites no legal authority for her position, nor

does she provide a legal theory upon which we might decide the

"bankrupt partner" issue in her favor.6

As a further basis for her position that the period for

assessment has expired, petitioner alleges that she was entitled

to notice of the administrative proceedings against Davenport,

6
As respondent points out, sec. 301.6231(c)-7T, Temporary
Proced. & Admin. Regs., 52 Fed. Reg. 6793 (Mar. 5, 1987),
provides for treating as nonpartnership items the partnership
items of a partner who is the debtor in bankruptcy. Petitioner
is not a partner who was a debtor in bankruptcy for the years at
issue.
Although not specifically cited by petitioner, to the extent
she relies on Third Dividend/Dardanos Associates v. Commissioner,
T.C. Memo. 1994-412, revd. 88 F.3d 821 (9th Cir. 1996), we find
the facts of that case distinguishable.
 - 8 -

and she received none. Petitioner, an indirect partner under

section 6231(a)(10), has not alleged that she was identified as a

partner entitled to notice under section 6223(c). Further, the

record is bereft of any facts that would allow us to conclude

that petitioner was entitled to notice from respondent under

section 6223.

Finally, petitioner prays, should the Court find the

statutory notice of deficiency was not issued timely, that the

Court direct respondent to make available to her any settlement

offer that was made available to other partners of Davenport.

Since we find the notice of deficiency to have been issued

timely, we shall not address this issue.

Negligence

Petitioner argues that her investment in Davenport through

Republic was: (1) Without tax motivation; (2) made by an

unsophisticated investor based upon the advice of a competent,

independent professional; (3) therefore not negligent; and (4) in

any event, not subject to the section 6653(a)(2) addition to tax

for her returns due prior to January 1, 1982 (tax years 1979 and

1980).

Respondent's determinations, contained in the notice of

deficiency, are presumed correct, and petitioner bears the burden

of proving otherwise. Rule 142(a); Welch v. Helvering, 290 U.S.

111, 115 (1933).
 - 9 -

Section 6653(a)(1) imposes an addition to tax if any portion

of an underpayment is due to negligence or intentional disregard

of rules or regulations. Section 6653(a)(2) imposes an addition

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

the portion of the underpayment attributable to negligence.

Negligence is defined as the failure to exercise the

due care that a reasonable and ordinarily prudent person would

employ under the circumstances. Neely v. Commissioner, 85 T.C.

934, 947 (1985). Thus, to avoid imposition of the addition to

tax, petitioner must prove that her actions in connection with

the deductions and credits from the plastics recycling venture

were reasonable in light of her experience and the nature of the

investment. See Henry Schwartz Corp. v. Commissioner, 60 T.C.

728, 740 (1973); Lucas v. Commissioner, T.C. Memo. 1995-341.

The exact nature of the investment here is not clear from

the record. No prospectus or offering memorandum was introduced,

few facts on the nature of the investment were stipulated, and no

witnesses save for petitioner testified at trial.

We are able to determine from the stipulations, pleadings,

motions and responses of the parties that petitioner was an

indirect investor in a limited partnership that generated

deductions and credits based at least in part upon the value of

one or more plastics recycling machines.
 - 10 -

Respondent argues7 that the underlying investment in this

case is similar to that in Provizer v. Commissioner, T.C. Memo.

1992-177, affd. without published opinion 996 F.2d 1216 (6th Cir.

1993). Petitioner in her brief represents that "This case is

substantially similar to" Zidanich v. Commissioner, T.C. Memo.

1995-382 (underlying transactions and recyclers were the same as

those considered in Provizer v. Commissioner, supra). Petitioner

distinguishes Provizer on bases other than the substance of the

underlying transaction. We therefore assume that the underlying

transaction in this case is similar to that of Provizer, where we

held that the transaction was a sham and lacked economic

substance.8

Petitioner contends that she was an "unsophisticated"

investor with no "formal training or work experience in

investments" and that she relied on Russell in making the

investment. She complains that she should not have to

"independently investigate every detail of her investment".

7
Although we have characterized respondent's position as one
of argument, she considers it stipulated that the underlying
transactions here are analogous to those in Provizer v.
Commissioner, T.C. Memo. 1992-177, affd. without published
opinion 996 F.2d 1216 (6th Cir. 1993). Paragraph 2 of the
stipulation of settled issues is ambiguous, but may be so
interpreted.
8
Even absent this assumption it would be petitioner's burden
to prove the context in which the deductions and credits were
taken. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115
(1933); Bixby v. Commissioner, 58 T.C. 757, 791-792 (1972).
 - 11 -

Petitioner argues that she was not motivated by tax savings in

making the investment and did not claim tax benefits "grossly

exceeding her investment".

Whether a taxpayer had a subjective profit motive may not be

dispositive in determining that she acted negligently. Klieger

v. Commissioner, T.C. Memo. 1992-734. Under some circumstances,

however, a taxpayer may avoid liability for the additions to tax

for negligence 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 (5th

Cir. 1990), affd. 501 U.S. 868 (1991). Such reliance is not an

absolute defense to negligence but is merely a factor to be

considered. Id.

For reliance on professional advice to excuse a taxpayer

from the negligence additions to tax, the taxpayer must show that

the professional adviser had the expertise and knowledge of the

pertinent facts to provide informed advice on the subject matter.

Id.; Stone v. Commissioner, T.C. Memo. 1996-230; Reimann v.

Commissioner, T.C. Memo. 1996-84.

Petitioner has failed to introduce any evidence regarding

Russell's expertise in tax matters, that he knew anything about

the nontax business aspects of the recycling venture, or that he

conferred with experts in the field of plastics recycling.
 - 12 -

A taxpayer may not have to investigate "every detail" of an

investment, but petitioner failed to investigate any detail of

her investment in Republic. She, a college graduate and

independent businesswoman, failed even to take the most basic

step of asking for and reading the pertinent portions of an

offering memorandum describing the recycling program. Instead,

petitioner chose to invest an amount representing 40 percent of

her 1982 reported taxable income in reliance on the advice of a

return preparer about whose professional credentials she had no

knowledge.

Petitioner's curiosity was apparently not even piqued by

her recovery of her $7,500 "investment" and an immediate "profit"

of over $5,000 (considering Federal tax deductions and credits),

no matter what happened to the recycler program as a business. A

reasonably prudent person would have asked a competent tax

adviser if this windfall were not "'too good to be true'". See

Pasternak v. Commissioner, 990 F.2d 893, 903 (6th Cir. 1993)

(quoting McCrary v. Commissioner, 92 T.C. 827, 850 (1989)), affg.

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

Petitioner should have exercised the same standard of care

in considering the Republic recycling investment as she routinely

exercised in her position as a buyer for Maas Bros and, we

presume, in running her own business. Based on this record, we
 - 13 -

conclude that petitioner's reliance on the alleged expertise of

Russell was neither reasonable nor prudent.

Application of Section 6653(a)(1) and (2) to 1979 and 1980

Petitioner argues that respondent erred in her determination

that the addition to tax under section 6653(a)(2) applies to her

underpayments of tax for 1979 and 1980 because this provision is

effective only for returns due after December 31, 1981.

Paragraph (2) of section 6653(a) was added to the Code by

section 722(b) of the Economic Recovery Tax Act of 1981 (ERTA),

Pub. L. 97-34, 95 Stat. 172, 342. The provision was meant to

augment the existing negligence penalty and to "encourage

accurate and good faith actions in compliance with tax laws."

H. Rept. 97-201, at 245 (1981), 1981-2 C.B. 352, 399.

ERTA section 722(b)(2), 95 Stat. 342, provides that section

6653(a)(1) and (2) "shall apply to taxes the last date prescribed

for payment of which is after December 31, 1981." The last date

prescribed for the payment of taxes for petitioner's 1979 and

1980 calendar years is April 15, 1980, and April 15, 1981,

respectively. Secs. 6072(a), 6151(a). We find therefore that

petitioner's position is correct; section 6653(a)(2) does not

apply to her 1979 and 1980 tax returns.

Respondent has also asserted that section 6653(a)(1) applies

to 1979 and 1980. For taxes due on or before December 31, 1981,

the addition to tax for negligence is found in section 6653(a).
 - 14 -

Section 6653(a) and "new" section 6653(a)(1) have substantially

identical language and provide for an addition to tax equal to 5

percent of the underpayment. Respondent's erroneous citation

will not affect our previous determination that petitioner's

underpayments of tax for all the years in suit, including 1979

and 1980, were negligent. See Burrill v. Commissioner, 93 T.C.

643, 670 n.28 (1989).

The Application of the Section 6659 Addition to Tax for 1981

Petitioner alleges that respondent erred in determining an

addition to tax for the year 1981 under section 6659 because the

underpayment of tax for that year is less than $1,000, citing

section 6659(d).

The statutory language is clear. Subsection (d) of section

6659 provides that the section shall not apply if the

underpayment attributable to the valuation overstatement is less

than $1,000. Since petitioner's underpayment of tax for 1981 is

less than $1,000, we find that petitioner is not liable for an

addition to tax under section 6659.

To reflect the foregoing,

Decision will be entered

under Rule 155.