T.C. Memo. 1997-271
UNITED STATES TAX COURT
ROBERT D. AND PATRICIA K. KALIBAN, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 4252-89, 4253-89 Filed June 16, 1997.
10802-89, 10803-89
27659-89, 27660-89.
Stuart A. Smith and David H. Schnabel, for petitioners.
Donald A. Glasel and Frances Ferrito Regan, for respondent
in docket Nos. 4252-89 and 27659-89.
Wendy Sands and Frances Ferrito Regan, for respondent in
docket No. 4253-89.
1
Cases of the following petitioners are consolidated for
opinion: Robert D. and Patricia K. Kaliban, docket Nos. 4252-89
and 27659-89; Estate of Karl Weber, Deceased, and Estate of
Marjorie Weber, Deceased, David Alter, Executor, docket No.
10802-89; Steve and Lispet Roland, docket No. 4253-89; and Lionel
and Betty Zimmer, docket Nos. 10803-89 and 27660-89.
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Mitchell B. Hausman and Frances Ferrito Regan, for
respondent in docket No. 10802-89.
Jennifer J. Kohler and Frances Ferrito Regan, for respondent
in docket Nos. 10803-89 and 27660-89.
CONTENTS
Page
MEMORANDUM FINDINGS OF FACT AND OPINION....................... 2
OPINION OF THE SPECIAL TRIAL JUDGE............................ 3
FINDINGS OF FACT.............................................. 6
A. The Plastics Recycling Transactions...................... 6
B. The Partnerships......................................... 8
C. David Alter and Martin Feinstein.........................11
D. Petitioners and Their Introduction to the Partnership
Transactions.............................................16
1. Robert and Patricia Kaliban..........................17
2. Steve and Lispet Roland..............................19
3. Karl and Marjorie Weber..............................21
4. Lionel and Betty Zimmer..............................23
OPINION.......................................................26
A. Section 6653(a)--Negligence..............................28
1. The So-Called Oil Crisis............................29
2. Petitioners' Purported Reliance on Advisers.........32
3. Miscellaneous.......................................43
4. Conclusion as to Negligence.........................53
B. Section 6659--Valuation Overstatement....................54
1. The Grounds for Petitioners' Underpayments..........55
2. Concession of the Deficiencies......................60
3. Section 6659(e).....................................64
C. Petitioners' Motions For Leave To File Motion For
Decision Ordering Relief From the Negligence Penalty
and the Penalty Rate of Interest and To File Supporting
Memorandum of Law........................................67
MEMORANDUM FINDINGS OF FACT AND OPINION
DAWSON, Judge: These cases were assigned to Special Trial
Judge Norman H. Wolfe pursuant to the provisions of section
7443A(b)(4) and Rules 180, 181, and 183. They were tried and
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briefed separately but consolidated for purposes of opinion.2
All section references are to the Internal Revenue Code in effect
for the tax years in issue, unless otherwise indicated. All Rule
references are to the Tax Court Rules of Practice and Procedure.
The Court agrees with and adopts the opinion of the Special Trial
Judge, which is set forth below.
OPINION OF THE SPECIAL TRIAL JUDGE
WOLFE, Special Trial Judge: These cases are part of the
Plastics Recycling group of cases. For a detailed discussion of
the transactions involved in the Plastics Recycling cases, see
Provizer v. Commissioner, T.C. Memo. 1992-177, affd. without
published opinion 996 F.2d 1216 (6th Cir. 1993). The facts of
the underlying transactions and the Sentinel recyclers in these
cases are substantially identical to those considered in the
Provizer case.
In four notices of deficiency, respondent determined the
following deficiencies in and additions to petitioners' 1981
Federal income taxes:
Additions to Tax
1 1
Petitioners Deficiency Sec. 6653(a)(1) Sec. 6653(a)(2) Sec. 6659
2 3
Kaliban $26,571 $1,328.55 $7,971.30
2 3
Roland 27,994 1,399.70 8,398.20
2 3
Weber 27,642 1,382 8,293
2
Zimmer 27,303 1,365 8,191
1
Except for the notice of deficiency issued to the Webers, the notices
refer to section 6653(a)(1)(A) and (B). During 1981, the additions to tax for
negligence were provided for under section 6653(a)(1) and (2).
2
By order dated Mar. 21, 1994, docket Nos. 4252-89 and 27659-
89 (the Kaliban cases) were consolidated for trial, briefing, and
opinion. By another order dated Mar. 21, 1994, docket Nos.
10803-89 and 27660-89 (the Zimmer cases) were also consolidated
for trial, briefing, and opinion.
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2
50 percent of the interest payable with respect to the portion of the
underpayment attributable to negligence.
3
In the alternative to the section 6659 addition to tax, respondent
determined an addition to tax under section 6661 for substantial understatement
of liability.
Respondent also determined that interest on the deficiencies
accruing after December 31, 1984, would be calculated at 120
percent of the statutory rate under section 6621(c).
In another two notices of deficiency, respondent determined
deficiencies in the 1982 Federal income taxes of the Kalibans and
the Zimmers in the amount of $204 each, plus additions to tax for
negligence under section 6653(a)(1) in the amount of $10.20 each,
and under section 6653(a)(2) on 50 percent of the interest
payable with respect to $204.3
The parties in each of these cases filed Stipulations of
Settled Issues concerning the adjustments relating to
petitioners' participation in the Plastics Recycling Program.
The stipulations generally provide:4
1. Petitioners are not entitled to any deductions,
losses, investment credits, business energy investment
credits or any other tax benefits claimed on their tax
returns as a result of their participation in the
Plastics Recycling Program.
3
The notices of deficiency for 1982 refer to sec.
6653(a)(1)(A) and (B). During 1982, the additions to tax for
negligence were provided for under sec. 6653(a)(1) and (2).
4
The stipulations of settled issues in the Kaliban cases
(docket Nos. 4252-89 and 27659-89) do not contain the fourth
stipulation. The stipulation of settled issues in the Weber case
(docket No. 10802-89) expressly refers to taxable year 1981.
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2. The underpayments in income tax attributable to
petitioners' participation in the Plastics Recycling
Program are substantial underpayments attributable to
tax motivated transactions, subject to the increased
rate of interest established under I.R.C. §6621(c),
formerly §6621(d).
3. This stipulation resolves all issues that relate to
the items claimed on petitioners' tax returns resulting
from their participation in the Plastics Recycling
Program, with the exception of petitioners' potential
liability for additions to the tax for valuation
overstatements under I.R.C. §6659 and for negligence
under the applicable provisions of §6653(a).
4. With respect to the issue of the addition to the
tax under I.R.C. §6659, the petitioners do not intend
to contest the value of the Sentinel Recycler or the
existence of a valuation overstatement on the
Petitioners' returns; however, Petitioners reserve
their right to argue that the underpayment in tax is
not attributable to a valuation overstatement within
the meaning of I.R.C. §6659(a)(1), and that the
Secretary should have waived the addition to tax
pursuant to the provisions of I.R.C. §6659(e).
Long after the trials of these cases, in each case
petitioners filed a Motion For Leave To File Motion For Decision
Ordering Relief From the Negligence Penalty and the Penalty Rate
of Interest and To File Supporting Memorandum of Law under Rule
50. These motions were filed with attached exhibits in October
and November of 1995. Petitioners concurrently lodged with the
Court motions for decision ordering relief from the additions to
tax for negligence and the increased rate of interest, with
attachments and memoranda in support of the motions.
Subsequently, respondent filed objections, with attachments and
memoranda in support thereof, and petitioners thereafter filed
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reply memoranda. For reasons discussed in more detail at the end
of this opinion, and also in Farrell v. Commissioner, T.C. Memo.
1996-295, these motions shall be denied; see also Sann v.
Commissioner, T.C. Memo. 1997-259; Friedman v. Commissioner, T.C.
Memo. 1996-558; Jaroff v. Commissioner, T.C. Memo. 1996-527;
Gollin v. Commissioner, T.C. Memo. 1996-454; Grelsamer v.
Commissioner, T.C. Memo. 1996-399; Zenkel v. Commissioner, T.C.
Memo. 1996-398.
The issues remaining in these consolidated cases are: (1)
Whether petitioners are liable for the additions to tax for
negligence under section 6653(a)(1) and (2); and (2) whether
petitioners are liable for the additions to tax under section
6659 for underpayments of tax attributable to valuation
overstatements.
FINDINGS OF FACT
Some of the facts have been stipulated in each case and are
so found. The stipulated facts and attached exhibits are
incorporated in the respective cases by this reference.
A. The Plastics Recycling Transactions
These cases concern petitioners' investments in two limited
partnerships that leased Sentinel expanded polyethylene (EPE)
recyclers: Clearwater Group (Clearwater) and Poly Reclamation
Associates (Poly Reclamation). Petitioners Kaliban, Roland, and
Zimmer are limited partners in Poly Reclamation. Petitioners
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Weber were limited partners in Clearwater. For convenience we
refer to these partnerships collectively as the Partnerships.
The Clearwater partnership and the transactions involving
the Sentinel EPE Recyclers leased by Clearwater were considered
in Provizer v. Commissioner, supra. The transactions involving
the Sentinel EPE recyclers purportedly leased by Poly Reclamation
are substantially identical to the Clearwater transactions.
Petitioners have stipulated substantially the same facts
concerning the underlying transactions as we found in the
Provizer case.
In the Provizer case, Packaging Industries, Inc. (PI),
manufactured and sold six Sentinel EPE recyclers to ECI Corp. for
$981,000 each. ECI Corp., in turn, resold the recyclers to F & G
Corp. for $1,162,666 each. F & G Corp. then leased the recyclers
to Clearwater, which licensed the recyclers to FMEC Corp., which
sublicensed them back to PI. The sales of the recyclers from PI
to ECI Corp. were financed with nonrecourse notes. Approximately
7 percent of the sales price of the recyclers sold by ECI Corp.
to F & G Corp. was paid in cash with the remainder financed
through notes. These notes provided that 10 percent of the notes
were recourse but that the recourse portion of the notes was only
due after the nonrecourse portion, 90 percent, was paid in full.
All of the monthly payments required among the entities in
the above transactions offset each other. These transactions
were done simultaneously. Although the recyclers were sold and
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leased for the above amounts under the structure of simultaneous
transactions, the fair market value of a Sentinel EPE recycler in
1981 and up to the end of 1982 was not in excess of $50,000.
PI allegedly sublicensed the recyclers to entities that
would use them to recycle plastic scrap. The sublicense
agreements provided that the end-users would transfer to PI 100
percent of the recycled scrap in exchange for a payment from FMEC
Corp. based on the quality and amount of recycled scrap.
Like Clearwater, Poly Reclamation leased Sentinel EPE
recyclers from F & G Corp. and licensed those recyclers to FMEC
Corp. Apart from the entity that leased the machines from F & G
Corp. and licensed them to FMEC Corp., the transactions of the
Partnerships do not differ in any substantive respects.
For convenience, we refer to the series of transactions
among PI, ECI Corp., F & G Corp., each of the Partnerships, FMEC
Corp., and PI as the Partnership transactions. In addition to
the Partnership transactions, a number of other limited
partnerships entered into transactions similar to the Partnership
transactions, also involving Sentinel EPE recyclers and Sentinel
expanded polystyrene (EPS) recyclers. We refer to these
collectively as the Plastics Recycling transactions.
B. The Partnerships
Clearwater and Poly Reclamation are New York limited
partnerships. Both partnerships closed during the last few
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months of 1981. Samuel L. Winer (Winer) is the general partner
of both Clearwater and Poly Reclamation.
With respect to each of the Partnerships, a private
placement memorandum was distributed to potential limited
partners. Reports by F & G Corp.'s evaluators, Dr. Stanley M.
Ulanoff (Ulanoff), a marketing consultant, and Dr. Samuel Z.
Burstein (Burstein), a mathematics professor, were appended to
the offering memoranda. Ulanoff owns a 1.27-percent interest in
Plymouth Equipment Associates and a 4.37-percent interest in
Taylor Recycling Associates, partnerships that leased Sentinel
recyclers. Burstein owns a 2.605-percent interest in Empire
Associates and a 5.82-percent interest in Jefferson Recycling
Associates, also partnerships that leased Sentinel recyclers.
Burstein also was a client and business associate of Elliot I.
Miller (Miller), the corporate counsel to PI.
The offering memoranda for Clearwater and Poly Reclamation
each state that the general partner will receive fees from those
partnerships in the amount of $60,000. In addition, each of the
offering memoranda provides that the general partner "may retain
as additional compensation all amounts not paid as sales
commissions or offeree representative fees". According to the
offering memoranda, 10 percent of the proceeds from the offering
($80,000 in each case) was allocated to the payment of sales
commissions and offeree representative fees. Winer therefore was
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to receive a minimum of $60,000 and up to $140,000 from each
Partnership.
The offering memoranda list significant business and tax
risk factors associated with investments in the Partnerships.
Specifically, the offering memoranda state: (1) There is a
substantial likelihood of audit by the Internal Revenue Service
(IRS) and the purchase price paid by F & G Corp. to ECI Corp.
probably will be challenged as being in excess of fair market
value; (2) the Partnerships have no prior operating history; (3)
the general partner has no prior experience in marketing
recycling or similar equipment; (4) the limited partners have no
control over the conduct of the Partnerships' business; (5) there
is no established market for the Sentinel EPE recyclers; (6)
there are no assurances that market prices for virgin resin will
remain at their current costs per pound or that the recycled
pellets will be as marketable as virgin pellets; and (7) certain
potential conflicts of interest exist.
Although the offering memoranda represented that the
Sentinel EPE recycler was a unique machine, it was not unique.
Several machines capable of densifying low density materials were
already on the market in 1981. Other plastics recycling machines
available during 1981 ranged in price from $20,000 to $200,000,
including the Foremost Densilator, Nelmor/Weiss Densification
System (Regenolux), Buss-Condux Plastcompactor, and Cumberland
Granulator. See Provizer v. Commissioner, T.C. Memo. 1992-177.
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C. David Alter and Martin Feinstein
David Alter (Alter) is a graduate of the Harvard Law School
and has been practicing law in New York since 1950. He has been
a partner in several law firms since 1954: From 1954 to 1966
Alter was a partner at the law firm of Squadron, Alter & Weinrib;
from 1966 to 1979 he was a partner at the law firm of Alter,
LeFevre, Raphael & Lowry (Alter, LeFevre);5 and from 1979 to 1989
he was a partner at the law firm of Shea & Gould. Alter has been
engaged in the general practice of law with a concentration in
entertainment and labor law. Among the services he provided to
his clients were the preparation and review of contracts, general
tax advice, estate planning, and administering and maintaining
financial records. On occasion, some of Alter's clients asked
him to review offering materials for investment opportunities
that they had learned of elsewhere. In the course of his
practice, Alter advised his clients as to the validity and merit
of such investments.
Alter learned of the Plastics Recycling transactions from
one of the partners at Shea & Gould, Stuart Hirshfield
(Hirshfield), who in turn had been introduced to the transactions
by Winer, the general partner of the Partnerships. Alter
5
Alter, LeFevre underwent several name changes during the
time Alter was a partner. Apparently, Alter, LeFevre, Raphael &
Lowry was the name of the firm by 1978. For convenience,
references to "Alter, LeFevre" include its predecessor names
while Alter was a partner.
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understood that Hirshfield had previously done business with
Winer and thought well of him. Alter read the Poly Reclamation
offering memorandum and attended some meetings with other
partners who were considering an investment in the Plastics
Recycling transactions, including Hirshfield, Dan Carroll
(Carroll), Joseph Ferraro (Ferraro), Lonn Trost (Trost), and Alan
Parker (Parker), a tax partner at Shea & Gould. He understood
that Carroll had a background in engineering, and that Ferraro,
who at the time represented British Petroleum, had worked at a
plastics company for one or more summers during law school.
Martin Feinstein (Feinstein), an associate at Shea & Gould, also
reviewed the Plastics Recycling transactions for Alter and some
of Alter's clients.
Feinstein has a B.A. in economics from Brooklyn College and
graduated cum laude from the New York University Law School. He
is a member of the New York State bar, and during 1981 he also
was a certified public accountant (C.P.A.). Feinstein earned the
credits that enabled him to sit for the C.P.A. exam from New York
University. During law school, and for a time afterward,
Feinstein worked at an accounting firm. He then was employed by
a business management company, Vincent Andrews, Inc. (VAI). VAI
managed the finances of people primarily in the entertainment and
theatrical industry. Feinstein specialized in tax matters and
budgeting at VAI. He and Alter met in 1969 through a VAI client,
Bill Cullen, who at the time also was represented by Alter in a
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tax matter. Feinstein subsequently became associated with Alter,
LeFevre sometime in 1969.
Feinstein continued to advise individuals regarding
financial and tax matters at Alter, LeFevre. The firm provided
various financial services to its clients. For some clients, it
maintained checking accounts, paid bills, and prepared weekly
statements showing the client's opening balance, deposits,
withdrawals, and expenditures. On January 1, 1979, Alter,
LeFevre merged with another law firm, Aranow & Brodsky, but the
resulting firm ceased operations by Labor Day of that year, and
that same month Alter became a partner at Shea & Gould and
Feinstein also became associated with that firm.
In the fall of 1981, Alter asked Feinstein to review the
Plastics Recycling transactions as a potential investment for
Alter and some of his clients. Feinstein received a copy of a
Partnership offering memorandum from Winer. He spent
approximately 4 to 6 hours reviewing it, including the financial
projections and the tax opinion. Feinstein understood that
Hirshfield and Ferraro had spoken to members of the law firm that
drafted the tax opinion, and that they and Trost were satisfied
with the opinion. He also understood that "someone asked one of
the tax partners to look at the thing in general", but he did not
know "how much detail * * * [Shea & Gould] did." Although Alter
claims that he asked Feinstein "to check with the tax partner in
the firm, Alan Parker," Feinstein did not speak to Parker.
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Feinstein relied on the offering memorandum for the value of
the Sentinel EPE recycler. He understood that the purported
value of the Sentinel EPE recycler was based upon a projected
stream of future income. Feinstein did not verify the
manufacturing cost of a Sentinel EPE recycler beyond speaking
with a friend and associate6 "about pricing and how things are
priced in that industry." He understood from his friend that the
stream-of-income method of valuation was not an unusual means of
pricing equipment. Feinstein reviewed the stream of income
projections in the offering memorandum, but did not verify any of
the assumptions upon which they were based. He did not research
or investigate the market for plastics recyclers or recycled
resin pellets.
Feinstein spoke to a friend, Jerry Lauren (Lauren), who was
a manufacturer's representative in the plastics packaging
industry. He understood from Lauren that PI was a privately
owned company that made specialized machinery for companies
involved in the packaging industry. Feinstein did not formally
hire or pay Lauren. He did not provide Lauren with a copy of the
Poly Reclamation offering memorandum. Lauren did not prepare a
written report for Feinstein. Feinstein "never asked * * *
[Lauren] anything about the partnership". He only asked Lauren
what he knew about PI. Feinstein did not ask Lauren, or anyone
6
Feinstein did not state who this friend and associate was or
what his or her credentials were.
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else, whether any plastics recycling machines comparable to the
Sentinel recycling machines already were available on the market.
Feinstein has no education or experience in plastics
materials or plastics recycling, and he was not under the
impression that Hirshfield, Trost, or Ferraro had any significant
education or experience in the plastics industry. He did not
visit PI, and he did not indicate that he ever saw a Sentinel EPE
recycler. Feinstein did not review any marketing plans or
research the market for plastics recyclers or recycled ground
resin pellets. He was unaware that the Sentinel EPE recycler was
incapable of recycling expanded polyethylene by itself, and had
to be used in a system of grinders, extruders, and pelletizers.
Feinstein did not know how many other partnerships would be
leasing Sentinel recyclers. Neither Feinstein nor Lauren
invested in any of the Plastics Recycling transactions.
Feinstein told Alter about Lauren and his comments about PI.
Alter knew that Lauren and Feinstein had not visited PI, or
investigated whether competitive machines existed, or made a
judgment as to the value of a Sentinel EPE recycler. He also
knew that neither Feinstein nor Lauren personally invested in a
Plastics Recycling transaction. Alter accepted the fair market
value of the Sentinel EPE recycler as set out in the Poly
Reclamation offering memorandum. He had "no competence to"
confirm the value of the machines or "to do any comparison", and
did not hire anyone to value the machine. Like Feinstein, Alter
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did not know that the Sentinel EPE recycler did not recycle
plastic by itself, but had to be used in connection with other
machines. Alter did not review any plastics industry trade
journals for competing recyclers or otherwise inquire as to
whether there were any comparable machines already on the market.
Alter told certain of his clients that he was investing in a
Plastics Recycling transaction and that the investment was open
to them as well. He informed them that he and other members of
Shea & Gould thought that the investment seemed sound. Feinstein
and Alter met with these clients and explained the investment.
Alter did not advise his clients to read an offering memorandum,
but one was available for them to read. He did not suggest that
they consult with any plastics experts. A number of Alter's
clients, as well as Alter, invested in a Plastics Recycling
transaction in 1981. Alter's knowledge of PI was limited to the
information in the offering materials, what he learned at
meetings with his partners at Shea & Gould, and what Feinstein
told him. The warnings and caveats in the offering memoranda did
not concern him. Alter knew that Feinstein did not have any
expertise in plastics materials or plastics recycling.
D. Petitioners and Their Introduction to the Partnership
Transactions
Petitioners in these cases do not have any education or work
experience in plastics recycling or plastics materials. They did
not read the offering materials distributed by the Partnerships
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or independently investigate the Sentinel EPE recyclers. None of
petitioners saw a Sentinel EPE recycler or any other type of
plastics recycler prior to participating in the recycling
ventures. Petitioners never made a profit in any year from their
respective investments in the Partnerships.
1. Robert and Patricia Kaliban
Petitioners Robert and Patricia Kaliban resided in Garden
City, New York, when their petitions were filed.7 Robert Kaliban
(Kaliban) earned a B.A. degree from Loras College in Dubuque,
Iowa, and an honors diploma from the Royal Academy of Dramatic
Art in London, England. He then served in the Army before
becoming a professional actor. Kaliban performed in touring
productions in Chicago, Milwaukee, Los Angeles, and San
Francisco. In 1960 he moved to New York City and performed in
Broadway shows and reviews, and at the World's Fair. Kaliban
then performed on-camera and did voice-overs for commercials.
Sometime in the late 1960's Kaliban became a member of the
board of directors of the Screen Actors Guild. In that capacity
he met Alter, who was counsel to the Screen Actors Guild.
Kaliban hired Alter to manage his personal finances in the early
1970's. Alter and Feinstein collected income disbursements from
various employers of Kaliban and oversaw the payment of his
7
Petitioner Patricia Kaliban is a party to the cases of
docket Nos. 4252-89 and 27659-89 solely because she filed a joint
Federal income tax return with her husband for the years in
issue.
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bills. They also prepared Kaliban's tax returns and reviewed
investment opportunities that had been suggested to him by
others. Prior to 1981, Kaliban invested in two successful real
estate ventures in which Alter also participated. On their joint
1981 Federal Income tax return, Robert and Patricia Kaliban
reported gross income from wages, interest, dividends, State and
local tax refunds, and capital gains in excess of $282,000.
Kaliban acquired a 1.547-percent interest in Poly
Reclamation for $12,500 in 1981. As a result of the investment
in Poly Reclamation, on their 1981 Federal income tax return
Kaliban and his wife Patricia claimed an operating loss in the
amount of $9,976 and an investment tax and business energy credit
in the amount of $21,584.8 The Kalibans also claimed an
operating loss from Poly Reclamation on their 1982 return in the
amount of $409. Respondent disallowed the Kalibans' claimed
operating losses and credits related to Poly Reclamation in full.
Kaliban learned of the Plastics Recycling transactions and
Poly Reclamation from Alter and Feinstein. He understood that
members of Shea & Gould had looked into PI and that some of them,
including Alter, were investing in the Plastics Recycling
transactions. Alter did not hold himself out as a plastics
expert, but Kaliban claims that he understood that Alter had
spoken to a member of Shea & Gould who apparently had been
8
On their 1981 return, the Kalibans claimed a total of
$21,797 in credits.
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involved in a plastics company. Kaliban did not read the Poly
Reclamation offering memorandum or otherwise investigate or
analyze any aspect of the transactions. He assumed that if Alter
was investing in the Plastics Recycling transactions, it was a
good investment.
2. Steve and Lispet Roland
Petitioners Steve and Lispet Roland resided in New York, New
York, when their petition was filed. After graduating from high
school, Steve Roland (Roland) pursued dramatic training for 2
years and then served in the Army. Upon completing his military
service, Roland performed on Broadway, in night clubs, and on
radio. His career eventually shifted to the commercial field
where he engaged in on camera performances and then concentrated
in voice-over work. Roland's workload and earnings grew quickly,
and in 1968 he retained Alter's firm to manage his finances and
plan for taxes. Alter and Feinstein received Roland's income and
paid his bills, such as his agent's commissions, maintained books
tracking Roland's investments and residuals, and prepared the
Rolands' tax returns. They also reviewed investments that had
been suggested to Roland by others. Roland incorporated his
professional services under the name Steve Roland, Inc. (SRI) in
1968. SRI, whose only asset was its arrangement for the services
of Roland, filed a separate return from him. Prior to 1981,
Roland invested in a profitable commercial real estate venture in
which Alter also invested. On their joint 1981 Federal Income
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tax return, the Rolands reported gross income from wages,
interest, dividends, State and local tax refunds, and capital
gains in excess of $236,000.
Roland acquired a 1.547-percent interest in Poly Reclamation
for $12,500 in 1981. As a result of the investment in Poly
Reclamation, on their 1981 Federal income tax return the Rolands
claimed an operating loss in the amount of $9,977 and an
investment tax and business energy credit in the amount of
$21,584. Respondent disallowed the Rolands' claimed operating
losses and credits related to Poly Reclamation in full.
Roland learned of the Plastics Recycling transactions and
Poly Reclamation from Alter. Alter told Roland that he and
others at Shea & Gould were investing in a Plastics Recycling
transaction and that Roland could participate as well if he
wished. Roland discussed the Plastics Recycling transactions
with Alter and Feinstein. He understood that Feinstein had
conducted most of the research into the Plastics Recycling
transactions, but at trial Roland could not recall what research
Feinstein had done. Roland did not know and did not ask what the
assets of Poly Reclamation were. At trial, he could not recall
who manufactured the Sentinel recyclers or whether Feinstein or
Alter had investigated suitable end-users for the machines or had
inquired about existing competition. Roland did not read the
Poly Reclamation offering memorandum or otherwise learn about the
investment apart from discussing it with Alter and Feinstein. He
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explained that he believed that if Alter and other members of
Shea & Gould were investing in a Plastics Recycling transaction,
then he should too.
3. Karl and Marjorie Weber
Petitioners Karl and Marjorie Weber resided in Fort Meyers,
Florida, when their petition was filed. Both of the Webers died
prior to the trial of their case. The executor of their estates,
Alter, testified on their behalf.
Each Weber earned a college degree. Karl became a
successful voice-over performer and a member of the board of
directors of the Screen Actors Guild, and Marjorie managed their
finances. They met Alter in approximately 1969 or 1970 and
retained his firm to prepare their tax returns and provide other
tax services. Feinstein handled their tax matters and met with
the Webers approximately four times a year. Alter represented
the Webers in some real estate transactions, and Feinstein on
occasion reviewed investments that had been suggested to them by
others. Prior to 1981, Alter and the Webers both invested in a
successful nursing home venture. On their joint 1981 Federal
Income tax return, the Webers reported gross income from wages,
interest, dividends, and capital gains in excess of $221,000.
The Webers acquired a 1.547-percent interest in Clearwater
for $12,500 in 1981.9 As a result of their investment in
9
The parties stipulated that the Webers owned a one-quarter
(continued...)
- 22 -
Clearwater, on their 1981 Federal income tax return the Webers
claimed an operating loss in the amount of $10,002 and an
investment tax and business energy credit in the amount of
$21,584.10 Respondent disallowed the Webers' claimed operating
losses and credits related to Clearwater in full.
Alter introduced the Plastics Recycling transactions and
Clearwater to the Webers in 1981. As he recalled: "I informed
them of its availability and told them that I was investing in it
and if they were interested they could participate as well." The
Webers decided to invest in Clearwater after discussing it with
Alter and Feinstein. Alter specifically recalled that he
explained to the Webers the nature of the investment and what
might come out of this investment. Aside from speaking with
Alter, the Webers did not conduct any personal investigation with
respect to Clearwater.
9
(...continued)
interest in the profits, losses, and capital of Clearwater during
taxable year 1981. However, in their petition, the Webers stated
that they owned a one-quarter interest in a partnership unit, and
several of the 1981 Schedules K-1, Partner's Share of Income,
Credits, Deductions, etc. attached to Clearwater's 1981
partnership return (the Webers' 1981 Schedule K-1 was not among
them), indicate that an investment of $12,500 yielded a 1.547-
percent interest in Clearwater.
10
On their 1981 return, the Webers claimed total credits in
the amount of $21,655.
- 23 -
4. Lionel and Betty Zimmer
Petitioners Lionel and Betty Zimmer resided in New York, New
York, when their petitions were filed. Lionel Zimmer (Zimmer)
earned a B.A. degree in political science from the University of
North Carolina (UNC). While pursuing his undergraduate degree,
Zimmer joined the Naval ROTC, was commissioned, placed on active
duty, and served overseas. After completing his military service
Zimmer returned to UNC to finish his degree and then moved to Los
Angeles and worked for 2-1/2 years as a disk jockey at a radio
station. Then he went to Paris in 1949 to attend a film school.
Upon learning that the film school was not covered by the GI
Bill, Zimmer enrolled in a language school to learn French.
After several months he transferred to the Sorbonne and began a
course in French civilization.
Zimmer also pursued work as an actor in Paris. When his
career quickly flourished, he ended his schooling. Zimmer worked
as master of ceremonies of a radio program that was broadcast
weekly to the United States, worked with Orson Welles for much of
a year, and worked on a few movies. At the end of 1951 Zimmer
moved back to the United States and became a staff announcer in
Hollywood for the American Broadcasting Company (ABC). Nine
years later he left ABC and began freelancing. In 1967 he moved
to New York City and performed voice-overs for commercials. He
became active in the Screen Actors Guild and was elected to its
board of directors.
- 24 -
Zimmer met Alter through the Screen Actors Guild. He was
impressed with Alter's work and retained his firm in
approximately 1970 to manage his finances. Alter's firm
deposited Zimmer's receipts into various accounts and oversaw the
payment of his bills. Feinstein prepared the Zimmers' tax
returns and on occasion reviewed tax shelters and other
investments that had been suggested to Zimmer by others.11
Zimmer met with Feinstein on a weekly basis and met with Alter
several times each year. Alter rarely recommended investments to
Zimmer. Zimmer recalled making just one investment involving
Alter prior to 1981. They both invested in a profitable
commercial real estate venture. On their joint 1981 Federal
Income tax return, the Zimmers reported gross income from wages,
interest, dividends, State and local tax refunds, and capital
gains in excess of $139,500.
Zimmer acquired a 1.547-percent interest in Poly Reclamation
for $12,500 in 1981. As a result of his investment in Poly
Reclamation, on their 1981 Federal income tax return the Zimmers
claimed an operating loss in the amount of $9,976 and an
investment tax and business energy credit in the amount of
$21,584. The Zimmers also claimed an operating loss from Poly
11
Zimmer recalled: "I used to belong to a men's club at the
Vanderbilt YMCA and there was a chap there that used to sell tax
shelters, investments. He was always telling me I was a damn
fool, why don't you buy something, why don't you take advantage
of these things."
- 25 -
Reclamation on their 1982 return in the amount of $409.
Respondent disallowed the Zimmers' claimed operating losses and
credits related to Poly Reclamation in full.
Zimmer learned of the Plastics Recycling transactions and
Poly Reclamation at a meeting with Alter and Feinstein. Alter
and Feinstein explained the transactions to him. Zimmer recalled
that Alter and/or Feinstein had investigated the Plastics
Recycling transactions and PI, and had inspected the recyclers.
He understood that the investment would generate additional tax
credits because it purportedly saved energy. However, Zimmer
could not recall learning about the relationship between the
price of oil and the value of the recycled pellets. He was
encouraged that Alter and other members of Shea & Gould were
investing in a Plastics Recycling transaction.
Zimmer never read the Poly Reclamation offering memorandum
and never asked to see it. He claims that he expected to receive
royalty payments, but he did not independently investigate
whether the recycled pellets had any value. When asked if he was
aware that the first-year tax benefits would exceed the amount of
his investment, Zimmer stated: "I don't know that I was aware of
that. Yes, I am now. I knew it had a certain advantage. The
monetary, I honestly--it never made any impression upon me. No
one--if it was explained to me, it went by me, it went over my
head." Zimmer decided to invest in Poly Reclamation based on his
meeting with Alter and Feinstein. He recalled receiving progress
- 26 -
reports regarding Poly Reclamation from Alter's office. As he
recalled: "To be honest with you, I didn't pay that much
attention to anything I got but I know that I got very infrequent
reports * * *. It was minuscule."
OPINION
We have decided a large number of the Plastics Recycling
group of cases. Provizer v. Commissioner, T.C. Memo. 1992-177,
affd. without published opinion 996 F.2d 1216 (6th Cir. 1993),
concerned the substance of the partnership transaction and also
the additions to tax. See also Sann v. Commissioner, T.C. Memo
1997-259 and cases cited therein. The majority of these cases,
like the present cases, raised issues regarding additions to tax
for negligence and valuation overstatement. We have found the
taxpayers liable for such additions to tax in all but one of the
opinions to date on these issues.
In Provizer v. Commissioner, supra, a test case for the
Plastics Recycling group of cases, this Court (1) found that each
Sentinel EPE recycler had a fair market value not in excess of
$50,000, (2) held that the Clearwater transaction was a sham
because it lacked economic substance and a business purpose, (3)
upheld the section 6659 addition to tax for valuation
overstatement since the underpayment of taxes was directly
related to the overstatement of the value of the Sentinel EPE
recyclers, and (4) held that losses and credits claimed with
respect to Clearwater were attributable to tax-motivated
- 27 -
transactions within the meaning of section 6621(c). In reaching
the conclusion that the transaction lacked economic substance and
a business purpose, this Court relied heavily upon the
overvaluation of the Sentinel EPE recyclers.
Although petitioners have not agreed to be bound by the
Provizer opinion, the Clearwater transaction was considered in
Provizer v. Commissioner, supra, and petitioners Kaliban, Roland,
and Zimmer each stipulated that the Poly Reclamation transaction
is substantially identical to the Clearwater transaction. The
underlying transactions in these cases, and the Sentinel EPE
recyclers purportedly leased by the Partnerships, are the same
type of transaction and same type of machines considered in
Provizer v. Commissioner, supra.
Based on the entire records in these cases, including the
extensive stipulations, testimony of respondent's experts, and
petitioners' testimony, we hold that each of the Partnership
transactions herein was a sham and lacked economic substance. In
reaching this conclusion, we rely heavily upon the overvaluation
of the Sentinel EPE recyclers. Respondent is sustained on the
question of the underlying deficiencies. We note that
petitioners have explicitly conceded this issue in the
stipulations of settled issues filed shortly before trial. The
records plainly support respondent's determinations regardless of
such concessions. For a detailed discussion of the facts and the
- 28 -
applicable law in a substantially identical case that also
involved Clearwater, see Provizer v. Commissioner, supra.
A. Section 6653(a)--Negligence
In notices of deficiency, respondent determined that each of
petitioners was liable for the additions to tax for negligence
under section 6653(a)(1) and (2) for 1981, and that petitioners
Kaliban and Zimmer were liable for the negligence additions to
tax for 1982.12 Petitioners have the burden of proving that
respondent's determinations of these additions to tax are
erroneous. Rule 142(a); Luman v. Commissioner, 79 T.C. 846, 860-
861 (1982).
Section 6653(a)(1) imposes 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) imposes an addition to tax equal
to 50 percent of the interest payable with respect to the portion
of the underpayment attributable to negligence or intentional
disregard of rules or regulations.
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). The question is whether a particular taxpayer's actions
12
As noted, in all but one of the notices of deficiency
respondent referred to sec. 6653(a)(1)(A) and (B). During 1981
and 1982, the negligence additions to tax were provided for under
sec. 6653(a)(1) and (2).
- 29 -
in connection with the transactions were reasonable in light of
his experience and the nature of the investment or business. See
Henry Schwartz Corp. v. Commissioner, 60 T.C. 728, 740 (1973).
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. McPike v. Commissioner, T.C.
Memo. 1996-46. Compare Spears v. Commissioner, T.C. Memo. 1996-
341 with Zidanich v. Commissioner, T.C. Memo. 1995-382.
Petitioners maintain that they were reasonable in claiming
deductions and credits with respect to the Partnerships. They
argue that they expected an economic profit in light of the so-
called oil crisis in the United States in 1981 and that they
reasonably relied upon Alter and Feinstein as qualified advisers
on this matter.
1. The So-Called Oil Crisis
Petitioners in their posttrial briefs each contend that they
reasonably expected to make an economic profit from the
Partnerships because plastic is an oil derivative and the United
States was experiencing a so-called oil crisis during the year
1981. Based upon our review of the records, we find petitioners'
claims unconvincing, regardless of the so-called oil crisis.
Moreover, testimony by one of respondent's experts establishes
that the oil pricing changes during the late 1970's and early
1980's did not justify petitioners' claiming excessive investment
- 30 -
credits and purported losses based on vastly exaggerated
valuations of recycling machinery.
Petitioners did not educate themselves in, or personally
investigate, the Plastics Recycling transactions. They did
nothing more than discuss the transactions with Alter and
Feinstein. Petitioners did not even read the offering materials.
Asked during his direct examination if he had any recollection of
the relationship between the projected profitability of Poly
Reclamation and the price of oil, and whether it was described to
him by Alter and Feinstein, Zimmer replied: "I don't believe
so." Based upon the records in these cases, we are not convinced
that petitioners gave due consideration to any business aspects
of the Partnerships. Petitioners have failed to show that they
intended and reasonably expected to make an economic profit from
the transactions, except from tax benefits.
Moreover, petitioners did not adequately explain how the so-
called oil crisis provided a reasonable basis for them to invest
in the Partnerships and claim the associated tax deductions and
credits. Although petitioners chose not to read them, the
offering memoranda warned that there could be no assurances that
prices for new resin pellets would remain at their then-current
level. Also, one of respondent's experts, Steven Grossman,
explained that the price of plastics materials is not directly
proportional to the price of oil. In his report, he stated that
less than 10 percent of crude oil is utilized for making plastics
- 31 -
materials and that studies have shown that "a 300% increase in
crude oil prices results in only a 30 to 40% increase in the cost
of plastics products." Furthermore, during 1980 and 1981, in
addition to the media coverage of the so-called oil crisis, there
was "extensive continuing press coverage of questionable tax
shelter plans." Zmuda v. Commissioner, 731 F.2d 1417, 1422 (9th
Cir. 1984), affg. 79 T.C. 714 (1982).
Petitioners' reliance on Krause v. Commissioner, 99 T.C. 132
(1992), affd. sub nom. Hildebrand v. Commissioner, 28 F.3d 1024
(10th Cir. 1994), is misplaced. The facts in the Krause case are
distinctly different from the facts of these cases. In the
Krause case, the taxpayers invested in limited partnerships whose
investment objectives concerned enhanced oil recovery (EOR)
technology. The Krause opinion states that during the late
1970's and early 1980's, the Federal Government adopted specific
programs to aid research and development of EOR technology. Id.
at 135-136. In holding that the taxpayers in the Krause case
were not liable for the negligence additions to tax, this Court
noted that one of the Government's expert witnesses acknowledged
that "investors may have been significantly and reasonably
influenced by the energy price hysteria that existed in the late
1970s and early 1980s to invest in EOR technology." Id. at 177.
In the present cases, however, as explained by respondent's
expert Steven Grossman, the price of plastics materials was not
directly proportional to the price of oil, and there is no
- 32 -
persuasive evidence that the so-called oil crisis had a
substantial bearing on petitioners' decisions to invest. While
EOR was, according to our Krause opinion, in the forefront of
national policy and the media during the late 1970's and 1980's,
there is no showing in these records that the so-called energy
crisis would provide a reasonable basis for petitioners'
investing in recycling of polyethylene, particularly in the
machinery here in question.
In addition, the taxpayers in the Krause case were
experienced in or investigated the oil industry and EOR
technology specifically. One of the taxpayers in the Krause case
undertook significant investigation of the proposed investment
including researching EOR technology. The other taxpayer was a
geological and mining engineer whose work included research of
oil recovery methods and who hired an independent geologic
engineer to review the offering materials. Id. at 166. In the
present cases, petitioners were not experienced or educated in
plastics recycling, and they did not independently investigate
the Sentinel recyclers or hire an expert in plastics to evaluate
the Partnership transactions. We consider petitioners' arguments
with respect to the Krause case inapplicable.
2. Petitioners' Purported Reliance on Advisers
Petitioners contend that they reasonably relied upon Alter
and Feinstein as qualified advisers on this matter.
- 33 -
A taxpayer may avoid liability for the additions to tax
under section 6653(a)(1) and (2) if he or she reasonably relied
on competent professional advice. United States v. Boyle, 469
U.S. 241, 250-251 (1985); Freytag v. Commissioner, 89 T.C. 849,
888 (1987), affd. 904 F.2d 1011 (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. Freytag v. Commissioner, supra. For reliance on
professional advice to excuse a taxpayer from the negligence
additions to tax, the taxpayer must show that such professional
had the expertise and knowledge of the pertinent facts to provide
informed advice on the subject matter. David v. Commissioner, 43
F.3d 788, 789-790 (2d Cir. 1995), affg. T.C. Memo. 1993-621;
Goldman v. Commissioner, 39 F.3d 402 (2d Cir. 1994), affg. T.C.
Memo. 1993-480; Freytag v. Commissioner, supra; Buck v.
Commissioner, T.C. Memo. 1997-191; Sacks v. Commissioner, T.C.
Memo. 1994-217, affd. 82 F.3d 918 (9th Cir. 1996); Kozlowski v.
Commissioner, T.C. Memo. 1993-430, affd. without published
opinion 70 F.3d 1279 (9th Cir. 1995); see also Friedman v.
Commissioner, T.C. Memo. 1996-558; Gollin v. Commissioner, T.C.
Memo. 1996-454; Stone v. Commissioner, T.C. Memo. 1996-230;
Reimann v. Commissioner, T.C. Memo. 1996-84.
Reliance on representations by insiders, promoters, or
offering materials has been held an inadequate defense to
negligence. Goldman v. Commissioner, supra; Pasternak v.
- 34 -
Commissioner, 990 F.2d 893 (6th Cir. 1993), affg. Donahue v.
Commissioner, T.C. Memo. 1991-181; 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 (1989); Rybak v. Commissioner,
91 T.C. 524, 565 (1988). Pleas of reliance have been rejected
when neither the taxpayer nor the advisers purportedly relied
upon by the taxpayer knew anything about the nontax business
aspects of the contemplated venture. David v. Commissioner,
supra, Goldman v. Commissioner, supra; Freytag v. Commissioner,
supra; Beck v. Commissioner, 85 T.C. 557 (1985); Buck v.
Commissioner, supra; Lax v. Commissioner, T.C. Memo. 1994-329,
affd. without published opinion 72 F.3d 123 (3d Cir. 1995); Sacks
v. Commissioner, supra; Steerman v. Commissioner, T.C. Memo.
1993-447; Rogers v. Commissioner, T.C. Memo. 1990-619; see Sann
v. Commissioner, T.C. Memo. 1997-259 and the Plastics Recycling
cases cited therein.
Alter and Feinstein did not actively seek prospective
investments for petitioners. In addition to legal services, they
provided a bookkeeping and cash management service. They
received petitioners' income and paid their bills (except for
the Webers) and provided periodic financial statements.
- 35 -
Feinstein also prepared all of petitioners' tax returns. Alter
explained his and Feinstein's limited involvement in petitioners'
investment activity as follows:
The clients in almost all cases when they had an
investment proposal presented to them asked for our
opinion as to its validity and merit, and to the extent
that we were able to give advice, we gave advice.
* * * * * * *
Of course you should understand that many of these
clients were high income performers. They had
presented to them very frequently from other performers
proposals that involved * * * tax shelters, and they
brought them into our office for review.
Under my review or at my direction, Mr. Feinstein
reviewed these proposals and they involved all sorts of
* * * tax shelters and invariably these proposals were
rejected as being without merit. [Emphasis added.]
Feinstein explained that petitioners "would come in and say, I
spoke with so-and-so, he's got a terrific thing that was going to
make a lot of money or something and why don't you find out
something about it and let us know--let me know what you find
out."
Alter mentioned a few investments to petitioners for their
consideration, such as the Plastics Recycling transactions. He
did not, however, recommend that petitioners invest in the
Partnerships. Asked if, "in connection with the making of this
investment yourself, and in recommending" the investment to his
clients, he earned a commission, Alter replied: "No, I did not,
and I would like to correct your use of the word 'recommend.' I
told them I was going into it and it seemed sound, and if they
- 36 -
were interested they could participate as well." (Emphasis
added.) Alter reiterated this point on cross-examination in the
following exchange:
Q Did you suggest that your clients consult with
others who were plastics experts?
A No. I told them that I was investing and that it
seemed like a sound investment to me, and if they were
interested they could participate as well.
Q Did you recommend the investment?
A To the extent that I just stated.
Feinstein recalled Alter's presentation of the transactions as
follows: "It is my recollection and based on how I was and he
was with clients, that it was a possible investment. He thought
it would work for them and would work as an investment with no--
no pressure at all. * * * Most certainly not pressure." With
respect to what Feinstein himself advised petitioners, Feinstein
could not recall if he was asked for a recommendation, and could
only venture that "I probably would have said that it's--it's a
type of situation".13
Petitioners maintain that they reasonably inferred that
Alter's personal decision to invest was a tacit recommendation of
the Plastics Recycling transactions, particularly given his
history of rejecting tax shelters that had been suggested to them
13
In answers to interrogatories, incorporated into a
stipulation, petitioner Zimmer indicated that in his view Alter
and Feinstein had recommended the Plastics Recycling investment
to him. The testimony of Alter and Feinstein clarifies this
limited and qualified stipulation.
- 37 -
by others. However, petitioners failed to take adequately into
account Alter's lack of education and experience in plastics
materials and plastics recycling, and the limited nature of his
investigation of the Plastics Recycling transactions. Moreover,
it was Feinstein who reviewed the other tax shelters for
petitioners, not Alter, and Feinstein was primarily responsible
for reviewing the Plastics Recycling transactions. Petitioners
were well aware that Feinstein handled such work for Alter. In
their posttrial briefs, petitioners state that they "came to
value Feinstein's wisdom and ability to analyze financial data
and appraise the economic potential of a prospective investment."
Unlike Alter, however, Feinstein did not invest in the Plastics
Recycling transactions. In any event, under the circumstances of
these cases, petitioners' characterization of how Alter and/or
Feinstein presented the Plastics Recycling transactions to them
is not dispositive of the issue. See Buck v. Commissioner, T.C.
Memo. 1997-191.
Alter and Feinstein conducted a limited investigation of the
Plastics Recycling transactions. Alter read the offering
materials, discussed the investment with others at Shea & Gould,
and spoke to Winer. The colleagues he spoke to included
Hirshfield, Carroll, Parker, and Ferraro, but he primarily relied
upon Feinstein, in whom Alter indicated he reposed particular
confidence based upon their long professional association. Alter
recalled the investigation by his colleagues at Shea & Gould in
- 38 -
general terms, and portions of his testimony were different from
Feinstein's recollection of events. For example, Alter testified
that he asked Feinstein to speak with Parker, but Feinstein
testified that Parker "didn't speak to me." Also, Alter was
under the impression that "Feinstein's friend" (Lauren) had read
the Poly Reclamation offering memorandum, but Feinstein testified
that Lauren had not seen an offering memorandum. With respect to
Winer, Alter believed that he indicated that end-users had been
scheduled for the machines, but Winer did not name the end-users.
Alter accepted at face value all of the representations made
in the offering materials, including the value of the Sentinel
EPE recycler. During the course of his testimony, he was asked
what made the Sentinel EPE recycler unique. He replied:
Again, I'm not an expert in the industry. I believe
the representation was that they had a special fluid
cooling process that was not available elsewhere. They
made the representations that it had a dual set of
blades, I believe, rotary blades, exterior rotary
blade[s] as well as the interior blades, that would
crush the plastic material more effectively.
In Provizer v. Commissioner, T.C. Memo. 1992-177, PI's vice
president of manufacturing and a developer of PI's prototype
recycler, William Strlzelewicz,
explained that the coolant used in the process was
plain water and not some "trade secret" chemical
compound. End-users stated that a usual method by
which the water might be "injected" was for a factory
worker to dump it on the heated material.
Asked what he did to confirm the value of the machine, Alter
testified: "I had no competence to do that, to do any
- 39 -
comparison." Alter did not hire an expert to value the Sentinel
EPE recycler, and he knew that Feinstein and Lauren had not made
a judgment as to the value of the machine.
Feinstein's investigation of the Plastics Recycling
transactions was similarly limited. He spoke with Lauren, who
may have had some insight into plastics materials, but Feinstein
only asked Lauren about PI's reputation. Feinstein did not
provide Lauren with a copy of an offering memorandum, or ask him
about the prospects for a Sentinel EPE recycler, or inquire as to
whether there were any competing machines already on the market.
He accepted the purported value of the Sentinel EPE recycler
after speaking with a friend and associate "about pricing and how
things are priced in * * * [the plastics] industry." The friend
and associate--unidentified by Feinstein--did nothing more than
confirm that the stream-of-income method of valuation was
commonly used. Feinstein did not verify any of the underlying
assumptions upon which the income projections in the offering
materials were based.
Neither Feinstein nor Lauren visited PI to see a Sentinel
EPE recycler, or investigated whether competitive machines
existed, or made a judgment as to the value of the machine.
Feinstein testified that he had telephone conversations with
Winer, but Feinstein did not explain the substance of Winer's
comments. See Howard v. Commissioner, 931 F.2d 578, 582 (9th
Cir. 1991), affg. T.C. Memo. 1988-531; Patin v. Commissioner, 88
- 40 -
T.C. 1086, 1131 (1987), affd. without published opinion 865 F.2d
1264 (5th Cir. 1989), affd. without published opinion sub nom.
Hatheway v. Commissioner, 856 F.2d 186 (4th Cir. 1988), affd. sub
nom. Skeen v. Commissioner, 864 F.2d 93 (9th Cir. 1989), affd.
sub nom. Gomberg v. Commissioner, 868 F.2d 865 (6th Cir. 1989),
sustaining negligence determinations despite claims by taxpayers
that they relied on advisers, where such advisers lacked relevant
expertise or knowledge of underlying transactions. Feinstein
claimed that he came to a positive conclusion with respect to the
soundness of the Plastics Recycling transactions, and that he
communicated this conclusion to Alter. However, Feinstein did
not personally invest in a Plastics Recycling transaction; nor
did his friend Lauren. In the end, Alter and Feinstein relied on
the offering materials and representations by insiders for the
value of the machines and the economic viability of the Plastics
Recycling transactions. See Vojticek v. Commissioner, T.C. Memo.
1995-444, to the effect that advice from such persons "is better
classified as sales promotion."
We hold that petitioners' purported reliance on Alter and
Feinstein was not reasonable, not in good faith, nor based upon
full disclosure. Petitioners' testimony in these cases was self-
serving and in significant respects not credible, and this Court
is not required to accept it as true. Wood v. Commissioner, 338
F.2d 602, 605 (9th Cir. 1964), affg. 41 T.C. 593 (1964);
Niedringhaus v. Commissioner, 99 T.C. 202, 212 (1992); Tokarski
- 41 -
v. Commissioner, 87 T.C. 74, 77 (1986); Snyder v. Commissioner,
T.C. Memo. 1995-285; Sacks v. Commissioner, T.C. Memo. 1994-217.
We find petitioners' claims of financial naivete and ignorance,
particularly with respect to the nature and amount of the tax
benefits, disingenuous.14 The direct reductions claimed on
petitioners' 1981 tax returns, from the investment tax credits
alone, equaled 173 percent of their cash investments. Therefore,
like the taxpayers in Provizer v. Commissioner, supra, "except
for a few weeks at the beginning, petitioners [Kaliban, Roland,
Weber, and Zimmer] never had any money in the * * * [Partnership
transactions]." A reasonably prudent person would have asked a
qualified adviser if such a windfall were not too good to be
true. McCrary v. Commissioner, 92 T.C. at 850.
The purported value of the Sentinel EPE recycler generated
the deductions and credits in these cases, and that circumstance
was reflected in the offering memoranda. Petitioners chose not
to read the offering materials, but Alter and Feinstein did read
them. Certainly Feinstein recognized and understood the nature
of the tax benefits, and he discussed it with Alter. Together
they met with each of petitioners and, as Feinstein recalled:
14
In their posttrial briefs, petitioners claim that they "had
no knowledge of the extent of the tax benefits available to
investors in" the Partnerships or that "the tax benefits in the
first year would exceed" their respective investments. However,
the majority of the previous investments they had asked Alter and
Feinstein to review, if not all of them, were tax shelters. The
notion that Alter and Feinstein failed to highlight the amounts
of the tax benefits generated by the Partnerships is incredible.
- 42 -
"touched on what we had all learned about the background of the
people, what I had learned by my discussions with people, what
the other partners had learned about the venture and conveyed to
me." As a result of these meetings, petitioners learned about
the nature of the tax benefits, as well as Alter's and
Feinstein's reliance on the offering materials and
representations by insiders for the value of the machines and the
economic viability of the Plastics Recycling transactions.
Neither Alter nor Feinstein had any expertise or experience
in plastics materials or plastics recycling, and petitioners had
no reason to believe otherwise. Alter had no competence to value
the machines, and neither he nor Feinstein independently
confirmed their value or the economic viability of the Plastics
Recycling transactions. The records in these cases show that
petitioners clearly possessed the intelligence and background to
recognize that further investigation was required. A taxpayer
may rely upon his adviser's expertise, but it is not reasonable
or prudent for a taxpayer to rely upon an adviser regarding
matters outside of his field of expertise or with respect to
facts that he does not verify. See David v. Commissioner, 43
F.3d at 789-790; Goldman v. Commissioner, 39 F.3d at 408; Skeen
v. Commissioner, supra; Lax v. Commissioner, T.C. Memo. 1994-329;
Sacks v. Commissioner, supra; Rogers v. Commissioner, T.C. Memo.
1990-619.
- 43 -
3. Miscellaneous
The parties in these consolidated cases stipulated that the
fair market value of a Sentinel EPE recycler in 1981 and up to
1982 was not in excess of $50,000. Notwithstanding this
concession, petitioners contend that they were reasonable in
claiming credits on their Federal income tax returns based upon
each recycler having a value of $1,162,666. In support of this
position, petitioners submitted into evidence preliminary reports
prepared for respondent by Ernest D. Carmagnola (Carmagnola), the
president of Professional Plastic Associates. Carmagnola had
been retained by the IRS in 1984 to evaluate the Sentinel EPE and
EPS recyclers in light of what he described as "the fantastic
values placed on the * * * [recyclers] by the owners." Based on
limited information available to him at that time, Carmagnola
preliminarily estimated that the value of the Sentinel EPE
recycler was $250,000. However, after additional information
became available to him, Carmagnola concluded in a signed
affidavit, dated March 16, 1993, that the machines actually had a
fair market value of not more than $50,000 each in the fall of
1981.
We accord no weight to the Carmagnola reports submitted by
petitioners. The projected valuations therein were based on
inadequate information, research, and investigation, and were
subsequently rejected and discredited by their author. In one
- 44 -
preliminary report, Carmagnola states that he has "a serious
concern of actual profit" of a Sentinel EPE recycler and that to
determine whether the machines actually could be profitable, he
required additional information from PI. Carmagnola also
indicates that in preparing the report, he did not have
information available concerning research and development costs
of the machines and that he estimated those costs in his
valuations of the machines.
Respondent rejected the Carmagnola reports and considered
them unsatisfactory for any purpose, and there is no indication
in the records that respondent used them as a basis for any
determinations in the notices of deficiency. Even so, counsel
for petitioners obtained copies of these reports and urge that
they support the reasonableness of the values reported on
petitioners' returns. Not surprisingly, petitioners' counsel did
not call Carmagnola to testify in these cases, but preferred
instead to rely solely upon his preliminary ill-founded valuation
estimates. (Carmagnola has not been called to testify in any of
the Plastics Recycling cases before us.) The Carmagnola reports
were a part of the record considered by this Court and reviewed
by the Court of Appeals for the Sixth Circuit in the Provizer
case, where we held the taxpayers negligent. Consistent
therewith, we find in these cases, as we have found previously,
that the reports prepared by Carmagnola are unreliable and of no
- 45 -
consequence. Petitioners are not relieved of the negligence
additions to tax based on the preliminary reports prepared by
Carmagnola.
Petitioners also submitted several documents into the
records of their cases as evidence that they monitored their
investments. Of those documents, just one concerned Poly
Reclamation and none concerned Clearwater. The one that
concerned Poly Reclamation, dated September 30, 1982, indicated
that three of its Sentinel EPE recyclers had been placed and were
running.15 The remaining documents included two financial
statements for another Plastics Recycling partnership, Stevens
Recycling Associates (Stevens), for the years ended 1982, 1983,
and 1984; two reports regarding the placement of the Sentinel EPS
recyclers owned by Stevens; and an August 29, 1985, letter that
discussed "the impossible pricing situation that continues in the
polystyrene market." On the subject of the progress reports,
Zimmer testified: "To be honest with you, I didn't pay that much
attention to anything I got but I know that I got very infrequent
reports * * *. It was minuscule." We are not convinced from the
lone Poly Reclamation progress report that petitioners monitored
or took an active interest in their investments in the
15
The Sept. 30, 1982 update concerning Poly Reclamation was
not made a part of the record in docket No. 10802-89 (the Weber
case).
- 46 -
Partnerships, particularly in view of their lack of effort to
learn about or independently investigate the Plastics Recycling
transactions prior to investing in them.
Petitioners cite a number of cases in support of their
positions, but primarily rely on Balboa Energy Fund 1981 v.
Commissioner, 85 F.3d 634 (9th Cir. 1996), affg. in part and
revg. in part without published opinion Osterhout v.
Commissioner, T.C. Memo. 1993-251; Durrett v. Commissioner, 71
F.3d 515 (5th Cir. 1996), affg. in part and revg. in part T.C.
Memo. 1994-179; Chamberlain v. Commissioner, 66 F.3d 729 (5th
Cir. 1995), affg. in part and revg. in part T.C. Memo. 1994-228;
Wright v. Commissioner, T.C. Memo. 1994-288; Wood v.
Commissioner, T.C. Memo. 1991-205; Davis v. Commissioner, T.C.
Memo. 1989-607; Mollen v. United States, 72 AFTR 2d 93-6443, 93-2
USTC par. 50,585 (D. Ariz. 1993).
Petitioners' reliance on the Wright, Wood, and Davis cases,
wherein this Court declined to sustain the negligence additions
to tax, is misplaced. In the Wright case, the taxpayers, who
suddenly had acquired wealth after a lifetime of modest earnings,
relied upon a well-recommended financial planner who expressly
recommended the subject investment as part of an overall plan
that included a variety of investments. The taxpayers reviewed
the offering memorandum and were advised that the investment
partnership already had been audited by the IRS and that the
- 47 -
audit had resulted in no change. They agreed to the overall plan
with the objective of making a profit and personally monitored
the investment. In Wood, a group of consolidated cases, a
financial planner recommended the investment, all of the
taxpayers had profit objectives, the transactions were not sham
transactions, and one pair of taxpayers inspected the equipment
at issue. In the Davis case, the taxpayers relied in part upon
the express recommendation of a "trusted and long-term adviser",
and in part upon their review of the offering materials, which
did not reflect that the principals in the venture lacked
experience in the pertinent line of business.
The facts of petitioners' cases differ in several key
respects from the Wright, Wood, and Davis cases. Unlike the
Wright and Wood cases, petitioners' purported advisers were not
financial planners actively seeking out investment opportunities
for them. In contrast to all three cases, petitioners' purported
advisers did not expressly recommend that they invest in the
Partnerships. Also, none of petitioners read the offering
memoranda, saw a Sentinel EPE recycler, or made any effort to
learn about the Plastics Recycling transactions beyond discussing
them with Alter and Feinstein. In addition, the Partnership
transactions are shams lacking economic substance, and we are not
convinced that any of petitioners had an honest objective of
- 48 -
making an economic profit. Accordingly, we consider petitioners'
reliance on the Wright, Wood, and Davis cases misplaced.
In Mollen v. United States, supra, the taxpayer was a
medical doctor who specialized in diabetes and who, on behalf of
the Arizona Medical Association, led a continuing medical
education (CME) accreditation program for local hospitals. The
underlying tax matter involved the taxpayer's investment in
Diabetics CME Group, Ltd., a limited partnership that invested in
the production, marketing, and distribution of medical
educational video tapes. The District Court found that the
taxpayer's personal expertise and insight in the underlying
investment gave him reason to believe it would be economically
profitable. Although the taxpayer was not experienced in
business or tax matters, he did consult with an accountant and a
tax lawyer regarding those matters. Moreover, the District Court
noted that the propriety of the taxpayer's disallowed deduction
therein was "reasonably debatable." Id. at 93-6447, 93-2 USTC
par. 50,585, at 89,895; see Zfass v. Commissioner, T.C. Memo.
1996-167.
In contrast, in these cases neither petitioners nor their
purported advisers had any personal insight or industry know-how
in plastics recycling that would reasonably lead them to believe
that the Plastics Recycling transactions would be economically
- 49 -
profitable.16 Feinstein spoke to Lauren, but their discussion
was limited to Lauren's impression of PI. Lauren did not read an
offering memorandum, see a Sentinel EPE recycler, or do any type
of investigation into the plastics recycling market. Neither
petitioners nor their purported advisers hired any independent
experts in the field of plastic materials or plastics recycling.
They relied upon the offering materials and representations by
insiders to the Plastics Recycling transactions. Accordingly, we
consider petitioners' arguments with respect to the Mollen case
inapplicable under the circumstances of these cases.
Petitioners' reliance upon the Court of Appeals for the
Ninth Circuit's partial reversal of our decision in Osterhout v.
Commissioner, supra, is misplaced. In Osterhout, we found that
certain oil and gas partnerships were not engaged in a trade or
business and sustained the Commissioner's imposition of the
negligence additions to tax with respect to one of the partners
therein.17 The Court of Appeals for the Ninth Circuit reversed
16
Alter claimed that he spoke to Ferraro, who apparently
worked for one or more summers at a plastics company, and
Carroll, who purportedly had an engineering background. However,
neither Ferraro nor Carroll testified in these cases, and the
records fail to establish that they were qualified to analyze the
Sentinel EPE recycler or the Plastics Recycling transactions.
Further, Feinstein testified that he did not believe Ferraro or
any of the other members of Shea & Gould that he spoke with had
any education or experience in the plastics industry.
17
Osterhout v. Commissioner, T.C. Memo. 1993-251, affd. in
(continued...)
- 50 -
our imposition of the negligence additions to tax. Petitioners
point out that the taxpayer in that case relied in part upon a
tax opinion contained in the offering materials. However, none
of petitioners in the cases before us read the Poly Reclamation
or Clearwater offering memoranda, let alone the tax opinions
appended thereto.
Moreover, the offering memoranda for the Partnerships herein
warned prospective investors that the accompanying tax opinion
letters were not in final form, and were prepared for the general
partner, and that prospective investors should consult their own
professional advisers with respect to the tax benefits and tax
risks associated with the Partnerships. The tax opinion letters
accompanying the Clearwater and Poly Reclamation offering
memoranda were addressed solely to the general partner and began
with the following opening disclaimer:
This opinion is provided to you for your individual
guidance. We expect that prospective investors will
rely upon their own professional advisors with respect
to all tax issues arising in connection with their
investment in the Partnership and the operations
thereof. We recognize that you intend to include this
17
(...continued)
part and revd. in part without published opinion sub nom. Balboa
Energy Fund 1981 v. Commissioner, 85 F.3d 634 (9th Cir. 1996),
involved a group of consolidated cases. The parties therein
agreed to be bound by the Court's opinion regarding the
application of the additions to tax under sec. 6653(a), inter
alia. Accordingly, although the Court's analysis focused on one
taxpayer, the additions to tax were sustained with respect to all
of the taxpayers.
- 51 -
letter with your offering materials and we have
consented to that with the understanding that the
purpose in distributing it is to assist your offerees'
tax advisors in making their own analysis and not to
permit any prospective investor to rely upon our advice
in this matter. [Emphasis added.]
Accordingly, the tax opinion letters expressly indicated that
prospective investors such as petitioners were not to rely upon
the tax opinion letter. See Collins v. Commissioner, 857 F.2d
1383, 1386 (9th Cir. 1988), affg. Dister v. Commissioner, T.C.
Memo. 1987-217. The limited, technical opinion of tax counsel
expressed in these letters was not designed as advice upon which
taxpayers might rely, and the opinion of counsel itself so
states.
Petitioners' reliance on the Durrett and Chamberlain cases
is also misplaced. In those cases, the Court of Appeals for the
Fifth Circuit reversed this Court's imposition of the negligence
additions to tax in two nonplastics recycling cases. The
taxpayers in the Durrett and Chamberlain cases were among
thousands who invested in the First Western tax shelter program
involving alleged straddle transactions of forward contracts. In
the Durrett and Chamberlain cases, the Court of Appeals for the
Fifth Circuit concluded that the taxpayers reasonably relied upon
professional advice concerning tax matters. In other First
Western cases, however, the Courts of Appeals have affirmed
decisions of the Tax Court imposing negligence additions to tax.
- 52 -
See Foulds v. Commissioner, T.C. Memo. 1994-489 (the well-
educated taxpayer failed to establish the substance of advice,
and the purported adviser lacked tax expertise), affd. without
published opinion 94 F.3d 651 (9th Cir. 1996); Chakales v.
Commissioner, T.C. Memo. 1994-408 (reliance on a long-term
adviser, who was a tax attorney and accountant, and who in turn
relied on a promoter of the venture, held unreasonable), affd. 79
F.3d 726 (8th Cir. 1996); Kozlowski v. Commissioner, T.C. Memo.
1993-430 (reliance on an adviser held unreasonable absent a
showing that the adviser understood the transaction and was
qualified to give an opinion whether it was bona fide), affd.
without published opinion 70 F.3d 1279 (9th Cir. 1995); Freytag
v. Commissioner, 89 T.C. at 849 (reliance on tax advice given by
attorneys and C.P.A.'s held unreasonable absent a showing that
the taxpayers consulted any experts regarding the bona fides of
the transactions). The records in the cases before us establish
that Alter and Feinstein did not possess sufficient knowledge of
the plastics or recycling industries to render a competent
opinion.18 See Friedman v. Commissioner, T.C. Memo. 1996-558.
18
This fact has been deemed relevant by the Court of Appeals
for the Second Circuit. See David v. Commissioner, 43 F.3d 788,
789-790 (2d Cir. 1995) (taxpayers' reliance on expert advice not
reasonable where expert lacks knowledge of business in which
taxpayers invested), affg. T.C. Memo. 1993-621; Goldman v.
Commissioner, 39 F.3d 402, 408 (2d Cir. 1994) (same), affg. T.C.
Memo. 1993-480. The Court of Appeals for the Second Circuit is
(continued...)
- 53 -
Accordingly, petitioners will not be relieved of the negligence
additions to tax based upon the decisions in the Durrett and
Chamberlain cases by the Court of Appeals for the Fifth Circuit.
4. Conclusion as to Negligence
Under the circumstances of these consolidated cases,
petitioners failed to exercise due care in claiming large
deductions and tax credits with respect to the Partnerships on
their Federal income tax returns. Petitioners did not read the
offering materials or otherwise learn about or independently
investigate the Plastics Recycling transactions aside from
speaking with Alter and Feinstein. Alter and Feinstein are not
investment planners and they did not perform such services for
petitioners. Petitioners' purported advisers had no education or
experience in plastics materials or plastics recycling and
ultimately relied upon the offering materials with respect to the
capabilities and market demand for the machines. We hold that
petitioners did not reasonably rely upon Alter and Feinstein.
The records in these cases indicate that Alter and Feinstein knew
that the tax benefits were contingent upon the purported value of
the Sentinel EPE recycler, and that they explained all that they
had learned to petitioners. Yet neither petitioners nor their
18
(...continued)
the court to which appeal in the Kaliban, Roland, and Zimmer
cases lies. See Golsen v. Commissioner, 54 T.C. 742, 756-758
(1970), affd. 445 F.2d 985 (10th Cir. 1971).
- 54 -
purported advisers in good faith investigated the fair market
value of a Sentinel EPE recycler, or the underlying viability,
financial structure, and economics of the Partnership
transactions. We hold, upon consideration of the entire records,
that petitioners are liable for the negligence additions to tax
under section 6653(a)(1) and (2) for the taxable years at issue.
Respondent is sustained on this issue.
B. Section 6659--Valuation Overstatement
In the notices of deficiency for 1981, respondent determined
that petitioners were each liable for the section 6659 addition
to tax on the portions of their respective underpayments
attributable to valuation overstatement. Petitioners have the
burden of proving that respondent's determinations of the section
6659 additions to tax in their cases are erroneous. Rule 142(a);
Luman v. Commissioner, 79 T.C. at 860-861.
A graduated addition to tax is imposed when an individual
has an underpayment of tax that equals or exceeds $1,000 and "is
attributable to" a valuation overstatement. Sec. 6659(a), (d).
A valuation overstatement exists if the fair market value (or
adjusted basis) of property claimed on a return equals or exceeds
150 percent of the amount determined to be the correct amount.
Sec. 6659(c). If the claimed valuation exceeds 250 percent of
the correct value, the addition is equal to 30 percent of the
underpayment. Sec. 6659(b).
- 55 -
Petitioners claimed tax benefits, including investment tax
credits and business energy credits, based on purported values of
$1,162,666 for each Sentinel EPE recycler. Petitioners concede
that the fair market value of a Sentinel EPE recycler in 1981 was
not in excess of $50,000. Therefore, if disallowance of
petitioners' claimed tax benefits is attributable to such
valuation overstatements, petitioners are liable for the section
6659 additions to tax at the rate of 30 percent of the
underpayments of tax attributable to the tax benefits claimed
with respect to the Partnerships.
Petitioners contend that section 6659 does not apply in
their cases for the following three reasons: (1) Disallowance of
the claimed tax benefits was attributable to other than a
valuation overstatement; (2) petitioners' concessions of the
claimed tax benefits preclude imposition of the section 6659
additions to tax; and (3) respondent erroneously failed to waive
the section 6659 additions to tax. We reject each of these
arguments for reasons set forth below.
1. The Grounds for Petitioners' Underpayments
Section 6659 does not apply to underpayments of tax that are
not "attributable to" valuation overstatements. See McCrary v.
Commissioner, 92 T.C. at 827; Todd v. Commissioner, 89 T.C. 912
(1987), affd. 862 F.2d 540 (5th Cir. 1988). To the extent
taxpayers claim tax benefits that are disallowed on grounds
- 56 -
separate and independent from alleged valuation overstatements,
the resulting underpayments of tax are not regarded as
attributable to valuation overstatements. Krause v.
Commissioner, 99 T.C. at 178 (citing Todd v. Commissioner,
supra). However, when valuation is an integral factor in
disallowing deductions and credits, section 6659 is applicable.
See Illes v. Commissioner, 982 F.2d 163, 167 (6th Cir. 1992),
affg. T.C. Memo. 1991-449; Gilman v. Commissioner, 933 F.2d 143,
151 (2d Cir. 1991) (the section 6659 addition to tax applies if a
finding of lack of economic substance is "due in part" to a
valuation overstatement), affg. T.C. Memo. 1989-684; Masters v.
Commissioner, T.C. Memo. 1994-197, affd. without published
opinion 70 F.3d 1262 (4th Cir. 1995); Harness v. Commissioner,
T.C. Memo. 1991-321.
Petitioners argue that the disallowance of the claimed tax
benefits was not "attributable to" a valuation overstatement.
According to petitioners, the tax benefits were disallowed
because the Partnership transactions lacked economic substance,
not because of any valuation overstatements. It follows,
petitioners reason, that because the "attributable to" language
of section 6659 requires a direct causative relationship between
a valuation overstatement and an underpayment in tax, section
6659 cannot apply to their deficiencies. Petitioners cite the
following cases to support this argument: Heasley v.
- 57 -
Commissioner, 902 F.2d 380 (5th Cir. 1990), revg. T.C. Memo.
1988-408; Gainer v. Commissioner, 893 F.2d 225 (9th Cir. 1990),
affg. T.C. Memo. 1988-416; McCrary v. Commissioner, supra; and
Todd v. Commissioner, supra.
Petitioners' argument rests on the mistaken premise that our
holding herein that the Partnership transactions lacked economic
substance was separate and independent from the overvaluation of
the Sentinel EPE recyclers. To the contrary, in holding that the
Partnership transactions lacked economic substance, we relied
heavily upon the overvaluation of the recyclers. Overvaluation
of the recyclers was an integral factor in regard to: (1) The
disallowed tax credits and other benefits in these cases; (2) the
underpayments of tax; and (3) our finding that the Partnership
transactions lacked economic substance.
Petitioners argue that in Provizer v. Commissioner, T.C.
Memo. 1992-177, we found that the Clearwater transaction lacked
economic substance for reasons independent of the valuation
reported in that case. According to petitioners, the purported
value of the recyclers in the Clearwater transaction was
predicated upon a projected stream of royalty income, and this
Court merely rejected the taxpayers' valuation method.
Petitioners misread and distort our Provizer opinion. In the
Provizer case, overvaluation of the Sentinel EPE recyclers,
irrespective of the technique employed by the taxpayers in their
- 58 -
efforts to justify the overvaluation, was the dominant factor
that led us to hold that the Clearwater transaction lacked
economic substance. Likewise, overvaluation of the Sentinel EPE
recyclers in these cases is the ground for our holding herein
that the Partnership transactions lacked economic substance.
Moreover, a virtually identical argument was recently
rejected in Gilman v. Commissioner, supra, by the Court of
Appeals for the Second Circuit. In the Gilman case, the
taxpayers engaged in a computer equipment sale and leaseback
transaction that this Court held was a sham transaction lacking
economic substance. The taxpayers therein, citing Todd v.
Commissioner, supra, and Heasley v. Commissioner, supra, argued
that their underpayment of taxes derived from nonrecognition of
the transaction for lack of economic substance, independent of
any overvaluation. The Court of Appeals for the Second Circuit
sustained imposition of the section 6659 addition to tax because
overvaluation of the computer equipment contributed directly to
this Court's earlier conclusion that the transaction lacked
economic substance and was a sham. Gilman v. Commissioner, supra
at 151. In addition, the Court of Appeals for the Second Circuit
agreed with this Court and with the Court of Appeals for the
Eighth Circuit that "'when an underpayment stems from disallowed
* * * investment credits due to lack of economic substance, the
deficiency is * * * subject to the penalty under section 6659.'"
- 59 -
Id. at 151 (quoting Massengill v. Commissioner, 876 F.2d 616,
619-620 (8th Cir. 1989), affg. T.C. Memo. 1988-427); see also
Rybak v. Commissioner, 91 T.C. at 566-567; Zirker v.
Commissioner, 87 T.C. 970, 978-979 (1986); Donahue v.
Commissioner, T.C. Memo. 1991-181, affd. without published
opinion 959 F.2d 234 (6th Cir. 1992), affd. sub nom. Pasternak v.
Commissioner, 990 F.2d 893 (6th Cir. 1993).
Petitioners' reliance on Gainer v. Commissioner, supra, Todd
v. Commissioner, supra, and McCrary v. Commissioner, 92 T.C. at
827, is misplaced. In those cases, in contrast to the
consolidated cases herein, it was found that a valuation
overstatement did not contribute to an underpayment of taxes. In
the Todd and Gainer cases, the underpayments were due exclusively
to the fact that the property in each case had not been placed in
service. In the McCrary case, the underpayments were deemed to
result from a concession that the agreement at issue was a
license and not a lease. Although property was overvalued in
each of those cases, the overvaluations were not the grounds on
which the taxpayers' liability was sustained. In contrast, "a
different situation exists where a valuation overstatement * * *
is an integral part of or is inseparable from the ground found
for disallowance of an item." McCrary v. Commissioner, supra at
859. Petitioners' cases present just such a "different
situation": overvaluation of the recyclers was integral to and
- 60 -
inseparable from petitioners' claimed tax benefits and our
holding that the Partnership transactions lacked economic
substance.19
2. Concession of the Deficiencies
Petitioners argue that their concessions of the deficiencies
preclude imposition of the section 6659 additions to tax.
Petitioners contend that their concessions render any inquiry
into the grounds for such deficiencies moot. Absent such
inquiry, petitioners argue that it cannot be known whether their
underpayments were attributable to a valuation overstatement or
another discrepancy. Without a finding that a valuation
overstatement contributed to an underpayment, according to
petitioners, section 6659 cannot apply. In support of this line
of reasoning, petitioners rely heavily upon Heasley v.
Commissioner, 902 F.2d 380 (5th Cir. 1990) and McCrary v.
Commissioner, supra.
19
To the extent that Heasley v. Commissioner, 902 F.2d 380
(5th Cir. 1990), revg. T.C. Memo. 1988-408, merely represents an
application of Todd v. Commissioner, 89 T.C. 912 (1987), affd.
862 F.2d 540 (5th Cir. 1988), we consider it distinguishable. To
the extent that the reversal in the Heasley case is based on a
concept that where an underpayment derives from the disallowance
of a transaction for lack of economic substance, the underpayment
cannot be attributable to an overvaluation, this Court and the
Court of Appeals for the Second Circuit have disagreed. See
Gilman v. Commissioner, 933 F.2d 143, 151 (2d Cir. 1991) (The
lack of economic substance was due in part to the overvaluation,
and thus the underpayment was attributable to the valuation
overstatement), affg. T.C. Memo. 1989-684.
- 61 -
Petitioners' open-ended concessions do not obviate our
finding that the Partnership transactions lacked economic
substance due to overvaluation of the recyclers. This is not a
situation where we have "to decide difficult valuation questions
for no reason other than the application of penalties." See
McCrary v. Commissioner, supra at 854 n.14. The value of the
Sentinel EPE recycler was established in Provizer v.
Commissioner, T.C. Memo. 1992-177, and stipulated by the parties.
As a consequence of the inflated value assigned to the recyclers
by the Partnerships, petitioners claimed deductions and credits
that resulted in underpayments of tax, and we held that the
Partnership transactions lacked economic substance. Regardless
of petitioners' concessions, in these cases the underpayments of
tax were attributable to the valuation overstatements.
Moreover, concession of the investment tax credit in and of
itself does not relieve taxpayers of liability for the section
6659 addition to tax. See Dybsand v. Commissioner, T.C. Memo.
1994-56; Chiechi v. Commissioner, T.C. Memo. 1993-630. Instead,
the ground upon which the investment tax credit is disallowed or
conceded is significant. Dybsand v. Commissioner, supra. Even
in situations in which there are arguably two grounds to support
a deficiency and one supports a section 6659 addition to tax and
the other does not, the taxpayer may still be liable for the
addition to tax. Gainer v. Commissioner, 893 F.2d at 228; Irom
- 62 -
v. Commissioner, 866 F.2d 545, 547 (2d Cir. 1989), vacating in
part T.C. Memo. 1988-211; Harness v. Commissioner, T.C. Memo.
1991-321.
In the present cases, no argument was made and no evidence
was presented to the Court to prove that disallowance and
concession of the claimed investment tax credits and other tax
benefits related to anything other than a valuation
overstatement. To the contrary, petitioners each stipulated
substantially the same facts concerning the Partnership
transactions as we found in Provizer v. Commissioner, T.C. Memo.
1992-177. In the Provizer case, we held that the taxpayers were
liable for the section 6659 addition to tax because the
underpayment of taxes was directly related to the overvaluation
of the Sentinel EPE recyclers. The overvaluation of the
recyclers, exceeding 2,325 percent, was an integral part of our
findings in Provizer that the transaction was a sham and lacked
economic substance. Similarly, the records in these cases
plainly show that the overvaluation of the recyclers is integral
to and is the core of our holding that the underlying
transactions here were shams and lacked economic substance.
Petitioners reliance on McCrary v. Commissioner, supra, is
misplaced. In that case, the taxpayers conceded disentitlement
to their claimed tax benefits and the section 6659 addition to
tax was held inapplicable. However, the taxpayers' concession of
- 63 -
the claimed tax benefits, in and of itself, did not preclude
imposition of the section 6659 addition to tax. In McCrary v.
Commissioner, supra, the section 6659 addition to tax was
disallowed because the agreement at issue was conceded to be a
license and not a lease. In contrast, the records in
petitioners' cases plainly show that petitioners' underpayments
were attributable to overvaluation of the Sentinel EPE recyclers.
We hold that petitioners' reliance on McCrary v. Commissioner,
supra, is inappropriate.20
We held in Provizer v. Commissioner, supra, that each
Sentinel EPE recycler had a fair market value not in excess of
$50,000. Our finding in Provizer that the Sentinel EPE recyclers
had been overvalued was integral to and inseparable from our
holding of a lack of economic substance. Petitioners stipulated
that the Partnership transactions were similar to the Clearwater
transaction described in the Provizer case, and that the fair
market value of a Sentinel EPE recycler in 1981 was not in excess
of $50,000. Given those concessions, and the fact that the
records here plainly show that the overvaluations of the
20
Petitioners' citation of Heasley v. Commissioner, supra, in
support of the concession argument is also inappropriate. That
case was not decided by the Court of Appeals for the Fifth
Circuit on the basis of a concession. Moreover, see supra note
19 to the effect that the Court of Appeals for the Second Circuit
and this Court have not followed the Heasley opinion with respect
to the application of sec. 6659.
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recyclers was the only reason for the disallowance of the claimed
tax benefits, we conclude that the deficiencies were attributable
to overvaluation of the Sentinel EPE recyclers.
3. Section 6659(e)
Petitioners argue that respondent erroneously failed to
waive the section 6659 additions to tax. Section 6659(e)
authorizes the Commissioner to waive all or part of the addition
to tax for valuation overstatement if taxpayers establish that
there was a reasonable basis for the adjusted bases or valuations
claimed on the returns and that such claims were made in good
faith. The Commissioner's refusal to waive a section 6659
addition to tax is reviewable by this Court for abuse of
discretion. Krause v. Commissioner, 99 T.C. at 179. Abuse of
discretion has been found in situations where the Commissioner's
refusal to exercise discretion is arbitrary, capricious, or
unreasonable. See Mailman v. Commissioner, 91 T.C. 1079 (1988);
Estate of Gardner v. Commissioner, 82 T.C. 989 (1984); Haught v.
Commissioner, T.C. Memo. 1993-58.
We note initially that petitioners did not request
respondent to waive the section 6659 additions to tax until well
after the trials of these cases. Petitioners each made their
requests approximately 4 months after the trials of their cases.
We are reluctant to find that respondent abused discretion in
these cases when respondent was not timely requested to exercise
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it and there is no direct evidence of any abuse of administrative
discretion. Haught v. Commissioner, supra; cf. Wynn v.
Commissioner, T.C. Memo. 1995-609; Klieger v. Commissioner, T.C.
Memo. 1992-734.
However, we do not decide this issue solely on petitioners'
failure timely to request waivers, but instead we have considered
the issue on its merits. Petitioners urge that they relied on
Alter and Feinstein in deciding on the valuation claimed on their
tax returns. Petitioners contend that such reliance was
reasonable, and, therefore, that respondent should have waived
the section 6659 additions to tax.21 However, as we explained
above in finding petitioners liable for the negligence additions
to tax, petitioners' purported reliance on Alter and Feinstein
under the circumstances here was not reasonable.
Neither Alter nor Feinstein had any education or experience
in plastics materials or plastics recycling. They did not visit
PI or see a Sentinel EPE recycler or any competing machines in
their review of the transactions. Alter acknowledged that he had
no competence to confirm the value of the Sentinel EPE recycler
or to conduct a comparison, and he and Feinstein ultimately
21
In their posttrial briefs, petitioners referenced the
reports prepared by Carmagnola in support of the reasonableness
of the claimed valuations. For reasons discussed supra, we
consider the reports prepared by Carmagnola to be unreliable and
of no consequence.
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relied upon the offering memoranda for the value of the machine.
In their meetings with petitioners, Alter and Feinstein explained
all that they had learned of the Plastics Recycling transactions,
including the nature and amounts of the tax benefits. In the
end, neither petitioners nor their purported advisers in good
faith investigated the fair market value of a Sentinel EPE
recycler, or the underlying viability, financial structure, and
economics of the Partnership transactions.
In support of their contention that they acted reasonably,
petitioners cite Mauerman v. Commissioner, 22 F.3d 1001 (10th
Cir. 1994), revg. T.C. Memo. 1993-23. However, the facts in the
Mauerman case are distinctly different from the facts of these
cases. In Mauerman, the Court of Appeals for the Tenth Circuit
held that the Commissioner had abused discretion by failing to
waive a section 6661 addition to tax. Like the section 6659
addition, a section 6661 addition to tax may be waived by the
Commissioner if the taxpayer demonstrates that there was
reasonable cause for his underpayment and that he acted in good
faith. Sec. 6661(c). The taxpayer in Mauerman relied upon
independent attorneys and accountants for advice as to whether
payments were properly deductible or capitalized. The advice
relied upon by the taxpayer in Mauerman was within the scope of
the advisers' expertise, the interpretation of the tax laws as
applied to undisputed facts. In petitioners' cases, however,
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particularly with respect to valuation, petitioners relied upon
advice that was outside the scope of expertise and experience of
their purported advisers. Alter and Feinstein had no education,
special qualifications, or professional skills or experience in
plastics engineering, plastics recycling, or plastics materials.
Consequently, we consider petitioners' reliance on the Mauerman
case inappropriate.
We hold that petitioners did not have a reasonable basis for
the adjusted bases or valuations claimed on their tax returns
with respect to their investments in the Partnerships. In these
cases, respondent could find that petitioners' respective
reliance on Alter and Feinstein was unreasonable. The records in
these cases do not establish an abuse of discretion on the part
of respondent but support respondent's position. We hold that
respondent's refusal to waive the section 6659 additions to tax
in these cases is not an abuse of discretion. Petitioners are
liable for the respective section 6659 additions to tax at the
rate of 30 percent of the underpayments of tax attributable to
the disallowed tax benefits. Respondent is sustained on this
issue.
C. Petitioners' Motions For Leave To File Motion For Decision
Ordering Relief From the Negligence Penalty and the Penalty Rate
of Interest and To File Supporting Memorandum of Law
Long after the trials of these cases, petitioners each filed
a Motion For Leave To File Motion For Decision Ordering Relief
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From the Negligence Penalty and the Penalty Rate of Interest and
To File Supporting Memorandum of Law under Rule 50. Petitioners
also lodged with the Court motions for decision ordering relief
from the additions to tax for negligence and from the increased
rate of interest, with attachments and memoranda in support of
the motions. Respondent filed objections, with attachments and
memoranda in support thereof and petitioners thereafter filed
reply memoranda. Petitioners argue that they should be afforded
the same settlement that was reached between other taxpayers and
the IRS in docket Nos. 10382-86 and 10383-86, each of which was
styled Miller v. Commissioner. See Farrell v. Commissioner, T.C.
Memo. 1996-295 (denying a motion similar to petitioners'
motions); see also Sann v. Commissioner, T.C. Memo. 1997-259;
Friedman v. Commissioner, T.C. Memo. 1996-558; Jaroff v.
Commissioner, T.C. Memo. 1996-527; Gollin v. Commissioner, T.C.
Memo. 1996-454; Grelsamer v. Commissioner, T.C. Memo. 1996-399;
Zenkel v. Commissioner, T.C. Memo. 1996-398.
Counsel for petitioners seek to raise a new issue long after
the trials in these cases. Resolution of such issue might well
require new trials. Such further trials "would be contrary to
the established policy of this Court to try all issues raised in
a case in one proceeding and to avoid piecemeal and protracted
litigation." Markwardt v. Commissioner, 64 T.C. 989, 998 (1975);
see also Haft Trust v. Commissioner, 62 T.C. 145, 147 (1974).
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Consequently, under the circumstances here, at this late date in
the litigation proceedings, long after trial and briefing and
after the issuance of numerous opinions on issues and facts
closely analogous to those in these cases, petitioners' motions
for leave are not well founded. Farrell v. Commissioner, supra.
Even if petitioners' motions for leave were granted, the
arguments set forth in each of petitioners' motions for decision
and attached memoranda, lodged with this Court, are invalid and
the motions would be denied. Therefore, and for reasons set
forth in more detail below, petitioners' motions for leave shall
be denied.
Some of our discussion of background and circumstances
underlying petitioners' motions is drawn from documents submitted
by the parties and findings of this Court in two earlier
decisions. See Estate of Satin v. Commissioner, T.C. Memo. 1994-
435; Fisher v. Commissioner, T.C. Memo. 1994-434. These matters
are not disputed by the parties. We discuss the background
matters for the sake of completeness. As we have noted, granting
petitioners' motions for leave would require further proceedings.
The Estate of Satin and Fisher cases involved Stipulation of
Settlement agreements (piggyback agreements) made available to
taxpayers in the Plastics Recycling project, whereby taxpayers
could agree to be bound by the results of three test cases:
Provizer v. Commissioner, T.C. Memo. 1992-177, and the two Miller
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cases. We held in Estate of Satin and Fisher that the terms of
the piggyback agreement bound the parties to the results in all
three lead cases, not just the Provizer case. Petitioners assert
that the piggyback agreement was extended to them, but they do
not claim to have accepted the offer timely, so they effectively
rejected it.22
On or about February of 1988, a settlement offer (the
Plastics Recycling project settlement offer or the offer) was
made available by respondent in all docketed Plastics Recycling
cases, and subsequently in all nondocketed cases. Baratelli v.
Commissioner, T.C. Memo. 1994-484. Pursuant to the offer,
taxpayers had 30 days to accept the following terms: (1)
Allowance of a deduction for 50 percent of the amount of the cash
investment in the venture in the year(s) of investment to the
extent of loss claimed; (2) Government concession of the
substantial understatement of tax penalties under section 6661
and the negligence additions to tax under section 6653(a)(1) and
(2); (3) taxpayer concession of the section 6659 addition to tax
for valuation overstatement and the increased rate of interest
under section 6621; and (4) execution of a closing agreement
22
In each of their motions for decision, petitioners state:
"After the lead counsel for taxpayers and Respondent had agreed
upon the designation of the lead cases, Respondent's counsel
prepared piggyback agreements and offered them to counsel for the
taxpayers in this case and to other taxpayers." (Emphasis
added.)
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(Form 906) stating the settlement and resolving the entire matter
for all years.23 Petitioners assert that the Plastics Recycling
project settlement offer was extended to them, but they do not
claim to have accepted the offer timely, so they effectively
rejected it.24
In December 1988, the Miller cases were disposed of by
settlement agreement between the taxpayers and respondent.25
This Court entered decisions based upon those settlements on
December 22, 1988. The settlement provided that the taxpayers in
the Miller cases were liable for the addition to tax under
section 6659 for valuation overstatement, but not for the
23
The records do not include a settlement offer to
petitioners. However, petitioners in each case have attached to
their motions for decision a copy of a settlement offer to
another taxpayer with respect to a plastics recycling case, and
respondent has not disputed the accuracy of the statement of the
plastics recycling settlement offer.
24
In each of their motions for decision, petitioners state,
"Respondent formulated a standard settlement position which was
extended to all taxpayers having docketed or non-docketed cases
in the plastics recycling group, including Petitioner."
(Emphasis added.)
In docket No. 10802-89 (the Weber case), respondent attached
to the objection to the Webers' motion for leave a copy of a Form
5402, Appeals Transmittal Memorandum and Supporting Statement,
which states that the Webers refused a settlement offer with
respect to Clearwater.
25
Although it is not otherwise a part of the records in these
cases, respondent attached copies of the Miller closing agreement
and disclosure waiver to respondent's objections to petitioners'
motions for leave, and petitioners do not dispute the accuracy of
the document.
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additions to tax under the provisions of section 6661 and section
6653(a). The increased interest under section 6621(c), premised
solely upon Miller's interest in the recyclers for the taxable
years at issue, was not applicable because Miller made payments
prior to December 31, 1984, so no interest accrued after that
time. Respondent did not notify petitioners or any other
taxpayers of the disposition of the Miller cases. Estate of
Satin v. Commissioner, supra; Fisher v. Commissioner, supra.
Petitioners argue that they are similarly situated to
Miller, the taxpayer in the Miller cases, and that pursuant to
the principle of "equality" they are therefore entitled to the
same settlement agreement executed by respondent and Miller in
those cases. In effect, petitioners seek to resurrect the
piggyback agreement offer and/or the settlement offer they
previously failed to accept.
Petitioners contend that under the principle of "equality,"
the Commissioner has a duty of consistency toward similarly
situated taxpayers and cannot tax one and not tax another without
some rational basis for the difference. United States v. Kaiser,
363 U.S. 299, 308 (1960) (Frankfurter, J., concurring); see Baker
v. United States, 748 F.2d 1465 (11th Cir. 1984); Farmers' &
Merchants' Bank v. United States, 476 F.2d 406 (4th Cir. 1973).
According to petitioners, the principle of equality precludes the
Commissioner from making arbitrary distinctions between like
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cases. See Baker v. Commissioner, 787 F.2d 637, 643 (D.C. Cir.
1986), vacating 83 T.C. 822 (1984).
The different tax treatment accorded petitioners and Miller
was not arbitrary or irrational. While petitioners and Miller
both invested in the Plastics Recycling transactions, their
actions with respect to such investments provide a rational basis
for treating them differently. Miller foreclosed any potential
liability for increased interest in his cases by making payments
prior to December 31, 1984; no interest accrued after that date.
In contrast, petitioners made no such payment, and they conceded
that the increased rate of interest under section 6621(c) applies
in their cases. Liability for the increased rate of interest is
the principal difference between the settlement in the Miller
cases, which petitioners declined when they failed to accept the
piggyback agreement offer, and the settlement offer that
petitioners also failed to accept.
Petitioners argue that section 6621(c) must have been an
issue in the Miller cases since each of the decisions in Miller
recites "That there is no increased interest due from the
petitioner[s] for the taxable years [at issue] under the
provisions of IRC section 6621(c)." According to petitioners,
"if the Millers were not otherwise subject to the penalty
interest provisions because of the particular timing of their tax
payments, there would have been no need for the Court to include
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such a recital in its decisions." This argument by petitioners
is entirely conjectural and is not supported by the documentation
on which counsel relies. In fact, the recital that no increased
interest under section 6621(c) was due in the Miller cases was an
express term of the settlement documents in those cases and
apparently included in the decisions for completeness and
accuracy. There is nothing on the record in the present cases,
or in the Court's opinions in Estate of Satin v. Commissioner,
T.C. Memo. 1994-435, or Fisher v. Commissioner, T.C. Memo. 1994-
434, or in any of the material submitted to us in these cases
that would indicate that the Millers were "otherwise subject to
the penalty interest provisions". Petitioners' argument is based
on a false premise.
We find that petitioners and Miller were treated equally to
the extent they were similarly situated and differently to the
extent they were not. Miller foreclosed the applicability of the
section 6621(c) increased rate of interest in his cases, while
petitioners concede it applies in their cases. Petitioners
failed to accept a piggyback settlement offer that would have
entitled them to the settlement reached in the Miller cases, and
also rejected a settlement offer made to them prior to trial of a
test case. In contrast, Miller negotiated for himself and
accepted an offer that was essentially the same as the Plastics
Recycling project settlement offer rejected by petitioners prior
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to trial of their cases. Accordingly, petitioners' motions are
not supported by the principle of equality on which they rely.
Cf. Baratelli v. Commissioner, T.C. Memo. 1994-484.
To reflect the foregoing,
Appropriate orders will be
issued denying petitioners' motions,
and decisions will be entered for
respondent.