Dyckman v. Commissioner

T.C. Memo. 1999-79

UNITED STATES TAX COURT

RICHARD L. AND KATHRYN DYCKMAN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 24248-95. Filed March 12, 1999.

Richard L. and Kathryn Dyckman, pro sese.

Louise R. Forbes and John R. Mikalchus, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

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

the provisions of section 7443A(b)(3) and Rules 180, 181, and

182.1

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

Respondent issued a so-called affected items notice of

deficiency for the taxable year 1982. In the notice, respondent

determined that petitioners were liable for (1) additions to tax

for negligence under section 6653(a)(1) and (a)(2) in the amounts

of $492 and 50 percent of the interest due on $9,835,

respectively, and (2) an addition to tax for valuation

overstatement under section 6659 in the amount of $2,436.

After concessions by petitioners,2 the issues for decision

are as follows:

(1) Whether petitioners are liable for additions to tax for

negligence or intentional disregard of rules or regulations under

section 6653(a)(1) and (2). We hold that they are not.

(2) Whether petitioners are liable for the addition to tax

for underpayment of tax attributable to valuation overstatement

under section 6659. We hold that they are.

FINDINGS OF FACT

Some of the facts have been stipulated, and they are so

found. Petitioners resided in Toms River, New Jersey, at the

time that their petition was filed with the Court.

During the year in issue, petitioners were both 55 years

old. During the preceding 30 years, petitioner husband (Mr.

2
Petitioners concede that partnership assets valued at
$1,750,000 did not have a value exceeding $50,000. Further,
petitioners raised a statute of limitations issue in their
petition, but petitioners appear to have abandoned that issue.
Nevertheless, we observe that the notice of deficiency was timely
issued. See sec. 6229(d), (g).
 - 3 -

Dyckman) had been a carpet salesman and petitioner wife (Mrs.

Dyckman) had been an elementary school teacher. In 1982,

petitioners' gross income was approximately $60,000 and their net

worth was approximately $50,000.

Petitioners were referred to Mr. Ira Kipness, a certified

public accountant (C.P.A.). Mr. Kipness was touted as a

knowledgeable, experienced, and trustworthy accountant. Mr.

Kipness began to prepare petitioners' tax returns in 1975. Soon

thereafter, petitioners became close friends with Mr. Kipness and

his family. Mrs. Dyckman began to tutor Mr. Kipness' daughter.

Mr. Kipness and his family moved to California in 1984.

Petitioners continued to mail Mr. Kipness their tax information,

and he continued to prepare their returns for sometime after the

move to California.

Petitioners had virtually no experience in financial or

investment matters. Until the year in issue, petitioners'

investment experience had been limited to bank accounts, a few

certificates of deposits, and securities financed through

withholdings from their paychecks for investment through employer

plans. Mr. Kipness advised petitioners that because they were

approaching retirement, they should seriously consider investing

for their future. Petitioners requested Mr. Kipness to suggest a

suitable investment for that purpose. Mr. Kipness suggested

investment in a "waste management" or "recycling" program. Mrs.

Dyckman was concerned about the environment and had organized a

paper recycling program in her school. She was especially
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enthusiastic about what she thought would be an environmentally

conscious investment.

Petitioners issued a $5,000 check in Mr. Kipness' name

leaving him to take care of any remaining details. Mr. Kipness

invested petitioners' $5,000 in a partnership known as D L & K

Associates, making Mr. Dyckman a limited partner in that

partnership. Petitioners were not provided with any literature,

such as an offering letter or prospectus, regarding their

investment.

Because they were unsophisticated in financial matters,

petitioners did not inquire much about their investment. Mr.

Kipness simply told petitioners that they were investing in some

sort of "waste management" or "recycling" venture, that any

possible loss would be limited to their investment, and that

their short-term profit potential would be limited, but that in

the long run their investment could be highly profitable.

Petitioners expected to receive literature regarding their

investment at some future time. When such information was not

forthcoming, petitioners contacted Mr. Kipness a few months later

and inquired regarding their investment and its status.

Subsequently, petitioners were informed that petitioners'

investment had been a "bust". Petitioners were devastated to

lose their investment, and they did not thereafter make any

similar investments.

Unbeknownst to petitioners, their investment was in a

partnership formed chiefly to produce tax benefits. D L & K
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Associates was a limited partner in a partnership known as Taylor

Recycling Associates (Taylor). Taylor was a first-tier TEFRA

partnership involved in plastics recycling. Taylor was involved

in a series of transactions similar to those of the Clearwater

Group partnership, which was the subject of Provizer v.

Commissioner, T.C. Memo. 1992-177, affd. per curiam without

published opinion 996 F.2d 1216 (6th Cir. 1993). In Provizer,

this Court found that assets valued at $1,162,666 had a fair

market value not exceeding $50,000. The Court also held that the

Clearwater Group transactions were a sham and lacked economic

substance.

In 1988, a partnership proceeding captioned Taylor Recycling

Associates, D L & K Associates, A Partner Other Than the Tax

Matters Partner v. Commissioner, docket No. 10184-88 (the Taylor

case) was commenced in this Court on behalf of Taylor. On July

21, 1994, the Court entered decision in the Taylor case pursuant

to the Commissioner's motion for entry of decision under Rule

248(b). All deductions and credits claimed by Taylor in

connection with its plastics recycling activities were

disallowed.

Pursuant to the Taylor decision, in 1995, respondent

assessed petitioners $9,835 in tax and approximately $40,000 in

interest. Having not heard anything about their investment for

approximately 13 years, petitioners were initially convinced that

respondent had made a mistake. Upon learning that they were in

fact liable for the assessed amounts pursuant to the Taylor
 - 6 -

decision, petitioners cashed in an IRA and paid their liability.

Thereafter, on September 5, 1995, respondent issued the

affected items notice of deficiency for 1982 determining

additions to tax under sections 6653(a)(1) and (2) and 6659.

Petitioners filed their petition with this Court on November 20,

1995.

OPINION

Issue (1) Section 6653(a)(1) and (2) Negligence

Section 6653(a)(1) and (2) imposes additions to tax if any

part of the underpayment of the tax is due 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 exercise under the

circumstances. See Neely v. Commissioner, 85 T.C. 934, 947

(1985).

A taxpayer may avoid liability for negligence in the case of

reasonable reliance on a competent professional adviser. See

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). Although reliance on

professional advice, standing alone, is not an absolute defense

to negligence, it is a factor to be considered. See Freytag v.

Commissioner, supra.

The pertinent question is whether a particular taxpayer's

actions are reasonable in light of the taxpayer's experience, the

nature of the investment, and the taxpayer's actions in
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connection with the transactions. See Henry Schwartz Corp. v.

Commissioner, 60 T.C. 728, 740 (1973). In this regard, the

determination of negligence is highly factual. "When considering

the negligence addition, we evaluate the particular facts of each

case, judging the relative sophistication of the taxpayers as

well as the manner in which the taxpayers approached their

investment." Turner v. Commissioner, T.C. Memo. 1995-363.

There are a number of special and unusual circumstances

present in petitioners' case that in combination provide a

reasonable basis for petitioners' actions. The special and

unusual circumstances include petitioners' complete lack of

sophistication in investment matters as well as the long-term

special relationship of trust and friendship that existed between

petitioners and their C.P.A.. Cf. Schwalbach v. Commissioner,

111 T.C. 215, 230-231 (1998); Zidanich v. Commissioner, T.C.

Memo. 1995-382.

Petitioners are a carpet salesman and an elementary school

teacher who did not have any independent investment experience.

They are unsophisticated investors who relied on their C.P.A., a

trusted friend and a knowledgeable professional. Because of his

reputation and status, petitioners surmised that Mr. Kipness had

the expertise to choose an appropriate investment for them.

Because of their friendship, petitioners were confident that Mr.

Kipness would do all that was necessary to protect their

investment. In sum, petitioners relied in good faith on a

financially savvy accountant and their long-time friend to act in
 - 8 -

their best interest. Given the relationship of the parties and

the level of sophistication involved, petitioners acted

reasonably.

We have also considered other factors in holding

petitioners' actions to be reasonable. For example, petitioners'

sole motivation for making the investment was to provide for

their retirement. Petitioners did not invest as a means to

obtain tax benefits, nor were petitioners even aware that their

investment was in a partnership designed to produce tax benefits.

Hence, petitioners were not motivated by an offering of

improbable tax advantages or sizeable tax deductions. Compare

Wolf v. Commissioner, 4 F.3d 709, 715 (9th Cir. 1993) ("We need

look no farther than * * * [the partnership's] own marketing

literature to hold that the tax court's findings of negligence

are not clearly erroneous: the prospectus focused primarily on

the tax benefits of the investment, and established on its face

that a profit was highly unlikely."), affg. T.C. Memo. 1991-212;

Pasternak v. Commissioner, 990 F.2d 893, 902 (6th Cir. 1993)

(holding reasonably prudent person should investigate claims when

they are likely "too good to be true"), affg. Donahue v.

Commissioner, T.C. Memo. 1991-181; Collins v. Commissioner, 857

F.2d 1383, 1386 (9th Cir. 1988) ("The discussions in the

prospectus of high write-offs and the risk of audits should have

alerted taxpayers that their deductions were questionable at

best."), affg. Dister v. Commissioner, T.C. Memo. 1987-217.
 - 9 -

There is also no indication that Mr. Kipness was himself an

investor in D L & K Associates, Taylor, or any related

partnership. As a result, petitioners were not relying on

professional advice from someone they knew to be burdened with an

inherent conflict of interest. Compare Goldman v. Commissioner,

39 F.3d 402 (2d Cir. 1994) (reliance on the advice of an

interested individual supported a holding of negligence), affg.

T.C. Memo. 1993-480; Pasternak v. Commissioner, supra at 903

(same).

A failure to make even minimal inquiries regarding an

investment is ordinarily a strong indication of negligence. See

Goldman v. Commissioner, supra. We are convinced, given the

totality of the circumstances in the present case, that

petitioners' inquiries were limited because petitioners lacked

the sophistication to make the type of prudent inquiries that one

would expect a more sophisticated investor to make.

As already noted, the determination of negligence is a

highly factual matter. Respondent seeks to analogize

petitioners' situation to a number of cases where this Court has

held that the taxpayer's reliance on the advice of a professional

did not justify relief from negligence additions. We have

reviewed those cases and conclude that petitioners' situation

more closely resembles Zidanich v. Commissioner, supra (lack of

sophistication coupled with professional advice from a trusted

and seemingly knowledgeable friend or relative) where the

taxpayer was held not to be negligent. We are convinced that
 - 10 -

petitioners have demonstrated exercise of due care in their

individual situation and with their particular background and

circumstances. Accordingly, we hold for petitioners on this

issue.

Issue (2) Section 6659 Valuation Overstatement

Petitioners also contest the addition to tax under section

6659 for a valuation overstatement. A valuation that exceeds the

correct valuation by 150 percent or more constitutes a valuation

overstatement. See sec. 6659(c). Petitioners have conceded that

assets with values not exceeding $50,000 were valued at

$1,750,000. There was therefore a valuation overstatement under

section 6659.

Petitioners contend that respondent abused his discretion in

failing to exercise the authority under section 6659(e) to waive

the addition to tax for the valuation overstatement. Under

section 6659(e) the Commissioner may waive all or any part of the

valuation overstatement addition upon a showing by the taxpayer

that there was a "reasonable basis for the valuation * * *

claimed on the return and that such claim was in good faith."

The Commissioner's waiver is discretionary and subject to review

for an abuse of discretion. See Krause v. Commissioner, 99 T.C.

132 (1992), affd. sub nom. Hildebrand v. Commissioner, 28 F.3d

1024 (10th Cir. 1994).

On the record before us, there is no indication that

petitioners requested a waiver from respondent at any time prior

to the filing of their posttrial brief. Given that petitioners
 - 11 -

have failed to establish a timely request for a waiver, we cannot

hold that respondent abused his discretion to waive the addition

to tax for the valuation overstatement. See Haught v.

Commissioner, T.C. Memo. 1993-58. Further, petitioners concede

that there was an improper valuation, and there is nothing else

on the record before us to establish that there was a reasonable

basis for the valuation as required by section 6659(e). In light

of the stringent abuse of discretion standard, we cannot conclude

that respondent abused his discretion in failing to exercise the

authority under section 6659(e) to waive the section 6659

addition to tax.

In view of the foregoing, we sustain respondent's

determination that petitioners are liable for the section 6659

valuation overstatement addition to tax.

To reflect our disposition of the disputed issues,

Decision will be entered

for petitioners as to the additions to

tax under section 6653(a)(1) and (2)

and for respondent as to the addition

to tax under section 6659.