Downs v. Commissioner

T.C. Memo. 2000-155

UNITED STATES TAX COURT

JAMES L. AND EVA J. DOWNS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 1991-99. Filed May 10, 2000.

James L. Downs, pro se.

Rodney J. Bartlett, for respondent.

MEMORANDUM OPINION

NAMEROFF, Special Trial Judge: Respondent issued a notice

of deficiency to petitioners for the taxable years 1982 and 1983.

In the notice, respondent determined that petitioners were liable

for additions to tax for negligence pursuant to section

6653(a)(1)1 of $464 and $8 for 1982 and 1983, respectively, and

under section 6653(a)(2) for 50 percent of the interest due on

1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue.
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$9,286 and $162, respectively. Respondent also determined an

addition to tax for a substantial understatement of tax under

section 6661(a) of $2,322 for 1982.

The issues for decision are: (1) Whether petitioners are

liable for the additions to tax for negligence or intentional

disregard of rules or regulations pursuant to section 6653(a)(1)

and (2) for both years; and (2) whether petitioners are liable

for the addition to tax for a substantial understatement of tax

under section 6661(a) for 1982.

Background

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

The stipulation of facts and the attached exhibits are

incorporated herein by this reference. Petitioners resided in

Dana Point, California, at the time they filed their petition.

During the years at issue, James L. Downs (petitioner) was a

corporate officer and major shareholder of Carburetor Sales and

Services, Inc., and Eva J. Downs was employed as a teacher.

Petitioner received a degree in business education in the 1970's.

Petitioners had been active in the stock market for a number of

years, and they also invested in several real estate limited

partnerships through a broker.

In 1982, petitioner attended a lecture given by Consolidated

Financial Services, Inc. (CFS), at the University of Southern

California (USC). Petitioners’ son was a student at USC, and he
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told them about the lecture. CFS offered financial planning, and

petitioner spoke with Keith Maynes (Mr. Maynes), CFS’s financial

planner, on several occasions. Mr. Maynes proposed an investment

in a limited partnership called Utah Jojoba I Research (Utah

Jojoba I) which would engage in the farming of jojoba plants.

Petitioner read articles on prospective business for jojoba

oil and its many uses. Petitioners received a “Private Placement

Memorandum” (the prospectus) to review. According to the

prospectus, dated November 10, 1982, the cost to invest was

$8,480 per unit with a minimum of four units per investor. For

each unit, the investor was to pay cash of $2,500 and execute a

promissory note for the remainder, payable annually for 10 years.

On the front page of the prospectus, it is stated that the

offering involved a high degree of risk. The prospectus also

contained the following statements: “Investors are urged to

consult their own counsel as to all matters concerning this

investment” and “Each purchaser of units herein should and is

expected to consult with his own tax advisor as to the tax

aspects.” The prospectus also cautioned about agricultural risks

and warned that there was no structured market for jojoba oil and

there were limited processing facilities.

Petitioner scanned the prospectus but did not read it

carefully. He did not seek any outside professional advice

because he has “always made his own judgments on these things”.
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Petitioner knew it was a high-risk investment, and he considered

the cautions in the prospectus about the risks to be standard

language.

On November 19, 1982, petitioners signed a “Subscription

Agreement”, a “Promissory Note”, and a “Limited Guarantee

Agreement”. In the Subscription Agreement, petitioners purchased

four units in the partnership and agreed to pay $10,000. In the

Promissory Note petitioners promised to make yearly payments over

the next 10 years to the partnership for a total of $23,920.

About 6 months after investing in the partnership,

petitioner drove out to Desert Center, California, where the

jojoba plantation was located. To him, it looked like the

plantation was flourishing. A few months after the visit to the

plantation, petitioner visited the offices of CFS in Salt Lake

City, Utah, which looked reputable to him. During the years at

issue, petitioner did not have much contact with the partnership.

In 1983, pursuant to the promissory note, petitioners made a

payment to the partnership of $2,600.

On their 1982 Federal income tax return, petitioners

reported income of $116,522, and claimed a partnership loss of

$20,919 from Utah Jojoba I.2 On their 1983 Federal income tax

return, petitioners reported income of $110,000 and claimed a

2
There also were other losses claimed in this year from
other investments.
 - 5 -

partnership loss of $810 from Utah Jojoba I. In a partnership

proceeding, Utah Jojoba I Research v. Commissioner, T.C. Memo.

1998-6, the Court determined that the partnership’s claimed loss

deductions for 1982 and 1983 were not allowable. The resultant

adjustments to petitioners’ 1982 and 1983 Federal income taxes

resulted in deficiencies of $9,286 and $162, respectively. See

sec. 6225.

Validity of Notice of Deficiency.

Petitioners contend that they were unaware that the Utah

Jojoba I partnership was being audited and that there was

litigation in the Tax Court. Petitioners claim that they

received no correspondence from the Commissioner or from the tax

matters partner until they were notified of the computational

adjustment resulting from the partnership level proceeding.

While it is not clear, it appears that petitioners are claiming

that the notice of deficiency for the affected items is invalid.

Petitioners contend that if they had been notified about the

audit and litigation, they would have “taken care of the matter

at an earlier date” instead of having to deal currently with the

additions to tax and accrued interest.

Petitioners rely on a letter found in respondent’s file.

The letter was prepared by the Internal Revenue Service (IRS) and

addressed to 13723 Walnut Street, Whittier, CA (the Walnut Street

address). A copy of an envelope attached to the letter bears a
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stamp reflecting that it was returned because the forwarding

order had expired for the Walnut Street address. Petitioners had

moved from Walnut Street in 1984 to 24672 Jeremiah Drive, Dana

Point, California (Jeremiah Drive address). The letter states

that the IRS was beginning an examination of the Utah Jojoba I

partnership for tax year 1983. There is no clear date on the

letter, but it is stamped as “Received” by the TEFRA/tax shelter

section of the IRS on July 25, 1986, presumably the date it was

returned as undeliverable.

Section 6223 requires the Commissioner to send the notice of

beginning administrative proceeding (NBAP) and the notice of

final partnership administrative adjustment (FPAA) to each

partner whose name is furnished to the Commissioner. Under

subsection (c) of that section, unless additional information is

provided by the tax matters partner, the Commissioner is required

to use the address shown on the partnership return in mailing the

NBAP and the FPAA. The Walnut Street address is shown on

petitioners’ 1982 and 1983 Federal income tax returns as well as

on the Schedules K-1 for Utah Jojoba I for 1982 and 1983. There

is no indication that respondent was advised of any different

address for petitioners in accordance with section 6223(c)(2).

Therefore, there was no error on behalf of respondent regarding

the NBAP.
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In a letter dated October 9, 1999, from James Elliott, Chief

of Appeals, to Congressman Packard, Mr. Elliott states:

Our records show that * * * [petitioners] were mailed a
certified notice of the partnership audit on July 14, 1986.
* * * [Petitioners] were also mailed certified notices of
final partnership adjustments on April 9, 1990. These
notices were mailed to them at 24672 Jeremian Drive, Dana
Point, California. (We realize that the address on the 1986
and 1990 letters [varies] slightly from * * * [petitioners’]
address at 24672 Jeremiah.)

He furthers states that the other partners were also issued

notices, that the tax matters partner filed a petition with the

Tax Court, and that “On June 29, 1990, our office also sent a

letter to the taxpayers offering a settlement of the government

conceding the penalties if the taxpayer conceded the tax. In

TEFRA cases, the tax matters partner has the responsibility to

keep all partners informed of the progress of the case.”

The record does not reflect when respondent was advised of

petitioners’ Jeremiah Drive address nor, except for petitioner’s

self-serving testimony, whether the FPAA was returned to

respondent as undeliverable.

Once partnership level proceedings are completed, the

Commissioner is permitted to assess a computational adjustment

against a partner without issuing a deficiency notice. See sec.

6230(a)(1); N.C.F. Energy Partners v. Commissioner, 89 T.C. 741,

744 (1987). This must have occurred sometime between the date

the opinion for Utah Jojoba I Research v. Commissioner, supra,

was filed (January 5, 1998) and the date the instant notice of
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deficiency was sent to petitioners. The notice of deficiency,

dated October 30, 1998, was mailed to petitioners at the

misspelled Jeremian Drive address, and, subsequently, petitioners

timely petitioned this Court. We assume that petitioners also

received notice of the computational adjustment at the misspelled

Jeremian Drive address.

In Crowell v. Commissioner, 102 T.C. 683 (1994), the Court

held that a taxpayer may contest the validity of a notice of

deficiency for affected items on the ground that the taxpayer’s

partnership items converted to nonpartnership items by virtue of

the Commissioner’s alleged failure to properly notify the

taxpayer of partnership level proceedings.

As stated earlier, we do not find that respondent erred in

failing to notify petitioners about the beginning of the

partnership audit. Furthermore, although the address on the FPAA

was slightly misspelled, petitioners have received mail addressed

to Jeremian (sic) Drive. Insignificant typographical errors in

an address will not prevent a letter or notice from being valid.

See McMullen v. Commissioner, T.C. Memo. 1989-455; Riley v.

Commissioner, T.C. Memo. 1985-231. Therefore, we hold that

respondent notified petitioners of the partnership proceeding as

required by section 6223(a), and the notice of deficiency herein

is valid.
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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). “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.

Petitioner contends that, although he is not a professional,

he thought that he reasonably investigated the investment, and he

was seeking a long-term investment, not merely a tax-sheltered

one.

Petitioners have not demonstrated that they reasonably

investigated their investment in the Utah Jojoba I partnership.

Petitioner discussed the investment with Mr. Maynes, knowing that

CFS was receiving a commission for the sale of the limited

partner interests. Therefore, the only person he discussed the

investment with was someone who had an economic interest in the

investment. Petitioners did not seek professional advice from

outside sources which was recommended in the prospectus.
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Petitioner did not read the prospectus carefully, and he thought

the cautionary language therein was standard. Petitioners did

not have any expertise in or knowledge of jojoba farming, and

they did not seek the advice of an expert in this area.

Petitioners did not investigate the bona fides of the

investment. It was only after the investment that petitioner

visited the plantation and the offices, but it seems he was

merely looking at the appearance of the locations to determine

whether they were reputable.

We do not find that petitioners are naive investors. They

invested in the stock market for a number of years, and they also

participated in limited partnerships several times. Petitioners

had total wages in excess of $100,000 for each year, and they

have not established that tax savings was not a motivating

factor. We conclude that if petitioners were looking to make a

long-term profit, they would have investigated the jojoba

investment more thoroughly because of the high risk and lack of a

market for the oil.

On the record before us, we find that petitioners were

negligent, and we sustain respondent’s determination.

Substantial Understatement of Tax

Respondent determined that petitioners were liable under

section 6661(a) for a substantial understatement of tax for 1982.
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Section 6661(a) provides for an addition to tax equal to 25

percent of the amount of any underpayment attributable to a

substantial understatement. An understatement is substantial

when the understatement for the taxable year exceeds the greater

of (1) 10 percent of the tax required to be shown on the return

or (2) $5,000. The understatement is reduced to the extent that

the taxpayer (1) has adequately disclosed his or her position or

(2) has substantial authority for the tax treatment of an item.

See sec. 6661(b); sec. 1.6661-6(a), Income Tax Regs.

Petitioners made no argument that there was adequate

disclosure, nor have they produced substantial authority for

their position. The deficiency upon which the addition to tax

was imposed was $9,286. The understatement is substantial

because it exceeds the greater or $5,000 or 10 percent of the

amount required to be shown on the return. Accordingly, we

sustain respondent’s determination.

To reflect the foregoing,

Decision will be entered

for respondent.