Robnett v. Commissioner

T.C. Memo. 2001-17

UNITED STATES TAX COURT

JOHN Y. & MARION ROBNETT, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 8561-99. Filed January 26, 2001.

Hugh O. Mussina, for petitioners.

Rodney J. Bartlett, for respondent.

MEMORANDUM OPINION

DINAN, Special Trial Judge: Respondent determined that

petitioner was liable for the following additions to tax for

taxable year 1982: $1,070 under section 6653(a)(1), 50 percent

of the interest due on a $21,404 deficiency under section

6653(a)(2), and $5,351 under section 6661. Unless otherwise

indicated, section references are to the Internal Revenue Code in
 - 2 -

effect for the year in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure.

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

liable for additions to tax for negligence under section 6653(a);

(2) whether petitioners are liable for the addition to tax for a

substantial understatement under section 6661; (3) whether this

Court has jurisdiction to review the section 6621(c) tax-

motivated interest assessed by respondent and remaining unpaid by

petitioners; and (4) if this Court does have jurisdiction to

review the tax-motivated interest, whether such interest was

properly assessed in this case.1 The issues in this case concern

an investment in Yuma Mesa Jojoba, Ltd. (“Yuma Mesa” or “the

partnership”).2

1
In their petition, petitioners raised the additional issues
of the possible applicability of sec. 6404(g), regarding
suspension of interest and penalties, and the possible
applicability of the statute of limitations under sec. 6229(f).
Petitioners, however, did not include these issues in either
their trial memorandum or their posttrial brief. We therefore
consider them to have been abandoned.
2
The underlying deficiency in this case is based upon a
computational adjustment made by respondent in accordance with
partnership level adjustments. Those adjustments were upheld by
this Court in Cactus Wren Jojoba, Ltd. v. Commissioner, T.C.
Memo. 1997-504. In that case, this Court reviewed respondent’s
determinations with respect to Yuma Mesa and a related
partnership. We held that the partnerships did not directly or
indirectly engage in research or experimentation and that the
partnerships lacked a realistic prospect of entering into a trade
or business. In upholding respondent’s disallowance of
$1,298,031 in research and experimental expenditures claimed by
Yuma Mesa, we described the research and development agreement
(continued...)
 - 3 -

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

The stipulations of fact and the attached exhibits are

incorporated herein by this reference. Petitioners resided in

Dallas, Texas, on the date the petition was filed in this case.

In 1982 and at the time of trial, petitioner husband (Mr.

Robnett) was practicing as a dentist. He operated his practice

as a corporation and supervised two other employees. Petitioner

wife (Ms. Robnett) assisted her husband in his office on a part-

time basis in 1982 and worked as a receptionist in her husband’s

office at the time of trial. Mr. Robnett spent 4 years in

undergraduate education and 3 years earning his dentistry degree.

Ms. Robnett received a 4-year degree in elementary education and

spent 5 years teaching.

Although Ms. Robnett knew of the existence of jojoba and

some of its uses prior to the investment, she first learned of

the jojoba investment opportunity from petitioners’ accountant,

Mr. Ray Meinke. Mr. Meinke prepared petitioners’ tax return for

1982 and had been preparing their returns since 1958, the year in

which petitioners were married. He suggested to petitioners that

they invest in Yuma Mesa as a means to set aside money for

2
(...continued)
entered into by the partnership as “mere window dressing,
designed and entered into solely to decrease the cost of
participation in the jojoba farming venture for the limited
partners through the mechanism of a large upfront deduction for
expenditures that in actuality were capital contributions.” Id.
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retirement. Mr. Meinke handled the sale of the partnership

interests.

Ms. Robnett did not investigate Mr. Meinke’s experience, or

lack thereof, in agricultural investments and/or research and

development. Neither did she investigate the partnership’s

investment prospects--apart from the uses of jojoba--before

petitioners made the investment. She did not conduct cash-flow

analyses or evaluate potential jojoba markets. She did not

independently research other commercial jojoba plantations. She

never traveled to the plantation to investigate the progress

which had been made.

According to the private placement memorandum distributed by

the promoters of Yuma Mesa, the partnership was organized “to

engage in research and development and, thereafter, participate

in the marketing of the products of the jojoba plant.” Interests

in the partnership were offered for $12,245 each, payable by cash

of $3,571 and a 4-year promissory note of $8,674 bearing 10

percent annual interest.

Yuma Mesa was organized as a limited partnership with two

cogeneral partners. The general partners, G. Dennis Sullivan and

William Woodburn, were lawyers; the private placement memorandum

listed no experience of either outside the legal field. Yuma

Mesa was to enter into a “Research and Development Agreement”

with Hilltop Plantations, Inc. (Hilltop), which would in turn
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enter into a farming subcontract with its wholly owned

subsidiary, Mesa Plantations, Inc. (Mesa). Hilltop was then to

enter into an “Experimental Agricultural Lease” with Hilltop

Ventures, a general partnership with identical ownership as

Hilltop. This lease was to be assigned to Mesa upon completion

of the research and development. Finally, Hilltop was to enter

into a “Research and Development Management Agreement” with

Agricultural Investments, Inc., which was to be the “manager” of

the project.

Hilltop (as well as Mesa and Hilltop Ventures) was

controlled by four individuals. These individuals were Mr.

Meinke (president, director, and shareholder), Keith A. Damer

(vice president, secretary, director, and shareholder), Marlin G.

Peterson (vice president, treasurer, director, and shareholder),

and Cecil R. Almand (shareholder). The three officer/directors

of Hilltop were all listed as certified public accountants with

expertise in the tax field. The private placement memorandum

listed no experience of any of the officer/directors or

shareholders which is relevant to the farming of jojoba.

The private placement memorandum contained language

specifically alerting investors to the planned deduction of the

“research and development” costs, as well as other tax risks

involved in making an investment in the partnership. The

document also contained an opinion letter stating that the
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research and development agreement contained therein met the

requirements of section 174. A copy of this document was

distributed to Mr. Robnett. Potential investors were required to

provide information concerning any previous experience in tax

shelter investments, and the subscription agreement required

investors to initial a statement that the investor had been

advised to consult with an attorney concerning the tax

consequences of the investment.

Mr. Robnett executed the subscription agreement and

purchased six interests in Yuma Mesa in late 1982. In connection

with this purchase, he executed a promissory note and made a cash

payment. Mr. Robnett was issued a Schedule K-1 by the

partnership which allocated a $69,521 ordinary loss for taxable

year 1982 to Mr. Robnett.

Ms. Robnett received no information concerning the

partnership for several years after the investment. In the late

1980's, she learned that respondent had challenged the

partnership’s tax treatment of the purported research and

development costs. Petitioners never paid the promissory note

signed in connection with the investment in Yuma Mesa.

On petitioners’ joint Federal income tax return for taxable

year 1982, they reported $85,378.90 in compensation from Mr.

Robnett’s corporation. From this they subtracted a $66,465 loss

as reported on Schedule E, Supplemental Income and Loss. On the
 - 7 -

Schedule E, they reported Mr. Robnett’s $69,521 distributive

share of Yuma Mesa’s loss, an $80 loss from another partnership,

and $3,200 of income from a third partnership. They also

reported on the return $2,538 in investment expenses and $13,196

in investment interest expenses.

After examining Yuma Mesa’s partnership return for taxable

year 1982, respondent disallowed the $1,298,031 deduction claimed

as research and development costs and increased the partnership’s

income by a total of $1,307,781. Respondent’s determinations

were upheld in their entirety by this Court. Respondent

subsequently determined that petitioners’ portion of the

partnership level adjustment resulted in a $21,404 deficiency.

Respondent issued petitioners a statutory notice of deficiency

determining additions to tax under sections 6653(a)(1),

6653(a)(2), and 6661, in the respective amounts of $1,070, 50

percent of the interest due on a $21,404 deficiency, and $5,351.

The first issue for decision is whether petitioners are

liable for additions to tax for negligence under section

6653(a)(1) and (2). Section 6653(a)(1) imposes an addition to

tax equal to 5 percent of the underpayment of tax if any part of

the underpayment is attributable to negligence or intentional

disregard of rules or regulations. Section 6653(a)(2) provides

for a further addition to tax equal to 50 percent of the interest
 - 8 -

due on the portion of the underpayment attributable to negligence

or intentional disregard of rules and regulations.

Negligence includes “any failure to reasonably attempt to

comply with the tax code, including the lack of due care or the

failure to do what a reasonable or ordinarily prudent person

would do under the circumstances.” Chamberlain v. Commissioner,

66 F.3d 729, 732 (5th Cir. 1995), affg. in part and revg. in part

T.C. Memo. 1994-228. Generally, courts look both to the

underlying investment and to the taxpayer’s position taken on the

return in evaluating whether a taxpayer was negligent. See Sacks

v. Commissioner, 82 F.3d 918, 920 (9th Cir. 1996), affg. T.C.

Memo. 1994-217. However, the Court of Appeals for the Fifth

Circuit, to which appeal lies in this case, has held that the

proper inquiry in negligence cases is whether the taxpayer was

reasonable in claiming the loss. See Reser v. Commissioner, 112

F.3d 1258, 1271 (5th Cir. 1997), affg. in part and revg. in part

T.C. Memo. 1995-572; Durrett v. Commissioner, 71 F.3d 515, 518

(5th Cir. 1996), affg. in part and revg. in part T.C. Memo. 1994-

179; Chamberlain v. Commissioner, supra at 733. We therefore

focus on the reasonableness of petitioners’ claiming the loss on

their return.

Petitioners argue that they were not negligent because they

relied on the advice of a professional, Mr. Meinke, in claiming

the loss. Good faith reliance on professional advice concerning
 - 9 -

tax laws is a defense to the negligence penalties. See

Chamberlain v. Commissioner, supra at 732. The advice must be

objectively reasonable and must not be from one with an inherent

conflict of interest or from one with no knowledge concerning the

matter upon which the advice is given. See id.

There is little evidence in the record supporting

petitioners’ argument that they were not negligent. There is no

testimony in the record from the person primarily involved with

the investment, Mr. Robnett. Although Ms. Robnett testified that

she--not her husband--was primarily involved in the Yuma Mesa

investment, the stipulations of the parties and the evidence show

otherwise. The parties stipulated that it was Mr. Robnett who

acquired the interests in the partnership, executed the

subscription agreement, executed the promissory note, and

remitted the cash payment. The evidence in the record supports

these stipulations: The Schedule K-1 issued by the partnership

was issued solely to Mr. Robnett. There is also no testimony in

the record from Mr. Meinke, the person upon whom petitioners are

claiming reliance and basing their argument that they are not

negligent. The explanations offered for the absence of testimony

from Mr. Robnett and Mr. Meinke were not satisfactory, and in the

absence of the testimony we assume that their testimony would not

have been favorable to petitioners. See Mecom v. Commissioner,

101 T.C. 374, 386 (1993), affd. 40 F.3d 385 (5th Cir. 1994).
 - 10 -

Overlooking the lack of evidence, however, Mr. Meinke’s

advice was clearly from someone with an inherent conflict of

interest and as such cannot be the basis of petitioners’ defense

to the negligence penalties. See Chamberlain v. Commissioner,

supra; Rybak v. Commissioner, 91 T.C. 524, 565 (1988). Mr.

Meinke was a promoter of the Yuma Mesa partnership and was a

principal in the related entities. Petitioners were aware of

this conflict of interest at the time of the investment and when

they claimed the loss on their return. We find that petitioners’

decision to rely upon the advice of Mr. Meinke, who had helped to

establish the partnership and who convinced petitioners to make

their investment, was not the action of a reasonable or

ordinarily prudent person under the circumstances.

In their brief, petitioners cite Kantor v. Commissioner, 998

F.2d 1514 (9th Cir. 1993), affg. in part and revg. in part T.C.

Memo. 1990-380. In Kantor, the Court of Appeals for the Ninth

Circuit held that the taxpayers were not negligent because they

were not acting unreasonably in claiming a section 174 deduction

for the development of computer software. The court noted the

almost complete absence of case law interpreting section 174 at

the time the taxpayers claimed the deduction and stated that the

taxpayers reasonably could have been led to believe by the

general partner’s experience and involvement with the research

project that they were entitled to the deduction. The court
 - 11 -

further stated: “At the time appellants invested, there were

few, if any, warning signs that they would not be entitled to the

deduction.” Id. at 1522-1523. In this case, we have held that

petitioners’ reliance upon Mr. Meinke’s advice was not reasonable

because of the inherent conflict of interest. Furthermore, there

is no evidence that petitioners received advice from anyone

independent of the investment, or that they conducted their own

investigation into the propriety of the deduction. Petitioners

may not rely upon a “lack of warning” as a defense to negligence,

where there is no evidence that a reasonable investigation was

ever made which would have allowed them to discover such a lack

of warning.

Petitioners also cite Heasley v. Commissioner, 902 F.2d 380

(5th Cir. 1990), revg. T.C. Memo. 1988-408. The relevancy of

Heasley to petitioners’ situation is unclear. Unlike the

taxpayers in Heasley, petitioners are not moderate-income, blue-

collar investors. On the contrary, Mr. Robnett was a dentist,

and both petitioners had received college degrees. Furthermore,

Ms. Robnett did not read the private placement memorandum (there

is no evidence that Mr. Robnett did so either), and petitioners

made little or no effort to monitor their investment. Finally,

petitioners were educated and had at least some level of

investment experience--as indicated on their 1982 tax return;

petitioners were involved with at least two other partnership
 - 12 -

investments during 1982, and incurred $2,538 in investment

expenses and $13,196 in investment interest expenses that year.

We uphold respondent’s determination that petitioners are

liable for the section 6653(a)(1) and (2) additions to tax for

negligence.

The second issue for decision is whether petitioners are

liable for the addition to tax under section 6661 for a

substantial understatement of tax. Section 6661(a), as amended

by the Omnibus Budget Reconciliation Act of 1986, Pub. L. 99-509,

sec. 8002, 100 Stat. 1951, provides for an addition to tax of 25

percent of the amount of any underpayment attributable to a

substantial understatement of income tax for the taxable year. A

substantial understatement of income tax exists if the amount of

the understatement exceeds the greater of 10 percent of the tax

required to be shown on the return, or $5,000. See sec.

6661(b)(1)(A). Generally, the amount of an understatement is

reduced by the portion of the understatement which the taxpayer

shows is attributable to either (1) the tax treatment of any item

for which there was substantial authority, or (2) the tax

treatment of any item with respect to which the relevant facts

were adequately disclosed on the return. See sec. 6661(b)(2)(B).

If an understatement is attributable to a tax shelter item,

however, different standards apply. First, in addition to

showing the existence of substantial authority, a taxpayer must
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show that he reasonably believed that the tax treatment claimed

was more likely than not proper. See sec. 6661(b)(2)(C)(i)(II).

Second, disclosure, whether or not adequate, will not reduce the

amount of the understatement. See sec. 6661(b)(2)(C)(i)(I).

Substantial authority exists when “the weight of authorities

supporting the treatment is substantial in relation to the weight

of the authorities supporting contrary positions.” Sec. 1.6661-

3(b)(1), Income Tax Regs. Petitioners argue that no authority,

other than the statute itself, existed at the time they claimed

the loss. Lack of authority, however, necessarily cannot provide

the substantial authority required under the statute and

regulations.

Adequate disclosure may be made either in a statement

attached to the return or on the return itself if in accordance

with the requirements of Rev. Proc. 83-21, 1983-1 C.B. 680. See

sec. 1.6661-4(b), (c), Income Tax Regs. Nothing in the record

indicates petitioners attached such a statement to their 1982

return. Rev. Proc. 83-21, applicable to tax returns filed in

1983, lists information which is deemed sufficient disclosure

with respect to certain items, none of which are involved in this

case. If disclosure is not made in compliance with the

regulations or the revenue procedure, adequate disclosure on the

return may still be satisfied if sufficient information is

provided to enable respondent to identify the potential
 - 14 -

controversy involved. See Schirmer v. Commissioner, 89 T.C. 277,

285-286 (1987). Petitioners argue that the deduction was clearly

indicated on the return. Merely claiming the loss, without

further explanation, was not sufficient to alert respondent to

the controversial section 174 deduction of which the partnership

loss consisted.

Finally, section 6661(c) provides the Secretary with the

discretion to waive the section 6661(a) addition to tax if the

taxpayer shows he acted with reasonable cause and in good faith.

We review the Secretary’s failure to waive the addition to tax

for abuse of discretion. See Martin Ice Cream Co. v.

Commissioner, 110 T.C. 189, 235 (1998). Petitioners argue that

they acted in good faith and reasonably relied upon Mr. Meinke in

claiming the loss. However, nothing in the record indicates

petitioners requested a waiver for good faith and reasonable

cause under section 6661(c). In the absence of such a request,

we cannot review respondent’s determination for an abuse of

discretion. See id.

Because petitioners did not have substantial authority for

their treatment of the partnership loss and did not adequately

disclose the relevant facts of that treatment, we uphold

respondent on this issue.

The third issue for decision is whether this Court has

jurisdiction to review the section 6621(c) tax-motivated interest
 - 15 -

assessed by respondent. Section 6621(c), formerly section

6621(d)--as in effect for taxable years for which returns were

due prior to 1990, for interest accruing after 1984--provides an

increased rate of interest for substantial underpayments

attributable to tax-motivated transactions. This Court generally

lacks jurisdiction to redetermine interest prior to an entry of a

decision redetermining a deficiency. See sec. 7481(c) (as

currently in effect); Rule 261; Pen Coal Corp. v. Commissioner,

107 T.C. 249, 255 (1996). Furthermore, this Court generally does

not have jurisdiction to review respondent’s assessment of

section 6621(c) tax-motivated interest in affected item

proceedings, such as in the present case, even though the tax-

motivated interest is an affected item which requires a partner

level determination. See White v. Commissioner, 95 T.C. 209

(1990); Greene v. Commissioner, T.C. Memo. 1995-105. A narrow

exception to this rule applies if a taxpayer has paid the

assessed tax-motivated interest and subsequently invokes the

overpayment jurisdiction of this Court under section 6512(b).

See Barton v. Commissioner, 97 T.C. 548 (1991).

Petitioners nevertheless argue that this Court has

jurisdiction to review such assessments under section 6621(c)(4).

Section 6621(c)(4) provides as follows:

(4) Jurisdiction of Tax Court.--In the case of any
proceeding in the Tax Court for a redetermination of a
deficiency, the Tax Court shall also have jurisdiction to
determine the portion (if any) of such deficiency which is a
 - 16 -

substantial underpayment attributable to tax motivated
transactions.

Respondent presumably determined that the underlying deficiency

in this case was a substantial underpayment attributable to a

tax-motivated transaction. This Court does not have jurisdiction

to review the underlying deficiency, however, because it was a

computational adjustment made pursuant to an adjustment to a

partnership item determined in a partnership proceeding. See

Saso v. Commissioner, 93 T.C. 730, 734 (1989). Thus, because the

underlying deficiency is not before this Court, section

6621(c)(4) cannot confer jurisdiction on this Court to determine

what portion of such underlying deficiency is attributable to a

tax-motivated transaction. Furthermore, although each addition

to tax at issue in this case is a “deficiency” within the meaning

of section 6621(c)(4), section 6621(c)(2) excludes additions to

tax from the definition of “substantial underpayment attributable

to tax motivated transactions,” thereby precluding review under

section 6621(c)(4). White v. Commissioner, supra at 216.

Petitioners further argue that this court has jurisdiction

over this matter because the amount assessed by respondent under

the authority of section 6621(c) is a penalty, not interest.

Tax-motivated interest is clearly interest, prescribed in the

same manner as all interest--under section 6601(a), at the rate

set forth in section 6621. Even if the interest could be

considered a “penalty”, it is nonetheless prescribed by section
 - 17 -

6601(a) and therefore subject to the same jurisdictional

restrictions as regular interest prescribed by section 6601(a).

See Pen Coal Corp. v. Commissioner, supra at 255.

Because the record does not indicate that petitioners have

paid the section 6621(c) tax-motivated interest assessed by

respondent, this Court does not have jurisdiction to review its

assessment. Based upon this holding, we do not reach the issue

of whether such interest was properly assessed in this case.

To reflect the foregoing,

Decision will be entered

for respondent.