Hunt v. Commissioner

T.C. Memo. 2001-15

UNITED STATES TAX COURT

JACKIE H. HUNT, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 5060-99. Filed January 25, 2001.

Hugh O. Mussina, for petitioner.

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: $579 under section 6653(a)(1); 50 percent of

the interest due on an $11,587 deficiency under section

6653(a)(2); and $2,897 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 petitioner is

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

(2) whether petitioner is 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

petitioner; 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

petitioner’s participation as a limited partner in Yuma Mesa

Jojoba, Ltd. (Yuma Mesa or the partnership).2

1
In her petition, as twice amended, petitioner raised the
additional issues of (1) alleged errors by respondent in
determining the correct amount of interest; (2) the possible
applicability in this case of sec. 6404(g), regarding suspension
of interest and penalties; and (3) the denial of a request for
abatement of interest. Petitioner, however, did not include
these issues in either her trial memorandum or her post-trial
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
(continued...)
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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. Petitioner resided in

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

Petitioner is a retired medical doctor who was practicing as

an anesthesiologist in 1982. She spent 11 years as a student in

postsecondary education and at some time was on the teaching

staff of Southwestern Medical School and Children’s Medical

Center. Over the years, petitioner has had experience in several

investments other than Yuma Mesa, including other partnership

interests, rental properties, stocks, and mutual funds.

Petitioner learned of the Yuma Mesa investment opportunity

from a personal friend, Dr. Sam Huggins. Dr. Huggins talked to

the promoters of the partnership, who in turn contacted

petitioner. Petitioner then met with the promoters, including

Raymond H. Meinke, and as a result of this meeting agreed to

invest in the partnership. Prior to learning of Yuma Mesa,

petitioner had developed an interest for, and possessed general

knowledge concerning, jojoba and its potential medical and

cosmetic applications. Petitioner, however, did not

2
(...continued)
Yuma Mesa, we described the research and development agreement
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.
 - 4 -

independently research the current market for jojoba, its

availability or prices, or cash-flow projections. Neither did

she independently investigate the principals controlling Yuma

Mesa.

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

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
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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

research and development agreement contained therein met the

requirements of section 174. A copy of this document was

distributed to petitioner, but she did not thoroughly review it.

Potential investors were required to provide information

concerning any previous experience in tax shelter investments,

and the subscription agreement required investors to initial a
 - 6 -

statement that the investor had been advised to consult with an

attorney concerning the tax consequences of the investment.

Petitioner purchased two interests in Yuma Mesa in December

1982. At the time she purchased the interests, she knew of the

sizeable tax benefits that the promoters projected the partners

would receive for taxable year 1982. Petitioner was issued a

Schedule K-1 by the partnership which reflected a $23,174

ordinary loss for taxable year 1982. At this time, petitioner

had just recently contributed only $7,142 in cash to the

partnership.3

As a limited partner, petitioner did not participate in the

activities of the partnership. She did not hear of Yuma Mesa

until several years later, when she was contacted by other

limited partners who were concerned that they were being treated

unfairly by the general partners and that their investments might

have been diverted into another partnership.

On petitioner’s Federal income tax return for taxable year

1982, she reported $121,000 in compensation from her professional

association, and $2,421.61 in other income. From this she

subtracted a $23,254.99 loss as reported on Schedule E. On the

3
Petitioner testified that she was uncertain of the amount
of cash she contributed in 1982. Because nothing else in the
record indicates petitioner’s investment varied from that which
was stated in the private placement memorandum, we accept this
document’s stated terms as accurately reflecting petitioner’s
investment.
 - 7 -

Schedule E, she reported two rental losses totaling $13,527.99,

two partnership losses totaling $24,184 (including her $23,174

distributive share of Yuma Mesa’s loss), and a gain from another

partnership of $14,457.

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 petitioner’s portion of the

partnership level adjustment resulted in an $11,587 deficiency.

Respondent issued petitioner a statutory notice of deficiency

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

6653(a)(2), and 6661, in the respective amounts of $579, 50

percent of the interest due on an $11,587 deficiency, and $2,897.

The first issue for decision is whether petitioner is 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

due on the portion of the underpayment attributable to negligence

or intentional disregard of rules and regulations.
 - 8 -

Negligence is defined to include “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 will

therefore focus on the reasonableness of petitioner’s claiming

the loss on her return. Petitioner argues that she was not

negligent because she relied on the advice of professionals--Mr.

Meinke and Mr. Mussina--in claiming the loss.

Good faith reliance on professional advice concerning tax

laws is a defense to the negligence penalties. See Chamberlain

v. Commissioner, supra at 732. The advice must be objectively
 - 9 -

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.

The advice petitioner allegedly received from Mr. Meinke

fails as a defense to negligence due to the clear presence of a

conflict of interest. See id.; 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. Thus,

any reliance on Mr. Meinke by petitioner was not reasonable.

Petitioner asserts that she also received advice concerning

the proper tax treatment of the loss from Mr. Mussina. Mr.

Mussina was an accountant and attorney who had prepared tax

returns for petitioner and advised her concerning legal matters

such as the creation of a deferred compensation plan for her

professional association. The only evidence in the record

supporting petitioner’s assertion that she relied upon Mr.

Mussina is petitioner’s testimony that she made an inquiry into

the legality of the partnership, to which Mr. Mussina answered

that the partnership appeared to be “legal and properly put

together.” No testimony was given that she inquired into the

proper tax treatment of the partnership loss. No corroborating

evidence for the general advice was presented. The alleged

advice was sought before petitioner made her investment, and not

at the time she filed her return. Petitioner could not recall
 - 10 -

whether she visited Mr. Mussina in person or sent him papers to

review, she could not recall whether he provided her with a

written opinion, and she could not recall whether she was billed

for the advice.

The facts in this case are similar to those in Glassley v.

Commissioner, T.C. Memo. 1996-206. In that case we found that

the taxpayers--

acted on their fascination with the idea of participating in
a jojoba farming venture and their satisfaction with tax
benefits of expensing their investments, which were clear to
them from the promoter’s presentation. They passed the
offering circular by their accountants for a “glance” * * *.

Id. Similarly, petitioner in this case acted on her enthusiasm

for the potential uses of jojoba and acted with knowledge of the

tax benefits of making the investment. There is no reliable

evidence in the record suggesting the exact nature of the advice

that was given, or upon what facts such advice was based.

Petitioner has failed to establish that she consulted with Mr.

Mussina concerning the proper tax treatment of the partnership

loss, or even if she had, that her reliance on such advice was

reasonable or in good faith. See id.; Chamberlain v.

Commissioner, supra at 732.

In her brief, petitioner cites 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
 - 11 -

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

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

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

because of the inherent conflict of interest. Furthermore,

petitioner has not established that she received advice

concerning the deduction from anyone independent of the

investment, or that she conducted her own investigation into the

propriety of the deduction. Petitioner 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 her to discover such a lack of warning.

Petitioner also cites Heasley v. Commissioner, 902 F.2d 380

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

Heasley to petitioner’s situation is unclear. Unlike the

taxpayers in Heasley, petitioner is not a moderate income, blue

collar investor without prior investment experience who relied
 - 12 -

upon financial advisers and accountants in making an investment

and claiming a loss. On the contrary, she was a medical doctor

with previous involvement in several other types of investments.

Furthermore, petitioner did not thoroughly review the private

placement memorandum, despite her investment experience, and made

little or no effort to monitor her investment.

We uphold respondent’s determination that petitioner is

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

negligence.

The second issue for decision is whether petitioner is

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
 - 13 -

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

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.” See sec.

1.6661-3(b)(1), Income Tax Regs. Petitioner argues that no

authority, other than the statute itself, existed at the time she

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 it is 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 petitioner attached a statement to her 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
 - 14 -

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

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

285-286 (1987). Petitioner argues 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). Petitioner argues that

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

Mr. Mussina in claiming the loss. However, nothing in the record

indicates petitioner 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 petitioner did not have substantial authority for

her treatment of the partnership loss and did not adequately
 - 15 -

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

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).
 - 16 -

Petitioner nevertheless argues 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
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). See White v. Commissioner, supra at 216.

Petitioner further argues that this Court has jurisdiction

over this matter because the amount assessed by respondent under
 - 17 -

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

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 petitioner has

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.