T.C. Summary Opinion 2001-105
UNITED STATES TAX COURT
RODNEY M. FUJIYAMA AND VICKI ANN FUJIYAMA, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 16533-99S. Filed July 23, 2001.
Rodney M. Fujiyama and Vicki Ann Fujiyama, pro se.
Brian M. Harrington, for respondent.
MARVEL, Judge: This case was heard pursuant to the
provisions of section 7463 in effect at the time the petition was
filed.1 The decision to be entered is not reviewable by any
other court, and this opinion should not be cited as authority.
1
All subsequent section references are to the Internal
Revenue Code in effect for the year in issue, and all Rule
references are to the Tax Court Rules of Practice and Procedure.
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Respondent determined that petitioners are liable for an
addition to tax for negligence under section 6653(a)(2) for 1982.
The only issue for decision is whether petitioners are liable for
the addition to tax for negligence pursuant to section 6653(a)(2)
for 1982 in the amount of 50 percent of the interest due on the
underlying deficiency of $6,479,2 which respondent computed in
connection with the disallowance of research and development
expenditures deducted in 1982 by Jojoba Research Partners,
Hawaii, a limited partnership.
Background
Some of the facts have been stipulated and are so found. We
incorporate the stipulation of facts by this reference.
Petitioners resided in Honolulu, Hawaii, on the date the petition
was filed. Hereinafter, references to petitioner are to Rodney
M. Fujiyama.
Petitioner graduated from law school and has been licensed
to practice law since 1970. Petitioner’s legal practice focuses
primarily on business transaction planning. Petitioner does not
practice tax law and has very little tax experience. When one of
petitioner’s clients requires tax advice, petitioner engages the
services of a national or local accounting firm to assist him.
2
In his notice of deficiency, respondent determined that
petitioners are liable for a negligence penalty in the amount of
50 percent of the interest due on $13,367. Respondent conceded
in his trial memorandum that the penalty should be limited to 50
percent of the interest due on $6,479.
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Investment in Jojoba Research Partners, Hawaii
In 1982, petitioner’s accountant, Robert Mihara, introduced
petitioner to an investment opportunity in a limited partnership
known as Jojoba Research Partners, Hawaii (Jojoba). Jojoba had
entered into agreements with U.S. Agri-Research and Development
Corp. (Agri-Research) under which Agri-Research would provide
agricultural research and development services with respect to
the growing of jojoba plants. In connection with its activities,
Jojoba planned to deduct research and development expenditures
under section 174, which, it expected, would generate tax
benefits for its investors.
Petitioner believes, but is not certain, that he reviewed a
private placement memorandum (PPM) and a tax opinion letter in
connection with his proposed investment in Jojoba.3 He also
consulted his accountant, Mr. Mihara.
The PPM, dated October 28, 1982, stated: “THIS OFFERING
INVOLVES A HIGH DEGREE OF RISK”. The PPM also stated:
PROSPECTIVE INVESTORS ARE CAUTIONED NOT TO
CONSTRUE THIS MEMORANDUM OR ANY PRIOR OR SUBSEQUENT
COMMUNICATIONS AS CONSTITUTING LEGAL OR TAX ADVICE.
* * * INVESTORS ARE URGED TO CONSULT THEIR OWN COUNSEL
AS TO ALL MATTERS CONCERNING THIS INVESTMENT.
PRIOR TO THE SALE OF ANY UNITS, EACH PURCHASER
AND/OR HIS OFFEREE REPRESENTATIVE SHALL HAVE THE
OPPORTUNITY TO ASK QUESTIONS OF THE GENERAL PARTNER
3
Petitioner conceded that, even if he did review the PPM
before making his investment, he probably did not read the entire
document.
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CONCERNING ANY ASPECT OF THE INVESTMENT DESCRIBED
HEREIN. EACH INVESTOR MAY OBTAIN ANY ADDITIONAL
INFORMATION NECESSARY TO VERIFY THE ACCURACY OF THE
INFORMATION CONTAINED IN THIS MEMORANDUM TO THE EXTENT
THAT THE GENERAL PARTNER POSSESSES SUCH INFORMATION OR
CAN ACQUIRE IT WITHOUT UNREASONABLE EFFORT OR EXPENSE.
* * * * * * *
NO REPRESENTATIONS OR WARRANTIES OF ANY KIND ARE
INTENDED OR SHOULD BE INFERRED WITH RESPECT TO THE
ECONOMIC RETURN OR TAX ADVANTAGES WHICH MAY ACCRUE TO
THE INVESTORS IN THE UNITS.
EACH PURCHASER OF UNITS HEREIN SHOULD AND IS
EXPECTED TO CONSULT WITH HIS OWN TAX ADVISOR AS TO THE
TAX ASPECTS.
In addition to the general warnings, the PPM described the risk
factors with respect to the projected Federal income tax
consequences of an investment in Jojoba as follows:
The General Partner anticipates that a substantial
portion of the capital contributions of the Limited
Partners to the Partnership will be used for research
and experimental expenditures of the type generally
covered by Section 174 of the Code. However,
prospective investors should be aware that there is
little published authority dealing with the specific
types of expenditures which will qualify as research or
experimental expenditures within the meaning of Section
174, and most of the expenditures contemplated by the
Partnership have not been the subject of any prior
cases or administrative determinations.
* * * * * * *
No ruling by the Service has been or will be sought
regarding deductibility of the proposed expenditures
under Section 174 of the Code.
The PPM referred prospective investors to a November 8,
1992, tax opinion letter prepared by the law firm of Caplan &
Resnick and addressed to Jojoba’s general partner (Caplan
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letter). The Caplan letter discussed various Federal income tax
principles and opined regarding the application of those
principles to the Jojoba investment. Caplan & Resnick based its
opinion on the representations made by Jojoba’s general partner,
which the firm claimed it independently verified by personally
interviewing officers of Agri-Research, visiting a typical
experimental jojoba plantation, and reviewing various documents,
including the PPM, the research and development agreement, the
license agreement, and documentation concerning the acquisition
of rights to the use of real property upon which the research
would be conducted. The Caplan letter specifically addressed the
deductibility of research and development expenditures under
section 174 and concluded:
Because of the scarcity of judicial opinions and
legislative enactments regarding section 174 and
because * * * [Jojoba] may incur expenses which are not
presently contemplated, it is not possible to guarantee
the deductibility of certain expenditures as research
and development expenses. The General Partner intends
to conduct the * * * [Jojoba] business such that, to
the extent possible, substantially all * * * [Jojoba’s]
expenditures for research and development qualify under
section 174.
Before making the investment in Jojoba, petitioner discussed
with Mr. Mihara Jojoba’s profit potential and the research and
development deduction that Jojoba anticipated claiming.
Although Mr. Mihara had no expertise regarding jojoba as a
marketable commodity, research and development expenditures
generally, or the requirements of section 174 when he brought
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Jojoba to petitioner’s attention, he nevertheless assured
petitioner there would be no problem with the deduction. Mr.
Mihara relied upon representations made by Jojoba representatives
that Jojoba’s activities qualified as research and development
and that investors would “be able to take all these deductions
and get all these tax benefits.” Solely on the basis of those
representations, Mr. Mihara concluded that Jojoba was a
legitimate research and development activity. Neither he nor
petitioner did any independent research or analysis or consulted
with any experts regarding the Jojoba investment.4
Petitioner did not inquire regarding Mr. Mihara’s
involvement with Jojoba or his qualifications to advise
petitioner competently regarding the proposed investment. In
fact, Mr. Mihara was the accountant for, and an investor in,
Jojoba.
Shortly after petitioner discussed Jojoba with Mr. Mihara,
petitioner made the minimum investment in Jojoba. Petitioner
paid $5,000 by check and signed a promissory note for $9,250 with
10 percent interest per year in exchange for five limited
partnership units. Petitioner also executed a limited guaranty
4
Mr. Mihara had no personal knowledge regarding the jojoba
plantation, but he did receive occasional progress letters from
Agri-Research regarding the activities allegedly being conducted
on the jojoba plantation. Petitioner may have seen some of these
progress letters but, at the time of trial, he did not recall
whether he received any specific letter.
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agreement with Agri-Research and Jojoba guaranteeing, to the
extent of the promissory note balance, Jojoba’s liability to
Agri-Research under the research and development agreement.
Petitioners’ 1982 Federal Income Tax Return
For the taxable year 1982, Jojoba allocated an ordinary loss
of $12,971 to petitioner, as reflected in his 1982 Schedule K-1,
Partner’s Share of Income, Credits, Deductions, Etc., issued by
Jojoba, which petitioners deducted on their 1982 joint Federal
income tax return.
On October 18, 1993, the tax matters partner of Jojoba
entered into a stipulation with respondent agreeing to be bound
by this Court’s decision in Utah Jojoba I Research v.
Commissioner, T.C. Memo. 1998-6. The facts regarding the
underlying deficiency in Utah Jojoba I Research are substantially
identical to those in this case. In Utah Jojoba I Research, we
held that the partnership was not entitled to deduct its losses
for research and development expenditures under section 174. On
June 17, 1998, we entered a decision against Jojoba, the
partnership involved in this case, disallowing the research and
expense deduction claimed for 1982.
On August 6, 1999, respondent issued a notice of deficiency
to petitioners for 1982 in which he determined that petitioners
are liable for an addition to tax for negligence pursuant to
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section 6653(a)(2) in connection with a research and development
deduction disallowed at the partnership level.
Discussion
Section 6653(a)(2) imposes an addition to tax equal to 50
percent of the interest payable with respect to the portion of
underpayment attributable to negligence or intentional disregard
of rules and regulations for the period beginning on the last day
prescribed by law for payment of such underpayment (determined
without regard to any extension) and ending on the date of the
assessment of the tax. For purposes of section 6653, negligence
is defined as “lack of due care or failure to do what a
reasonable and ordinarily prudent person would do under the
circumstances.” Neely v. Commissioner, 85 T.C. 934, 947 (1985)
(quoting Marcello v. Commissioner, 380 F.2d 499, 506 (5th Cir.
1967), affg. in part and remanding in part 43 T.C. 168 (1964));
see Allen v. Commissioner, 925 F.2d 348, 353 (9th Cir. 1991),
affg. 92 T.C. 1 (1989); Zmuda v. Commissioner, 731 F.2d 1417,
1422 (9th Cir. 1984), affg. 79 T.C. 714 (1982). Negligence is
determined by testing a taxpayer’s conduct against that of a
reasonable, prudent person. Zmuda v. Commissioner, supra.
The Commissioner’s decision to impose the negligence penalty
is presumptively correct. Collins v. Commissioner, 857 F.2d
1383, 1386 (9th Cir. 1988), affg. Dister v. Commissioner, T.C.
Memo. 1987-217; Hansen v. Commissioner, 820 F.2d 1464, 1469 (9th
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Cir. 1987). The taxpayer has the burden of proving that the
Commissioner’s determination is erroneous and that he did what a
reasonably prudent person would have done under the
circumstances. Rule 142(a); Hansen v. Commissioner, supra; Hall
v. Commissioner, 729 F.2d 632, 635 (9th Cir. 1984), affg. T.C.
Memo. 1982-337; Bixby v. Commissioner, 58 T.C. 757, 791 (1972).
At trial,5 petitioner claimed that he reasonably relied on
representations made in the offering materials and on his
accountant, whom he described as a knowledgeable and experienced
tax adviser. Petitioner argued that he did not need to
independently investigate the investment because, as an investor
of moderate means, he was entitled to rely upon the offering
materials and the expertise of his accountant,6 citing Heasley v.
Commissioner, 902 F.2d 380, 383-384 (5th Cir. 1990), revg. T.C.
Memo. 1988-408. In support of his position, petitioner also
cited United States v. Boyle, 469 U.S. 241, 250-251 (1985), in
which the United States Supreme Court stated:
When an accountant or attorney advises a taxpayer
on a matter of tax law, such as whether a liability
5
The parties agreed not to submit posttrial briefs in this
case. After the trial, petitioner presented a closing argument,
and respondent submitted a memorandum of authorities with the
consent of petitioner.
6
Petitioners also argued that we should abate the interest
accrued on the 1982 deficiency. See sec. 6404(e). Petitioners,
however, have not complied with the statutory requirements for
abatement. Whether petitioners are entitled to abatement of
interest is not properly before us. See id.
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exists, it is reasonable for the taxpayer to rely on
that advice. Most taxpayers are not competent to
discern error in the substantive advice of an
accountant or attorney. To require the taxpayer to
challenge the attorney, to seek a “second opinion,” or
to try to monitor counsel on the provisions of the Code
himself would nullify the very purpose of seeking the
advice of a presumed expert in the first place.
“Ordinary business care and prudence” do not demand
such actions. [Citation omitted.]
Respondent argued that petitioner was negligent and that
petitioner did not have a reasonable basis for his reporting
position regarding Jojoba. We agree that petitioner’s reliance
on the offering materials and on the advice of his accountant is
not an adequate defense.
It is well settled that a taxpayer’s reliance upon offering
materials prepared in connection with the sale of an investment
or upon the representations of investment insiders and promoters
is not reasonable. Goldman v. Commissioner, 39 F.3d 402 (2d Cir.
1994) (reliance on representations by insiders, promoters, or
offering materials is an inadequate defense to negligence), affg.
T.C. Memo. 1993-480; Becker v. Commissioner, T.C. Memo. 1996-538.
In this case, not only was petitioner’s reliance on the offering
materials not reasonable, but petitioner ignored provisions in
the PPM warning him to consult a competent and independent
adviser.7
7
The PPM did not make any affirmative statements indicating
that the research and development deduction would be allowed by
the IRS and, in fact, warned against misconstruing the document
(continued...)
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It is equally well settled that, although a taxpayer may
avoid liability for the addition to tax under section 6653(a)(2)
if he reasonably relies in good faith on a competent
professional, United States v. Boyle, supra, “Reliance on
professional advice, standing alone, is not an absolute defense
to negligence, but rather a factor to be considered”, Freytag v.
Commissioner, 89 T.C. 849, 888 (1987), affd. 904 F.2d 1011 (5th
Cir. 1990), affd. 501 U.S. 868 (1991). In order to successfully
claim he reasonably relied on professional advice, petitioner
must demonstrate that the professional on whom he relied had
sufficient expertise and knowledge of the pertinent facts to
provide informed advice on the subject matter. Id.; Becker v.
Commissioner, supra; 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). Petitioner has not demonstrated that Mr. Mihara
had either the necessary expertise or the knowledge of pertinent
facts to render informed advice on the investment. To the
7
(...continued)
as indicating the deduction would be proper. Likewise, the
Caplan letter stated that the deduction might be subject to
attack by the IRS and that “Several commentators have discussed
the potential that the IRS may attack a research and development
partnership on the basis that it constitutes a material
distortion of income.” The Caplan letter also pointed out the
lack of judicial opinions and legislative enactments regarding
sec. 174 and stressed “it is not possible to guarantee the
deductibility of certain expenditures as research and development
expenses.”
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contrary, Mr. Mihara admitted at trial that he did not know much
about research and development at the time of the initial
investment in Jojoba but, nevertheless, assured petitioner there
would not be a problem with the research and development
deduction. See Hansen v. Commissioner, 820 F.2d 1464 (9th Cir.
1987); Glassley v. Commissioner, T.C. Memo. 1996-206.
Petitioner’s reliance on Heasley v. Commissioner, supra, is
misplaced. Although an investor “need not pore over every word
in a prospectus or in closing documents” before making an
investment, he must exercise reasonable care in ascertaining
basic information regarding his investment. Id. at 384. Unlike
the taxpayer in Heasley, petitioner made no effort to verify even
the most basic information regarding his investment or to ensure
that a competent and independent professional had done so on his
behalf. Moreover, after he made his investment in Jojoba,
petitioner failed to monitor his investment.
We find that petitioner’s failure to exercise reasonable
care in determining whether to invest in Jojoba was negligent and
that petitioner’s reliance on Mr. Mihara for advice regarding the
Jojoba investment was not reasonable. Accordingly, we hold that
petitioners are liable for the addition to tax for negligence
under section 6653(a)(2) with respect to a deficiency for 1982 of
$6,479.
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To reflect the foregoing,
Decision will be entered
under Rule 155.