SWARTZ v. COMMISSIONER

T.C. Summary Opinion 2002-130

UNITED STATES TAX COURT

GILFRED B. & PATRICIA S. SWARTZ, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 10475-00S. Filed October 4, 2002.

E. Martin Davidoff, for petitioners.

Rodney J. Bartlett and Timothy S. Sinnott, for respondent.

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

the provisions of section 7463 of the Internal Revenue Code in

effect at the time the petition was filed. The decision to be

entered is not reviewable by any other court, and this opinion

should not be cited as authority. Unless otherwise indicated,

subsequent section references are to the Internal Revenue Code in

effect for the year in issue.
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Respondent determined that petitioners are liable for

additions to tax for taxable year 1983 under section 6653(a)(1)

and (2) in the respective amounts of $198.20 and 50 percent of

the interest due on a $3,964 deficiency. The issue for decision

is whether petitioners are liable for these additions to tax.1

Background

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

Eatontown, New Jersey, on the date the petition was filed in this

case.

Petitioner husband (petitioner) has a bachelor’s degree and

a master’s degree in electrical engineering and a doctorate in

mathematics. In the year in issue, he was a full professor and

the chairman of computer science and mathematics at Monmouth

College. He has no academic background in finance or taxation

and took only one course in economics as an undergraduate. Prior

to the year in issue, petitioners had limited experience in

making investments.

1
In the petition, petitioners argued (1) that the deficiency
upon which the additions to tax are based is incorrect, and (2)
that petitioners “believe the statute of limitations has
expired.” Petitioners did not address these issues at trial or
in their posttrial memorandum of authorities. We therefore
consider them to have been abandoned, and we need not address
them here.
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Petitioner met Paul Trimboli at some time prior to 1983,

when Mr. Trimboli began assisting petitioners with their taxes.

Mr. Trimboli had been working at the public accounting firm

Bugni, LaBanca & Paduano, doing primarily tax work and some

auditing work. In 1983, he started a business with a partner as

a certified public accountant and financial planner. By the end

of 1983, in addition to a bachelor’s degree in accounting, Mr.

Trimboli had completed four of the five courses required to

become a certified financial planner through the College of

Financial Planning.

Mr. Trimboli learned of jojoba investments in early 1983,

and he became especially interested in an investment known as

Arid Land Research Partners (“Arid Land” or “the partnership”).

In June 1983 and again in September 1983, Mr. Trimboli traveled

to California to investigate the partnership as a potential

investment opportunity. He traveled to Blythe, California, and

to Bakersfield, California, where there were plantations on which

jojoba was already being grown. He also visited a research

facility located at the University of California at Riverside

which was involved in the growing of jojoba. On these trips, Mr.

Trimboli met with Robert Cole, who would become the general

partner of the partnership, and Eugene Pace, who was the

president of what was to become the purported research and

development contractor to the partnership, U.S. Agri Research &
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Development Corp. Mr. Trimboli had no experience in farming or

in research and development ventures, and he was aware that Mr.

Cole, the general partner, also had no experience with respect to

jojoba. Prior to leaving Bugni, LaBanca & Paduano in 1983, Mr.

Trimboli had no experience as a financial planner.

After Mr. Trimboli opened his own business in 1983 and began

offering financial planning services, he and petitioner discussed

various investment strategies. In December 1983, Mr. Trimboli

advised petitioner that he should invest in Arid Land. As a part

of their discussion regarding this investment opportunity,

petitioner was told of certain tax benefits that the partnership

hoped to gain for its investors, and petitioner was convinced

there was nothing improper with the tax strategy.

A private placement memorandum for investments in the

partnership, dated December 1, 1983, was distributed to

petitioners. Prefatory material in the memorandum contained the

following caveats:

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.

* * * * * * *

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.
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EACH PURCHASER OF UNITS HEREIN SHOULD AND IS EXPECTED
TO CONSULT WITH HIS OWN TAX ADVISOR AS TO THE TAX ASPECTS.

In a section entitled “Use of Proceeds”, an estimation of various

expenditures, the memorandum stated that 90.7 to 93.0 percent of

the capital contributions from the partners would be allocated to

the research and development contract (regardless of the total

amount of the contributions). The only other expenses were to be

organizational costs, legal fees, and commissions. One of the

“risk factors” listed for the investment contained the following

discussion:

Federal Income Tax Consequences: An investment in the
units involves material tax risks, some of which are set
forth below. Each prospective investor is urged to consult
his own tax advisor with respect to complex federal (as well
as state and local) income tax consequences of such an
investment.

* * * * * * *

(c) Validity of Tax Deductions and Allocations.

The Partnership will claim all deductions for
federal income tax purposes which it reasonably
believes it is entitled to claim. There can be no
assurance that these deductions may not be contested or
disallowed by the Service * * * . Such areas of
challenge may include * * * expenditures under the R &
D Contract * * * .

* * * * * * *

The Service is presently vigorously auditing
partnerships, scrutinizing in particular certain
claimed tax deductions. * * * Counsel’s opinion is
rendered as of the date hereof based upon the
representations of the General Partner * * * . Counsel
shall not review the Partnership’s tax returns. * * *
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(d) Deductibility of Research or Experimental
Expenditures.

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 Sections 174 and 44F of the Code
(particularly in recently issued IRS regulations issued
thereunder). 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.

There are various theories under which such
deductions might be disallowed or required to be
deferred. * * * No ruling by the Service has been or
will be sought regarding deductibility of the proposed
expenditures under Section 174 of the Code.

A section entitled “Tax Aspects” contains the following

information concerning a legal opinion from outside counsel

obtained by the general partner:

The General Partner has received an opinion of counsel
concerning certain of the tax aspects of this investment.
The opinion * * * is available from the General Partner.
Since the tax applications of an investment in the
Partnership vary for each investor, neither the Partnership,
the General Partner nor counsel assumes any responsibility
for tax consequences of this transaction to an investor. *
* * The respective investors are urged to consult their own
tax advisers with respect to the tax implications of this
investment. * * *

The opinion letter referenced in the private placement

memorandum was one which purportedly had been written for Mr.

Cole by outside counsel based on information provided by Mr.

Cole. The letter, dated December 7, 1983, concludes by stating
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general caveats and disclaimers along with the opinion that “it

is more likely than not that a partner of Arid Land Research

Partners, a Limited Partnership will prevail on the merits of

each material tax issue presented herein.” However, the

conclusions regarding the issue of the section 174 deduction in

particular were vague and nonconclusive in nature.

Finally, the investor subscription agreement accompanying

the private placement memorandum required a subscriber upon

purchase of an interest to aver that:

He understands that an investment in the Partnership is
speculative and involves a high degree of risk, there is no
assurance as to the tax treatment of items of Partnership
income, gain, loss, deductions of credit and it may not be
possible for him to liquidate his investment in the
Partnership.

In December 1983, petitioners purchased five units in Arid

Land through Mr. Trimboli for a total of $5,500 in cash and a

promissory note of $8,250. Petitioner was aware that Mr.

Trimboli received a commission for his sale of the interests in

Arid Land, but he did not know of any other relationship which he

had with the partnership or its principals.

The commissions Mr. Trimboli received for selling interests

in the partnership were similar to the commissions he received

for selling other types of investments. In addition to the

commissions, Mr. Trimboli was retained by Arid Land to prepare

the 1983 tax return for the partnership. In preparing the

partnership’s return, Mr. Trimboli relied on financial
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information provided by Mr. Cole and on the opinion letter given

to Mr. Cole by outside counsel. The Schedule K-1, Partner’s

Share of Income, Credits, Deductions, etc., sent to petitioners

as partners in Arid Land reflected their share of the losses

claimed by the partnership on the return prepared by Mr.

Trimboli. Mr. Trimboli subsequently prepared petitioners’ joint

Federal income tax return for the taxable year 1983, claiming a

deduction for a loss arising from the Arid Land investment in the

amount of $12,407. At the time Mr. Trimboli prepared

petitioners’ return, petitioner was aware that Mr. Trimboli had

obtained a tax opinion letter, and petitioner was convinced that

there was nothing improper about the tax strategy.

As the result of partnership level proceedings concerning

Arid Land Research Partners, this Court ultimately entered a

decision disallowing in full the partnership’s claimed ordinary

loss of $463,688 for taxable year 1983. This decision was based

upon a stipulation by the partnership and the Commissioner to be

bound by the outcome of the case in which this Court rendered our

opinion in Utah Jojoba I Research v. Commissioner, T.C. Memo.

1998-6. In that case, we found that the Utah Jojoba I Research

partnership (“Utah I”) was not entitled to a section 174(a)

research or experimental expense deduction (or a section 162(a)

trade or business expense deduction) because (a) Utah I did not

directly or indirectly engage in research or experimentation, and
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(b) the activities of Utah I did not constitute a trade or

business, nor was there a realistic prospect of Utah I ever

entering into a trade or business. Id.

Following the entry of the decision concerning the

partnership, respondent adjusted petitioners’ return by

disallowing their claimed share of the partnership loss, $12,407.

In the statutory notice of deficiency which provides the basis

for our jurisdiction in this case, respondent determined that

petitioners are liable for additions to tax under section

6653(a)(1) and (2) in the respective amounts of $198.20 and 50

percent of the interest due on a $3,964 deficiency.

Discussion

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 or regulations. Negligence is

defined to include “any failure to reasonably 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.” Merino v. Commissioner, 196 F.3d 147, 154 (3d
 - 10 -

Cir. 1999) (quoting Heasley v. Commissioner, 902 F.2d 380, 383

(5th Cir. 1990)), affg. T.C. Memo. 1997-385.

Petitioners’ primary argument is that they were not

negligent because they relied on advice from Mr. Trimboli.

Reasonable reliance on professional advice may be a defense to

the negligence additions to tax. 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. on another

issue, 501 U.S. 868 (1991). The advice must be from competent

and independent parties, not from the promoters of the

investment. LaVerne v. Commissioner, 94 T.C. 637, 652 (1990),

affd. without published opinion sub nom. Cowles v. Commissioner,

949 F.2d 401 (10th Cir. 1991), affd. without published opinion

956 F.2d 274 (9th Cir. 1992); Rybak v. Commissioner, 91 T.C. 524,

565 (1988).

Petitioners analogize their case to the case of Anderson v.

Commissioner, 62 F.3d 1266, 1271 (10th Cir. 1995), affg. T.C.

Memo. 1993-607. In Anderson, the taxpayer relied on both an

investment adviser and an accountant in making his investment.

The court found that reliance on the investment adviser, who

received a commission for selling the investment to the taxpayer,

was reasonable under the circumstances of the case. Cf., e.g.,

Carmena v. Commissioner, T.C. Memo. 2001-177 (financial adviser

receiving commissions for sale of investments had inherent
 - 11 -

conflict of interest in advice given to investors). However, the

court stressed that the investment adviser--an independent

insurance agent and registered securities dealer--was a good

friend of the taxpayer and was not affiliated with the investment

the taxpayers entered into. Anderson v. Commissioner, supra at

1271.

The present case is distinguishable from Anderson in two

important respects. First, in the case at hand, Mr. Trimboli was

involved with principals of the investment prior to the creation

of the partnership. In particular, he was in contact with Mr.

Cole, who was to become the general partner of Arid Land, and

with Mr. Pace, who was to become the president of the research

and development contractor. Although petitioners argue that Mr.

Trimboli was an outsider who coincidentally prepared the

partnership’s return, we find that Mr. Trimboli’s relationship

with the partnership and its principals makes him more than a

disinterested commission-based salesman, as was the case in

Anderson. In light of his relationship to Arid Land, Mr.

Trimboli cannot be considered to be an independent adviser.

Second, the investment adviser in Anderson was a good friend

of the taxpayer. Petitioners’ relationship with Mr. Trimboli was

purely professional and is not analogous to the close friendship

between taxpayer and adviser in Anderson. See also Dyckman v.

Commissioner, T.C. Memo. 1999-79 (taxpayers reasonably relied on
 - 12 -

an adviser who was a close personal friend); Reile v.

Commissioner, T.C. Memo. 1992-488 (taxpayers reasonably relied on

advice from an adviser who was an acquaintance and fellow “temple

recommend holder”). Furthermore, petitioners’ professional

dealings with Mr. Trimboli were only in the context of an

accountant-client relationship. Petitioners could not have had

prior dealings with Mr. Trimboli as a financial planner because

he had no experience in the field prior to 1983. Cf. Wright v.

Commissioner, T.C. Memo. 1994-288 (taxpayers reasonably relied

upon an individual who was recommended to them as a financial

adviser, who had a strong presence in the community as such, and

who misled the taxpayers concerning the propriety of an

investment). Thus, the relationship between petitioners and Mr.

Trimboli was not close enough or prolonged enough--either

personally or professionally--to merit special consideration in

the level of due care required by petitioners in this case.

With respect to his role as tax adviser, Mr. Trimboli

largely relied on the opinion letter addressed to Arid Land’s

general partner, Mr. Cole. There is little to indicate that Mr.

Trimboli researched the issues himself thoroughly enough to come

to any independent conclusions concerning the propriety of the

deductions. We find that Mr. Trimboli’s reliance on the opinion

letter further supports our conclusion that Mr. Trimboli did not

render independent, objective advice concerning the propriety of
 - 13 -

the partnership’s position on tax issues. Thus, we do not accept

petitioners’ assertion that Mr. Trimboli’s reliance on the

opinion letter should itself insulate petitioners from the

negligence additions to tax.

Because Mr. Trimboli was not an independent adviser,

petitioners’ reliance on any advice from him was not reasonable.

Bello v. Commissioner, T.C. Memo. 2001-56 (reliance on advice

from an accountant concerning an investment was unreasonable

where the accountant had been retained by the investment

promoter); LaVerne v. Commissioner, supra; Rybak v. Commissioner,

supra.

Petitioners point to the standard set forth by the Fifth

Circuit Court of Appeals in Heasley v. Commissioner, 902 F.2d 380

(5th Cir. 1990), revg. T.C. Memo. 1988-408. In Heasley, the

court found that the taxpayers--who were moderate-income, blue-

collar investors with little education or prior investment

experience--were to be held to a lower standard of due care when

evaluating whether they were negligent in making an investment.

The court found that the taxpayers, the Heasleys, were not

negligent because, among other reasons, they had relied on

financial advisers. Id. at 384. The financial consultant who

had sold the Heasleys the investment had referred them to an

independent accountant for assistance in preparing their tax

return with respect to the investment. The accountant, in turn,
 - 14 -

had reviewed the investment materials prior to completing the

return. The court noted that “nothing in the record supports a

finding that Smith [the accountant] did not independently assess

the Heasleys’ tax liability or that Danner [the financial

consultant] influenced Smith’s calculations.” Id. at 384 n.9.

Heasley is not applicable to the case at hand. First,

although with limited investment experience, petitioner is highly

educated and was employed as a full professor at the time

petitioners made their investment. Second, we have found

petitioners’ reliance on Mr. Trimboli to be unreasonable because

he was not an independent adviser. Furthermore, petitioners

relied solely on one individual, and that individual both sold

them their investment and advised them as to its legal effect

without independently researching the legal issues involved.

Finally, petitioners cite Hummer v. Commissioner, T.C. Memo.

1988-528, for the proposition that taxpayers cannot be negligent

where the relevant legal issue was “not well settled”.

Petitioners, however, did not receive substantive advice

concerning the deduction from anyone independent of the

investment, nor did they conduct their own investigation into the

propriety of the deduction. Indeed, there is no indication that

petitioners ever were aware of the nature of the purportedly

uncertain legal issues involved. Petitioners may not rely upon a

“lack of warning” as a defense to negligence where no reasonable
 - 15 -

investigation was ever made which would have allowed them to

discover such a lack of warning, and where they were repeatedly

warned of the relevant risks in the private placement memorandum.

Christensen v. Commissioner, T.C. Memo. 2001-185; Robnett v.

Commissioner, T.C. Memo. 2001-17.

The private placement memorandum contained numerous warnings

regarding the tax risks involved with making an investment in

Arid Land. Although the parties stipulated that petitioners

received a copy of the private placement memorandum, petitioner

could not recall having reviewed the memorandum prior to making

the investment. In any case, the warnings were there and would

have been evident if petitioners had exercised reasonable care

and read the memorandum. After making their investment

regardless of these risks, petitioners claimed a loss of $12,407

despite the fact that they had only recently invested cash of

just $5,500.2 This disproportionate and accelerated loss--along

with the resulting substantial tax savings--should have been

further warning to petitioners for the need to obtain outside,

2
Petitioners argue that the instructions for Schedules K-1
provided by the Internal Revenue Service required them to report
the loss. The instructions state that the individual taxpayer
“must treat partnership items * * * consistent with the way the
partnership treated the items on its filed return.” The
instructions have further provisions dealing with errors on
Schedules K-1 as well as with the filing of statements to explain
inconsistencies between the partnership’s return and the
taxpayer’s return. We find to be unreasonable any belief by
petitioners that they were required by law to mechanically deduct
a loss which was improper.
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independent advice regarding the propriety of the deduction.

Despite these warnings, petitioners did not seek such advice or

conduct any other type of inquiry into the propriety of the

deduction. We find that it was negligent for petitioners to have

claimed this deduction under the circumstances of this case. We

sustain respondent’s determination that petitioners are liable

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

negligence.

Reviewed and adopted as the report of the Small Tax Case

Division.

To reflect the foregoing,

Decision will be entered

for respondent.