T.C. Memo. 2004-275
UNITED STATES TAX COURT
RONALD F. AND CYNTHIA G. VAN SCOTEN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 24946-96. Filed December 6, 2004.
Wendy S. Pearson, Terri A. Merriam, and Jennifer A. Gellner,
for petitioners.
Nhi T. Luu-Sanders and Alan E. Staines, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GOLDBERG, Special Trial Judge: Respondent determined that
petitioners are liable for a section 6662(a) accuracy-related
penalty of $2,872 for the taxable year 1991. Unless otherwise
indicated, section references are to the Internal Revenue Code in
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effect for the year in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
The sole issue before this Court is whether petitioners are
liable for the section 6662(a) accuracy-related penalty for
negligence or disregard of rules or regulations in the year in
issue.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The first, second, third, and fourth stipulations of facts and
the attached exhibits are incorporated herein by this reference.
Petitioners resided in Sandy, Utah, on the date the petition was
filed in this case.
I. Walter J. Hoyt III and the Hoyt Partnerships
The accuracy-related penalty at issue in this case arises
from adjustments of partnership items on petitioners’ 1991
Federal income tax return. The adjustments are the result of
petitioners’ involvement in a partnership organized and promoted
by Walter J. Hoyt III (Mr. Hoyt).
Mr. Hoyt’s father was a prominent breeder of Shorthorn
cattle, one of the three major breeds of cattle in the United
States. In order to expand his business and attract investors,
Mr. Hoyt’s father had started organizing and promoting cattle
breeding partnerships by the late 1960s. Before and after his
father’s death in early 1972, Mr. Hoyt and other members of the
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Hoyt family were extensively involved in organizing and operating
numerous cattle breeding partnerships. From about 1971 through
1998, Mr. Hoyt organized, promoted to thousands of investors, and
operated as a general partner more than 100 cattle breeding
partnerships. Mr. Hoyt also organized and operated sheep
breeding partnerships in essentially the same fashion as the
cattle breeding partnerships (collectively the investor
partnerships or Hoyt partnerships). Each of the investor
partnerships was marketed and promoted in the same manner.
Beginning in 1983, and until removed by this Court due to a
criminal conviction, Mr. Hoyt was the tax matters partner of each
of the investor partnerships that are subject to the provisions
of the Tax Equity & Fiscal Responsibility Act of 1982, Pub. L.
97-248, 96 Stat. 324. As the general partner managing each
partnership, Mr. Hoyt was responsible for and directed the
preparation of the tax returns of each partnership, and he
typically signed and filed each return. Mr. Hoyt also operated
tax return preparation companies, variously called “Tax Office of
W.J. Hoyt Sons”, “Agri-Tax”, and “Laguna Tax Service”, that
prepared most of the investors’ individual tax returns during the
years of their investments. Petitioners’ 1991 return was
prepared in this manner and was signed by Mr. Hoyt. From
approximately 1980 through 1997, Mr. Hoyt was a licensed enrolled
agent, and as such he represented many of the investor-partners
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before the Internal Revenue Service (IRS) until he was
disenrolled as an enrolled agent in 1998.
Beginning in February 1993, respondent generally froze and
stopped issuing income tax refunds to partners in the investor
partnerships. The IRS issued prefiling notices to the investor-
partners advising them that, starting with the 1992 taxable year,
the IRS would disallow the tax benefits that the partners claimed
on their individual returns from the investor partnerships, and
the IRS would not issue any tax refunds these partners might
claim attributable to such partnership tax benefits.
Also beginning in 1993, an increasing number of investor-
partners were becoming disgruntled with Mr. Hoyt and the Hoyt
organization. Many partners stopped making their partnership
payments and withdrew from their partnerships, due in part to
respondent’s tax enforcement. Mr. Hoyt urged the partners to
support and remain loyal to the organization in challenging the
IRS’s actions. The Hoyt organization warned that partners who
stopped making their partnership payments and withdrew from their
partnerships would be reported to the IRS as having substantial
debt relief income, and that they would have to deal with the IRS
on their own.
On June 5, 1997, a bankruptcy court entered an order for
relief, in effect finding that W.J. Hoyt Sons Management Company
and W.J. Hoyt Sons MLP were both bankrupt. In these bankruptcy
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cases, the U.S. trustee moved in 1997 to have the bankruptcy
court substantively consolidate all assets and liabilities of
almost all Hoyt organization entities and all of the investor
partnerships. On November 13, 1998, the bankruptcy court entered
its Judgment for Substantive Consolidation, consolidating all the
above-mentioned entities for bankruptcy purposes. The trustee
then sold off what livestock the Hoyt organization owned or
managed on behalf of the investor partnerships.
Mr. Hoyt and others were indicted for certain Federal crimes
and a trial was conducted in the U.S. District Court for the
District of Oregon. The District Court described Mr. Hoyt’s
actions as “the most egregious white collar crime committed in
the history of the State of Oregon.” Mr. Hoyt was found guilty
on all counts, and as part of his sentence in the criminal case
he was required to pay restitution in the amount of $102 million.
This amount represented the total amount that the United States
determined, using Hoyt organization records, was paid to the Hoyt
organization from 1982 through 1998 by investor-partners in
various investor partnerships.
II. Petitioners and Their Investment
Petitioner husband (Mr. Van Scoten) has an associate’s
degree, and petitioner wife (Ms. Van Scoten) completed 1 year of
a college education. During the year in issue, Mr. Van Scoten
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worked as an equipment salesman, and Ms. Van Scoten was a
respiratory therapist.1
Mr. Van Scoten’s father, Edward Van Scoten, has a bachelor’s
degree. He served in the Air Force for approximately 21 years,
after which time he taught at a community college and worked for
an electronics corporation. He also had limited experience with
dairy farms-–he spent his childhood living on or near dairy
farms, and as a teenager and for 1 year, amidst his Air Force
career, he worked on a dairy farm.
Edward Van Scoten invested in a Hoyt partnership in December
1983. He first learned about the Hoyt organization from his
nephew, who had already invested in a Hoyt partnership. In
making his own investment, Edward Van Scoten relied upon
information obtained from his nephew and from the Hoyt
organization. He did not seek outside advice, such as advice
from an attorney or accountant. After making his investment,
Edward Van Scoten spent one summer working on a Hoyt ranch, where
he drove a truck hauling hay bales. He also attended monthly
Hoyt partner meetings over a period of several years starting in
the early 1990s.
Petitioners first learned of the Hoyt partnership
investments from Mr. Van Scoten’s father in 1988. Mr. Van Scoten
knew that his father “had been in it for quite a number of years,
1
On the 1990 and 1991 Federal income tax returns signed by
Ms. Van Scoten, both state that she was a receptionist.
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didn’t appear to have a problem with or any issues about it, so
my wife and I had talked about it and about two years later we
decided that we would invest.” During the time between 1988 and
petitioners’ investment in early 1991, Mr. Van Scoten spoke to
his father about the Hoyt partnerships on a regular basis. His
father told him that
the partnership involved cattle; in particular, what he
called “Borrow-A-Bull.” That entailed investing money into
the partnership, buying what I presumed was a percentage of
a group of cattle, and from there, after a number of years
or after the initial investment, then we would receive a
return on our investment.
Mr. Van Scoten’s father also told him that he had seen cattle and
“numerous trucks with the Walter J. Hoyt logo and insignia” on
them. Mr. Van Scoten trusted his father’s advice to invest in a
Hoyt partnership because his father had attended partnership
meetings and had seen Hoyt cattle and trucks.2 When giving his
son advice concerning the investment, Edward Van Scoten relied
partially on the information he had received from the Hoyt
organization, and also answered “yes” to his son’s inquiry “does
this makes sense”.
Petitioners first invested in a Hoyt partnership in January
1991.3 At the time that petitioners invested in the partnership,
2
While the record is clear that Ms. Van Scoten was an
investor in the Hoyt partnership, because she did not testify at
trial there is no evidence in the record with respect to her
understanding of the investment or her decision to invest.
3
Although Mr. Van Scoten testified at trial that “I believe
(continued...)
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Mr. Van Scoten had no investment experience. Although Mr. Van
Scoten had lived on a family farm for approximately 2 years,
neither petitioner had experience in cattle ranching. Because he
trusted his father’s advice, Mr. Van Scoten did not personally
investigate the partnership. While Mr. Van Scoten relied on his
father’s advice concerning the Hoyt investment, he did not review
his father’s partnership documents, and he was unaware in which
partnership his father had invested.
At the time that petitioners initially made their
investment, Mr. Van Scoten believed that the investment would
produce a profit and provide retirement income. Mr. Van Scoten
understood that the investment generally required petitioners to
remit 75 percent of the Federal income tax refunds that they
received and that petitioners were to retain the remaining 25
percent. Before investing in the Hoyt partnerships, petitioners
did not consult with anyone other than members of the Hoyt
organization and investors in Hoyt partnerships--for example,
they did not consult with cattle ranchers, independent investment
consultants, or independent tax advisers--concerning either the
partnerships or the tax claims made by the partnerships.
Prior to investing, petitioners received promotional
materials prepared by the Hoyt organization. Petitioners relied
3
(...continued)
the first year we invested” was 1990, the documentary evidence
shows that the investment was in fact made in January 1991.
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on these promotional materials which, in general, purported to
provide rationales for why the partnerships were good investments
and why the purported tax savings were legitimate. One document
on which petitioners relied, entitled “Hoyt and Sons -- The 1,000
lb. Tax Shelter”, provided information concerning the Hoyt
investment partnerships and how they purportedly would provide
profits to investors over time. The document emphasized that the
primary return on an investment in a Hoyt partnership would be
from tax savings, but that the U.S. Congress had enacted the tax
laws to encourage investment in partnerships such as those
promoted by Mr. Hoyt. The document stated that an “investment in
cattle [is arranged] so the cash required to keep it going is
only about seventy five percent” of an investor’s tax savings,
while the other twenty-five percent of the tax savings is “a
thirty percent return on investment.” This arrangement
purportedly provided protection to investors: “If the cows do
die and the sky falls in, you have still made a return on the
investment, and no matter what happens you are always better off
than if you paid taxes.” After an explanation of the tax
benefits, the document asked: “Now, can you feel good about not
paying taxes, and feeling like you were not, somehow, abusing the
system, or doing something illegal?”
A section of the “1,000 lb. Tax Shelter” document that was
devoted to a discussion of audits by the IRS, stated that the
partnerships would be “branded an ‘abuse’ by the Internal Revenue
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Service and will be subject to automatic” and “constant audit”.
Statements in the document compared the IRS to children, stating
that IRS employees did not have the “proper experience and
training” and “working knowledge of concepts required by the
Internal Revenue Code” to evaluate the partnerships. In a
section of the document titled “Tax Aspects”, the following
“warning” was given:
Out here, tax accountants don’t read brands, and our cowboys
don’t read tax law. If you don’t have a tax man who knows
you well enough to give you specific personal advice as to
whether or not you belong in the cattle business, stay out.
The cattle business today cannot be separated from tax law
any more than cattle can be separated from grass and water.
Don’t have anything to do with any aspect of the cattle
business without thorough tax advice, and don’t waste much
time trying to learn tax law from an Offering Circular.
Despite this warning, the document spent numerous pages
explaining the tax benefits of investing in a Hoyt partnership,
and explaining why investors should trust only Mr. Hoyt’s
organization to prepare their individual tax returns:
It is the recommendation of the General Partner, as outlined
in the private placement offering circular, that a
prospective Partner seek independent advice and counsel
concerning this investment. * * * The Limited Partners
should then authorize the Tax Office of W.J. Hoyt Sons to
prepare their personal returns. * * * Then you have an
affiliate of the Partnership preparing all personal and
Partnership returns and controlling all audit activity with
the Internal Revenue Service. * * * Then, all Partners are
able to benefit from the concept of “Circle the Wagons,” and
no individual Partner can be isolated and have his tax
losses disallowed because of the incompetence or lack of
knowledge of a tax preparer who is not familiar with the
law, regulations, format, procedures, and operations
concerning the Partnership that are required to protect the
Limited Partners from Internal Revenue audits. * * * If a
Partner needs more or less Partnership loss any year, it is
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arranged quickly within the office, without the Partner
having to pay a higher fee while an outside preparer spends
more time to make the arrangements.
Finally, the document warned that there remained a chance that “A
change in tax law or an audit and disallowance by the IRS could
take away all or part of the tax benefits, plus the possibility
of having to pay back the tax savings, with penalties and
interest.”
Prior to petitioners’ investment in the partnership, Mr. Van
Scoten also received from the Hoyt organization a copy of this
Court’s opinion in Bales v. Commissioner, T.C. Memo. 1989-568.
Mr. Hoyt touted the Bales opinion as proof that the Hoyt
partnerships were legal, and that the IRS was incorrect in
challenging their tax claims. Mr. Van Scoten believed that the
Bales opinion meant “basically, that a partnership either similar
to ours or like it was--it had gone to court and the Bales had
won the case. As far as the details about it, I don’t know.”
On January 7, 1991, petitioners signed a document comprised
of four sections in order to invest in the Hoyt partnership known
as Durham Shorthorn Breed Syndicate 1987-C (DSBS 87-C). The
first section was titled “Subscription Agreement -- Durham
Shorthorn Breed Syndicate 1987-C J.V. -- Series ‘A’ Units”. This
section expressed petitioners’ intent to make a capital
contribution to and become a limited partner of DSBS 87-C with
respect to certain “Series ‘A’ Units”. Included in this section
was a “Power of Attorney” form, which provided in relevant part:
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The UNDERSIGNED hereby constitutes and appoints Walter
J. Hoyt III his/her true and lawful attorney with power and
authority to act in the UNDERSIGNEDS’ behalf in the
execution, acknowledging, and filing of the documents as
follows:
1. The Partnership Certificates for filing, and
2. Any document which may be required to effect the
restructuring, amending, or continuation of the Partnership,
the admission of any substituted or added Partner, or the
dissolution and termination of the Partnership, provided
such restructuring, continuation, admission or dissolution
and termination are in accordance with the terms of the
Partnership Agreement, and
3. Any and all documents required to be executed by a
substituted, substituting or added Partner, to effectuate
the transfer of a Partner’s interest in the Partnership, and
4. Any other instrument, application, certificate, or
affidavit which may be required to be filed by the
Partnership under the laws of any State or any Federal, or
local agency or authority, and
5. Any promissory notes, bills-of-sale or other
instruments required for the conduct of the Partnership
business, including an assumption of primary liability form
attached to promissory notes for which the UNDERSIGNED
becomes personally liable for operating deficits of the
Partnership up to a maximum of Five Thousand Dollars
($5,000.00) per SERIES “A” UNIT if needed to meet the
business goals of the partnership.
The second section of the document was a “Partnership Agreement”,
purportedly affirming certain “oral Partnership Agreements that
were made on or about” January 7, 1991. The third section was
titled “Subscription Agreement -- Durham Shorthorn Breed
Syndicate 1987-C J.V. -- Series ‘B’ Units”, and was similar to
the first section, without a power of attorney form. The fourth
section was titled “Subscription Agreement -- Durham Shorthorn
Breed Syndicate 1987-C J.V. -- Series ‘C’ Units”. This section
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was similar to the first section, and it included a “Debt
Assumption” provision “to memorialize, affirm and set out the
oral Debt Assumption Agreement” along with another power of
attorney form with similar provisions as those detailed above.
Paragraph 5 of the power of attorney form, which differed from
the prior form, provided Mr. Hoyt with the authority to execute:
5. Any promissory notes, bills-of-sale or other
instruments required for the conduct of the Partnership
business, including a certificate of assumption of primary
liability form attached to promissory notes and held by the
lender for which the UNDERSIGNED becomes personally liable
directly to the lender for recourse debt of the Partnership
in order to pay his initial capital contribution to the
partnership.
On July 31, 1991, Mr. Van Scoten signed a document titled
“Subscription Agreement and Signature Page for Limited Partners”.
This document contained provisions similar to those in the prior
document, and it included another power of attorney form. The
document purported to evidence a financial institution’s purchase
of four “units” of the partnership Hoyt & Sons Ranch Properties,
Ltd., at a cost of $2,000, to be held in trust for the benefit of
Mr. Van Scoten. When Mr. Van Scoten signed the various
partnership documents and power of attorney forms, he believed
that petitioners would be required to repay the promissory notes
signed on their behalf by Mr. Hoyt.
Petitioners made substantial cash payments to the Hoyt
organization during the years 1991 through 1997. In a summary of
such payments prepared by petitioners, they estimate that the
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total amount of these payments exceeds $40,000. These payments
included the remittance of their tax refunds, the payment of
quarterly and monthly installments on their promissory notes,
special “assessments” imposed by the partnership, and
contributions to purported individual retirement account plans
maintained by the Hoyt organization. Petitioners continued
contributing to the partnership even after they stopped receiving
refunds from respondent. During and after the year in issue,
petitioners received numerous documents purporting to show both
the legitimacy of the Hoyt partnerships and the legality of the
tax claims being made by the Hoyt organization. The Hoyt
organization also portrayed employees of the IRS as incompetent
and claimed that they were engaging in unjust harassment of Hoyt
investors. Petitioners trusted these documents and believed and
relied upon what the Hoyt organization told them.
III. Petitioners’ Federal Tax Claims
On June 10, 1991, petitioners filed a joint Federal income
tax return for 1990, on which they reported the following:
Wage income $46,162
Interest income 29
Pension and annuity income 8,422
Loss from DSBS 87-C (148,390)
IRA contribution (2,000)
Adjusted gross income (95,777)
Tax liability 842
Overpayment 3,771
Upon filing their 1990 return, petitioners also filed a Form
1045, Application for Tentative Refund. On this form,
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petitioners claimed a net operating loss (NOL) carryback from
1990 in the amount of $102,228. Petitioners reported the
following after application of the carryback to the respective
taxable years:
1987 1988 1989
AGI on return $49,726 $38,967 $40,889
Tax liability on return 5,949 3,529 3,549
Corrected tax liability -0- -0- -0-
Overpayment 5,949 3,529 3,549
The 1990 return and the Form 1045 were prepared by individuals
affiliated with the Hoyt organization. The refund and tentative
refunds requested by petitioners with respect to the 1990 return
and the carryback years totaled $16,798. Petitioners remitted
two payments to the Hoyt organization during 1991 in the form of
two cashier’s checks dated May 8, 1991, and August 20, 1991, in
the respective amounts of $7,000 and $9,750.
In January 1992, prior to the time petitioners signed their
1991 return, respondent mailed Hoyt investors, including
petitioners, a letter regarding the application of section 469
(relating to passive activity loss limitations). That same
month, Mr. Hoyt mailed a letter to investors, including
petitioners, setting forth arguments that Hoyt investors
materially participated in their investments within the meaning
of section 469. In this letter, Mr. Hoyt stated that
respondent’s assertions in the preceding letter were incorrect,
and that the investors should do what was necessary to
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participate in their investment at least 100 or 500 hours per
year, depending upon the circumstances, in order to meet the
section 469 requirements. Mr. Hoyt stated that the time
investors spent in recruiting new investors, as well as “reading
and thinking about these letters”, would count toward the
material participation hourly requirements. Finally, in this
letter Mr. Hoyt emphasized that “The position of your partnership
is that it is not a tax shelter”, because tax shelters “are never
recognized for Federal income tax purposes.” By letter dated
February 11, 1992, respondent mailed petitioners a notice
stating:
In Mr. Hoyt’s letter misleading and/or inaccurate
premises were made which may directly affect you and your
decision-making process in filing your 1991 individual tax
return.
First, a “tax shelter” is not necessarily synonymous
with a “sham” investment. Low income housing credits, your
personal residence, and real estate rentals are examples of
tax shelters. It is an oversimplification to state tax
shelters are never recognized for Federal income tax
purposes.
The letter stated that I failed to include number seven
of the regulations which addresses the facts and
circumstances test. Enclosed is the exact wording of this
test, Regulation 1.469-5T(a)(7), and example #8 which refers
to this regulation. Also enclosed is paragraph (b) that is
referred to in paragraph (a)(7). Section 1402 noted in
paragraph (b) defines income subject to self-employment tax.
In the past, and currently, Mr. Hoyt has used Revenue
Rulings 56-496, 57-58, and 64-32 as authorities for
investors having met the material participation requirement.
These rulings and the court cases he has cited are prior to
the enactment of section 469 and all refer to section 1402.
Please note in (b)(2) that meeting the material
participation requirement of Section 1402 is specifically
excluded from being taken into account for having met the
material participation requirement of section 469 in using
the facts and circumstances test of (a)(7).
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Whether a person meets the material participation
requirement of section 469 is a factual determination. The
Reg. 1.469-5T(f)(2)(ii) defines investors’ activities that
are not considered in meeting the hourly requirement.
Simply signing a statement or making an election are not a
means in meeting the requirement. Although Section 469 may
not have existed at the time of your initial investment, it
is law that investors have to address in claiming investment
losses today. Contrary to Mr. Hoyt’s statement, time spent
reading and thinking about this issue should not be
considered as material participation hours for 1992.
If this letter is somewhat confusing or you are
questioning the accuracy of this letter, I recommend you
consider having an independent accountant or attorney review
this matter with you.
In addition to the above correspondence, petitioners received a
letter dated February 3, 1992 that informed them that respondent
was beginning an examination of DSBS 87-C with respect to its
taxable year ending in 1990. When petitioners received any
correspondence from respondent, petitioners would mail or fax
copies to the Hoyt organization, but they would take no further
action, and they sought no advice concerning the information that
they were receiving from respondent.
Petitioners filed a joint Federal income tax return for
taxable year 1991, the year in issue, reporting the following:
Wage income $51,362
Interest income 71
State tax refunds 1,433
Loss from DSBS 87-C (45,510)
Farm income 22,199
IRA contribution (2,000)
Self-employment tax deduction (240)
Adjusted gross income 27,315
Tax liability 1,798
Overpayment 2,471
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The Schedule K-1, Partner’s Share of Income, Credits, Deductions,
Etc., attached to petitioners’ return indicates that the DSBS 87-
C loss comprised of a “nonpassive activity deduction” of $18,810,
and a “special allocation deduction” of $26,700. The Schedule K-
1 also lists farm income of $22,199 as nonemployee compensation
earned by petitioners, and the schedule lists this amount as a
contribution to the partnership. A statement attached to the
return indicates that petitioners “contributed $2,000.00 in cash
to the partnership as part of his [sic] total cash contribution”
and that petitioners “should claim $2,000.00 as an I.R.A.
contribution for 1991" if they qualify. Another statement,
separately signed by petitioners, indicates that petitioners
materially participated in partnership-related activities–-on the
blank line following “The numbers [sic] of hours we spent working
in our business activity in 1991 was”, petitioners filled in “all
that was needed to be done.” The 1991 return was prepared by one
of Mr. Hoyt’s tax preparation services and was signed by Mr.
Hoyt. Mr. Hoyt signed the return on April 10, 1992, and
petitioners signed the return on April 14, 1992.
Petitioners remitted two payments to the Hoyt organization
during 1992, one in the form of a cashier’s check dated June 15,
1992, in the amount of $3,000, and a second payment in December
1992 in the amount of $1,250.
Upon signing the returns and forms prepared by the Hoyt
organization, Mr. Van Scoten did not know how the Hoyt-related
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items were derived; he knew only that Mr. Hoyt or a member of his
organization had entered the items on the returns, and he assumed
the items were therefore correct. Mr. Van Scoten did not
question any of the amounts shown on the return, and petitioners
did not have the returns reviewed by an accountant or anyone else
outside the Hoyt organization prior to signing them.
Respondent issued a Notice of Final Partnership
Administrative Adjustment (FPAA) to petitioners with respect to
DSBS 87-C that reflected the disallowance of various deductions
claimed on the partnership return for its taxable year ending in
1991. Because a timely petition to this Court was not filed in
response to the FPAA issued for DSBS 87-C, respondent made a
computational adjustment assessment against petitioners with
respect to the FPAA. The computational adjustments changed
petitioners’ claimed DSBS 87-C loss of $45,510 to income of
$4,998, disallowed the partnership-related IRA contribution
deduction of $2,000, and made computational adjustments to
petitioners’ itemized deductions and self-employment tax
deduction based on the above two changes.4 These changes
increased petitioners’ tax liability to $16,479, an increase of
$14,681 above petitioners’ reported tax liability of $1,798. In
the notice of deficiency underlying this case, respondent
4
The amount of the farm income reported by petitioners on
their 1991 return was not changed by respondent pursuant to the
computational adjustment assessment, presumably because the farm
income was not a partnership item.
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determined that petitioners are liable for the section 6662(a)
accuracy-related penalty for negligence or disregard of rules or
regulations with respect to $14,359 of the underpayment resulting
from the DSBS 87-C computational adjustment.
OPINION
I. Evidentiary Issues
As a preliminary matter, we address evidentiary issues
raised by the parties in the stipulations of facts. The parties
reserved objections to a number of the exhibits and paragraphs
contained in the stipulations, all on the grounds of relevancy.
Federal Rule of Evidence 4025 provides the general rule that all
relevant evidence is admissible, while evidence which is not
relevant is not admissible. Federal Rule of Evidence 401
provides that “‘Relevant evidence’ means evidence having any
tendency to make the existence of any fact that is of consequence
to the determination of the action more probable or less probable
than it would be without the evidence.” While certain of the
exhibits and stipulated facts are given little to no weight in
our finding of ultimate facts in this case, we hold that the
exhibits and stipulated facts meet the threshold definition of
“relevant evidence” under Federal Rule of Evidence 401, and that
the exhibits and stipulated facts therefore are admissible under
Federal Rule of Evidence 402. Accordingly, to the extent that
5
The Federal Rules of Evidence are applicable in this Court
pursuant to sec. 7453 and Rule 143(a).
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the Court did not overrule the relevancy objections at trial, we
do so here.
II. The Section 6662(a) Accuracy-Related Penalty
Section 6662(a) imposes an addition to tax of 20 percent on
the portion of an underpayment attributable to any one of various
factors, one of which is “negligence or disregard of rules or
regulations”. Sec. 6662(a) and (b). “Negligence” includes any
failure to make a reasonable attempt to comply with the
provisions of the Internal Revenue Code, and “disregard of rules
or regulations” includes any careless, reckless, or intentional
disregard. Sec. 6662(c). The regulations under section 6662
provide that negligence is strongly indicated where: A taxpayer
fails to make a reasonable attempt to ascertain the correctness
of a deduction, credit or exclusion on a return which would seem
to a reasonable and prudent person to be “too good to be true”
under the circumstances * * * . Sec. 1.6662-3(b)(1)(ii), Income
Tax Regs.
Negligence is defined as the “‘lack of due care or failure
to do what a reasonable or 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 on another
ground 43 T.C. 168 (1964)); see Anderson v. Commissioner, 62 F.3d
1266, 1271 (10th Cir. 1995), affg. T.C. Memo. 1993-607.
Negligence is determined by testing a taxpayer’s conduct against
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that of a reasonable, prudent person. Anderson v. Commissioner,
supra at 1272-1273. Courts generally look both to the underlying
investment and to the taxpayer’s position taken on the return in
evaluating whether a taxpayer was negligent. Id.; Keeler v.
Commissioner, 243 F.3d 1212, 1221 (10th Cir. 2001), affg. Leema
Enters., Inc. v. Commissioner, T.C. Memo. 1999-18; Sacks v.
Commissioner, 82 F.3d 918, 920 (9th Cir. 1996), affg. T.C. Memo.
1994-217. When an investment has such obviously suspect tax
claims as to put a reasonable taxpayer under a duty of inquiry, a
good faith investigation of the underlying viability, financial
structure, and economics of the investment is required. Roberson
v. Commissioner, T.C. Memo. 1996-335, affd. without published
opinion 142 F.3d 435 (6th Cir. 1998) (citing LaVerne v.
Commissioner, 94 T.C. 637, 652-653 (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); Horn v. Commissioner, 90 T.C. 908, 942 (1988)).
The Commissioner’s decision to impose the negligence penalty
is presumptively correct.6 Rule 142(a); Anderson v.
Commissioner, supra at 1271. A taxpayer has the burden of
proving that respondent’s determination is erroneous and that he
6
While sec. 7491 shifts the burden of production and/or
burden of proof to the Commissioner in certain circumstances,
this section is not applicable in this case because respondent’s
examination of petitioners’ return did not commence after July
22, 1998. See Internal Revenue Service Restructuring and Reform
Act of 1998, Pub. L. 105-206, sec. 3001(c), 112 Stat. 727.
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did what a reasonably prudent person would have done under the
circumstances. Bixby v. Commissioner, 58 T.C. 757, 791 (1972).
III. Application of the Negligence Standard
Although petitioners had no background in cattle ranching,
and petitioners did not consult any independent investment
advisers, petitioners made the decision to invest in a cattle
ranching activity as a means to provide for their retirement. As
part of their initial investment in the Hoyt partnerships,
petitioners provided Mr. Hoyt with the authority to sign
promissory notes on their behalf. The power of attorney forms
which petitioners signed granted Mr. Hoyt the authority to incur
personal debts on petitioners’ behalf, debt that Mr. Van Scoten
believed petitioners would be required to repay in the event
something went wrong with the partnership. In addition to the
promissory notes, the power of attorney forms granted Mr. Hoyt
the power to control numerous aspects of petitioners’ investment
without prior consultation with petitioners. Nevertheless,
petitioners placed their trust entirely with the Hoyt
organization, and they did not investigate the legitimacy of the
partnerships with anyone not employed by or invested in the Hoyt
organization. We conclude that petitioners were negligent in
signing the power of attorney forms and in entering into the
investment. Furthermore, we note that we do not accept Mr. Van
Scoten’s testimony that he did not intend to invest in a tax
shelter, and that he “never intended not to pay” his taxes. The
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promotional materials received by petitioners specifically called
the Hoyt investment a “tax shelter” and specifically stated that
the primary return on any investment would be from tax savings.
In the years preceding their investment, 1987 through 1989,
petitioners reported adjusted gross income (AGI) averaging
approximately $43,000 each year. In each of these years,
petitioners paid Federal income taxes in an amount averaging
approximately $4,300. After making their investment in DSBS 87-C
in January 1991, petitioners filed a 1990 return on which they
claimed a deduction for a partnership loss of $148,390, reducing
their 1990 tax liability on $46,162 of wage income to only $842.
Petitioners then filed the Form 1045 on which they used the
partnership loss to reduce their tax liability to zero in each of
1987, 1988, and 1989. Finally, for the year in issue, 1991,
petitioners claimed an additional partnership loss deduction of
$45,510, resulting in a tax liability of $1,798. While this loss
was partially offset by the farm income reported on the return,
petitioners’ tax liability was nevertheless less than half of
petitioners’ average tax liability before application of the
carryback in the years prior to their investment.
Petitioners claimed the tax benefits from the partnership
losses based solely on the advice that they received from the
promoters of the investment and from other Hoyt investors.
Furthermore, the promotional materials that petitioners received
had clearly indicated that there were substantial tax risks in
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making an investment. Nevertheless, petitioners did not
investigate the tax claims being made by the Hoyt organization
with anyone who was not involved with the organization.
When it came time to prepare petitioners’ tax returns and
claim the losses being reported by the Hoyt partnerships,
petitioners relied on the very people who were receiving the bulk
of the tax savings generated by the claims. Thus, the same
individuals who sold petitioners an interest in the Hoyt
partnerships and who ran the purported ranching operations also
prepared the partnerships’ tax returns, prepared petitioners’ tax
returns, and received from petitioners most of the tax savings
that resulted from the positions taken on petitioners’ returns.
When petitioners filed their 1991 return, Mr. Van Scoten did not
know, and there is no evidence that Ms. Van Scoten knew, how the
loss or other amounts were derived; he knew only that the Hoyt
organization had reported the amounts on petitioners’ tax return.
Petitioners claimed the loss despite the fact that respondent had
warned petitioners, as well Mr. Van Scoten’s father, that there
were potential problems with the tax claims being made on both
the partnership returns and on petitioners’ returns. Prior to
signing their 1991 return, petitioners had received at least two
separate letters from respondent alerting petitioners to
suspected problems or alerting petitioners to reviews that had
been commenced with respect to their partnership. Despite these
letters, petitioners did not further investigate the partnership
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losses, such as by consulting an independent tax adviser, before
claiming the losses as deductions on their 1991 return. Instead,
petitioners essentially ignored the letters, merely sending
copies of them to the Hoyt organization as petitioners had been
instructed to do.
Finally, petitioners’ actions with respect to the 1991
return reflect a nonchalant attitude with respect thereto, rather
than a reasonable attempt to ascertain their proper tax
liability. For example, on the statement attached to
petitioners’ return regarding material participation, petitioners
merely stated that they worked “all that was needed to be done”,
rather than specifying an accurate number of hours. When
questioned at trial concerning a partnership-related item
appearing on the return, Mr. Van Scoten testified twice that he
“probably looked at it and did not pay any attention to” the
amount appearing on the return. Petitioner further testified
that, in reviewing the 1991 return, “like most naive people, I’d
look for the smiley face at the end, not the numbers that got to
it.”
Upon the basis of the record before the Court, we conclude
that petitioners were negligent in 1991 in deducting the $45,510
partnership loss from DSBS 87-C.
IV. Alleged Defenses to the Accuracy-Related Penalty
Section 6664(c)(1) provides that the section 6662(a)
accuracy-related penalty is not imposed “with respect to any
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portion of an underpayment if it is shown that there was a
reasonable cause for such portion and that the taxpayer acted in
good faith with respect to such portion.” “The determination of
whether a taxpayer acted with reasonable cause and in good faith
is made on a case-by-case basis, taking into account all
pertinent facts and circumstances.” Sec. 1.6664-4(b)(1), Income
Tax Regs. The extent of the taxpayer’s effort to ascertain his
proper tax liability is generally the most important factor. Id.
A. Reliance on the Hoyt Organization and Edward Van Scoten
Petitioners first argue that they should escape the
negligence penalty because they relied in good faith on various
individuals with respect to the Hoyt investment: Mr. Hoyt and
other members of the Hoyt organization, tax professionals hired
by the Hoyt organization, and Mr. Van Scoten’s father, Edward Van
Scoten.
Good faith reliance on professional advice concerning tax
laws may be a defense to the negligence penalties. United States
v. Boyle, 469 U.S. 241, 250-251 (1985); see also sec. 1.6664-
4(b)(1), Income Tax Regs. However, “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 be considered as such,
the reliance must be reasonable. Id. To be objectively
reasonable, the advice generally must be from competent and
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independent parties unburdened with an inherent conflict of
interest, not from the promoters of the investment. Goldman v.
Commissioner, 39 F.3d 402, 408 (2d Cir. 1994), affg. T.C. Memo.
1993-480; LaVerne v. Commissioner, 94 T.C. at 652); Rybak v.
Commissioner, 91 T.C. 524, 565 (1988); Edwards v. Commissioner,
T.C. Memo. 2002-169.
It is clear in this case that petitioners’ reliance on the
Hoyt organization to prepare their tax returns was not
objectively reasonable. We note that petitioners did not receive
any specific advice concerning the deduction of the partnership
loss--they simply accepted whatever numbers were placed on the
return by the Hoyt organization and signed the returns as they
were presented to them. Petitioners’ reliance on the Hoyt
organization to prepare the returns was not objectively
reasonable because Mr. Hoyt and his organization created and
promoted the partnership, they completed petitioners’ tax return,
and they received the bulk of the tax benefits from doing so.
For petitioners to trust Mr. Hoyt or members of his organization
to prepare their return under these circumstances was inherently
unreasonable.
In addition to members of the Hoyt organization itself,
petitioners argue that they relied on tax professionals hired by
the Hoyt organization. Petitioners, however, have only
established that they believed that the Hoyt organization had
consulted with tax professionals. Petitioners have not
- 29 -
established in what manner they personally relied upon any such
professionals, or even the details of what advice the
professionals provided that would be applicable to petitioners’
situation with respect to the year in issue. Furthermore,
because all of these individuals were affiliated with the Hoyt
organization, it would have been objectively unreasonable for
petitioners to rely upon them in claiming the tax benefits
advertised by that very organization.
We reach a similar conclusion with respect to petitioners’
reliance on Mr. Van Scoten’s father, Edward Van Scoten. While
Mr. Van Scoten trusted Edward Van Scoten because of their
relationship, Edward Van Scoten lacked the expertise necessary to
provide objectively reasonable advice concerning an investment in
a Hoyt partnership. Although he had experience working on dairy
farms, this experience was not directly transferable to a
purportedly vast cattle ranching operation with a complex
financial and ownership structure. Furthermore, Edward Van
Scoten’s information pertaining to the tax benefits of an
investment in the Hoyt organization was derived from the same
source as Mr. Van Scoten’s information--from the promotional
materials and newsletters issued by the Hoyt organization.
Ultimately, petitioners’ reliance on Mr. Van Scoten’s father for
advice concerning the Hoyt partnership investment does not
absolve petitioner from the negligence penalty.
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B. Deception and Fraud by Mr. Hoyt
Petitioners next argue that they should not be liable for
the negligence penalty because they were defrauded and otherwise
deceived by Mr. Hoyt with respect to their investment in the Hoyt
partnerships. In this regard, petitioners first argue that the
doctrine of judicial estoppel bars application of the negligence
penalty because the U.S. Government successfully prosecuted Mr.
Hoyt for, in general terms, defrauding petitioners.
Judicial estoppel is a doctrine that prevents parties in
subsequent judicial proceedings from asserting positions
contradictory to those they previously have affirmatively
persuaded a court to accept. United States ex rel. Am. Bank v.
C.I.T. Constr., Inc., 944 F.2d 253, 258-259 (5th Cir. 1991);
Edwards v. Aetna Life Ins. Co., 690 F.2d 595, 598-599 (6th Cir.
1982). While this Court has accepted the doctrine of judicial
estoppel, see Huddleston v. Commissioner, 100 T.C. 17, 28-29
(1993), the Court of Appeals for the Tenth Circuit, to which
appeal lies in this case, has expressly rejected the doctrine.
United States v. 162 MegaMania Gambling Devices, 231 F.3d 713,
726 (10th Cir. 2000). Consequently, the doctrine of judicial
estoppel is not applicable in this case. See Golsen v.
Commissioner, 54 T.C. 742, 757 (1970) (holding that this Court
must “follow a Court of Appeals decision which is squarely in
point where appeal from our decision lies to that Court of
Appeals and to that court alone”).
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Despite the inapplicability of the judicial estoppel
doctrine in this case, we note that respondent’s position herein
is in no manner contradictory to the position taken by the United
States in the criminal conviction of Mr. Hoyt. See, e.g.,
Goldman v. Commissioner, 39 F.3d at 408 (taxpayer-appellants’
argument that an investment partnership “constituted a fraud on
the IRS, as found by a civil jury * * * and by the tax court * *
* cannot justify appellants’ own failure to exercise reasonable
care in claiming the losses derived from their investment”). To
the contrary, this Court has sustained a finding of negligence
with respect to investors who had been victims of deception by
tax shelter promoters. For example, in Klieger v. Commissioner,
T.C. Memo. 1992-734, this Court held that taxpayers in a
situation similar to that of petitioners were negligent. In
Klieger, we addressed taxpayers’ involvement in certain
investments that were sham transactions that lacked economic
substance:
Petitioners are taxpayers of modest means who were
euchred by Graham, a typical shifty promoter. Graham sold
petitioners worthless investments by giving spurious tax
advice that induced them to reduce their withholding and
turn their excess pay over to Graham as initial payments to
acquire interests in “investment programs” that did not
produce any economic return and apparently never had any
prospects of doing so. Graham purported to fulfill his
prophecies about the tax treatment of the Programs by
preparing petitioners’ tax returns and claiming deductions
and credits that have been disallowed in full, with
resulting deficiencies * * *.
* * * * * * *
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When a tax shelter is a sham devoid of economic
substance and a taxpayer relies solely on the tax shelter
promoter to prepare his income tax return or advise him how
to prepare the return with respect to the items attributable
to the shelter that the promoter has sold him, it will be
difficult for the taxpayer to carry his burden of proving
that he acted reasonably or prudently. Although a tax
shelter participant, as a taxpayer, has a duty to use
reasonable care in reporting his tax liability, the promoter
who prepares the participant’s tax return can be expected to
report large tax deductions and credits to show a relatively
low amount of tax due, and thereby fulfill the prophecies
incorporated in his sales pitch. * * *
In a vein similar to their judicial estoppel argument,
petitioners further argue that Mr. Hoyt’s deception resulted in
an “honest mistake of fact” by petitioners when they entered into
their investment. More specifically, petitioners assert that
they had insufficient information concerning the losses and that
“all tangible evidence available to the Hoyt partners supported
Jay Hoyt’s statements.”
Reasonable cause and good faith under section 6664(c)(1) may
be indicated where there is “an honest misunderstanding of fact
or law that is reasonable in light of all the facts and
circumstances, including the experience, knowledge, and education
of the taxpayer.” Sec. 1.6664-4(b)(1), Income Tax Regs.
However, “reasonable cause and good faith is not necessarily
indicated by reliance on facts that, unknown to the taxpayer, are
incorrect.” Id.
For the reasons discussed above in applying the negligence
standard, whether or not petitioners had a “mistake of fact” does
not alter our conclusion that petitioners’ actions in relation to
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their investment and the tax claims were objectively
unreasonable. Furthermore, and again for the reasons discussed
above, petitioners’ failure to investigate further--beyond what
was made available to them by Mr. Hoyt and his organization--was
also not an objectively reasonable course of action.
C. Petitioners’ Investigation
Petitioners further argue that they had reasonable cause for
the underpayment because they made a reasonable investigation
into the partnership, taking into account the level of their
sophistication. Petitioners assert that this investigation
yielded no indication of wrongdoing by Mr. Hoyt, and petitioners
further assert that an average taxpayer would have been unable to
uncover Mr. Hoyt’s fraud. As we have held, petitioners’
investigation into the partnership went no further than members
of the Hoyt organization and Mr. Van Scoten’s father, who was
another Hoyt investor and who in turn was relying on the Hoyt
organization. Relying on these individuals as a source of
objective information concerning the partnerships was not
reasonable. Furthermore, petitioners were negligent in not
further investigating the partnership and/or seeking independent
advice concerning it.
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D. The Bales Opinion
Petitioners next argue that they had reasonable cause for
the underpayment because of this Court’s opinion in Bales v.
Commissioner, T.C. Memo. 1989-568.7 Bales involved deficiencies
asserted against various investors in several different cattle
partnerships marketed by Mr. Hoyt. This Court found in favor of
the investors on several issues, stating that “the transaction in
issue should be respected for Federal income tax purposes.” The
Bales case involved different investors, different partnerships,
different taxable years, and different issues than those
underlying the present case.
First, petitioners argue they relied on Bales in claiming
the deduction for the partnership loss. We find that petitioners
have not established that they relied on Bales in this manner.
While petitioners received the opinion, there is no evidence that
they, without any background in law or accounting, personally
relied upon the opinion in claiming the relevant partnership
loss. To the contrary, Mr. Van Scoten testified at trial that he
7
Petitioners also argue that the Bales opinion provided
“substantial authority for the positions taken on petitioners’
1991 income tax return.” There is no explicit “substantial
authority” exception to the sec. 6662(a) accuracy-related penalty
for negligence. Hillman v. Commissioner, T.C. Memo. 1999-255
n.14 (citing Wheeler v. Commissioner, T.C. Memo. 1999-56). While
petitioners refer to the “reasonable basis” exception to the
negligence penalty, set forth in sec. 1.6662-3(b)(3), Income Tax
Regs., they do not specifically argue that the exception applies
in this case. Nevertheless, we note that the record does not
establish that petitioners had a reasonable basis for claiming
the partnership loss at issue in this case.
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did not know any details concerning the opinion, and, when
questioned about a letter from the Hoyt organization regarding
another case in this Court, he further testified that he “didn’t
care about” the portions of the letter pertaining to the “Tax
Court writing stuff”. In short, the record shows that if
petitioners relied on Bales to any degree, they relied only on
the interpretation of Bales provided by Mr. Hoyt and members of
his organization, who repeatedly claimed that Bales was proof
that the partnerships and the tax positions were legitimate. We
have already found that petitioners’ reliance on Mr. Hoyt and his
organization was objectively unreasonable and, as such, not a
defense to the negligence penalty. Accepting Mr. Hoyt’s
assurances that Bales was a wholesale affirmation of his
partnerships and his tax claims was no less unreasonable.
Second, petitioners argue that, because this Court was
unable to uncover the fraud or deception by Mr. Hoyt in Bales,
petitioners as individual taxpayers were in no position to
evaluate the legitimacy of their partnership or the tax benefits
claimed with respect thereto. This argument employs the Bales
case as a red herring: Bales involved different investors,
different partnerships, different taxable years, and different
issues. Furthermore, adopting petitioners’ position would imply
that taxpayers should have been given carte blanche to invest in
partnerships promoted by Mr. Hoyt, merely because Mr. Hoyt had
previously engaged in activities which withstood one type of
- 36 -
challenge by the Commissioner, no matter how illegitimate the
partnerships had become or how unreasonable the taxpayers were in
making investments therein and claiming the tax benefits that Mr.
Hoyt promised would ensue.
E. Fairness Considerations
Petitioners’ final arguments concerning application of the
accuracy-related penalty are in essence arguments that imposition
of the penalty would be unfair or unjust in this case.
Petitioners argue that “The application of penalties in the
present case does not comport with the underlying purpose of
penalties.” To this effect, petitioners argue that, in this
case,
The problem was not Petitioners’ disregard of the tax laws,
but was Jay Hoyt’s fraud and deception. Petitioners did not
engage in noncompliant behavior, instead [they] were the
victims of a complex fraud that it took Respondent years to
completely unravel.
Petitioner Ron Van Scoten made a good faith effort to comply
with the tax laws and punishing him by imposing penalties
does not encourage voluntary compliance, but instead has the
opposite effect of the appearance of unfairness by punishing
the [victim].
We are mindful of the fact that petitioners were victims of Mr.
Hoyt’s fraudulent actions. Petitioners ultimately lost the bulk
of the tax savings that they received, which they had remitted to
Mr. Hoyt as part of their investment. Nevertheless, petitioners
believed that this money was being used for their own personal
benefit--at the time that they claimed the tax savings, they
believed that they would eventually benefit from them. Mr.
- 37 -
Hoyt’s conduct does not alter our conclusion that petitioners
were negligent with respect to entering the Hoyt investment, and
that they were negligent with respect to the position that they
took on their 1991 tax return. Despite Mr. Hoyt’s actions, the
positions taken on the 1991 return signed by petitioners were
ultimately the positions of petitioners, not of Mr. Hoyt.
V. Conclusion
Upon the basis of the record before the Court, we conclude
that petitioners’ actions in relation to the Hoyt investment
constituted a lack of due care and a failure to do what
reasonable or ordinarily prudent persons would do under the
circumstances. First, petitioners entered into an investment, in
which they gave Mr. Hoyt authority to incur personal debts on
their behalf and control petitioners’ interest in their
partnership, without investigating the legitimacy of the
partnerships beyond the advice of Mr. Van Scoten’s father.
Second, and foremost, petitioners trusted individuals who told
them that they effectively could escape paying Federal income
taxes for a number of years--petitioners reported a combined tax
liability of $2,640 on $106,046 of wage, interest, and pension
income over 2 years, and reported zero tax liability on $129,582
of AGI for the prior 3 years--based solely upon the tax advice of
the individuals promoting the tax shelter. Our conclusion is
reinforced by the fact that petitioners received warnings from
respondent, warnings that petitioners chose to ignore. We find
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that petitioners were negligent with respect to entering the Hoyt
investment, and that they were negligent with respect to claiming
the DSBS 87-C loss on their return.
To reflect the foregoing,
Decision will be entered
for respondent.