T.C. Memo. 2004-279
UNITED STATES TAX COURT
GLENN A. MORTENSEN, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 25991-96. Filed December 15, 2004.
Wendy S. Pearson, Terri A. Merriam, and Jennifer A. Gellner,
for petitioner.
Nhi T. Luu-Sanders and Catherine Caballero, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GOLDBERG, Special Trial Judge: Respondent determined that
petitioner is liable for a section 6662(a) accuracy-related
penalty of $784 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 petitioner is
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.
Petitioner resided in Hixson, Tennessee, 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 an adjustment of a partnership item on petitioner’s 1991
Federal income tax return. This adjustment is the result of
petitioner’s involvement in certain partnerships 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. Petitioner’s 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 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. Petitioner and His Investment
Petitioner has a college education with a bachelor of
science degree in engineering. During the year in issue,
petitioner was employed as a field engineer. At the time that he
invested in the Hoyt partnerships, petitioner did not have any
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significant investment experience, and he did not have any
experience with farming or cattle.
Petitioner first learned about the Hoyt partnerships from a
coworker in late 1985 or early 1986. At the suggestion of this
coworker, who was already an investor in a Hoyt partnership,
petitioner decided to look into making an investment.
Petitioner, along with a group of four or five other coworkers,
acquired an informational packet from the Hoyt organization.
Petitioner first invested in the Hoyt partnerships in 1986.
Prior to investing, petitioner received promotional materials
prepared by the Hoyt organization, some of which he had acquired
in his initial request for information. Petitioner relied on
these promotional materials which, in general, provided
rationales for why the partnerships were good investments and why
the purported tax savings were legitimate. One document on which
petitioner 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
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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
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
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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
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.”
At the time that he initially made the investment in 1986,
petitioner believed that the investment would produce a profit
and provide retirement income.
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In July 1986, petitioner invested in a Hoyt partnership
known as Durham Genetic Engineering 1986-1 (DGE 86-1). However,
this partnership was “rescinded” later that year, forcing
petitioner to invest in another partnership known as Shorthorn
Genetic Engineering 1986 Ltd. (SGE 86). On December 22, 1986,
petitioner signed a series of four documents relating to his
investment in SGE 86. The first document was titled “1986
Acknowledgement”. This document provided: “This is to
acknowledge I became a Partner in DGE 1986-1 on/or about July 22,
1986, and that I owned an undivided 1/30th interest in the
partnership on that date through a binding oral and/or written
agreement * * * . I agree to adopt and to be bound by all the
terms of the Partnership Agreement.” The second document, titled
“Instructions to the Managing General Partner and and [sic]
Acknowledgement of Certain Agreements”, provided in relevant
part:
(1) I [petitioner] hereby give you [Mr. Hoyt] the
irrevocable authority to sign my name to a Certificate of
Assumption of Primary Liability Form on a full recourse
Promissory Note in the amount of $75,000.00 that will become
part of a transfer of debt agreement between me, the
Partnership and HOYT & SONS RANCHES, said note having been
delivered to pay for breeding cattle purchased from HOYT &
SONS RANCHES, an Oregon Partnership, in Burns, Oregon, which
are to be held as breeding cattle by the above named
Partnership. This authorizes you to sign my name on notes
that were made for the purchase of Registered Shorthorn
Breeding cattle from HOYT & SONS RANCHES, and no other
purpose. I understand I will owe this amount directly to
HOYT & SONS RANCHES and not to my Partnership. I understand
I must pay this debt myself. It is my goal to pay it out of
my share of the Partnership profits.
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The third document, titled “Instructions to Hoyt and Sons Ranches
-- Acknowledgement of Appointment of Power of Attorney”,
provided:
(1) I have given Walter J. Hoyt III the irrevocable
authority to sign my name to a Certificate of Assumption of
Primary Liability Form as part of a transfer on a full
recourse Promissory Note in the amount of $75,000.00, that
will become part of a transfer of debt agreement between me,
the Partnership known as Shorthorn Genetic Engineering 1986
Ltd., and HOYT & SONS RANCHES, said note having been
delivered to HOYT & SONS RANCHES to pay for breeding cattle
purchased from HOYT & SONS RANCHES, an Oregon Partnership,
in Burns, Oregon, which are to be held as breeding cattle by
the above named Partnership. This authorizes Mr. Hoyt to
sign my name on the notes that were made for the purchase of
Registered Durham Breeding cattle from HOYT & SONS RANCHES,
and no other purpose. I understand I will owe this amount
directly to HOYT & SONS RANCHES, and not to my partnership.
* * * * * * *
(4) My goal is that the value of my share of the cattle
owned by the Partnership, in which you have a secured party
interest, must never fall below the amount for which I am
personally liable. If the value of my cattle does fall
below the amount of my loan, and you become aware of that,
you must so notify me within thirty days in order that I may
make a damage claim to W.J. Hoyt Sons Management Company for
possible default on the Share-Crop Operating Agreement,
and/or the cattle fertility warranties.
The final document was titled “Subscription Agreement --
Shorthorn Genetic Engineering 1986 Ltd. -- Series ‘C’ Units”.
This document expressed petitioner’s intent to make a capital
contribution to and become a limited partner of SGE 86 by
purchasing units valued at $75,000. Included with this document
was a “Power of Attorney” form, which provided in relevant part:
The UNDERSIGNED hereby constitutes and appoints Walter
J. Hoyt III his/her true and lawful attorney with power and
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authority to act in the UNDERSIGNEDS’ behalf in the
execution, acknowledging, and filing of the documents as
follows:
1. The Partnership agreements for filing, and
2. Any documents 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 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.
When petitioner entered into the investment, he believed that he
would be liable for the promissory notes, but he also believed
that cattle existed that could be sold to cover the debt.
On December 31, 1986, Mr. Hoyt signed a “Certificate of
Assumption of Primary Liability” on petitioner’s behalf. This
document provided that petitioner “personally assumes primary
liability for the prompt payment when due of any and all
liability or indebtedness of the Partnership” in the amount of
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$122,000. While the documents signed by petitioner described
above pertain to SGE 86, this document signed by Mr. Hoyt
referred to the partnership known as Shorthorn Genetic
Engineering 1984-2 (SGE 84-2).
In 1989, petitioner 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. Petitioner did not read the entire
opinion, instead relying on information from the Hoyt
organization interpreting the opinion.
Beginning sometime in the early 1990s, petitioner started
attending a number of monthly meetings of Hoyt partners that were
held near petitioner’s home. At these meetings, petitioner would
discuss various issues pertaining to the partnerships with the
other partners, including a number of partners who had visited
the Hoyt ranches. Petitioner considered attendance at these
meetings, as well as any time that he was “actively aware of the
proceedings of the business”, to be material participation with
respect to his investment.
Throughout the years of his involvement with the Hoyt
organization, petitioner’s investment was transferred between
partnerships without any action being taken by petitioner.
Petitioner believed that Mr. Hoyt was using his power of attorney
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to do the necessary paperwork, and, if asked, petitioner would
accept any suggestions made by the Hoyt organization for changes
to his investment. Petitioner believed that at least one reason
for the changes was to maximize tax savings available to him.
Petitioner typically did not receive any type of verification
that his partnership interest had been successfully transferred,
or that his name had been taken off any promissory notes that had
been signed on his behalf.
The underlying partnership adjustment in this case was made
with respect to a partnership known as Durham Shorthorn Breeding
Syndicate 1987-C (DSBS 87-C). There are no documents in the
record pertaining to any investment by petitioner in DSBS 87-C.
Petitioner made substantial cash payments to the Hoyt
organization during the years 1986 through 1997; petitioner
estimates that the total amount of these payments was
approximately $93,000. These payments included the remittance of
his tax refunds, the payment of quarterly and monthly
installments on his promissory notes, special “assessments”
imposed by the partnerships, and contributions to purported
individual retirement account plans maintained by the Hoyt
organization. Petitioner has received only nominal amounts of
his contributions back from the Hoyt organization. Before and
after the year in issue, petitioner received numerous documents
purporting to show both the legitimacy of the Hoyt partnerships
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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. Petitioner trusted these
documents and believed and relied upon what the Hoyt organization
told him.
III. Petitioner’s Federal Tax Claims
Petitioner reported the following on his Federal income tax
returns in each of the respective years:
1986 1987 1988 1989 1990
Wage income $43,112 $40,033 $46,858 $44,813 $45,734
Interest income 3,126 2,010 1,974 2,633 3,577
Other income1 -0- 1,754 -0- 1,608 -0-
Partnership losses 141,260 24,931 33,712 23,741 20,180
Tax liability -0- 464 1,054 926 1,181
1
The other income was derived from capital gain from the sale of a
residence in 1987, and income from pensions and annuities in 1989.
The amounts listed above for 1986 are those amounts that appear
on the amended return filed by petitioner for that year. On the
original return, petitioner had reported a partnership loss of
$27,170 and an investment tax credit of $17,412, both derived
from the “rescinded” partnership DGE 86-1. The original return
also reflected zero tax liability. The amended return,
reflecting a $141,260 loss from SGE 84-2, explained the reason
for the amended return as follows:
During 1986, the Taxpayers [sic] became a General Partner in
the Partnership known as Durham Genetic Engineering 1986-1.
Taxpayers’ partnership purchased a group of registered
cattle during 1986. After the Partnership began business,
the Taxpayers elected to accept rescission of their
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partnership interest offered by the Managing General Partner
on behalf of the Partnership, and no longer claim any loss
or Investment Tax Credit allocated to them by that
Partnership.
As a former General Partner, the Taxpayers now adopt the
position they became a co-owner/joint tenant in the herd of
cattle that was purchased in the name of the partnership on
the date of purchase, which they paid for by signing a full
recourse promissory note on Dec. 28, 1986. The Taxpayers
have now elected to combine their cattle with another
Partnership known as [SGE 84-2]. Accordingly, the Taxpayers
are now reporting the 1986 expenses from the cattle owned by
them on Schedule E, and the depreciation on Schedule F.
Taxpayers now claim, or will claim in 1987, the Investment
Tax Credit on their cattle as a transferee of used
transition property that was placed in service by the
transferor prior to the transfer. The Taxpayers have
obtained certain rights in a binding purchase agreement
signed by the transferor prior to December 31, 1985, for the
purchase of the cattle.
After filing the 1986 return, petitioner also filed a Form 1045,
Application for Tentative Refund, based on a carryback of a
claimed net operating loss (NOL) of $98,148 from 1986. This form
reflected the following:
1983 1984 1985
Adjusted gross income $34,618 $43,487 $38,065
Tax liability on original return 4,821 7,517 6,210
Tax liability after NOL carryback -0- -0- -0-
In addition to this Form 1045, there is in the record a copy of
another Form 1045 that reflects a credit carryback rather than an
NOL carryback. It is unclear whether this form was submitted to
respondent; regardless, it is clear that the Form 1045 reflecting
the NOL carryback was meant to supersede the other form. The
superseded Form 1045 reflected a carryback of a $16,868 general
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business credit from petitioner’s taxable year 1986. While
application of the credit purportedly would have resulted in the
elimination of petitioner’s regular tax liability in 1983, 1984,
and 1985, petitioner would have reported liability for
alternative minimum tax of $855 in 1984 and $992 in 1985.
By letter dated May 23, 1988, respondent notified petitioner
that SGE 84-2's taxable year 1987 was under review. This letter
stated in relevant part:
Our information indicates that you were a partner in the
above partnership during the above tax year. Based upon our
review of the partnership’s tax shelter activities, we have
apprised the Tax Matters Partner that we believe the
purported tax shelter deductions and/or credits are not
allowable and, if claimed, we plan to examine the return and
disallow the deductions and/or credits. The Internal
Revenue Code provides, in appropriate cases, for the
application [of various penalties].
By similar letter dated May 9, 1989, respondent notified
petitioner that another of his Hoyt partnerships, Timeshare
Breeding Service (TBS), was under review with respect to its
taxable year 1988.
In January 1992, respondent mailed Hoyt investors, including
petitioner, 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
petitioner, setting forth arguments that Hoyt investors
materially participated in their investments within the meaning
of section 469. In this letter, Mr. Hoyt stated that
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respondent’s assertions in the preceding letter were incorrect,
and that the investors should do what was necessary to
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 petitioner 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
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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).
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.
Petitioner also received several notices informing him that
respondent was beginning an examination of the various
partnerships in which petitioner was involved, including DSBS 87-
C. Petitioner received such notices dated August 21, 1989, May
21, 1990, August 13, 1990, February 19, 1991 (two notices),
February 3, 1992, and February 18, 1992. Finally, respondent had
frozen the refunds petitioner claimed on his 1987 and 1988
Federal income tax returns that were derived from the Hoyt
partnership losses. In late 1988 and mid-1989, petitioner twice
inquired into the status of the 1987 refund; respondent
subsequently notified petitioner by letter that his 1984 through
1988 accounts were being audited.
When petitioner received any correspondence from respondent,
petitioner would send copies to the Hoyt organization; petitioner
would take no further action or seek advice concerning the
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information that he was receiving from respondent. Petitioner
interpreted the letters that he was receiving from respondent to
mean that respondent was “claiming that we’re not running a
legitimate business and that they are going to disallow any
deductions or credits that we had claimed.”
On April 22, 1992, after the year in issue but before filing
his return for that year, petitioner signed a series of documents
evidencing petitioner’s intention to invest in the partnership
SGE 84-2.
Petitioner filed an individual Federal income tax return for
his taxable year 1991, the year in issue. He reported the
following on this return:
Wage income $48,405
Interest income 4,512
SGE 84-2 loss (39,160)
DSBS 87-C loss (16,720)
Capital gain 13,003
Farm income 4,824
IRA contribution deduction (2,000)
Adjusted gross income 12,864
Tax liability 724
The losses from SGE 84-2 and DSBS 87-C were reported on Schedules
K-1, Partner’s Share of Income, Credits, Deductions, Etc., issued
to petitioner by the partnerships for the partnerships’ taxable
years ending in 1991. Both the capital gain and the IRA
contribution deduction reported on petitioner’s return are
derived from SGE 84-2. Although it appears from the return that
the farm income is related to petitioner’s Hoyt investment, it is
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unclear how this amount of income was calculated or earned.
Attached to the return was a “Material Participation Statement”,
on which petitioner averred that he spent 121 hours during 1991
working in various Hoyt-related activities. The 1991 return was
signed by Mr. Hoyt as the return preparer on June 18, 1992, and
it was signed by petitioner on July 26, 1992.
Starting with the 1986 return and the Form 1045, and
continuing through the 1991 return, Mr. Hoyt or a member of the
Hoyt organization prepared petitioner’s tax forms. Upon signing
the returns, petitioner did not know how the Hoyt-related items
were derived; he knew only that Mr. Hoyt or a member of his
organization had entered the items on the Schedules K-1 and on
the returns, and he assumed the items were therefore correct.
Petitioner did not have the returns reviewed by an accountant or
anyone else outside the Hoyt organization prior to signing them.
The section 6662(a) accuracy-related penalty in this case is
derived solely from the loss that petitioner claimed in 1991 with
respect to DSBS 87-C. Respondent issued a Notice of Final
Partnership Administrative Adjustment (FPAA) to petitioner 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 petitioner
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with respect to the FPAA. The computational adjustment changed
petitioner’s claimed DSBS 87-C loss of $16,720 to income of
$4,421, increasing petitioner’s tax liability by $3,918, from
$724 to $4,642. In the notice of deficiency underlying this
case, respondent determined that petitioner is liable for the
section 6662(a) accuracy-related penalty for negligence or
disregard of rules or regulations with respect to the entire
amount 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.
We address here those objections that were not withdrawn by the
parties at trial. Federal Rule of Evidence 4021 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
1
The Federal Rules of Evidence are applicable in this Court
pursuant to sec. 7453 and Rule 143(a).
- 22 -
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 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)(1). “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.
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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 Pasternak v. Commissioner, 990
F.2d 893, 902 (6th Cir. 1993), affg. Donahue v. Commissioner,
T.C. Memo. 1991-181. Negligence is determined by testing a
taxpayer’s conduct against that of a reasonable, prudent person.
Zmuda v. Commissioner, 731 F.2d 1417, 1422 (9th Cir. 1984), affg.
79 T.C. 714 (1982). 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. 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)).
- 24 -
The Commissioner’s decision to impose the negligence penalty
is presumptively correct.2 Rule 142(a); Pasternak v.
Commissioner, supra at 902. Thus, a taxpayer has the burden of
proving that respondent’s determination is erroneous and that he
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 petitioner had no background in farming or
ranching, and petitioner did not consult any independent
investment advisers, petitioner made the decision to invest in a
cattle ranching activity as a means to provide for retirement.
As part of his initial investment in the Hoyt partnerships,
petitioner provided Mr. Hoyt with the authority to sign
promissory notes on his behalf in an amount of at least $75,000.
Petitioner also gave Mr. Hoyt the authority to control a number
of aspects of his investment, without requiring any confirmation
or consultation with petitioner. Nevertheless, petitioner placed
his trust entirely with the promoters of the investment and, as
discussed in detail below, he did not adequately investigate
either the legitimacy of the partnerships or the implications of
2
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 petitioner’s 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.
- 25 -
the promissory notes. This trust continued even when the Hoyt
organization switched petitioner’s investment from partnership to
partnership, at times without notifying petitioner or verifying
the status of the promissory notes that had been signed on
petitioner’s behalf. We conclude that petitioner was negligent
in signing the power of attorney forms and in entering into the
investment.
In the years 1986 through 1991, petitioner used the Hoyt
investment to report a total Federal income tax liability of
$4,349 on income totaling $290,149. In addition, petitioner
filed the Form 1045 which purportedly completely eliminated his
Federal income tax liabilities for 1983 through 1985, resulting
in a requested refund of $18,548. Petitioner claimed these tax
benefits based solely on the advice that he received from the
promoters of the investment and from other Hoyt investors--
petitioner never questioned the amounts on the tax returns, and
he never had the returns reviewed by a tax professional.
Furthermore, the promotional materials that petitioner received
had clearly indicated that there were substantial tax risks in
making an investment. Nevertheless, petitioner did not inquire
into the tax claims being made on his tax returns by the Hoyt
organization with anyone outside the organization. This failure
to inquire is especially notable with respect to petitioner’s
1986 return and amended return. In preparing petitioner’s
- 26 -
amended return for that year, the Hoyt organization prepared a
statement in which it was claimed that petitioner’s partnership
interest had been switched from DGE 86-1 to SGE 84-2. At that
time, however, petitioner had signed partnership agreements and
other documents pertaining only to SGE 86; the investment
documents in the record show that petitioner did not invest in
SGE 84-2 until April 1992. Furthermore, the Hoyt organization
reported to petitioner that the claimed investment tax credit of
$17,412 that was no longer available was being replaced by a loss
of $141,260. Petitioner accepted at face value that these
amounts were accurate, even when the amounts were of such size
that they purportedly completely eliminated petitioner’s tax
liability for 3 prior years.
When it came time to prepare petitioner’s tax returns and
claim the losses being reported by the Hoyt partnerships,
petitioner relied on the very people who were receiving the bulk
of the tax savings generated by the claims. Thus, the same
individuals who sold petitioner an interest in the Hoyt
partnerships and who managed the purported ranching operations
also prepared the partnerships’ tax returns, prepared
petitioner’s tax returns, and received from petitioner most of
the tax savings that resulted from the positions taken on his
returns.
- 27 -
With respect to 1991, the year in issue in this case,
petitioner claimed that he incurred $55,880 in losses from the
Hoyt partnerships. Petitioner did not know how these losses were
derived; he knew only that the Hoyt organization had reported the
amounts on the Schedules K-1 and on his tax return. Petitioner
claimed these losses despite the fact that respondent had been
warning petitioner, at least since May 1988, that there were
potential problems with the tax claims being made on both the
partnership returns and on petitioner’s returns. Prior to
signing his 1991 return, petitioner had received at least 12
separate letters from respondent alerting petitioner to suspected
problems or alerting petitioner to reviews that had been
commenced with respect to various Hoyt partnerships in which he
was involved. Despite these letters, petitioner did not further
investigate the partnership losses, such as by consulting an
independent tax adviser, before claiming the losses as deductions
on his 1991 return. We conclude that petitioner was negligent in
1991 in claiming the Hoyt partnership loss at issue in this case;
namely, the $16,720 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
portion of an underpayment if it is shown that there was a
reasonable cause for such portion and that the taxpayer acted in
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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. Petitioner’s Investigation and Reliance on Others
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
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. Furthermore, the taxpayer must show that
any expert rendering an opinion with respect to an investment had
- 29 -
the expertise and knowledge of the pertinent facts necessary to
render such an opinion. Barlow v. Commissioner, 301 F.3d 714,
724 (6th Cir. 2002), affg. T.C. Memo. 2000-339; Freytag v.
Commissioner, supra at 888.
1. Reliance on the Hoyt Organization and Partners
Petitioner argues that he should escape the negligence
penalty because he 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 other Hoyt investor-partners.
It is clear in this case that the advice petitioner received
from the Hoyt organization, if any, concerning the partnership
loss deduction that resulted in the underpayment underlying the
penalty was not objectively reasonable. First, we note that
petitioner has not established that he received any advice at all
concerning the deduction. Although petitioner relied on Mr. Hoyt
and his organization to prepare the return, petitioner does not
even suggest that he directly questioned Mr. Hoyt or his
organization about the nature of the tax claims. Instead, when
petitioner signed the return, he did not question or seek advice
from anyone concerning the large partnership loss at issue--he
merely assumed the items on the return were proper.
Nevertheless, assuming arguendo that petitioner did receive
advice from Mr. Hoyt or someone within his organization, any such
- 30 -
advice that he received is in no manner objectively reasonable.
Mr. Hoyt and his organization created and promoted the
partnership, they completed petitioner’s tax return, and they
received the bulk of the tax benefits from doing so. For
petitioner to trust Mr. Hoyt or members of his organization for
tax advice and/or to prepare his return under these circumstances
was inherently unreasonable.
In addition to members of the Hoyt organization itself,
petitioner argues that he relied on tax professionals hired by
the Hoyt organization and on other Hoyt investors. Petitioner,
however, has only established that he believed that the Hoyt
organization and the other partners had consulted with tax
professionals. Petitioner has not established in what manner he
personally relied upon any such professionals, or even the
details of what advice the professionals provided that would be
applicable to petitioner’s 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 petitioner to rely upon them in
claiming the tax benefits advertised by that very organization.
2. Petitioner’s Early Investigation
Petitioner next argues that he had reasonable cause for the
underpayment because he made a reasonable investigation into the
partnership. Petitioner asserts that this investigation yielded
- 31 -
no indication of wrongdoing by Mr. Hoyt, and that an “average
taxpayer” was unable to discover this wrongdoing. As we have
held, any reliance by petitioner on materials provided by the
Hoyt organization and its partners was not objectively
reasonable. Petitioner, however, argues that his investigation
went further than the Hoyt promotional materials and other Hoyt
partners.
Petitioner’s testimony at trial concerning his investigation
into the partnership can be summarized as follows. After
acquiring the informational packet from the Hoyt organization,
petitioner mailed the packet to his father so that his father
could show it to a tax professional. Petitioner’s father
subsequently told petitioner that “The attorney looked over it
and he said there was nothing illegal.” In addition, one of the
group of petitioner’s coworkers who was also interested in
investing decided to contact the IRS for information. This
coworker told petitioner that “there was no indication from the
IRS that there was anything wrong with Hoyt or anything like
that.” Finally, a second coworker traveled to California “to go
to their [Hoyt’s] offices and also * * * to at least one ranch to
be sure that it was a viable business and that there was actually
people running a business and there was actually cows involved.”
Assuming arguendo the veracity of petitioner’s version of
events, we do not find that petitioner reasonably relied upon any
- 32 -
advice from a tax professional concerning the Hoyt investment.
Petitioner’s testimony concerning his reliance on his father’s
tax professional--to whom petitioner did not pay any fee for
advice--was vague and lacked any degree of detail. In
particular, it remains unclear exactly what information was
contained in the packet that petitioner asserts he sent to his
father. Petitioner also did not provide the name of the
professional, and while he initially testified that the
professional was a tax lawyer, he later referred to him a his
father’s “tax accountant”. Petitioner provided no
contemporaneous written statement from the professional, and he
testified that because of his father’s death he was unable to
discover the professional’s name prior to trial. Petitioner’s
description of the advice from the professional was also vague,
consisting merely of a broad and conclusory statement that
nothing about the investment was illegal. Petitioner admits that
he did not personally speak with the professional, that he did
not provide him with any details concerning his particular
investment with the Hoyt organization, and that he was unsure how
much of the informational packet the professional reviewed.
Furthermore, although the professional purportedly told
petitioner’s father that there were risks involved with the
investment, petitioner did not question the professional
concerning the nature of the risks or otherwise investigate them.
- 33 -
In conclusion, we find that petitioner did not reasonably rely on
any advice that he received from the professional through his
father because any such advice was not provided by someone who
had all the necessary information to make an informed decision,
and because the advice was conclusory and did not address any of
the specific risks involved in an investment, including the tax
risks. See Barlow v. Commissioner, supra; Hunt v. Commissioner,
T.C. Memo. 2001-15.
We similarly find that any reliance upon petitioner’s
coworkers to investigate the partnership was not reasonable.
With respect to the coworker who purportedly contacted the IRS,
the record is completely devoid of any detail concerning what
information he provided to the IRS or what information he
received in return. With respect to the coworker who purportedly
traveled to visit a Hoyt ranch, there has been no suggestion that
this coworker had any background in cattle ranching or was
otherwise qualified to investigate the Hoyt organization. See
Freytag v. Commissioner, supra at 888.
We note that, even if petitioner did rely upon the
individuals discussed above, any such reliance would have been 5
years before he signed the return that resulted in the penalty at
issue in this case. Petitioner’s continued reliance on any
information gained from these individuals over such a long period
of time--in light of the large losses being claimed by the
- 34 -
partnerships, the discrepancies in the partnerships in which
petitioner was involved, and the continuous warnings being sent
by respondent--was unreasonable under the circumstances.
In summary, petitioner asserts that his investigation
yielded no indication of wrongdoing by Mr. Hoyt, and that an
“average” taxpayer would have been unable to uncover Mr. Hoyt’s
fraud. However, we conclude that petitioner was nevertheless
negligent in not adequately investigating the partnership and/or
seeking qualified independent advice concerning it.
B. Deception and Fraud by Mr. Hoyt
Petitioner next argues that he should not be liable for the
negligence penalty because he was defrauded and otherwise
deceived by Mr. Hoyt with respect to his investment in the Hoyt
partnerships. In this regard, petitioner first argues 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 petitioner.
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). Both this Court and the Court of Appeals for the Sixth
- 35 -
Circuit, to which appeal in this case lies, have accepted the
doctrine of judicial estoppel. See Edwards v. Aetna Life Ins.
Co., supra; Huddleston v. Commissioner, 100 T.C. 17, 28-29
(1993).
The doctrine of judicial estoppel focuses on the
relationship between a party and the courts, and it seeks to
protect the integrity of the judicial process by preventing a
party from successfully asserting one position before a court and
thereafter asserting a completely contradictory position before
the same or another court merely because it is now in that
party’s interest to do so. Edwards v. Aetna Life Ins. Co., supra
at 599; Huddleston v. Commissioner, supra at 26. Whether or not
to apply the doctrine is within the sound discretion of the
court, but it should be applied with caution in order “‘to avoid
impinging on the truth-seeking function of the court because the
doctrine precludes a contradictory position without examining the
truth of either statement.’” Daugharty v. Commissioner, T.C.
Memo. 1997-349 (quoting Teledyne Indus., Inc. v. NLRB, 911 F.2d
1214, 1218 (6th Cir. 1990)), affd. without published opinion 158
F.3d 588 (11th Cir. 1998).
Judicial estoppel generally requires acceptance by a court
of the prior position and does not require privity or detrimental
reliance of the party seeking to invoke the doctrine. Huddleston
v. Commissioner, supra at 26. Acceptance by a court does not
- 36 -
require that the party being estopped prevailed in the prior
proceeding with regard to the ultimate matter in dispute, but
rather only that a particular position or argument asserted by
the party in the prior proceeding was accepted by the court. Id.
Respondent’s position in this case 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 petitioner 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
- 37 -
and credits that have been disallowed in full, with
resulting deficiencies* * *. * * *
* * * * * * *
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. * * *
We conclude that there are no grounds for application of judicial
estoppel in the present case.
In a vein similar to his judicial estoppel argument,
petitioner further argues that Mr. Hoyt’s deception resulted in
an “honest mistake of fact” by petitioner when he entered into
his investment. More specifically, petitioner asserts that he
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
- 38 -
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 petitioner had an “honest mistake of
fact” does not alter our conclusion that petitioner’s actions in
relation to his investment and the tax claims were objectively
unreasonable. Furthermore, and again for the reasons discussed
above, petitioner’s failure to conduct an objectively reasonable
investigation--beyond what was made available to him by Mr. Hoyt
and his organization--was also negligent.
C. The Bales Opinion
Petitioner next argues that he had reasonable cause for the
underpayment because of this Court’s opinion in Bales v.
Commissioner, T.C. Memo. 1989-568.3 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
3
Petitioner also argues that the opinion in Bales v.
Commissioner, T.C. Memo. 1989-568, provided “substantial
authority for the positions taken on petitioner’s 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 petitioner refers to
the “reasonable basis” exception to the negligence penalty, set
forth in sec. 1.6662-3(b)(3), Income Tax Regs., he does not
specifically argue that the exception applies in this case.
Nevertheless, we note that the record does not establish that
petitioner had a reasonable basis for claiming the partnership
loss at issue in this case.
- 39 -
issue should be respected for Federal income tax purposes.”
Bales involved different investors, different partnerships,
different taxable years, and different issues than those
underlying the present case.
First, petitioner argues that he relied on the Bales opinion
in claiming the deduction for the partnership loss. Without
further addressing the applicability of Bales to petitioner’s
situation, we find that petitioner has not established that he
relied on Bales in this manner. While petitioner received the
opinion and may have read a portion of it, there is no evidence
that he, without any background in law or accounting, personally
relied upon the opinion in claiming the relevant partnership
loss. Rather, petitioner admits that he relied instead 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 petitioner’s 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, petitioner argues that, because this Court was
unable to uncover the fraud or deception by Mr. Hoyt in Bales,
petitioner as an individual taxpayer was in no position to
- 40 -
evaluate the legitimacy of his partnership or the tax benefits
claimed with respect thereto. This argument employs Bales as a
red herring: Bales involved different investors, different
partnerships, different taxable years, and different facts. The
taxpayers in Bales were individual investors whose taxable years
involved were 1974 through 1979. Although the Court held that
the cattle breeding partnerships were bona fide and should not be
disregarded as shams, the taxpayers did not receive all of the
tax benefits they claimed. However, in Durham Farms #1 v.
Commissioner, T.C. Memo. 2000-159, affd. 59 Fed. Appx. 952 (9th
Cir. 2003), we found that by the early 1980s the Hoyt
organization’s cattle management and record keeping practices
changed dramatically, and most of the records, documents, and tax
returns pertaining to the cattle breeding partnerships were
inaccurate and unreliable. In fact, many of the cattle
purportedly purchased by the partnerships never existed.
Therefore, all claimed tax benefits were disallowed in full.
Thus, it would not have been reasonable for petitioner to rely
upon Bales in making investments herein and claiming the tax
benefits that Mr. Hoyt promised would ensue.
- 41 -
D. Fairness Considerations
Petitioner’s 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.
Petitioner argues that “The application of penalties in the
present case does not comport with the underlying purpose of
penalties.” To this effect, petitioner argues that, in this
case:
the problem was not Petitioner’s disregard of the tax laws,
but was Jay Hoyt’s fraud and deception. Petitioner did not
engage in noncompliant behavior, instead he was the victim
of a complex fraud that it took Respondent years to
completely unravel.
Petitioner 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. Indeed, penalties are improper for any investor in
the Hoyt partnerships on a policy basis alone. [Fn. ref.
omitted.]
We are mindful of the fact that petitioner was a victim of Mr.
Hoyt’s fraudulent actions. Petitioner ultimately lost the bulk
of the tax savings that he received, which he had remitted to Mr.
Hoyt as part of his investment and which he never received back.
Nevertheless, petitioner believed that this money was being used
for his own personal benefit--at the time that he claimed the tax
savings, he believed that he would eventually benefit from them.
Petitioner also lost a substantial amount of out-of-pocket cash
which he paid to Mr. Hoyt in the years preceding and following
- 42 -
the year in issue. However, this does not alter our conclusion
that petitioner was negligent with respect to entering the Hoyt
investment, and that he was negligent with respect to the
positions that he took on his 1991 tax return. Despite Mr.
Hoyt’s actions, the positions taken on the 1991 return signed by
petitioner were ultimately the positions of petitioner, not of
Mr. Hoyt.
V. Conclusion
On the basis of the record before the Court, we conclude
that petitioner’s actions in relation to the Hoyt investment
constituted a lack of due care and a failure to do what a
reasonable or ordinarily prudent person would do under the
circumstances. First, petitioner entered into an investment--in
which he gave Mr. Hoyt the authority to incur personal debts on
his behalf and control his interest in his partnerships--without
adequately investigating the legitimacy of the partnerships.
Second, and foremost, petitioner trusted individuals who told him
that he effectively could escape paying Federal income taxes for
a number of years--petitioner reported a combined tax liability
of $4,349 on $290,149 of income over 6 years starting with 1986,
and reported zero tax liability on $116,170 of AGI for the prior
3 years--based solely upon the tax advice of the individuals
receiving some of the benefits of the tax savings. Our
conclusion is reinforced by the fact that petitioner received
- 43 -
multiple warnings from respondent, warnings that petitioner chose
to ignore. We find that petitioner was negligent with respect to
entering the Hoyt investment, and that he was negligent with
respect to claiming the DSBS 87-C loss on his return.
To reflect the foregoing,
Decision will be entered
for respondent.