Sanders v. Comm'r

T.C. Memo. 2005-163

UNITED STATES TAX COURT

EUGENE A. SANDERS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 25134-96. Filed July 5, 2005.

Douglas Alan Azar, for petitioner.

Nhi T. Luu-Sanders, for respondent.

MEMORANDUM OPINION

CARLUZZO, Special Trial Judge: In what is commonly referred

to as an affected item notice of deficiency, respondent

determined a section 6662(a)1 accuracy-related penalty of $8,411

(amounts are rounded) with respect to petitioner’s 1991 Federal

1
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for 1991, and Rule references are
to the Tax Court Rules of Practice and Procedure.
 - 2 -

income tax. The issue for decision is whether the underpayment

of tax required to be shown on petitioner’s 1991 Federal income

tax return is due to negligence or intentional disregard of rules

or regulations.

Background

Some of the facts have been stipulated and are so found. At

the time the petition was filed, petitioner resided in Athens,

Alabama.

A. Hoyt Partnerships

Walter J. Hoyt III (Mr. Hoyt) and some members of the Hoyt

family (hereinafter collectively referred to as Hoyt) were in the

business of organizing and promoting cattle-breeding

partnerships. From 1971 through 1992, Mr. Hoyt organized and

operated as a general partner nearly 100 partnerships.2

On February 12, 2001, Mr. Hoyt was convicted in the U.S.

District Court for the District of Oregon of 1 count of

conspiracy to commit fraud, 31 counts of mail fraud, 3 counts of

bankruptcy fraud, and 17 counts of money laundering. See United

2
For a general description of the Hoyt organization and
its operation, see Bales v. Commissioner, T.C. Memo. 1989-568;
see also River City Ranches #1, Ltd. v. Commissioner, T.C. Memo.
2003-150, affd. in part, revd. in part and remanded 401 F.3d 1136
(9th Cir. 2005); Mekulsia v. Commissioner, T.C. Memo. 2003-138,
affd. 389 F.3d 601 (6th Cir. 2004); Durham Farms #1, J.V. v.
Commissioner, T.C. Memo. 2000-159, affd. 59 Fed. Appx. 952 (9th
Cir. 2003); and River City Ranches #4, J.V. v. Commissioner, T.C.
Memo. 1999-209, affd. 23 Fed. Appx. 744 (9th Cir. 2001).
 - 3 -

States v. Barnes, No. CR 98-529-JO-04 (D. Or. Feb. 12, 2001),

affd. sub nom. United States v. Hoyt, 47 Fed. Appx. 834 (9th Cir.

2002).

B. Petitioner’s Backgound and Hoyt Investment

Petitioner holds a bachelor’s degree in nuclear engineering

and a master’s degree in business administration (MBA). As part

of his MBA curriculum, petitioner took accounting and law-related

classes. He has been employed as a mechanical design engineer

for over 25 years and was so employed during 1991.

Before 1989, petitioner invested exclusively in stocks and

mutual funds. He had no experience in cattle, ranching, or

farming, and he had never been a partner in a partnership.

In or around October 1989, petitioner was “making a lot of

money” and “looking for a way to defer taxes”, so he discussed

investing in a Hoyt partnership with a coworker, Gary Parker (Mr.

Parker). In November 1989, petitioner contacted a Hoyt partner

representative for additional information about various Hoyt

partnership investment opportunities. The Hoyt partner

representative provided petitioner with promotional materials

assembled by Hoyt that included pamphlets,3 newspaper articles,

trade articles, and the Court’s opinion in Bales v. Commissioner,

3
For example, the promotional materials stated, in part,
that investors could “earn 11.3% tax free annually paid quarterly
in cash and 12.93% in tax savings” and that “income from
operations is projected to be sheltered from income tax.”
 - 4 -

T.C. Memo. 1989-568.4 Petitioner also recalled seeing the

articles “The 1,000 lbs. Tax Shelter” and “Harvesting the Tax

Code” among the Hoyt promotional materials. Petitioner did not

consult an attorney or a tax professional with respect to the

information provided in the Hoyt promotional materials.

In November 1989, petitioner invested in the Hoyt

partnerships. Petitioner did not consult an attorney or a tax

professional at any time before making his Hoyt investment.

Petitioner originally invested in Hoyt’s Timeshares Breeding

Services (Timeshares) partnership.5 Petitioner signed and

executed a Joint Venture Partnership Agreement for five units at

a total price of $17,500. Petitioner also executed, among other

documents, a Power of Attorney and a Certificate Of Assumption Of

Primary Liability. Petitioner did not have an attorney review

these documents. Petitioner believed that his Hoyt investment

was an “undivided share of a herd.” At the time of his

investment, petitioner provided a check in the amount of $17,500

to Mr. Parker for “5 bull units”. Mr. Parker retained a portion

4
At that time, petitioner was aware that the Bales opinion
applied only to the 1977 through 1979 taxable years.
5
Timeshares was started by the Hoyt organization in the
mid-1980s. In general, Timeshares arranged leases of bulls
ostensibly owned by the Timeshares cattle-breeding partnerships
the Hoyt family had organized and promoted to numerous investors.
 - 5 -

of petitioner’s investment contribution, and the remainder was

remitted to Hoyt.

A year after petitioner’s initial investment in Timeshares,

petitioner’s investment was transferred by Hoyt to Durham

Shorthorn Breed Syndicate 1987-C (Durham).6 Petitioner did not

sign or receive any partnership documents from Hoyt, such as a

subscription agreement, power of attorney, or joint venture

partnership agreement, with respect to Durham. Petitioner was

not concerned that his investment was transferred by Hoyt to a

different partnership.7

At no time during his investment was petitioner aware of the

number of cattle owned by Durham. At no time did petitioner

request or review Durham’s tax returns or other partnership

records. The only financial information petitioner received from

Durham was a Schedule K-1, Partner’s Share of Income, Credits,

Deductions, Etc., issued for each taxable year 1989, 1990, and

1991. Petitioner had no “idea what the numbers on the [Schedule]

K-1 entailed.”

6
Durham is similar to the cattle-breeding partnership at
issue in the Court’s opinion in Durham Farms #1, J.V. v.
Commissioner, supra.
7
For instance, one of petitioner’s tax returns listed his
Hoyt partnership investment as Poison Creek. After an inquiry
with Hoyt, petitioner was told that “it doesn’t make any
difference. It’s all the same.” Petitioner added that “It was
so convoluted that it was hard to figure out what was going on.”
 - 6 -

Before his Hoyt investment, petitioner had always prepared

his own tax returns. As a Hoyt investor, petitioner chose to

have his tax returns prepared by Laguna Tax Service, a Hoyt

organization.

On April 15, 1990, petitioner filed a 1989 Federal income

tax return and reported wage and business income of $10,898 and

$95,674, respectively. Durham issued petitioner a Schedule K-1

for the period ending September 30, 1989, which reported $81,440

as petitioner’s distributive share of Durham’s ordinary loss. On

a Schedule E, Supplemental Income and Loss, attached to his 1989

return, petitioner reported a partnership loss of $81,440.

During 1991, petitioner claimed and received refunds of

$14,607 and $16,998 for the taxable years 1987 and 1988,

respectively, as a result of carrying back the 1989 loss from

Durham to these prior taxable years.

In a notice of beginning of administrative proceeding (NBAP)

dated February 19, 1991, respondent notified petitioner that

Durham’s 1989 taxable year would be examined.

On April 29, 1991, petitioner filed a 1990 Federal income

tax return which reported business income of $52,941. Durham

issued petitioner a Schedule K-1 for the period ending September

30, 1990, which reported $175,560 as petitioner’s distributive
 - 7 -

share of Durham’s ordinary loss. Attached to the Schedule K-1

was a Form 8271, Investor Reporting of Tax Shelter Registration

Number, which identified Durham as a tax shelter. On a Schedule

E attached to his 1990 return, petitioner reported a partnership

loss of $175,560.

During July 1991, petitioner traveled to Burns, Oregon, to

tour several Hoyt ranches. Petitioner did not review any Hoyt

records during his 4-day visit. During his visit to the Hoyt

ranches, petitioner saw “just a handful” of cattle. Petitioner

was unable to determine which cattle, if any, were specifically

owned by Durham.

On February 3, 1992, respondent sent to petitioner an NBAP

which notified petitioner that Durham’s 1990 taxable year was

under examination.

On February 11, 1992, Revenue Agent Norm Johnson sent

petitioner a letter. The letter noted, in part, that in prior

correspondence sent by Mr. Hoyt in January 1992 to petitioner and

other Hoyt investors, “misleading and/or inaccurate premises were

made which may directly affect you and your decision-making

process in filing your 1991 individual tax return.”8 The revenue

agent’s letter further stated that if petitioner was confused by,

or questioned the accuracy of, the information provided by

8
Mr. Hoyt’s letter to the Hoyt investors addressed
arguments with respect to material participation under sec. 469.
 - 8 -

respondent, then petitioner should “consider having an

independent accountant or attorney review this matter”.

On March 6, 1992, respondent sent to petitioner a letter

which again informed petitioner that Durham was under examination

for the 1989 taxable year. The letter further stated that “any

adjustments proposed to this entity could have a tax effect to

your return”.

On May 15, 1992, petitioner filed his 1991 Federal income

tax return and reported business income and income on Schedule F,

Profit or Loss From Farming, of $54,347 and $51,657,

respectively. Durham issued petitioner a Schedule K-1 for the

period ending September 30, 1991, which reported $94,050 as

petitioner’s distributive share of the ordinary loss from Durham.

Attached to the Schedule K-1 was a Form 8271 which identified

Durham as a tax shelter. On a Schedule E attached to the 1991

return, petitioner reported a partnership loss of $94,050.

Petitioner also claimed an individual retirement account

deduction of $2,000 on his 1991 return which was related to his

Hoyt investment.

On May 1, 1995, respondent issued a notice of final

partnership administrative adjustment (FPAA) to the tax matters

partner, as well as to petitioner, with respect to Durham’s 1991

taxable year. The FPAA determined that Durham had failed to

substantiate many of its claimed deductions. These deductions
 - 9 -

were subsequently disallowed partnership deductions which totaled

$3,055,313. The petition filed at docket No. 7714-96 by the tax

matters partner in response to the FPAA issued to Durham for the

taxable year 1991 was untimely. Accordingly, the case was

dismissed, and by an assessment made in September 1996,

respondent increased petitioner’s 1991 Federal income tax

liability by $42,057. In a notice of deficiency dated September

9, 1996, respondent determined that petitioner is liable for a

section 6662(a) accuracy-related penalty of $8,411 for 1991.9

Discussion

Respondent determined that petitioner is liable for the

accuracy-related penalty under section 6662(a) because of

negligence or disregard of rules or regulations under section

6662(b)(1) or, in the alternative, a substantial understatement

of income tax under section 6662(b)(2). Respondent’s

determination with respect to the imposition of the section

6662(a) penalty is presumed correct, and petitioner bears the

burden of proving that he is not liable for the accuracy-related

penalty under section 6662(a).10 See Rule 142(a); Welch v.

9
Respondent concedes that a portion of the partnership
adjustment is not subject to the accuracy-related penalty.
10
Sec. 7491 is not applicable in this case because the
examination of petitioner’s 1991 return commenced before July 22,
1998, the effective date of sec. 7491.
 - 10 -

Helvering, 290 U.S. 111, 115 (1933); Bixby v. Commissioner, 58

T.C. 757, 791 (1972).

Section 6662(a) imposes a penalty of 20 percent of the

portion of the underpayment of tax attributable to the taxpayer’s

negligence, disregard of rules or regulations, or substantial

understatement of income tax. Sec. 6662(a), (b)(1) and (2).

Negligence is defined as the lack of due care or failure to

do what a reasonable and ordinarily prudent person would do under

the circumstances. Neely v. Commissioner, 85 T.C. 934, 947

(1985). Negligence includes any failure to make a reasonable

attempt to comply with the law. Sec. 6662(c); sec. 1.6662-

3(b)(1), Income Tax Regs. Section 1.6662-3(b)(1), Income Tax

Regs., provides 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”. “Disregard” has been

described as any careless, reckless, or intentional disregard.

Sec. 6662(c).

Section 6664(c)(1) provides that the penalty under section

6662(a) shall not apply to any portion of an underpayment if

it is shown that there was reasonable cause for the taxpayer’s

position with respect to that portion and that the taxpayer acted

in good faith with respect to that portion. The determination of
 - 11 -

whether a taxpayer acted with reasonable cause and in good faith

within the meaning of section 6664(c)(1) is made on a case-by-

case basis, taking into account all the pertinent facts and

circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs. The most

important factor is the extent of the taxpayer’s effort to assess

his proper tax liability for the year. Id. Section 1.6664-

4(b)(1), Income Tax Regs., specifically provides: “Circumstances

that may indicate reasonable cause and good faith include an

honest misunderstanding of fact or law that is reasonable in

light of * * * the experience, knowledge and education of the

taxpayer.” See Neely v. Commissioner, supra. Reliance by the

taxpayer on the advice of a qualified adviser will constitute

reasonable cause and good faith if, under all of the facts and

circumstances, the reliance by the taxpayer was reasonable and

the taxpayer acted in good faith. Sec. 1.6664-4(b)(1), Income

Tax Regs.

We consider “the reasonableness of the taxpayer’s actions in

light of his experience and the nature of the investment.”

Fawson v. Commissioner, T.C. Memo. 2000-195; see also Henry

Schwartz Corp. v. Commissioner, 60 T.C. 728, 740 (1973); Greene

v. Commissioner, T.C. Memo. 1998-101, affd. without published

opinion 187 F.3d 629 (4th Cir. 1999); Glassley v. Commissioner,

T.C. Memo. 1996-206. Whether a taxpayer is negligent in claiming

a tax deduction “depends upon both the legitimacy of the
 - 12 -

underlying investment and due care in the claiming of the

deduction.” Sacks v. Commissioner, 82 F.3d 918, 920 (9th Cir.

1996), affg. T.C. Memo. 1994-217; Greene v. Commissioner, supra.

“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 (citing LaVerne v.

Commissioner, 94 T.C. 637, 652-653 (1990), affd. without

published opinion 956 F.2d 274 (9th Cir. 1992), affd. without

published opinion sub nom. Cowles v. Commissioner, 949 F.2d 401

(10th Cir. 1991)), affd. without published opinion 142 F.3d 435

(6th Cir. 1998); Horn v. Commissioner, 90 T.C. 908, 942 (1988).

Petitioner contends that he is not liable for the section

6662(a) accuracy-related penalty because he had reasonable cause

to believe that his claimed tax treatment with respect to his

Hoyt investment was proper. Petitioner specifically argues that

at the time he filed his 1991 return, he reasonably relied on the

Court’s opinion in Bales v. Commissioner, T.C. Memo. 1989-568, as

substantial authority for the tax treatment of the partnership

items.11

11
We note that 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).
 - 13 -

Petitioner is a well-educated individual who holds an

undergraduate degree in nuclear engineering as well as an MBA.

However, petitioner had no knowledge with respect to cattle

businesses before his Hoyt investment. Petitioner did not seek

professional legal or tax advice before his Hoyt investment.

Instead, petitioner relied on Hoyt promotional materials that

included articles titled “The 1,000 lbs. Tax Shelter” and

“Harvesting the Tax Code” and which stated that partnership

earnings from various Hoyt partnerships were “tax free” and

“sheltered from income tax”.

Before filing his 1991 return petitioner received two

separate notices from respondent that Durham was under

examination for the taxable years 1989 and 1990. In a separate

letter, respondent specifically informed petitioner that the

examination of Durham “could have a tax effect to your return”.

Petitioner also received a letter from respondent before filing

his 1991 return which stated that information which had been

previously sent to investors from Mr. Hoyt was “misleading and/or

inaccurate” and that petitioner should “consider having an

independent accountant or attorney review this matter”. Despite

these notices, petitioner did not make any inquiries with respect

to his Hoyt investment or have his 1991 return prepared or

reviewed by an independent tax professional.
 - 14 -

As a result of his Hoyt investment, on his 1991 Federal

income tax return petitioner claimed a $94,050 loss from Durham.

Petitioner had previously claimed losses from Durham of $81,440

and $175,560, respectively, on his 1989 and 1990 returns.

However, petitioner’s sole cash contribution to Durham was

$17,500. Considering the size of petitioner’s investment and the

disproportionately large losses generated by the partnership,

further investigation was warranted. See Todaro v. Commissioner,

T.C. Memo. 1995-398. As previously stated, petitioner made no

such investigation. The fact that petitioner was able to claim

in 1991 alone a loss that was five times his original investment

was enough to have put petitioner on “‘notice that the investment

was primarily for a tax purpose.’” Greene v. Commissioner,

supra. The amount of the losses petitioner claimed in 1991 and

prior years compared to the amount of his Hoyt investment created

a situation that was “too good to be true” within the meaning of

section 1.6662-3(b)(1)(ii), Income Tax Regs.

Finally, petitioner’s reliance on Bales v. Commissioner,

supra, is misplaced. Petitioner knew that the opinion generally

involved the taxable years 1977 through 1979. Petitioner also

knew that the Bales opinion did not deal with Durham, his

specific Hoyt partnership investment. While petitioner received

the opinion, there is no evidence that he personally relied upon

the opinion in taking the positions on his 1991 return. Instead,
 - 15 -

the record reflects that petitioner relied on the representations

of the Hoyt organization with respect to his Hoyt investment and

the preparation of his 1991 return.12

The Bales case involved different investors, different

partnerships, different taxable years, and different issues from

those underlying the present case. Additionally, this Court has

noted that by the 1980s the Hoyt organization’s cattle-

management and record-keeping practices changed dramatically.

See Durham Farms #1, J.V. v. Commissioner, T.C. Memo. 2000-159,

affd. 59 Fed. Appx. 952 (9th Cir. 2003).

12
While petitioner refers to the fraud and deceit of Mr.
Hoyt with respect to his Hoyt partnership investment, he does not
specifically argue that Mr. Hoyt’s fraud is a reasonable cause
for his tax return positions. Nevertheless, we note that good
faith reliance on professional advice concerning tax laws may be
a defense to the negligence penalty. United States v. Boyle, 469
U.S. 241, 250-251 (1985). However, it is also well established
that taxpayers generally cannot “reasonably rely” on the
professional advice of a tax shelter promoter. See Goldman v.
Commissioner, 39 F.3d 402, 408 (2d Cir. 1994), affg. T.C. Memo.
1993-480; Neonatology Associates, P.A. v. Commissioner, 115 T.C.
43, 98 (2000) (“Reliance may be unreasonable when it is placed
upon insiders, promoters, or their offering materials, or when
the person relied upon has an inherent conflict of interest that
the taxpayer knew or should have known about.”), affd. 299 F.3d
221 (3d Cir. 2002); Marine v. Commissioner, 92 T.C. 958, 992-993
(1989), affd. without published opinion 921 F.2d 280 (9th Cir.
1991). Such reliance is especially unreasonable when the advice
would seem to a reasonable person to be “‘too good to be true’”.
Pasternak v. Commissioner, 990 F.2d 893, 903 (6th Cir. 1993),
affg. Donahue v. Commissioner, T.C. Memo. 1991-181; Elliott v.
Commissioner, 90 T.C. 960, 974 (1988), affd. without published
opinion 899 F.2d 18 (9th Cir. 1990). Nevertheless, we note that
for the reasons discussed above, including petitioner’s failure
to make any independent inquiry or investigation into the Hoyt
partnerships, any reliance by petitioner on the Hoyt organization
or its representatives was objectively unreasonable.
 - 16 -

As we noted in Hansen v. Commissioner, T.C. Memo. 2004-269:

adopting [petitioner’s] 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 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.

Consequently, we reject petitioner’s claim that at the time he

filed his 1991 return, Bales v. Commissioner, T.C. Memo. 1989-

568, provided support for the positions taken on that return with

respect to his Hoyt investment.

We find that petitioner has failed to show that he was not

negligent with respect to the underpayment for the taxable year

at issue. We further find that petitioner has failed to show

that he acted with reasonable cause, or in good faith, with

respect to such underpayment. Accordingly, we find that

petitioner has failed to establish that he is not liable for the

accuracy-related penalty under section 6662(a) for the taxable

year at issue.13

13
We have found that petitioner is liable for the taxable
year at issue for the accuracy-related penalty under sec. 6662(a)
because of negligence or disregard of rules or regulations under
sec. 6662(b)(1). In light of that finding, we need not address
respondent’s alternative argument that petitioner is liable for
the taxable year at issue for the accuracy-related penalty under
sec. 6662(a) because of a substantial understatement of income
tax under sec. 6662(b)(2).
 - 17 -

To reflect the foregoing,

Decision will be entered

under Rule 155.