T.C. Memo. 2011-27
UNITED STATES TAX COURT
STEPHEN L. AND CINDY C. FLETCHER, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 23968-07, 23969-07, Filed January 31, 2011.
23970-07, 23971-07.
Chaya Kundra and Heather L. Bravi, for petitioners.
Erin R. Hines, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GOEKE, Judge: The sole issue for decision in these
deficiency cases is whether petitioners are liable for the
accuracy-related penalty under section 66621 in the following
amounts:
1
All section references are to the Internal Revenue Code.
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Penalty
Year Sec. 6662
1988 $8,222
1990 1,952
1991 2,735
1992 5,880
The accuracy-related penalty arises from an adjustment of
flowthrough losses that were reported on petitioners’ 1991 and
1992 Federal income tax returns and then carried back to 1988 and
1990. These adjustments are the result of petitioners’
involvement in cattle breeding and sheep breeding partnerships
organized and promoted by Walter J. Hoyt III. From 1971 through
1992 Mr. Hoyt organized and promoted cattle breeding and sheep
breeding partnerships (collectively referred to as the Hoyt
partnerships).
FINDINGS OF FACT
Petitioners resided in Maryland when they filed the
petitions in these consolidated cases. Mr. and Mrs. Fletcher
both completed high school. Neither has had any training or
experience in accounting or tax return preparation. Both were
raised in farming communities.
Mr. Fletcher learned of the Hoyt partnerships through a
coworker while employed in Florida. Petitioners subsequently
received brochures and promotional materials about the Hoyt
partnerships. In 1991 petitioners purportedly invested in the
Hoyt partnerships, specifically Durham Farms #3 (Durham Farms)
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and Washoe Ranches #6 (Washoe Ranches). Petitioners never signed
any partnership documents such as subscription agreements for
either Durham Farms or Washoe Ranches, nor have they ever visited
any of the properties related to the Hoyt partnerships.
Before becoming involved in the Hoyt partnerships,
petitioners engaged the services of Frank Sutton, a certified
public accountant, located in Kinston, North Carolina, to prepare
their 1988 and 1989 Federal tax returns; petitioners used H & R
Block to prepare their 1990 return. At trial Mr. Fletcher
maintained he had consulted with both Mr. Sutton and H & R Block
regarding the Hoyt partnerships, but his testimony was vague and
not credible in this regard. Neither Mr. Sutton nor H & R Block
provided petitioners with a prospectus about the Hoyt
partnerships.
Once petitioners became investors, the Hoyt partnerships
offered them the tax preparation services of Laguna Tax Service
(Laguna) to prepare their Federal tax returns. Beginning with
the 1991 return Laguna played an important role in facilitating
petitioners’ alleged investment in the Hoyt partnerships because
their initial payment was funded by refunds, resulting in claimed
losses on the 1991 return and carryback losses to their 1988 and
1990 years. As a result of carrying the 1991 loss back,
petitioners claimed refunds for 1988 and 1990 of $41,113 and
$9,762, respectively, on a Form 1045, Application for Tentative
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Refund, which was prepared by Laguna, signed by petitioners, and
filed in September 1992. The Form 1045 adjusted income initially
reported on petitioners’ 1988 and 1990 returns.
On May 22, 1992, petitioners signed a Form 1040, U.S.
Individual Income Tax Return, for 1991, and on April 15, 1993,
petitioners signed a Form 1040 for 1992. Both returns were
prepared by Laguna.
In October 1992 petitioners were issued refunds claimed on
their Form 1045. On July 6, 1992, petitioners were issued a
refund of $9,221 for 1991. On or about November 9, 1993,
respondent mailed petitioners a letter indicating that he had
reduced the amount of petitioners’ refund for 1992 attributable
to their investment in the Hoyt tax shelter. Petitioners were
not issued any refund for 1992.
On July 24, 2007, respondent issued a notice of deficiency
(notice) to petitioners for their 1988 tax year. The notice
determined a section 6662(a) penalty attributable to disallowed
partnership losses for Durham Farms and Washoe Ranches as
reported on petitioners’ 1991 tax return and carried back to 1988
via Form 1045. On July 24, 2007, respondent issued a notice for
1990 which reflected that petitioners were liable for a section
6662(a) penalty attributable to disallowed losses for Durham
Farms and Washoe Ranches as reported on their 1991 tax return and
carried back to 1990 via Form 1045. On July 24, 2007, respondent
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issued a notice for 1991 to petitioners which also determined a
section 6662(a) penalty attributable to disallowed losses for
Durham Farms and Washoe Ranches reported on their 1991 Form 1040.
Finally, on July 24, 2007, respondent issued a notice for 1992
and likewise determined a section 6662(a) penalty attributable to
disallowed losses for Durham Farms and Washoe Ranches reported on
petitioners’ 1992 Form 1040.
On August 27, 2008, petitioners made payments to respondent
of $38,413, $9,762, $13,678, and $29,400 for the 1988, 1990,
1991, and 1992 years, respectively, with respect to the
underlying tax liability. Petitioners stipulated that they will
not challenge computational adjustments made as a result of the
underlying TEFRA partnership proceedings for Durham Farms or
Washoe Ranches. However, for the years at issue, the penalties
are affected items which must be resolved at the partner level.
Cf. sec. 6221 (effective for years after Aug. 5, 1997). On
October 17, 2007, petitioners timely filed petitions disputing
respondent’s determinations of penalties.
OPINION
Section 6662(a) and (b)(1) and (2) imposes a 20-percent
penalty on an underpayment of tax required to be shown on a
return if the underpayment is attributable to a taxpayer’s
negligence or disregard of rules or regulations or substantial
understatement of income tax. Section 6662(d)(1)(A) defines a
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substantial understatement of income tax as a tax understatement
that exceeds the greater of 10 percent of the tax required to be
shown on the taxpayer’s tax return or $5,000.
Section 6662(c) defines negligence as including any failure
to make a reasonable attempt to comply with the provisions of the
internal revenue laws. Negligence has also been defined as the
failure to exercise due care or the failure to do what a
reasonable and prudent person would do under the circumstances.
Neely v. Commissioner, 85 T.C. 934, 947 (1985). Negligence also
includes any failure by the taxpayer to keep adequate books and
records or to substantiate items properly. Sec. 1.6662-3(b)(1),
Income Tax Regs.
Courts deciding a taxpayer’s liability for a negligence
penalty generally look both to whether the underlying investment
was legitimate and to whether the taxpayer exercised due care in
the position taken on the return. 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).
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Section 6664(c)(1) provides an exception to the accuracy-
related penalty if it shown that the taxpayer had reasonable
cause and acted in good faith. Sec. 6664(c)(1); sec. 1.6664-
4(b)(1), Income Tax Regs. The decision as to whether the
taxpayer acted with reasonable cause and good faith depends upon
all the pertinent facts and circumstances. Higbee v.
Commissioner, 116 T.C. 438, 448 (2001); see sec. 1.6664-4(b)(1),
Income Tax Regs.
Relevant factors include the taxpayer’s efforts to assess
his proper tax liability, including the taxpayer’s reasonableness
and good faith reliance on the advice of a professional such as
an accountant. Sec. 1.6664-4(b)(1), Income Tax Regs. Reliance
on the advice of a professional tax adviser can be a defense to
the negligence penalty but does not necessarily demonstrate
reasonable cause and good faith. United States v. Boyle, 469
U.S. 241, 250-251 (1985). Respondent has carried the threshold
burden of production under section 7491(c), and petitioners bear
the burden of proving reasonable cause with respect to reliance
on the advice of a tax professional and must establish: (1) That
the tax professional was competent and had expertise in the area
at issue; (2) that petitioners provided the tax professional with
all the necessary and accurate information; and (3) that
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petitioners relied upon the opinion of the tax professional in
good faith. See United States v. Boyle, supra; Tash v.
Commissioner, T.C. Memo. 2008-120.
Respondent argues that petitioners’ underpayments were
attributable to substantial understatements of income tax within
the meaning of section 6662(d). Respondent also argues that
petitioners’ underpayments were attributable to negligence or
disregard of rules or regulations. Finally, respondent argues
that petitioners have not established that they had reasonable
cause for the underpayments under section 6664(c). Petitioners
counter that they acted with reasonable cause. Petitioners
viewed the Hoyt partnerships as an investment in an agricultural
industry with which they were familiar and contend that they had
reasonable cause and acted in good faith in relying on advice
from their accountants.
Petitioners placed their trust entirely with the Hoyt
organization’s personnel and did not seek the advice of
independent tax professionals. Mr. Fletcher testified as to
alleged conversations with the preparer of a prior tax return,
Mr. Sutton, about the Hoyt organization, but the testimony was
neither specific nor credible. At one point Mr. Fletcher
testified that Mr. Sutton warned him about IRS scrutiny of the
Hoyt organization. However, if Mr. Fletcher actually had a
conversation with Mr. Sutton, he did not investigate this warning
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concerning the IRS’ scrutiny of Hoyt tax shelters. Petitioners
did not receive any written opinions in support of their
investment in the Hoyt partnerships from any independent tax
professional.
Petitioners cite their familiarity with farming, but they
have established no efforts to verify the alleged Hoyt breeding
activities.
The record consistently reflects that petitioners funneled
large sums of money to the Hoyt partnerships in 1992 with funds
generated by carrying back fictitious losses from 1991. The
substantial losses petitioners claimed warranted additional
scrutiny into the legitimacy of the transactions.
In sum, petitioners have not established that they had
reasonable cause or acted in good faith when they claimed the
purported losses. They did not question the amended returns
completed by Laguna. Rather, they negligently pursued an
aggressive tax position by asserting fictitious losses as part of
their scheme with the Hoyt organization. Accordingly, we sustain
respondent’s determination that petitioners are liable for the
accuracy-related penalty for negligence for the years in issue.
To reflect the foregoing,
Decisions will be entered
for respondent.