T.C. Summary Opinion 2011-94
UNITED STATES TAX COURT
DAVID H. ZATZ AND JOAN CASSIDY O’HOLLAND, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12618-10S. Filed July 19, 2011.
Pattie S. Christensen, for petitioners.
Richard W. Kennedy, for respondent.
SWIFT, Judge: This case was heard pursuant to the
provisions of section 7463 of the Internal Revenue Code in effect
when the petition was filed.1 Pursuant to section 7463(b), the
1
All section references are to the Internal Revenue Code in
effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
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decision to be entered is not reviewable by any other court, and
this opinion shall not be treated as precedent for any other
case.
Respondent proposed deficiencies and penalties with respect
to petitioners’ 2000, 2001, 2002, and 2003 Federal income taxes
as follows:
Penalty
Year Deficiency Sec. 6662(a)
2000 $6,785 $1,357
2001 66,079 13,216
2002 62,172 12,434
2003 26,801 5,360
Petitioners conceded that the proposed tax deficiencies were
correct and paid the proposed deficiencies before the issuance of
the notice of deficiency. The only issue before us is whether
petitioners are liable for the section 6662(a) accuracy-related
penalties due to negligence or substantial understatement of
income tax.
Background
This case has been fully stipulated under Rule 122, and the
stipulated facts are so found.
At the time of filing the petition, petitioners resided in
Utah.
David H. Zatz (petitioner) owned 100 percent of Crossways
Corp. (Crossways), a lucrative Utah corporation engaged in the
business of managing condominiums. Before the establishment of
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the various other entities described below, Crossways paid
petitioner a substantial salary for his personal services,
apparently as president and chief executive officer.2
In 2000 petitioner contacted a number of financial planners
to obtain tax advice. For a fee of $30,000 petitioner hired
Hewlett Brothers Financial (HBF), a Utah financial advisory firm
owned by John Hewlett.
HBF presented to petitioner a plan to reduce his Federal
income and employment taxes and Utah State income taxes under
which his salary each year from Crossways would be reported not
just by him; rather, his salary would be divided and reported in
part by him and in part by other entities that would be formed
and effectively controlled by him (the plan).
Also, under the plan petitioner (and possibly his wife)
would transfer to the other entities (to be set up and controlled
by him) ownership of a number of personal assets (e.g., home,
cars, airplane, and sailboats), and expenses relating to these
assets would be deducted as business expenses.
Larry Cox (Cox), a Utah licensed certified public accountant
(C.P.A.), and Miles Lignell (Lignell), a Utah attorney, both
apparent employees of HBF and not working independently of HBF,
prepared certain financial, legal, and tax documents for the
2
The record does not reflect petitioner’s exact title and
responsibilities with Crossways.
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entities that petitioner would form. At some point petitioner
questioned Cox and Lignell about the legitimacy of the purported
tax benefits of the plan. Cox and Lignell “assured” petitioner
that the plan was within the law.
In its promotional materials or presentations to petitioner
HBF also represented that the strategy proposed in the plan had
been reviewed with approval by “prominent and prestigious
accounting and law firms” and that the Internal Revenue Service
(IRS) “blesses” the HBF “process”.
No copy of any independent accounting or legal opinion
relating to the plan was offered into evidence. HBF’s
representation that the IRS blesses the HBF strategy was false.
Although petitioner interviewed other financial advisers
before formally engaging HBF,3 petitioners relied solely upon the
advice of Cox and Lignell in deciding to implement the plan.
In 2000 petitioner adopted HBF’s plan and formed the related
entities, and nominal ownership of a number of petitioners’
personal assets apparently was transferred to the related
entities.
In 2000, 2001, 2002, and 2003, relating to and in
compensation for petitioner’s personal services for Crossways,
Crossways paid salaries or commissions of $156,667, $439,099,
3
The record does not disclose the names of any other
financial, tax, or other professionals from whom petitioners
sought advice, nor what advice, if any, was received.
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$469,999, and $417,500, respectively. As explained, under the
HBF plan the above amounts were split among petitioner and the
related entities, reported accordingly, and offset by large
personal expenses of petitioner’s that were claimed as business
expenses of the related entities.
Of the total above salary or commission amounts Crossways
paid with respect to petitioner’s services in 2000, 2001, 2002,
and 2003, approximately 33, 78, 75, and 70 percent, respectively,
were offset by the claimed expenses.
To prepare their 2000, 2001, 2002, and 2003 Federal income
tax returns, petitioners hired FPG Business Services (FPG), an
independent accounting firm unrelated to HBF. Apparently,
petitioners relied on HBF to provide FPG with the financial data
required to file petitioners’ Federal income tax returns, and FPG
prepared petitioners’ tax returns on the basis of information HBF
provided.
Petitioners discussed the tax returns with FPG and were told
that the returns accurately reflected the financial data that HBF
had provided. Petitioners did not seek advice from FPG as to the
legitimacy of the plan under Federal tax law.
On audit respondent recast the salaries or commissions paid
by Crossways with respect to petitioner’s services as income
received solely by petitioner, disallowed the business expense
deductions claimed by the various entities that had been formed,
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reallocated legitimate deductions to petitioners’ individual tax
returns, and proposed the tax deficiencies and section 6662(a)
accuracy-related penalties set forth above.
Before the issuance of a notice of deficiency, petitioners
agreed with and paid the tax deficiencies. The only matter in
dispute is respondent’s determination of the section 6662(a)
accuracy-related penalties.
Discussion
Section 6662(a) authorizes respondent to impose a 20-percent
penalty for negligence or substantial understatement of income
tax. Sec. 6662(b)(1) and (2). For the purposes of section 6662,
negligence is defined as the failure to exercise the due care of
a reasonable and ordinarily prudent person under like
circumstances. Neely v. Commissioner, 85 T.C. 934, 947 (1985).
A substantial understatement of income tax is defined as an
understatement of tax that exceeds the greater of 10 percent of
the tax required to be shown on the return or $5,000. Sec.
6662(d)(1)(A).
Petitioners agree with the tax deficiencies for 2000
through 2003. Accordingly, respondent has met his burden of
production, and the burden of proof is on petitioners to show
that the section 6662(a) accuracy-related penalty does not apply
for any year. See sec. 7491(c); Higbee v. Commissioner, 116 T.C.
438, 446-447 (2001).
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Section 6664(c)(1) provides a defense to the section 6662(a)
accuracy-related penalty where the taxpayer establishes that
there was reasonable cause for a portion of an underpayment and
that the taxpayer acted in good faith with respect to such
portion. The determination of whether a taxpayer acted with
reasonable cause and in good faith is made on a case-by-case
basis, taking into account all the facts and circumstances,
including the taxpayer’s efforts to assess his proper tax
liability, the knowledge and experience of the taxpayer, and
reliance on the advice of a tax professional. Sec. 1.6664-
4(b)(1), Income Tax Regs.
Reasonable cause may be established where a taxpayer relies
on the advice of a competent tax adviser even where the advice
was wrong. See Hatfried, Inc. v. Commissioner, 162 F.2d 628, 635
(3d Cir. 1947), affg. in part and revg. in part a Memorandum
Opinion of this Court; Girard Inv. Co. v. Commissioner, 122 F.2d
843, 848 (3d Cir. 1941). However, the adviser must be a
competent professional with sufficient expertise to justify the
taxpayer’s reliance, the taxpayer must have provided necessary
and accurate information to the adviser, and the taxpayer must
have actually relied in good faith on the adviser. Neonatology
Associates, P.A. v. Commissioner, 115 T.C. 43, 99 (2000), affd.
299 F.3d 221 (3d Cir. 2002); Sklar, Greenstein & Scheer, P.C. v.
Commissioner, 113 T.C. 135, 144-145 (1999).
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Petitioner claims that his reliance on C.P.A. Cox and
Attorney Lignell was in good faith and should establish
reasonable cause.
We look first to determine whether Cox and Lignell had
sufficient expertise to justify petitioner’s reliance.
Petitioner emphasizes that both Cox and Lignell were licensed in
their fields. Being licensed as an accountant or attorney,
however, is only a minimum requirement to practice as an attorney
or accountant and by itself does not establish expertise in tax
law.
Relying on assurances of professionals may demonstrate good
faith, but only when the professionals are acting independently
from the entity promoting the claimed benefits. Van Scoten v.
Commissioner, 439 F.3d 1243, 1253 (10th Cir. 2006), affg. T.C.
Memo. 2004-275; Mortensen v. Commissioner, 440 F.3d 375, 387 (6th
Cir. 2006), affg. T.C. Memo. 2004-279; Rybak v. Commissioner, 91
T.C. 524, 565 (1988). The evidence does not indicate that Cox
and Lignell were providing advice to petitioner independently of
HBF. See Mortensen v. Commissioner, supra at 387. Advice from
otherwise qualified professionals with an interest in the
transaction “is better classified as sales promotion.” Vojticek
v. Commissioner, T.C. Memo. 1995-444. The conflict of interest
inherent in the relationships between HBF and Cox and Lignell
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should have caused petitioner to seek advice from an independent
adviser.
Petitioner points to a brochure of HBF which purports to
list the qualifications of Cox and Lignell. However, this self-
serving HBF brochure is not sufficient evidence to establish that
Cox and Lignell in fact were qualified and independent tax
experts on whose advice petitioner reasonably relied. Both
worked for HBF. Their testimony was not presented to us.
We conclude that petitioner’s reliance on Cox and Lignell
does not constitute reasonable cause.
Petitioners argue that they relied on the advice of FPG--an
independent tax preparer--to prepare their Federal income tax
returns. Petitioners emphasize that FPG had no association with
HBF. However, reliance on a second professional’s advice is
subject to the same test discussed above. See Addington v.
Commissioner, 205 F.3d 54, 59 (2d Cir. 2000), affg. Sann v.
Commissioner, T.C. Memo. 1997-259; Collins v. Commissioner, 857
F.2d 1383, 1386 (9th Cir. 1988), affg. Dister v. Commissioner,
T.C. Memo. 1987-217.
It appears that FPG was not provided the complete and
accurate information necessary to prepare accurately petitioners’
Federal income tax returns. As has been stated: “The mere fact
that a certified public accountant has prepared a tax return does
not mean that he or she has opined on any or all of the items
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reported therein.” Neonatology Associates, P.A. v. Commissioner,
supra at 100. The details of the discussions petitioners had
with representatives of FPG are not in the record, and there is
no evidence that petitioners either asked FPG to conduct a
meaningful review of the plan or that FPG did so on its own. FPG
represented to petitioners that the returns were correct only
according to the financial data HBF provided. FPG did not claim
that the plan HBF established was proper; FPG simply stated that
the returns accurately reflected data HBF provided.
Petitioner appears to be a successful businessman and
should not have implemented HBF’s plan without consulting
independent tax or legal counsel.
Petitioners pursued what appears to have been a patently
improper tax avoidance scheme which they have conceded was
improper. Petitioners have not established reasonable cause for
the accuracy-related penalties.
We sustain respondent’s determination of the section 6662(a)
accuracy-related penalty for each of the years in issue.
To reflect the foregoing,
Decision will be entered
for respondent.