Streber v. Commissioner

REVISED, April 16, 1998

UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT

_________________________

96-60443
__________________________

TRACY P. STREBER,
TERESA P. DELONEY,
STEPHEN J. DAVIS,

Defendant-Appellants,

versus

COMMISSIONER OF INTERNAL REVENUE,

Plaintiff-Appellee.
_________________________________________________________________

Appeals from the United States Tax Court
_________________________________________________________________
April 15, 1998

Before KING, JONES, Circuit Judges, and KENDALL,1 District Judge.

JONES, Circuit Judge:

Two sisters were about 20 and 25 years old when they

received over a million dollars each, and they hired a lawyer to

advise them on potential tax liability. The Commissioner charged

them with negligence and substantial understatement penalties2 for

1
District Judge of the Northern District of Texas, sitting by
designation.
2
I.R.C. § 6653(a), which has been amended following the
commencement of this action, provided for additions to tax on
account of negligence or intentional disregard of rules or
regulations. I.R.C. § 6661(a), which has since been repealed,
provided, during the years at issue, for an addition to tax in the
case of an underpayment due to a substantial understatement.
treating the money as a gift even though they followed one

alternative course recommended by the tax lawyer and even though

the Commissioner herself relied on their theory in asserting tax

liability of the girls’ father.3 Under these circumstances, the

Tax Court’s imposition of the penalties was clearly erroneous. The

Tax Court also erred in holding that Teresa’s ex-husband

procedurally defaulted his case. We REVERSE.

I. BACKGROUND

The underlying facts are simplified for present purposes.

In 1979, Larry Parker, the girls’ father, acquired an interest in

440 acres of undeveloped land known as Northgate Forest Property.

At least part of Parker’s interest in this joint venture was held

on behalf of his daughters, Teresa Deloney and Tracy Streber, who

were then aged nineteen and fourteen. On March 4, 1981, two

promissory notes in the amount of $2,000,000 each for sale of the

land were endorsed, one to Teresa and the other one to Teresa as

custodian for Tracy who was still a minor. Both notes were due and

payable on March 4, 1985. Neither Teresa nor Tracy was involved in

negotiating the terms of the agreement.

At some point, Parker and his then-wife, the sisters’

mother, divorced.

When the notes were not paid on the due date, Parker,

Teresa, Tracy, and other interested parties filed a suit against

3
On appeal, the daughters do not, however, contest liability
for the base amount of tax.

2
the makers of the notes. On April 23, 1985, the suit was settled,

and Teresa and Tracy received eighty-five percent of the face value

of the notes, i.e., $1,700,000 apiece.

Within a few weeks, Teresa and Tracy met with attorney

Edwin Hunter to discuss the tax consequences of their income from

the joint venture. Hunter provided Teresa and Tracy with two basic

alternatives: (1) pay capital gains tax on the income they

received; or (2) treat the income as a gift from Parker, who would

then be liable for any taxes due on receipt of the money.

Teresa and Tracy chose the latter option. Neither

Teresa, who filed a joint return with her then-husband Stephen

Davis, nor Tracy reported receipt of the joint venture income on

their 1985 tax returns. Parker did not report the receipt of the

income either.

On October 22, 1991, the Commissioner issued statutory

notices of deficiency to Tracy, Teresa, and Stephen for 1985,

stating that Tracy and Teresa should have included the joint

venture income they received in their 1985 income. All three filed

petitions for redetermination of the deficiency in the Tax Court.

Contemporaneously, the Commissioner, in order to avoid a

“whipsaw” situation, also issued a statutory notice of deficiency

against Parker and his wife for 1985. The notice of deficiency was

based on the determination that the Parkers should have included in

their 1985 income tax return the joint venture income that was paid

3
to Teresa and Tracy. Parker and his wife filed a petition for

redetermination of the deficiency in the Tax Court.

Upon a motion by the Commissioner, the Tax Court

consolidated all three cases for trial. The Commissioner averred

that either the Parkers or Teresa and Tracy were liable for the

tax, but not both.

The Tax Court found no deficiency in Parker’s 1985

income. Instead, the court found that Parker made a gift to his

daughters in 1980, and, therefore, Tracy and Teresa were liable for

the taxes on the joint venture income received in 1985. The court

also sustained the Commissioner’s determination of additions to tax

for negligence and substantial understatement against Tracy and

Teresa. Finally, the Tax Court found that Davis had failed to

prosecute his case and held him in default.

Teresa and Tracy filed a motion for reconsideration of

the decisions concerning only the additions to tax. They argued

that their actions were based on substantial authority and were

reasonable and in good faith. Moreover, they maintained that their

decision to treat the money as a gift from Parker was based on the

advice they had received from counsel. Davis moved for

reconsideration, claiming it was wrong for the court to have held

him in default. The Tax Court vacated its decision in order to

consider these motions.

Upon reconsideration, the Tax Court held that the

sisters’ assertion that there was substantial legal and factual

4
justification for their failure to report the joint venture income

was not sufficient to convince the court to change its

determination that the addition to tax should apply. The Court did

not believe that Tracy and Teresa “relied on an expert’s advice.”

The Tax Court found:

Movants met with an attorney, Edwin K. Hunter
(Hunter), who, based on the facts as he knew
them, explained to movants alternative tax
reporting positions. However, we do not find
that Hunter advised movants that they did not
have to report the gains in question. The
testimony on that point is ambiguous. Hunter,
however, was one of the movant’s attorneys and
was present throughout the trial. Hunter no
doubt could have resolved any ambiguity as to
what he advised movants. Nevertheless,
movants did not call Hunter as a witness. Our
rules do not preclude Hunter from testifying.
We infer from Hunter’s failure to testify that
his testimony would have been adverse to
movants. Movants cannot claim that, based on
expert advice, they acted with due care, or as
a reasonable and ordinarily prudent person
would act, in the circumstances.

The Tax Court also rejected Davis’s claim, holding that

Davis had a full opportunity to participate at the trial and did

not do so on his own account, although he participated in the

proceedings as a witness.

Tracy and Teresa now appeal. They contend that the Tax

Court erred in sustaining the Commissioner’s assessment of the

negligence and substantial understatement penalties. They argue

that they reasonably relied on the advice they received from their

attorney, and that reliance is not nullified under the factual

circumstances of this case where the taxpayers choose one of the

5
alternatives their advisor recommends.4 Davis filed a separate

appeal making the same claim and also arguing that the Tax Court

abused its discretion in holding him in default.

II. ANALYSIS

A. NEGLIGENCE PENALTY

This court reviews the tax court’s findings of negligence

under the clearly erroneous rule. See Sandvall v. Commissioner,

898 F.2d 455, 459 (5th Cir. 1990). Clear error exists when this

court is left with the definite and firm conviction that a mistake

has been made. See Chamberlain v. Commissioner, 66 F.3d 729, 732

(5th Cir. 1995).

“The IRS may penalize taxpayers for an underpayment due

to negligence or disregard of rules and regulations. Negligence

includes any failure to reasonably attempt to comply with the tax

code, including the lack of due care or the failure to do what a

reasonable or ordinarily prudent person would do under the

circumstances. ‘Disregard’ includes careless, reckless, or

intentional conduct.” Heasley v. Commissioner, 902 F.2d 380, 383

(5th Cir. 1990) (citations omitted).

The relevant inquiry for the imposition of a negligence

penalty is whether the taxpayer acted reasonably. See Reser v.

Commissioner, 112 F.3d 1258, 1271 (5th Cir. 1995). “Taxpayers may

not rely on someone with a conflict of interest or someone with no

4
Edwin K. Hunter, appellant’s counsel of record before the tax
court, filed an amicus curiae brief.

6
knowledge concerning the matter upon which the advice is given.”

Chamberlain, 66 F.3d at 732. “Good faith reliance on professional

advice concerning tax laws is a defense.” Durrett v. Commissioner,

71 F.3d 515, 518 (5th Cir. 1996).

In this case we find that the Tax Court clearly erred

when it sustained the Commissioner’s assessment of a negligence

penalty, because appellants reasonably relied on the advice they

received from their attorney, Edwin Hunter.

Due care does not require young, unsophisticated

individuals to independently examine their tax liabilities after

taking the reasonably prudent step of securing advice from a tax

attorney.5 At relatively tender ages, the appellants received

large sums of money. Tracy Streber testified that she and her

sister came to the conclusion that they had to seek advice from an

attorney to make sure they did “the legal thing.” As she

explained:

It was just known that when you get money like
that, some kind of tax had to be paid and we
didn’t know what it was, so we went to get
counseled.

. . . .

I knew that is why you had to go to a tax
person.

5
Cf. Heasley v. Commissioner, 902 F.2d 380, 383 (5th Cir.
1990) (“[D]ue care does not require moderate-income investors . .
. to independently investigate their investments. They may rely on
the expertise of their financial advisors and accountants . . .
.”).

7
Given their level of understanding in these matters, the appellants

took the appropriate steps to secure legal advice from attorney

Edwin Hunter to ensure that their tax returns for the upcoming year

complied with the law. Not only Tracy Streber, but also Davis and

Betty Berwick (Tracy and Teresa’s mother, and Larry Parker’s first

wife) testified that the purpose of seeking legal advice was to

understand the tax consequences of their income from the joint

venture and to ensure that any position they took was on sound

legal footing.

Hunter advised appellants that they could either treat

the joint venture income as a capital gain or as a gift from

Parker. Relying on Hunter’s opinion, the appellants chose to treat

the joint venture income as a gift. Due care does not require that

the appellants challenge their attorney’s opinion or independently

investigate the propriety of his advice. See Chamberlain, 66 F.3d

at 733. As the Supreme Court held:

When an accountant or attorney advises a
taxpayer on a matter of tax law, such as
whether liability exists, it is reasonable for
the taxpayer to rely on that advice. Most
taxpayers are not competent to discern error
in the substantive advice of an accountant or
attorney. To require the taxpayer to
challenge an attorney, to seek a “second
opinion,” or to try to monitor counsel on the
provisions of the Code himself would nullify
the very purpose of seeking the advice of a
presumed expert in the first place. “Ordinary
business care and prudence” do not demand such
actions.

United States v. Boyle, 469 U.S. 241, 251, 105 S. Ct. 687, 692-93

(1985) (citation omitted). Having done no less than reasonable

8
prudence demands, the appellants should not be held negligent in

their treatment of the joint venture income.

The I.R.S. asserts that the Tax Court found that Hunter

never advised them “that they did not have to report the gains in

question.” This conclusion, however, is contrary to the

overwhelming weight of the evidence, which supports the proposition

Hunter did in fact tell the appellants that they should treat the

joint venture income as a gift from Parker.

First, according to the witnesses, Hunter advised his

clients to select the alternative that would result in more tax

revenue for the government and would, therefore, be less likely to

receive an I.R.S. challenge. Although the position the sisters

ultimately adopted meant that they would not be personally liable

for tax on their joint venture income, when Hunter was rendering

his advice, the appellants were concerned over the way in which the

I.R.S. might have viewed a decision that would have resulted in

less tax liability for their father than other positions would have

required. The appellants were worried that Parker’s own rather

questionable practices might make them more susceptible to a

government audit and possible penalties if they took anything less

than a careful tax position in this case. Tracy Streber testified

about the appellants’ choice to treat the joint venture income as

a gift: “We didn’t want to defraud the government. We didn’t want

them to think we were in cahoots or whatever with my father, to

defraud them.” Because the gift tax rate was higher than the

9
capital gains tax rate, Hunter stated that the I.R.S. might view

the appellants’ decision to treat the joint venture income as a

capital gain as an attempt to conspire with Parker to limit his tax

liability and the tax liability for all the family members.6

Second, the evidence shows that Hunter actively supported

his clients’ position to treat the joint venture income as a gift.

In June 1986, for example, Parker’s attorney wrote to Hunter

encouraging him to reconsider Hunter’s filing of the appellants’

amended tax returns, which “reflect[ed] their receipt of certain

income as a gift from their father.”7 A month earlier, Hunter

participated in his clients’ efforts to notify the I.R.S. of the

possible deficiencies in Parker’s 1985 tax return.8 Given the

substantial risks associated with voluntarily reporting to the

I.R.S. in this case, it is hard to understand how the Tax Court

could have concluded that Hunter would have advised the appellants

to take any position other than the one they adopted in this

matter. Although the appellants understood that by informing the

agency they might receive a financial reward from the government if

the information proved useful, they must also have understood that

6
Davis testified that Hunter explained that if they were to
choose to treat the joint venture income as a capital gain, it was
very likely that the I.R.S. would maintain that they “still have a
liability as far as owing tax on the money.”
7
Letter from David S. Gamble, Attorney to Larry Parker, to
Edwin K. Hunter 1 (June 25, 1986).
8
See Memorandum of Interview, Internal Revenue Service (May 9,
1986) (noting the presence of Edward K. Hunter, Attorney for
Informants, Teresa Davis and Stephen Davis).

10
this action would highlight their own tax returns for scrutiny.9

The decision to inform on Parker to the I.R.S. not only placed the

appellants at personal risk of a government audit, but it also

placed Hunter’s professional judgment and reputation under review.

In the face of this risk, Hunter actively promoted his clients’ tax

position. It is impossible to reconcile Hunter’s later actions

with the Tax Court finding that his initial tax advice to the

sisters was “ambiguous” or that he did not actually recommend

treating the joint venture income as a gift.10

The I.R.S. also contends that Tracy and Teresa did not in

fact rely on Hunter’s advice, propounded in alternatives, because

they made the “ultimate decision” not to report the income from the

joint venture on their tax returns. I.R.S. does not dispute that

the legal advisor here offered several possibilities and discussed

the tax ramifications of each.11 IRS contends, however, that

9
The Evaluation Report on Claim for Reward makes clear that
the information provided to the I.R.S. had substantial value,
because otherwise Parker’s 1985 tax return would not have been
audited.
10
The dissent does not even mention the correspondence between
Hunter and Parker’s attorney, which has to be premised on Hunter’s
advice that the income the girls received was a gift. The dissent,
like the Tax Court, casts no doubt on the veracity of Berwick’s and
Davis’s testimony about Hunter’s advice. Finally, the dissent
unnecessarily flays Hunter over a subsequent legal malpractice
action the girls have pending against him. The lawsuit is
irrelevant to the question of their lack of negligence and due
diligence, at least in a case such as this, where the advice he
gave -- that there was a gift -- was sound enough to be the basis
of one of I.R.S.’s alternative positions.
11
The dissent goes even further than the Tax Court did in
implying that Tracy and Teresa decided on their own not to report

11
because the Tax Court found he did not affirmatively recommend a

preferred course of action, which the taxpayers followed, the

reliance on counsel defense is unavailable. We need not reach this

conclusion because, overruling the Tax Court’s erroneous findings,

we find that Hunter did in fact affirmatively advise and vigorously

assist taxpayers’ chosen course of action. But even if the Tax

Court’s findings here are accurate, unless circumstances show that

a tax advisor discussed and discounted alternative tax strategies,

the taxpayers should ordinarily not be held negligent for following

any of the bona fide alternatives developed by an advisor

acquainted with the relevant facts. To find otherwise adds a new

requirement to the reliance on counsel defense: not only must the

taxpayer show that his advisor discussed how to treat a tax-related

transaction, he must also show that the advisor ranked any

alternatives hierarchically, and he (the taxpayer) adopted

whichever alternative was at the top of the list. Otherwise, the

advisor’s recommendation in a situation where bona fide alternative

tax strategies exist will be found “ambiguous” and cannot furnish

the basis for a taxpayer’s reasonable reliance. If this proffered

method of analysis is not simply a semantical quibble designed to

determine the outcome of this case, it drives a mischievous wedge

the income from the notes. First, the dissent does not concede, as
IRS does, that Hunter advised the girls of alternative tax
treatments of the income. Second, the dissent accuses the girls of
not furnishing Hunter with appropriate documentation, but neither
IRS nor the Tax Court mentioned this sort of problem, which is not
inferable from any of the Tax Court’s findings.

12
between advisors and taxpayers. Advisors will be deterred from

recommending alternative tax strategies, and clients will be

discouraged from seeking any but the most tax-advantageous advice.

The I.R.S. finally emphasizes that the Tax Court ruled

against the appellants because the court did not find Tracy Streber

and Teresa Deloney to be credible. The Tax Court gave their

testimony and answers “little weight.” Moreover, in its opinion on

reconsideration, the Tax Court noted that Hunter could have

testified on behalf of the appellants to clear up any ambiguity

that might have existed over whether he, in fact, advised them to

treat the joint venture income as a gift from Parker. Because the

appellants chose not to call him as a witness, the court inferred,

his testimony would have been adverse to their position. This

reasoning is unpersuasive.

In general, a court may draw a negative inference from a

party’s failure to produce a witness “whose testimony would

elucidate the transaction.” Graves v. United States, 150 U.S. 118,

121, 14 S. Ct. 40, 41 (1893). The strength of the inference “is

rooted in notions of common sense[,] . . . will vary with the facts

of each case,” United States v. Tucker, 552 F.2d 202, 210 (7th

Cir. 1977), and may be drawn only where a witness has information

“peculiarly within his knowledge,” McKay v. Commissioner, 886 F.2d

1237, 1238 (9th Cir. 1989) (citing Wichita Terminal Elevator Co. v.

Commissioner, 6 T.C. 1158, 1165 (1946)). Thus, a party need not

call a witness whose testimony would be cumulative “without any

13
apprehension” that a court will draw a negative inference.” 2 John

Henry Wigmore, Evidence § 287, at 202-03 (Chadbourne rev. 1979).12

In this case, the tax court examined the evidence of four

witnesses who were privy to Hunter’s conversation with his clients.

These witnesses, Teresa, Tracy, Davis, and Berwick, all testified

that Hunter advised his clients that they could either pay capital

gains tax on the income they received or treat the income as a gift

from Parker. Even assuming that Teresa and Tracy were not

credible, the Tax Court never referred to the testimony of Davis

and Berwick, who each confirmed that Hunter did advise his clients

to treat the joint venture income as a gift from Parker. Davis

said that Hunter “felt from . . . hearing the case and the

documents -- he felt that it was a gift.” When Berwick was asked

why the appellants chose to treat the income as a gift, she

answered: “Because Mr. Hunter told them that in his opinion, that

was the correct one.” Contrary to this testimony, which the Tax

Court neither questioned nor commented upon, the court still held

that it could not find that “Hunter advised [appellants] that they

did not have to report the gains in question.” Once again, even

12
“In general, put somewhat more strongly, there is a general
limitation . . . that the inference cannot fairly be drawn except
from the nonproduction of witnesses whose testimony would be
superior in respect to the fact to be proved.” 2 Wigmore § 287, at
203. Two witnesses -- Berwick and Davis -- whose credibility went
unchallenged by the I.R.S. were present during the meeting in which
Hunter rendered his advice. Under these circumstances, Hunter’s
hypothetical testimony could not fairly be characterized as
superior to that of these other witnesses. Their testimony of what
they heard Hunter say is not a priori inferior to Hunter’s possible
testimony of what he remembers advising to his clients.

14
assuming Tracy Streber and Teresa Deloney were not credible, at

least two other witnesses independently supported the position that

Hunter had advised his clients to treat the joint venture income as

a gift from Parker. This testimony was uncontradicted. Moreover,

because Hunter’s testimony would have been cumulative, and maybe

counterproductive -- focusing attention away from the primary issue

of whether his clients were liable in the first place -- and

because the subject of Hunter’s advice was not peculiarly within

his knowledge, see McKay, 886 F.2d at 1238, the tax court erred

when it drew an inference adverse to the appellants. To hold

otherwise would in essence require the attorney to testify in all

cases involving an advice of counsel defense.

After reviewing the record, “we are left with the

definite and firm conviction that a mistake has been made.”

Chamberlain, 66 F.3d at 732. The appellants did rely on their

attorney’s advice when they elected to treat the joint venture

income as a gift from Parker. Furthermore, given the appellants’

relative youth and inexperience in business matters, they acted

with all the care a reasonably prudent person would exercise under

similar circumstances. See Reser, 112 F.3d at 1271. Our laws

demand nothing more. Thus, we hold that the Tax Court clearly

erred when it sustained the imposition of negligence penalties

against the appellants.

15
 B. SUBSTANTIAL UNDERSTATEMENT PENALTY

The second issue before this court is whether the Tax

Court abused its discretion when it held appellants liable for the

addition to tax for substantial understatement, pursuant to I.R.C.

§ 6661(a). See Heasley v. Commissioner, 902 F.2d 380, 385 (5th

Cir. 1990). Section 6661 provides for an addition to tax equal to

twenty-five percent of the amount of any underpayment attributable

to a substantial understatement of tax. If a taxpayer is able to

show that there was a reasonable cause for the understatement and

good faith, which may stem from reasonable reliance on the advice

of professional, the I.R.S. may waive the understatement penalty.

See Heasley, 902 F.2d 384-85; see also Reser v. Commissioner, 112

F.3d 1258, 1271-72 (5th Cir. 1997).

First, as has been noted, the appellants reasonably

relied on the advice they received from their attorney. I.R.S.

acknowledges that “the extent of the taxpayer’s effort to assess

her proper tax liability under the law is the most important

factor” in determining reasonable cause and good faith. Heasley,

905 F.2d at 385. Because of appellants’ youth and inexperience in

business, reliance on counsel, and proof of “good faith” in their

position by reporting the transaction to the Service as to their

father’s potential liability, the conclusions this court reached in

Heasley are controlling:

Applying the I.R.S.’s own regulatory
standards, we find that the I.R.S. abused its
discretion by failing to waive the penalty in
this case. We are at a loss to determine just

16
 what the I.R.S. would find to be a reasonable
cause given the Heasleys’ experience,
knowledge, and education. First, the Heasleys
attempted to assess their proper tax liability
by taking their taxes to a C.P.A., something
they never did before. The accountant found
no problem with the plan. While Danner
suggested that the Heasleys use Smith, nothing
else in the record connects the two.
Therefore, considering this “most important
factor,” the Heasleys showed reasonable cause
and good faith. Second, the Heasleys read the
portions of the prospectus and other O.E.C.
materials and relied on Danner to explain the
rest. If neither Danner nor their C.P.A.
found anything wrong with the investment, how
could the Heasleys? Certainly, their failure
to out-guess their financial advisor and
accountant is not negligence. Finally, the
Heasleys believed that they legitimately
claimed the deduction and investment tax
credit. Given the Heasleys’ inexperience and
limited knowledge about investing, and their
level of education, their misunderstanding is
reasonable. The I.R.S. abused its discretion
by failing to waive the penalty and the tax
court erred by upholding the I.R.S.’s
decision.
Id.

Second, I.R.S. too narrowly interprets the meaning of the

substantial authority defense on which appellants rely to defeat

this penalty.13 This case turned on one factual issue: when Parker

made the gift to his daughters. If the gift was made before 1985,

Tracy and Teresa are liable for the income they received in 1985;

if it was effectively made in 1985, Parker is liable. The

subsidiary facts relating to this transaction were complex, largely

13
I.R.C. § 6661(b)(2)(B)(i) provided that any “substantial”
understatement of tax “shall be” reduced “by that portion of the
understatement which is attributable to []the tax treatment of any
item . . . if there is or was substantial authority for such
treatment . . . .”

17
undisputed, and not materially affected by the Tax Court’s

assessment of the sisters’ lack of credibility. In a recent

decision, the Eleventh Circuit explained that where the substantial

authority issue turns on evidence going both ways, “there is

substantial authority from a factual standpoint for the taxpayer’s

position. Only if there was a record upon which the Government

could obtain a reversal under the clearly erroneous standard could

it be argued that from an evidentiary standpoint, there was not

substantial authority . . . .” Osteen v. Commissioner, 62 F.3d

356, 359 (11th Cir. 1995). Apart from trying to confine Osteen to

its facts, an untenable position, I.R.S. does not demonstrate how

its principle is inapt here. The government makes no effort to

assert that the only rational tax treatment of the transaction was

as a gift made before 1985.14

For these reasons, the I.R.S. abused its discretion in

failing to waive the penalty and the Tax Court erred in upholding

the I.R.S.’s decision. See Heasley, 902 F.2d at 385. It is clear

upon review of the record that the appellants had substantial

factual authority for the tax position they asserted and reasonably

relied on the advice of their attorney.

14
The dissent ignores Osteen and makes a legal argument that
neither I.R.S. nor the Tax Court did, namely, that “substantial
authority” means only legal, not factual authority.

18
 C. FAILURE TO PROSECUTE

Because we have held that the sisters are not liable for

negligence and substantial understatement penalties, we need not

reach the merits of the dispute over Davis’s possible failure to

prosecute. Davis’s derivative liability for his ex-wife’s income

vitiates a default judgment. The Tax Court decision holding the

appellant in default for failure to prosecute his case is reversed.

CONCLUSION

These appellants are not liable for negligence and

substantial understatement penalties from their decision to treat

the joint venture income as a gift. The decision of the Tax Court

is REVERSED.

ENDRECORD

19
KING, Circuit Judge, dissenting:

In reversing the judgment of the tax court, the majority errs

on two levels. First, under the guise of a review only for clear

error, the majority rejects the tax court’s determination that the

appellants were liable for an addition to tax based upon their

negligence pursuant to former § 6653 of the Internal Revenue Code.

In so doing, the majority exceeds its authority as an appellate

court by usurping the fact-finding function properly relegated to

the tax court. Second, the majority concludes that the tax court

erred in holding the appellants liable for an addition to tax based

upon a substantial understatement of their tax liability because

substantial authority within the meaning of former § 6661 of the

Internal Revenue Code existed for the tax position taken by the

appellants. In order to justify this conclusion, the majority

adopts a construction of the substantial authority standard that

fails to comport with the treasury regulations interpreting § 6661

and that strips the statute of much of its force as a deterrent of

taxpayer misconduct. I respectfully dissent.

I. Addition to Tax for Negligence

The majority improperly holds that the tax court clearly erred

in finding that the appellants acted negligently in declining to

report the joint venture income as a capital gain and that the

appellants were therefore liable for negligence penalties pursuant

to former § 6653(a) of the Internal Revenue Code. See 26 U.S.C.A.

§ 6653(a) (West 1989) (amended in 1989). Because the majority

makes no mention of the burden of proof applicable to the parties’
dispute over the negligence penalty, it is worth noting here that

the Commissioner’s determination of negligence is presumed correct

and that the taxpayer therefore bears the burden of proving the

absence of negligence. See Westbrook v. Commissioner, 68 F.3d 868,

880 (5th Cir. 1995); Sandvall v. Commissioner, 898 F.2d 455, 459

(5th Cir. 1990).

The majority concludes that the tax court erred in declining

to accept the appellants’ contention that their failure to report

the income from the joint venture on their 1985 tax returns did not

constitute negligence because they made the decision based on the

advice of counsel. In reaching this conclusion, the majority pays

lip service to the fact that, as an appellate court, our review of

the tax court’s finding of negligence is limited to a review for

clear error. See Streber v. Commissioner, ___ F.3d at ___ (5th

Cir. 1998), Majority op. at 6 (citing Sandvall, 898 F.2d at 459).

It then proceeds to conduct a thinly veiled de novo review of the

facts, reversing the tax court’s judgment regarding the negligence

penalty merely because it reaches a different factual conclusion

than that reached by the tax court. The majority’s conclusion that

“the overwhelming weight of the evidence . . . supports the

proposition [Edwin] Hunter did in fact tell the appellants that

they should treat the joint venture income as a gift from Parker,”

Streber, ___ F.3d at ___, Majority op. at 9, simply cannot

withstand scrutiny.

21
 First, the majority points to the testimony of Tracy Streber,

Teresa Deloney (by affidavit and deposition), Betty Berwick, and

Steve Davis as establishing that Hunter told the appellants that

they should treat the joint venture income as a gift. Credibility

assessments regarding this testimony were exclusively within the

province of the tax court, as it was the trier of fact. See

Durrett v. Commissioner, 71 F.3d 515, 517 (5th Cir. 1996). The tax

court explicitly concluded that it “did not find [Tracy and Teresa]

to be credible witnesses” and therefore accorded their testimony

“little weight.” While it is not our place as an appellate court

to strictly scrutinize the tax court’s credibility determinations,

it is worth noting that the court had every reason to make the

credibility assessments that it did in this case.

Tracy’s testimony at trial was exceptionally vague and riddled

with lapses of memory. For example, when asked by the court what

advice Hunter had given Tracy and her sister, Tracy replied as

follows: “I don’t--well, there was this chalk talk thing, and

there was--and ultimately it was, well it was a gift. And we--you

know, that is--so your dad owes the tax.” When answering a number

of related questions posed by the court regarding the sisters’

meeting with Hunter, Tracy responded that she could not remember or

did not know. The tax court could properly decline to credit

Tracy’s testimony. See id.; see also MacGuire v. Commissioner, 450

F.2d 1239, 1244 (5th Cir. 1971) (“‘The Tax Court not only may, but

should, base its findings on the testimony it believes to be true,

22
rejecting after due consideration that which it believes is

false.’” (quoting Boyett v. Commissioner, 204 F.2d 205, 208 (5th

Cir. 1953))).

The tax court concluded that Teresa, whose affidavit and

deposition were entered into evidence, had “failed to tell the

truth” in “various important respects.” The court specifically

concluded that Teresa had previously misrepresented her involvement

in reporting her father’s alleged understatement of his tax

liability to the IRS. In response to interrogatories sent to her

in the discovery phase of the trial, Teresa made the following

statement:

I never gave advice to the Internal Revenue Service about
shortcomings in the income tax returns filed by Larry and
Martha [Parker] for 1985, nor do I have personal
knowledge that any relative or counsel did so.
When later asked in deposition whether she provided the IRS with

any communication regarding her father’s tax liability, she stated

that she did not remember making such a communication. When asked

if she had heard of anyone else making such a communication, she

stated that she “ha[d] heard” during the pretrial proceedings

“[t]hat it was done.” When asked by whom, she responded “by myself

and my husband through our attorney.” When asked in a later

deposition session what this earlier statement meant, Teresa

responded, “It means that all I have heard in these proceedings is

that--that Steve and I were supposedly the informants, but I have

no knowledge of who informed, when it was done. I did not do it.

He did not do it.” A reward application bearing Teresa’s signature

23
and containing information regarding her father’s tax liability was

filed with the IRS and entered into evidence. Additionally, an IRS

memorandum reciting that Teresa was in attendance at a meeting with

an IRS special agent in 1986 at which she provided information

relating to her father’s 1985 tax return was also entered into

evidence. Based on its conclusion that Teresa had testified

falsely about her involvement in informing on her father to the

IRS, the tax court had every right to infer that Teresa had also

testified falsely about the advice that she received from Hunter

and her reliance on it. See Toussaint v. Commissioner, 743 F.2d

309, 312 (5th Cir. 1984) (concluding that the tax court could

properly infer that the taxpayer had testified falsely about a

particular matter based on the taxpayer’s false testimony regarding

a related matter).

The majority also notes that two other witnesses--Berwick and

Davis--indicated that Hunter felt that Tracy and Teresa could

legally treat the joint venture income as a gift from their father

and decline to report it as a capital gain. As noted earlier, the

tax court had the exclusive authority to make credibility

assessments regarding this testimony. More importantly, however,

none of the witnesses established that Tracy and Teresa provided

Hunter with all of the information relevant to an informed

determination of the appropriate tax treatment of the joint venture

income.

24
 In order to take advantage of the defense to negligence

penalties provided by good-faith reliance on the advice of counsel,

a taxpayer must prove that the advice of counsel allegedly relied

upon was “based on knowledge of all the facts” relevant to the

advice given. See Leonhart v. Commissioner, 414 F.2d 749, 750 (4th

Cir. 1969), cited with approval in Heasley v. Commissioner, 902

F.2d 380, 383-84 n.8 (5th Cir. 1990). The taxpayers did not meet

this burden here.

Tracy testified at trial that she did not provide Hunter with

any documents relating to the joint venture and that she could not

remember whether anyone else provided Hunter with any such

documents. Teresa’s affidavit states that she and Davis “provided

Mr. Hunter numerous documents [they] believed relevant to this

situation and other legal matters [they] were discussing with him,”

but does not specify the exact nature of those documents. Davis

testified that Teresa provided Hunter with some documents, but was

vague as to their contents. When asked what kind of documents

Teresa provided to Hunter, Davis stated, “She had, you know,

documents how the deal--you know, wasn’t a lot of documents, but

she did have some as far as the deal--land deal . . . .” As to

what Hunter was told at the meeting with the sisters, Tracy

testified that she “[could] only speculate” about what she had told

Hunter and that she “[could not] speak for [her] sister.” Such

testimony fails to establish that Hunter knew all of the facts

relevant to a determination of whether the joint venture income

25
constituted a gift and therefore fails to establish that Tracy and

Teresa did not act negligently.

The majority next concludes that, in light of the fact that

Hunter assisted the appellants in reporting on Parker to the IRS,

thereby subjecting them to heightened scrutiny regarding their

treatment of the joint venture income, “it is hard to understand

how the Tax Court could have concluded that Hunter would have

advised the appellants to take any position other than the one they

adopted in this matter.” Streber, ___ F.3d at ___, Majority op. at

10. This analysis is problematic on two levels. First, the

majority takes it upon itself to theorize about the cost-benefit

analysis that the appellants conducted in weighing the cost of

reporting to the IRS and thereby increasing their risks of an audit

against the benefit of a potential cash reward for providing the

IRS with what the majority acknowledges was information of

“substantial value.” Id. at ___, Majority op. at 11 n.9. Second,

based on an assumption that Hunter provided the appellants with

sound advice regarding the risks of heightened IRS scrutiny that

would flow from reporting on Parker, the majority concludes that

Hunter must have provided advice regarding the appropriate

treatment of the joint venture income that, at least in the view of

the appellants, was so unsound that it constituted legal

malpractice.15

15
The appellants have filed a legal malpractice action
against Hunter, the law firm where he is employed, and other
attorneys related to Hunter’s alleged advice that they treat the

26
 The majority also concludes that the tax court erred in

drawing a negative inference from the fact that Hunter did not

testify at the trial. In support of this conclusion, the majority

states that, unless a potential witness has information “peculiarly

within his knowledge,” a party should feel free not to produce the

potential witness “‘without any apprehension’ that a court will

draw a negative inference.” Streber, ___ F.3d at ___, Majority op.

at 13-14. (quoting McKay v. Commissioner, 886 F.2d 1237, 1238 (9th

Cir. 1989), and JOHN HENRY WIGMORE, EVIDENCE § 287, at 202-03 (Chadbourn

rev. 1979)). The legal authority that the majority cites for this

proposition fails to bear it out.

First, McKay does not stand for the proposition that the trier

of fact may draw a negative inference from a party’s failure to

produce a witness only when that witness possesses information

peculiarly within his knowledge. The sentence containing the

passage quoted by the majority states the following: “Moreover,

petitioner declined to testify and since the fact at issue was

peculiarly within his knowledge, the court properly concluded his

testimony would be unfavorable to him . . . .” McKay, 886 F.2d at

1238. The most that one can glean from this passage is that the

Ninth Circuit has concluded that a scenario in which a party

declines to produce a witness to present testimony peculiarly

within the witness’s knowledge constitutes one circumstance in

which the fact-finder may properly infer that the witness’s

joint venture income as a gift for tax purposes.

27
testimony would be unfavorable to the party. In no sense does the

Ninth Circuit’s language preclude the existence of other such

circumstances.

Second, Wigmore does not support the evidentiary rule

advocated by the majority. In the passage cited by the majority,

Wigmore states the general rule regarding when the trier of fact

may draw negative inferences from a party’s failure to produce a

witness within his control as follows:

[T]here is a general limitation (depending for its
application on the facts of each case) that the inference
[that a witness would testify in a manner unfavorable to
the party that declines to produce him] cannot fairly be
drawn except from the nonproduction of witnesses whose
testimony would be superior in respect to the fact to be
proved.

WIGMORE, supra, § 287, at 203. One can hardly doubt that the

testimony of Hunter--the purveyor of the legal advice at issue

here--regarding the substance of that advice would have been in

some sense superior to that of the witnesses who testified

regarding the matter. Indeed, given the vague and conclusory

nature of the testimony of the witnesses at trial regarding

Hunter’s advice and Tracy’s substantial lapse of memory as to its

substance, one might even conclude that the details of that advice

were peculiarly within Hunter’s knowledge.

More importantly, however, in the same paragraph quoted by the

majority, Wigmore goes on to say that the general limitation on the

fact-finder’s authority to draw negative inferences from a party’s

failure to produce a witness rests on “grounds of expense and

28
inconvenience” and “should not be enforced with any strictness;

otherwise it would become practically objectionable.” Id. In this

case, the expense and inconvenience of placing Hunter on the

witness stand would have been negligible. Not only was he

available to the appellants, he was in the court room throughout

the trial. Furthermore, the tax court found--and the appellants do

not dispute--that the Tax Court Rules of Practice and Procedure

would have allowed Hunter to testify without disqualification. See

26 U.S.C. foll. § 7453 R. 24(f).

The majority also contends that a conclusion that the tax

court could properly draw a negative inference from Hunter’s

failure to testify “would in essence require the attorney to

testify in all cases involving an advice of counsel defense.”

Streber, ___ F.3d at ___, Majority op. at 15. This is simply not

true. Allowing the tax court to draw such an inference does not

imply that the testimony of counsel is necessary to establish a

viable advice of counsel defense. It does not imply that the court

must draw such an inference or that, when the court does draw such

an inference, it is foreclosed from concluding that the other

evidence in the record nonetheless establishes that the taxpayer

reasonably relied on the advice of counsel.

In sum, given (1) the tax court’s exclusive power to make

credibility assessments regarding the witnesses at trial, (2) the

paucity of evidence regarding what information Hunter had when he

gave the advice at issue here, and (3) the tax court’s discretion

29
to draw a negative inference from Hunter’s failure to testify, the

tax court had ample basis on this factual record for concluding

that the appellants did not bear their burden of proving that they

were shielded from liability for negligence by good-faith reliance

on the advice of counsel. As an appellate court, our inquiry

properly ends there.

II. Substantial Understatement

The majority next errs in concluding that the tax court abused

its discretion in holding the appellants liable for a substantial

understatement penalty pursuant to former § 6661 of the Internal

Revenue Code. Section 6661, repealed after the tax years at issue

in this case, provided for the imposition of a penalty based on a

taxpayer’s substantial understatement of tax liability for a

taxable year. See 26 U.S.C.A. § 6661(a) (West 1989) (repealed in

1989). The section provided that, for purposes of computing the

penalty, the amount of the taxpayer’s understatement of tax

liability is “reduced by that portion of the understatement which

is attributable to . . . the tax treatment of any item by the

taxpayer if there is or was substantial authority for such

treatment.” Id. § 6661(b)(2)(B)(i). The taxpayer bears the burden

of proving the existence of substantial authority. See Westbrook,

68 F.3d at 882.

The majority concludes that, from a factual standpoint,

substantial authority for a taxpayer’s position within the meaning

of § 6661 exists unless “‘there was a record upon which the

30
Government could obtain a reversal under the clearly erroneous

standard’” had the tax court accepted the taxpayer’s position.

Streber, ___ F.3d at ___, Majority op. at 18 (quoting Osteen v.

Commissioner, 62 F.3d 356, 359 (11th Cir. 1995)). This

construction of the substantial authority standard contravenes

§ 6661's interpretive regulations. Section 1.6661-3 of the

Treasury Regulations indicates that § 6661's substantial authority

standard does not contemplate substantial evidentiary authority.

Rather, the regulation provides an exclusive list of potential

sources of authority, all of which are legal sources, which

indicates that § 6661 contemplates only substantial legal

authority. Section 1.6661-3 provides in relevant part as follows:

Types of authority. In determining whether there is
substantial authority . . . , only the following will be
considered authority. Applicable provisions of the
Internal Revenue Code and other statutory provisions;
temporary and final regulations construing such statutes;
court cases; administrative pronouncements (including
revenue rulings and revenue procedures); tax treaties and
regulations thereunder, and Treasury Department and other
official explanations of such treaties; and Congressional
intent as reflected in committee reports, joint
explanatory statements of managers included in conference
committee reports, and floor statements made prior to
enactment by one of a bill's managers.

26 C.F.R. § 1.6661-3(b)(2) (1997) (emphasis added). Noticeably

absent from this list of potential sources of authority is any

mention of factual evidence favorable to the taxpayer’s position.

Furthermore, the majority’s construction of the substantial

authority standard implies that, in many circumstances, if a

taxpayer is able to survive summary judgment, he is shielded from

31
liability for substantial understatement penalties because

substantial authority--in the form of some evidence--supports his

tax position.16 Moreover, when a taxpayer’s entitlement to a

particular tax benefit hinges upon facts that will be elucidated by

witness testimony, the taxpayer need only lie about the facts that

would entitle him to the benefit in order to shield himself from

liability for a substantial understatement penalty resulting from

his improperly claiming the benefit. In such a circumstance, the

taxpayer’s testimony would constitute some evidence indicating his

entitlement to the benefit, and, the majority opinion in this case

notwithstanding, it is doubtful that we would be in a position on

appeal to conclude that the trial court would have clearly erred

had it credited the taxpayer’s testimony. Surely Congress did not

intend to impose such a toothless penalty for substantial

understatement of tax liability.17

16
It is true that “[a] finding is clearly erroneous when,
although some evidence supports the decision, we are ‘left with the
definite and firm conviction that a mistake has been committed.’”
United States v. Tello, 9 F.3d 1119, 1122 (5th Cir. 1993) (quoting
United States v. United States Gypsum Co., 333 U.S. 364, 395
(1948)). However, on numerous occasions, we have concluded that a
factual finding is not clearly erroneous based on an inquiry that
appears to begin and end with a determination that the record
contains some evidence supporting the factual finding. See, e.g.,
United States v. Jobe, 101 F.3d 1046, 1066 (5th Cir. 1996); Lewis
v. NLRB, 750 F.2d 1266, 1278-79 (5th Cir. 1985).
17
It is worth noting that the majority’s construction of the
substantial authority standard also provides a disincentive for
taxpayers to settle with the IRS in situations in which they are
potentially liable for substantial understatement penalties. If
the taxpayer is able to create a fact issue about which reasonable
minds could differ regarding his entitlement to a particular tax
benefit, he can avoid liability for substantial understatement

32
 The majority’s erroneous construction of the substantial

authority standard is rendered even more unfortunate by the fact

that it is entirely gratuitous. The majority independently

concludes that the IRS abused its discretion by declining to waive

the substantial understatement penalty pursuant to § 6661(c)

because the appellants relied in good faith on the advice of

counsel in choosing to treat the joint venture income as a gift.

As I indicated above in my discussion of the majority’s treatment

of the tax court’s imposition of negligence penalties, the majority

errs in this regard by making an independent assessment of the

factual issue of whether the appellants truly acted in good-faith

reliance on the advice of counsel. However, the majority’s

conclusion that the appellants were entitled to waiver of the

penalty provides an independent, albeit legally unsound, basis for

its decision to reverse the tax court’s imposition of the

substantial understatement penalty. Nevertheless, the majority

proceeds to heap one legal error onto another by promulgating in

dicta a construction of the substantial authority standard that

fails to comport with the treasury regulations interpreting § 6661

and that robs the statute of much of its value as a deterrent of

taxpayer misconduct. I therefore respectfully dissent.

penalties. In some circumstances, this heightened incentive may be
sufficiently strong that it convinces the taxpayer to proceed to
trial rather than settle the dispute.

33