GOLLIN v. COMMISSIONER
This text of 1996 T.C. Memo. 454 (GOLLIN v. COMMISSIONER) is published on Counsel Stack Legal Research, covering United States Tax Court primary law. Counsel Stack provides free access to over 12 million legal documents including statutes, case law, regulations, and constitutions.
Opinion
*470 An appropriate order will be issued denying petitioners' motions, and decisions will be entered under Rule 155.
MEMORANDUM FINDINGS OF FACT AND OPINION
DAWSON,
*472 OPINION OF THE SPECIAL TRIAL JUDGE
WOLFE,
In notices of deficiency, respondent determined the following deficiencies in and additions to petitioners' Federal income taxes:
| Penalty | ||||
| Docket No. | Petitioner | Year | Deficiency | Sec. 6621(c) |
| 16922-90 | Stuart A. and | |||
| Harriet J. Gollin | 1979 | 1 $ 11,888 | 3 | |
| 1980 | ||||
| 1982 | 9,348 | |||
| 19612-90 | Myron and Patricia | |||
| Fishbach | 1982 | 17,471 | ||
| 21847-90 | Charles Fredericks, Jr. | |||
| and Stephanie Fredericks | 1982 | 2 128,880 |
| Penalty | ||||
| Docket No. | Petitioner | Year | Deficiency | Sec. 6621(c) |
| 16922-90 | Stuart A. and | |||
| Harriet J. Gollin | 1979 | 1 $ 11,888 | 3 | |
| 1980 | ||||
| 1982 | 9,348 | |||
| 19612-90 | Myron and Patricia | |||
| Fishbach | 1982 | 17,471 | ||
| 21847-90 | Charles Fredericks, Jr. | |||
| and Stephanie Fredericks | 1982 | 2 128,880 |
| Additions to Tax | ||||
| Docket No. | Sec. 6653(a)(1) | Sec. 6653(a)(2) | Sec. 6659 | Sec. 6661 |
| 16922-90 | 4 $ 594 | -- | $ 3,566 | -- |
| -- | 818 | -- | ||
| 467 | 5 | 2,804 | 6 $ 2,337 | |
| 19612-90 | 873.55 | -- | 2,941.75 | |
| 21847-90 | 6,444 | 30,752.70 | ||
*473 On March 2, 1994, respondent filed a
The parties in these consolidated cases filed Stipulations of Settled Issues concerning the adjustments relating to their participation in the Plastics Recycling Program. In docket Nos. 16922-90 (the Gollins) and 19612-90 (the Fishbachs), the stipulations provide: 1. Petitioners are not entitled to any deductions, losses, investment credits, business energy investment credits or any other tax benefits claimed on their tax returns as a result of their participation in the Plastics Recycling Program. 2. The underpayments in income tax attributable to petitioners' participation in the Plastics Recycling Program are substantial underpayments*474 attributable to tax-motivated transactions, subject to the increased rate of interest established under 3. This stipulation resolves all issues that relate to the items claimed on petitioners' tax returns resulting from their participation in the Plastics Recycling Program, with the exception of petitioners' potential liability for additions to the tax for valuation overstatements under 4. With respect to the issue of the addition to the tax under
Long after the trials of these cases, petitioners in docket Nos. 16922-90 (the Gollins) and 19612-90 (the Fishbachs) each filed a Motion For Leave To File Motion For Decision Ordering Relief From the Negligence Penalty and the Penalty Rate of Interest and To File Supporting Memorandum of Law under Rule 50. These motions were filed with attached exhibits on October 30, 1995, and on October 23, 1995, respectively. On those same dates, petitioners Gollin and Fishbach each also lodged with the Court a motion for decision ordering relief from the additions to tax for negligence and the increased rate of interest, with attachments, and a memorandum in support of such motion. Subsequently, respondent filed objections, with attachments, and memoranda in*476 support thereof, and petitioners Gollin and Fishbach thereafter filed reply memoranda. For reasons discussed in more detail at the end of this opinion, and also in
The issues remaining in these consolidated cases are: (1) Whether petitioners are liable for the additions to tax for negligence under the provisions of section 6653(a); and (2) whether petitioners Gollin and Fishbach are liable for additions to tax under
FINDINGS OF FACT
Some of the facts have been stipulated in each case and are so found. The stipulated facts and attached exhibits are incorporated in the respective cases by this reference.
A. The Plastics Recycling Transactions
These cases concern petitioners' investments in three limited partnerships that leased Sentinel expanded polyethylene (EPE) recyclers: SAB Resource Recovery Associates (SAB Recovery), SAB*477 Resource Recycling Associates (SAB Recycling), and SAB Resource Reclamation Associates (SAB Reclamation). Petitioners Gollin are limited partners in SAB Reclamation; petitioners Fishbach are limited partners in SAB Recovery and SAB Recycling; 2 and petitioners Fredericks are limited partners in SAB Recycling. For convenience, we refer to these partnerships collectively as the Partnerships.
The transactions involving the Sentinel EPE Recyclers leased by the Partnerships are substantially identical to those in the Clearwater Group limited partnership (Clearwater), the partnership considered in
In the
All of the monthly payments required among the entities in the above transactions offset each other. These transactions were done simultaneously. Although the recyclers were sold and leased for the above amounts under the structure of simultaneous transactions, the fair market value of a Sentinel EPE recycler in 1981 and 1982 was not in excess of $ 50,000.
PI allegedly sublicensed the recyclers to entities that would use them to recycle plastic scrap. The sublicense*479 agreements provided that the end-users would transfer to PI 100 percent of the recycled scrap in exchange for a payment from FMEC Corp. based on the quality and amount of recycled scrap.
Like Clearwater, each of the Partnerships leased Sentinel EPE recyclers from F & G Corp. and licensed those recyclers to FMEC Corp. The transactions of the Partnerships differ from the underlying transactions in the
For convenience, we refer to the series of transactions among PI, ECI Corp., F & G Corp., each of the Partnerships, FMEC Corp., and PI as the Partnership transactions. In addition to the Partnership transactions, a number of other limited partnerships entered into transactions similar to the*480 Partnership transactions, also involving Sentinel EPE recyclers and Sentinel expanded polystyrene (EPS) recyclers. We refer to these collectively as the Plastics Recycling transactions.
B. The Partnerships
SAB Recovery, SAB Recycling, and SAB Reclamation are New York limited partnerships. SAB Recovery was formed in late 1981; SAB Recycling and SAB Reclamation were formed in early 1982. All three partnerships were organized and promoted by Stuart Becker (Becker), a certified public accountant (C.P.A.) and the founder and principal owner of Stuart Becker & Co., P.C. (Becker Co.), an accounting firm that specialized in tax matters. Becker organized a total of six recycling partnerships (the SAB Recycling Partnerships). Two of the SAB Recycling Partnerships closed in late 1981, two closed in early 1982, and two more closed in late 1982.
The general partner of each of the SAB Recycling Partnerships, including SAB Recovery, SAB Recycling, and SAB Reclamation, is SAB Management Ltd. (SAB Management). SAB Management is wholly owned by Scanbo Management Ltd. (Scanbo), which is wholly owned by Becker. Scanbo is an acronym for the names of three of Becker's children: Scott, Andy, and*481 Bonnie. The officers and directors of SAB Management and Scanbo are as follows: (1) Becker, president and director; (2) Noel Tucker (Tucker), vice president, treasurer, and director; and (3) Steven Leicht (Leicht), vice president, secretary, and director. During the years in issue, Tucker and Leicht also worked at Becker Co. Tucker was vice president. Each owned approximately 5 to 7 percent of the stock of Becker Co. SAB Management did not engage in any business before becoming involved with the SAB Recycling Partnerships.
With respect to each of the Partnerships, a private placement memorandum was distributed to potential limited partners. Reports by F & G Corp.'s evaluators, Dr. Stanley M. Ulanoff (Ulanoff), a marketing consultant, and Dr. Samuel Z. Burstein (Burstein), a mathematics professor, were appended to the offering memoranda. Ulanoff owns a 1.27-percent interest in Plymouth Equipment Associates and a 4.37-percent interest in Taylor Recycling Associates, partnerships that leased Sentinel recyclers. Burstein owns a 2.605-percent interest in Empire Associates and a 5.82-percent interest in Jefferson Recycling Associates, also partnerships that leased Sentinel recyclers. Burstein*482 also was a client and business associate of Elliot I. Miller (Miller), the corporate counsel to PI.
The offering memoranda for SAB Recovery, SAB Recycling, and SAB Reclamation state that the general partner will receive fees from those partnerships in the respective amounts of $ 97,800, $ 97,375, and $ 110,000. SAB Management received fees of approximately $ 500,000 as the general partner of the SAB Recycling Partnerships. In addition, Becker Co. prepared the partnership returns and Forms K-1 for all of the SAB Recycling Partnerships and received fees for those services.
The offering memoranda for the Partnerships also allocate 7.5 percent of the proceeds from each offering to the payment of sales commissions and offeree representative fees. In addition, the offering memoranda provide that the respective general partners "may retain as additional compensation all amounts not paid as sales commissions or offeree representative fees." However, neither SAB Management nor Becker retained or received any sales commissions or offeree representative fees. Instead, after the closing of each SAB Recycling Partnership, Becker rebated to each investor whose investment was not subject to a *483 sales commission or offeree representative fee an amount equal to 7.5 percent of such investor's original investment.
The offering memoranda list significant business and tax risk factors associated with investments in the Partnerships. Specifically, the offering memoranda state: (1) There is a substantial likelihood of audit by the Internal Revenue Service (IRS), and the purchase price paid by F & G Corp. to ECI Corp. probably will be challenged as being in excess of fair market value; (2) the Partnerships have no prior operating history; (3) the general partner has no prior experience in marketing recycling or similar equipment; (4) the limited partners have no control over the conduct of the Partnerships' business; (5) there is no established market for the Sentinel EPE recyclers; (6) there are no assurances that market prices for virgin resin will remain at their current costs per pound or that the recycled pellets will be as marketable as virgin pellets; and (7) certain potential conflicts of interest exist.
C. Stuart Becker and Steven Leicht
Becker does not have an engineering background, and he is not an expert in plastics materials or plastics recycling. He received*484 a B.S. degree in accounting from New York University in 1964 and an M.B.A. in taxation from New York University School of Business Administration in 1973. He passed the certified public accountancy test in 1967 and was the winner of the gold medal, awarded for achieving the highest score on the examination for that year. Since early 1966, Becker has practiced as a C.P.A. exclusively in the tax area. From 1964 until 1972 he worked for the accounting firm of Touche, Ross & Co., and in 1972 he joined the accounting firm of Richard A. Eisner & Co. as the partner in charge of the tax department. In 1977, Becker founded Becker Co.
Becker had considerable experience involving tax shelter transactions before he organized the SAB Recycling Partnerships. He prepared opinions regarding tax shelters' economic and tax projections, advised individuals and companies with respect to investments in tax shelters, lectured extensively about tax shelter investments generally, and lectured and published with respect to leveraged tax shelters. Becker described a leveraged tax shelter as "a transaction where [the ratio of] the effective [tax] writeoff, which includes the value of the tax credit, * * * *485 [to the amount invested] exceeds one to one." Becker Co. specialized in tax-advantaged investments. From 1980 to 1982, approximately 60 percent of the work done by Becker Co. involved tax sheltered and private investments. Becker has owned minority interests in general partners of numerous limited partnerships. Prior to organizing the SAB Recycling Partnerships, Becker owned 5 percent of the general partner of partnerships involved in approximately 14 transactions concerning river transportation (such as barges, tow boats, and grain elevators).
Although investment counseling was related to his firm's line of business, Becker did not consider himself in the business of providing investment advice. Becker did not normally hire other professionals for consultation or advice. In circumstances where he believed there was a need for outside advice, he would so advise the client. Between 30 and 40 of Becker's clients invested in the Plastics Recycling partnerships.
Becker learned of the Plastics Recycling transactions when a prospective client presented him with an offering memorandum concerning the transactions in August or September 1981. Becker reviewed the offering memorandum and spoke*486 to Miller, one of the key figures in the transactions and an acquaintance of Becker's. Miller was a shareholder of F & G Corp. and, as noted, the corporate counsel to PI. He also represented Robert Grant (Grant), the president and 100 percent owner of the stock of ECI Corp., and some of Grant's clients. Thereafter, Becker recommended the investment to the prospective client. Although the prospective client did not invest in the Plastics Recycling transactions, Becker became interested in the proposal and organized the SAB Recycling Partnerships in order to make similar investments in Sentinel EPE recyclers conveniently available to appropriate clients.
In organizing the SAB Recycling Partnerships, Becker was not allowed to change the format of the transactions or the purchase, lease, or licensing prices of the Sentinel EPE recyclers. He was allowed only to conduct a limited investigation of the proposed investments and choose whether or not to organize similar partnerships. Becker relied heavily upon the offering materials and discussions with persons involved in the matter to evaluate the Plastics Recycling transactions. He and two other members of Becker Co., Leicht and Tucker, *487 investigated PI and visited its plant in Hyannis, Massachusetts, where they saw the Sentinel EPE recyclers. Leicht testified in docket Nos. 16922-90 and 19612-90 (the Gollin and Fishbach cases). His testimony has been disregarded with respect to docket No. 21847-90 (the Fredericks case). Tucker did not testify in any of the trials.
During his investigation of the Plastics Recycling transactions, Becker did not hire any plastics, engineering, or technical experts, or recommend that his clients do so. Becker discussed the transactions with Michael Canno (Canno) of the Equitable Bag Co., a manufacturer of paper and plastic bags. Canno never saw the recyclers or the pellets and never wrote any reports assessing the equipment or the pellets. In addition, Becker retained a law firm, Rabin & Silverman, to assist him in organizing the SAB Recycling Partnerships. See
Leicht and Tucker also familiarized themselves with the Plastics Recycling transactions. Leicht has a B.A. degree in finance and accounting*488 from Penn State University, a J.D. from SUNY Buffalo, and an LL.M. in taxation from New York University School of Law. Leicht ran a mathematical check on the numbers contained in the offering materials for Becker, but he did not test the underlying assumptions upon which they were based. He also visited PI in Hyannis and met with Miller and other insiders to the transactions. Leicht never communicated an opinion as to the value of the recyclers other than what was presented in the offering memoranda. He has no education or expertise in plastics materials or plastics recycling.
D. Petitioners and Their Introduction to the Partnership Transactions
Petitioners Stuart and Harriet J. Gollin (the Gollins) resided in Scarsdale, New York, when their petition was filed. Stuart Gollin (Gollin) graduated from City College of New York in 1963 with a bachelor of business administration in accounting. Thereafter he joined the accounting firm of Touche, Ross & Co. (Touche, Ross) and within 3 to 4 years became a certified public accountant in New York and New Jersey. Gollin became a national retailing director and a senior audit partner at Touche, Ross. *489 He was in charge of their bankruptcy and litigation practice, an accounting specialty otherwise known as "forensic accounting." In 1980 Gollin joined Laventhol and Horwath (Laventhol) and headed their retail and forensic accounting practices.
Gollin explained that forensic accounting is distinct from auditing, taxation, and consulting. Generally, it is investigatory in nature. Forensic accounting entails, inter alia, bankruptcy and insolvency work, litigation consulting, insurance claims work, white-collar crime work, securities fraud, securities investigation, and fraud investigation. As an example of the type of work a forensic accountant does, Gollin related that in one case he was hired by a major food service company to learn whether a senior financial officer was defrauding the company. It was Gollin's job to determine the nature and amount of the fraud and to help in the potential recovery, including recovery negotiations. Gollin describes himself as "very into investigation and potential scams and the like."
Gollin acquired a 2.25-percent interest in SAB Reclamation for a gross investment of $ 12,500 in 1982, without taking into consideration any sales commission rebate *490 or advance royalty distribution. As a result of his investment in SAB Reclamation, on their 1982 Federal income tax return Gollin and his wife Harriet claimed an operating loss in the amount of $ 10,025. Of a total of $ 20,928 in investment tax and business energy credits flowing from SAB Reclamation, the Gollins claimed $ 6,391 of the regular investment credit on their 1982 return and carried back the remainder, $ 4,073, to 1979, 3 and they carried back $ 6,919 of the business energy credit to 1979 and $ 3,545 to 1980. Respondent disallowed the Gollins' claimed operating loss and credits related to Gollin's investment in SAB Reclamation.
Gollin learned of the Plastics Recycling transactions and SAB Reclamation in 1981 or 1982 from Becker. The *491 two had known each other since 1964 when Becker joined Touche, Ross, and they stayed in touch after Becker left that firm. Becker and Gollin first discussed the Plastics Recycling transactions at a social occasion. Gollin asked Becker whether he had any interesting investments, and Becker mentioned the SAB Recycling Partnerships. Becker provided Gollin with a copy of the SAB Reclamation offering memorandum and Gollin reviewed it. Gollin asked Becker whether there really was a machine and whether it passed the "kick-the-tire test" (that is, according to Gollin, whether anyone looked at it, touched it, and felt it). Becker described his visit to PI and other particulars of his investigation, such as talking to Canno. In the end, Gollin relied on Becker's judgment. According to Becker, Gollin said, "Tell me what you think I should do." Gollin was very well acquainted with Becker's background, and he knew that Becker did not have any experience in recycling, plastics technology, or engineering.
Neither of the Gollins has any education or experience in plastics materials or plastics recycling. They did not see a Sentinel EPE recycler prior to investing in SAB Reclamation. Gollin never *492 asked to see the books and records of SAB Reclamation. At the time he made his investment, Gollin knew that there were no end-users lined up to use the machines. Gollin stipulated that he does not know whether SAB Reclamation had any assets. Gollin did not consult an independent expert in plastics materials or plastics recycling. He relied exclusively on Becker. The Gollins never made a profit in any year from their participation in SAB Reclamation. This was the only investment Gollin made with Becker.
2. Myron and Patricia Fishbach
Petitioners Myron and Patricia Fishbach (the Fishbachs) resided in Stamford, Connecticut, when their petition was filed. Myron Fishbach (Fishbach) attended Syracuse University and later earned a law degree at Fordham Law School in 1963. After briefly working part time for a lawyer in Manhattan, Fishbach joined the law firm of Pollan & Zimmer in Hicksville, Long Island. He eventually became a named partner of that firm. Pollan & Zimmer underwent several name changes: during taxable years 1981 and 1982 the firm was named Zimmer, Fishbach & Hertan. For convenience, we shall refer to it, and its predecessors, as "ZFH" or "the firm." ZFH concentrated in*493 real estate, transactional work, commercial matters, and some litigation. Over time the firm acquired an office in New York City, although it continued to maintain an office in Long Island.
Sometime in the late 1960's John Mosler (Mosler) of the Mosler Safe Co. hired ZFH. Mosler had recently acquired a substantial interest in a company called Bell Television (Bell), and he wanted Fishbach to analyze the legal structure of Bell and its affiliated companies. Touche, Ross was Bell's accounting firm at the time, and Fishbach became acquainted with Becker at meetings held at Bell. Fishbach found that Becker was well respected. Sometime in the mid-1970's ZFH hired Richard Eisner & Co. to service its accounting and financial needs. Becker retained the ZFH account when he left Richard Eisner & Co. and formed Becker Co. Apart from their interaction at Bell, Fishbach's relationship with Becker consisted primarily of client referrals to Becker and consultations with him on select client financial matters. Becker also prepared Fishbach's Federal income tax returns.
Another partner at ZFH, Jay Hertan (Hertan), oversaw the bookkeeping and general financial affairs of the firm. Becker interacted*494 primarily with Hertan regarding ZFH's accounting and financial needs. Hertan had a business degree from Indiana University, a banking degree from Northwestern University, and a law degree from Yale Law School. He became a member of ZFH in 1967. Before that he represented Long Island banks and was active in civic affairs. His financial and banking related experience included work as an appraiser and mortgage related services. In 1982 Hertan became a trustee and officer of a real estate investment trust that operated out of an office adjacent to ZFH's office. Hertan often suggested investments to the firm. As an unwritten policy, either all of the members of ZFH would participate or the firm would not invest in the particular venture. ZFH invested primarily in real estate development projects.
ZFH acquired a 4.479638-percent interest in SAB Recovery for $ 50,000 in 1981 and a 2.538461-percent interest in SAB Recycling for $ 25,000 in 1982, without taking into consideration any sales commission rebates or advance royalty distributions. 4 As a general partner of ZFH, Fishbach is a second-tier owner of those interests. Fishbach testified that during 1981 and 1982 he was approximately*495 a one-third partner in ZFH. As a result of Fishbach's second-tier interests in SAB Recycling and SAB Recovery, on their 1982 return Fishbach and his wife Patricia claimed an operating loss in the amount of $ 7,230 and investment tax and business energy credits in the amount of $ 13,743. 5
*496 Respondent disallowed the Fishbachs' claimed operating loss and credits related to Fishbach's second-tier investments in SAB Recycling and SAB Recovery.
Fishbach learned of the Plastics Recycling transactions from Hertan. Hertan discussed the Plastics Recycling transactions with Becker. Fishbach understood that Hertan had seen the machines on a visit to PI in Hyannis, and that Hertan and Becker were exploring various aspects of the investment. Fishbach spent just a short amount of time flipping through the offering materials, looking particularly to see if he recognized any of the people involved with the Partnerships. He did not see a Sentinel EPE recycler prior to investing. Other than speaking to Hertan and Becker, Fishbach did not independently investigate the Plastics Recycling transactions. Through ZFH Fishbach invested in SAB Recovery in 1981 and SAB Recycling in 1982. He did not monitor his plastics recycling investments or, for that matter, any investments made by the firm. The Fishbachs never made a profit in any year from their participation in the Plastics Recycling transactions. Neither of the Fishbachs has any education or work experience in plastics, and Fishbach*497 did not know whether Hertan or Becker had any education or experience in plastics.
Petitioners Charles Fredericks, Jr. and Stephanie Fredericks (the Fredericks) resided in New York, New York, when their petition was filed. Charles Fredericks, Jr. (Fredericks) earned an undergraduate degree from Princeton University and a law degree from Harvard Law School in 1948. After he was admitted to the New York State bar, Fredericks practiced law for about one year with his father, a real estate attorney in New York City. He then pursued a very successful career in advertising beginning in approximately 1950. Fredericks spent the first 20 years of his advertising career at Ogilvy & Mather and rose to executive vice president of that agency. Thereafter, Fredericks served as the president, chief operating officer, and as a director of an advertising agency in which he held a major amount of stock, Wells, Rich, Greene.
In addition to the foregoing, from 1970 through the years in issue, Fredericks served as a director of Product Design and Engineering (PDE), a corporation located in Minneapolis, Minnesota. PDE manufactures polyethylene *498 and polystyrene closures for consumer packaged goods as well as all kinds of small plastic parts. The president and principal stockholder of PDE during that time was A. J. Porter (Porter), a graduate of the University of Minnesota and a licensed engineer. Fredericks explained that the closures and other plastic parts manufactured by PDE are molded from raw material under hot presses. During the mid to late 1970's, in order to economize its purchases of raw material, PDE began recycling its scrap plastic. Scrap plastic was run through grinders--no other processing was necessary--and fed into another batch to be molded.
In October of 1981, Fredericks sought to leave the employ of Wells, Rich, Greene. Fredericks hired an attorney, Robert Stephen Cohen (Cohen), to negotiate a settlement of his contract, and Cohen enlisted the assistance of Becker. The Fredericks and Cohen met with Becker, and they determined that his contract was worth between $ 3.5 million and $ 4 million. Cohen then negotiated a settlement package that had a present value, at that time, of approximately $ 1,750,000. Under the terms of the settlement, Fredericks was to continue as a consultant to Wells, Rich, Greene *499 for a 4-year period at $ 250,000 a year, and thereafter he would receive $ 30,000 a year for life.
Cohen told Fredericks that Becker could give Fredericks and his wife Stephanie financial advice, investment advice, and tax advice. Fredericks was familiar with one of Becker's earlier investment ventures, a physicians' leisure magazine in which Fredericks had placed advertisements for clients. He and Becker entered into a retainer agreement for tax services. Becker Co. agreed to provide income tax planning and tax return preparation services for 1982, in addition to recommending tax-oriented investments. The agreement provided: [Becker Co.] will perform an analysis of your past and present tax status in order to properly reflect on your current and future tax shelter needs. [Becker Co.] will continually seek such tax sheltered investments which are appropriate for you and which make sense from an economic point of view.
Fredericks acquired*500 a 5.076923-percent interest in SAB Recycling for $ 50,000 in 1982, without taking into consideration any sales commission rebate or advance royalty distribution. As a result of his investment in SAB Recycling, on their 1982 return he and his wife Stephanie claimed an operating loss in the amount of $ 39,741 and investment tax and business energy credits in the amount of $ 82,638. Respondent disallowed the Fredericks' claimed operating loss and credits related to his investment in SAB Recycling.
Fredericks learned about the Plastics Recycling transactions and SAB Recycling from Becker in 1982. Becker had forwarded at least 6 prospectuses to Fredericks in early 1982, one of which was for SAB Recycling. SAB Recycling was the only one of those investments that interested Fredericks. Fredericks reviewed the SAB Recycling offering memorandum. He did not understand most of the material outlining the structure of the leasing transactions. Fredericks claims he did not notice any conflicts of interest problems with F & G Corp.'s evaluators or that Becker would be receiving a general partner fee. At trial he could not recall reading that the projected losses and credits for the first year would*501 exceed the amount of his investment.
After reviewing the offering memorandum, Fredericks telephoned Porter to ask him whether he thought a polyethylene or polystyrene recycler was viable, and he also called Cohen and asked him if he would review the transaction. Fredericks understood from Cohen that Cohen had invested in at least one plastics recycling partnership in 1981 and that SAB Recycling was virtually the same. He also understood that Cohen thought it was a good deal with good tax advantages. Fredericks did not ask Cohen if he had received any royalty distributions. He did not consider Cohen to be an engineer or an expert in plastics recycling. According to Fredericks, Porter thought a polyethylene or polystyrene recycler was economically viable depending upon the price of oil. Fredericks did not otherwise discuss plastics recycling with Porter. He did not inform Porter of, or ask for his opinion about, the Sentinel EPE recycler or the Plastics Recycling transactions; he did not send Porter a copy of the offering memorandum; he did not tell Porter what machine he was investing in; he did not describe the machine to Porter; he did not tell Porter the price of the machine; and*502 he did not ask Porter if there were any comparable machines already on the market. Porter and Cohen did not testify at the trial in docket No. 21847-90.
Fredericks next spoke to Becker and Steele about SAB Recycling. He asked Becker whether he had seen the machines and if they worked. Becker described his visit to PI and advised Fredericks that he would be receiving commissions as general partner, 6 which also was disclosed in the SAB Recycling offering memorandum. Fredericks discussed the impact the investment would have on his estimated tax and matters of that nature with Steele; the two did not discuss the economics of the investment. The Fredericks do not have any education or experience in engineering or plastics recycling. Becker and Steele never said that they were expert in engineering or plastics recycling, and Fredericks never thought they had expertise on these subjects. Fredericks did not ask Becker on whom he relied in conducting his investigation or whether he consulted any independent experts unrelated to SAB Recycling, the promoters, or F & G Corp. He did not ask Becker if he had any conflict of interest. Fredericks did not ask Becker how many machines would be placed*503 by PI or if there were any similar recyclers already on the market. The Fredericks did not see a Sentinel EPE or EPS Recycler prior to their investment in SAB Recycling. They did not know whether the machines were unique at the time of their investment. The Fredericks never made a profit in any year from their participation in SAB Recycling.
OPINION
We have decided a large number of the Plastics Recycling group of cases. 7*505 The majority of these cases, like the consolidated cases herein, raised issues regarding additions to tax for negligence and valuation overstatement. We have found the taxpayers liable for such additions to tax in all but one of the opinions to date on these issues, although procedural rulings have involved*504 many more favorable results for taxpayers. 8
In
Although petitioners have not agreed to be bound by the
Based on the entire records in these cases, including the extensive stipulations, testimony of respondent's experts, and petitioners' testimony, we hold that each of the Partnership transactions herein was a sham and lacked economic substance. In reaching this conclusion, we rely heavily upon the overvaluation of the Sentinel EPE recyclers. Respondent is sustained on the question of the underlying deficiencies. We note that petitioners have explicitly conceded this issue in the respective stipulations of settled issues filed shortly before trial. The records plainly support respondent's determinations regardless of such concessions. For a detailed discussion of the facts and the applicable law in a substantially identical case, see
A. Section 6653(a)--Negligence
In notices of deficiency, respondent determined that each of petitioners was liable for the additions to tax for negligence under section 6653(a)(1) and*508 (2) for 1982, and in the case of the Gollins, under section 6653(a) for 1979 and 1980 as well. Petitioners have the burden of proving that respondent's determinations of these additions to tax are erroneous. 9 Rule 142(a);
Section 6653(a) for 1979 and 1980 and section 6653(a)(1) for 1982 impose an addition to tax equal to 5 percent of the underpayment if any part of an underpayment of tax is due to negligence or intentional disregard of rules or regulations. Section 6653(a)(2) imposes an addition to tax*509 equal to 50 percent of the interest payable with respect to the portion of the underpayment attributable to negligence or intentional disregard of rules or regulations.
Negligence is defined as the failure to exercise the due care that a reasonable and ordinarily prudent person would employ under the circumstances.
Petitioners argue that they were reasonable in claiming deductions*510 and credits with respect to the Partnerships. They maintain that they reasonably expected an economic profit in light of the so-called oil crisis in the United States in 1981 and 1982, and that they reasonably relied upon the offering materials and one or more qualified advisers. Petitioners each claim to have relied on Becker. In addition, Fishbach maintains that he also relied on Hertan, and Fredericks contends that he also relied on Steele, Cohen, and Porter.
1. The So-Called Oil Crisis
Petitioners contend that they reasonably expected to make an economic profit from the Partnership transactions because plastic is an oil derivative and the United States was experiencing a so-called oil crisis during the years 1981 and 1982. In support of this argument, petitioners cite
Petitioners' assertion that they reasonably expected an economic*511 profit from the Partnership transactions is not credible. Petitioners did not seriously review the offering memoranda, investigate the Plastics Recycling transactions, or otherwise educate themselves in plastics recycling. Moreover, testimony by one of respondent's experts establishes that the oil pricing changes during the late 1970's and early 1980's did not justify petitioners' claiming excessive investment credits and purported losses based on vastly exaggerated valuations of recycling machinery.
Petitioners' failure seriously to learn about the Partnership transactions undermines their contention that they reasonably expected an economic profit from them. Gollin was an experienced forensic accountant who described himself as "very into investigation and potential scams and the like," yet he did not ask to see SAB Reclamation's books and records, nor did he see a Sentinel EPE recycler prior to investing. Also, Gollin knew there were no end-users committed to the transaction, and he stipulated that he does not know whether SAB Reclamation had any assets. Fishbach was unsure if he had read the offering memoranda, but speculated that he spent just a short amount of time perusing*512 them and that he flipped through the risk factors. Asked if he reviewed the financial projections, Fishbach replied, "Absolutely not." Fredericks did not understand most of the material in the SAB Recycling offering memorandum describing the structure of the transaction. He testified that he was unaware that F & G Corp.'s evaluators had any conflicts of interest, that Becker was the de facto general partner of SAB Recycling, or that Becker would be receiving a fee as such. Yet the offering memorandum disclosed Becker's ownership of SAB Management, the fees accruing to the general partner, and also explained that Miller was the attorney for and a business associate of Burstein. Fredericks' discussion with Porter, who may have had some insight into plastics and/or plastics recycling, did not address the Sentinel EPE recycler or the Plastics Recycling transactions. In light of petitioners' lack of knowledge about and perfunctory investigations of the Partnership transactions, we find their claim that they reasonably expected an economic profit from the Partnerships unconvincing, even taking into consideration the so-called oil crisis.
Moreover, petitioners did not explain how the so-called*513 oil crisis provided a reasonable basis for them to invest in the Partnerships and claim the associated tax deductions and credits. The offering materials warned that there could be no assurances that prices for new resin pellets would remain at their then current level. One of respondent's experts, Steven Grossman, explained that the price of plastics materials is not directly proportional to the price of oil. In his report, he stated that less than 10 percent of crude oil is utilized for making plastics materials and that studies have shown that "a 300% increase in crude oil prices results in only a 30 to 40% increase in the cost of plastics products." Furthermore, during 1980 and 1981, in addition to the media coverage of the so-called oil crisis, there was "extensive continuing press coverage of questionable tax shelter plans."
Petitioners' reliance on
Petitioners' reliance on
In addition, the taxpayers in the
2. Petitioners' Purported Reliance on Tax Advisers
Petitioners maintain that they reasonably relied upon the advice of qualified advisers. Gollin contends that he reasonably relied on Becker; Fredericks contends that he reasonably relied upon Becker, *517 Steele, Cohen, and Porter; and Fishbach contends that he reasonably relied upon Hertan and Becker.
The concept of negligence and the argument of reliance on an expert are highly fact intensive. Petitioners in these cases are very well educated professionals: Two are lawyers and the third is a forensic accountant. These professionals ultimately relied upon an accountant to investigate the tax law and the underlying business circumstances of a proposed investment, the success of which depended upon a purportedly technologically unique machine. Becker, who is experienced in tax matters, explains that he made an investigation within the limits of his resources and abilities and fully disclosed what he had done. The question here is whether petitioners actually and reasonably relied on the accountant with respect to valuation problems requiring expertise in engineering and plastics technology, or whether the accountant gave the tax advice, facilitated the transaction, but did not make a full and independent investigation of the relevant business and technology, and did clearly inform his clients of the limits of his knowledge and investigation of the transaction. For reasons set forth*518 below, we believe the latter statement more accurately describes what happened here.
A taxpayer may avoid liability for the additions to tax under section 6653(a)(1) and (2), and the former section 6653(a), if he or she reasonably relied on competent professional advice.
Reliance on representations by insiders, promoters, or offering materials has been held an inadequate defense to negligence.
Becker had no education, special qualifications, or professional skills in plastics engineering, plastics recycling, or plastics materials. In evaluating the Plastics Recycling transactions and organizing the SAB Recycling Partnerships, Becker supposedly relied upon: (1) The offering materials; (2) a tour of the PI facility in Hyannis; (3) discussions with insiders to the transactions; (4) Canno; and (5) his investigation of the reputation and background of PI and persons involved in the transactions.
Despite his lack of knowledge regarding the product, the target market, and the technical aspects at the heart of the Plastics Recycling transactions, Becker did not hire an expert in plastics materials or plastics recycling, or recommend that his clients do so. The only independent person having any connection with the plastics industry with whom Becker spoke was Canno. A client of Becker Co., Canno was a part owner and the production manager of Equitable Bag Co., a manufacturer of paper and plastic bags. Becker spoke to Canno about*522 the recyclers and PI, but did not hire or pay him for any advice. Canno did not visit the PI plant in Hyannis, see or test a Sentinel EPE recycler, or see or test any of the output from a Sentinel EPE recycler or the recycled resin pellets after they were further processed by PI. According to Becker, Canno endorsed the Partnership transactions after reviewing the offering materials. Asked at trial if Canno had done any type of comparables analysis, Becker replied, "I don't know what Mr. Canno did."
Becker visited the PI plant in Hyannis, toured the facility, viewed a Sentinel EPE recycler in operation, and saw products that were produced from recycled plastic. Becker claims that during his visit, he was told that the recycler was unique and that it was the only machine of its type. In fact, the Sentinel EPE recycler was not unique; instead, several machines capable of densifying low density materials were already on the market. Other plastics recycling machines available during 1982 ranged in price from $ 20,000 to $ 200,000, including the Foremost Densilator, Nelmor/Weiss Densification System (Regenolux), Buss-Condux Plastcompactor, and Cumberland Granulator. See
Becker was also told that PI had put an enormous amount of research and development--10 to 12 years' worth--into the creation and production of the Sentinel EPE recycler. When he asked to see the cost records for some kind of independent verification, however, his request was denied. Becker was informed that such information was proprietary and secret, and that he would just have to take PI's representations as true. Although PI claimed that all of its information was a trade secret, and that it never obtained patents on any of its machines, PI had in fact obtained numerous patents prior to the recycling transactions and had also applied for a trademark for the Sentinel recyclers. Becker decided to accept PI's representations after speaking with Miller (the corporate counsel to PI), Canno (who had never been to PI's plant or seen a Sentinel EPE recycler), and a surrogate judge from Rhode Island who did business in the Boston/Cape Cod area (and who had no expertise in engineering or plastics materials). Becker testified that he was allowed to see PI's internal accounting controls regarding the allocation of royalty payments and PI's recordkeeping system in general. In
Becker confirmed at trial that he relied on the offering materials and discussions with PI personnel to establish the value and purported uniqueness of the recyclers. Becker testified that he relied upon the reports of Ulanoff and Burstein contained in the offering materials, despite the fact: (1) Ulanoff's report did not contain any hard data to support his opinion; (2) Ulanoff was not an economics or plastics expert; (3) Becker did not know whether Burstein was an engineer; and (4) Burstein was a client of Miller's and was not an independent expert. In addition, Ulanoff and Burstein each owned an interest in more than one partnership that owned Sentinel recyclers as part of the Plastics Recycling Program.
Becker explained at trial that in the course of his practice when evaluating prospective investments for clients, he focuses on the economics of the transaction and investigates whether there is a need or market for the product or service. With respect to the Partnership transactions, the records indicate that Becker overlooked several red flags regarding the economic viability and market for the Sentinel EPE*525 recyclers. The offering memoranda for the Partnership transactions warned that there was no established market for the Sentinel EPE recyclers. Becker never saw any marketing plans for selling the pellets or leasing the recyclers. He accepted representations by PI personnel that they would be marketing the recyclers to clients and that there was a sufficient base of end-users for the machines; yet he never saw PI's client list. At the time of the closing of the Partnerships, Becker did not know who the end-users were or if there were any end-users actually committed to the transaction.
Becker purportedly checked the price of the pellets by reading trade journals of the plastics industry. However, he did not use those same journals to investigate the recyclers' purported value or to see whether there were any advertisements for comparable machines. The records in these cases do not indicate that any of petitioners or their advisers other than Becker asked to see those journals for their own examination. In concluding that the Partnerships would be economically profitable, Becker made two assumptions that he concedes were unsupported by any hard data: (1) That there was a market for*526 the pellets; and (2) that market demand for them would increase.
Becker had a financial interest in SAB Recovery, SAB Recycling, SAB Reclamation, and the SAB Recycling Partnerships generally. He received fees in excess of $ 500,000 with respect to the SAB Recycling Partnerships, more than $ 300,000 of which was derived from SAB Recovery, SAB Recycling, and SAB Reclamation. Becker also received fees for investment advice from some individual investors, including Fredericks but not Gollin or Fishbach. In addition, Becker Co. received fees from the SAB Recycling Partnerships for preparing their partnership returns. As Becker himself testified, potential investors could not have read the offering materials and been ignorant of the financial benefits accruing to him.
We find that petitioners' purported reliance on Becker was not reasonable, not in good faith, nor based upon full disclosure. Becker's expertise was in taxation, not plastics materials or plastics recycling, and his investigation and analysis of the Plastics Recycling transactions reflected this circumstance. Gollin knew that Becker was not an engineer or expert in plastics materials or plastics recycling, and Fishbach and*527 Fredericks had no reason to believe otherwise. Becker testified that he was very careful not to mislead any of his clients regarding the particulars of his investigation. As he put it: "I don't recall saying to a client I did due diligence * * * [Rather,] I told [my clients] precisely what I had done to investigate or analyze the transaction. I didn't just say I did due diligence, and leave it open for them to define what I might or might not have done."
The purported value of the Sentinel EPE recycler generated the deductions and credits in these cases, and that circumstance was reflected in the offering memoranda. Certainly Becker recognized the nature of the tax benefits and, given their education and professional experience, petitioners should have recognized it as well. Yet neither petitioners nor Becker verified the purported value of the Sentinel EPE recycler. Petitioners ultimately relied on Becker, and Becker confirmed at trial that he relied on PI for the value of the Sentinel EPE recyclers. Investors as sophisticated as petitioners either learned or should have learned the source and shortcomings of Becker's valuation information when he "precisely" disclosed "what [he] *528 had done to investigate or analyze the transaction."
Gollin was a partner in an accounting firm and had nearly 20 years' experience as a forensic accountant investigating "potential scams and the like." Fishbach was a named partner in a law firm in which he had been practicing for nearly 20 years, and through which he had made a number of investments locally and nationally. Fredericks was the president and chief operating officer of a successful advertising agency and a board member of a plastics molding company that was recycling plastic scrap. Certainly petitioners possessed the resources and acumen properly to investigate the Partnership transactions. We hold that petitioners did not reasonably or in good faith rely on Becker as an expert or a qualified professional working in the area of his expertise to establish the fair market value of the Sentinel EPE recycler and economic viability of the Partnership transactions. Becker never assumed such responsibility, and he fully described the particulars of his investigation, taking care not to mischaracterize it as "due diligence."
In the end, Becker and petitioners relied on PI personnel for the value of the Sentinel EPE recyclers*529 and the economic viability of the Partnership transactions. See
Fishbach learned of the Plastics Recycling transactions from Hertan, his partner at ZFH. Hertan oversaw the bookkeeping and general financial affairs of ZFH. He and Fishbach lived near each other and carpooled in and out of Manhattan. With respect to the Partnership transactions, Fishbach testified that Hertan "found an investment that he thought was of interest" and that he mentioned visiting Hyannis to look at some equipment. Asked if Hertan gave him a report about what he found at Hyannis, Fishbach replied: Well, generally he would just, you know, talk about it * * * We had sort of a balancing out process. He would talk about something looked good and I would say, great * * * It was sort of implicit in our relationship at that time and the things we did that [Hertan] would go about evaluating things * * *.
Fishbach had ample opportunity to question Hertan about the Plastics Recycling transactions and the nature and extent of Hertan's investigation, but the record in this case indicates that he did not do so. He never asked Hertan if he had a background in plastics engineering or recycling. Fishbach believed that Hertan had thoroughly reviewed the offering memoranda, and he testified that he understood from Hertan that PI "seemed to have a real foothold in the marketplace." The offering memoranda, however, warned that there was no established market for the recyclers. Fishbach testified that it was hard for him to say honestly that he "knew all of the tax benefits" associated with the Partnerships. Yet the tax benefits flowing from SAB Recovery, SAB Recycling, and SAB Recovery Associates were reported on the Fishbachs' returns and attached Forms K-1, which Fishbach testified that he reviewed "in toto." Fishbach testified that he did not review the financial projections set out in the offering *532 memoranda; that he did not check the prognosis for royalty distributions; and that he did not monitor his 1981 investment in SAB Recovery. Apparently based upon an implicit understanding, Fishbach expected Hertan to do those things. Yet it is not clear from the record in docket No. 19612-90 how thoroughly Hertan reviewed the offering memoranda and investigated the respective Partnership transactions. Notwithstanding his purported ignorance of the performance of his 1981 investment in SAB Recovery, and the tax benefits associated therewith, Fishbach invested in two more SAB Recycling Partnerships in 1982.
At the time Fishbach invested in the respective SAB Recycling Partnerships, he had been practicing law for nearly 20 years and was a named partner in a law firm with offices in Manhattan and Long Island. Prior to 1981 he had invested in a number of ventures through the firm, including the financing and development of properties, construction of buildings, shopping centers throughout the country, and the construction of a television station. With respect to the Partnership transactions, the essence of Fishbach's testimony is that he left everything to Hertan, including monitoring the*533 investments. Fishbach did not pursue with Hertan any of the particulars of the Plastics Recycling transactions or Hertan's purported investigation of them. In light of his education and professional and investment experience, we consider Fishbach's claim of blind faith reliance on Hertan to be unconvincing. Fishbach has not established that his purported reliance on Hertan was reasonable, in good faith, or based upon full disclosure.
Fredericks contends that, in addition to relying on Becker, he also relied on Steele, Cohen, and Porter. Neither Steele, Cohen, nor Porter testified at trial.
Steele was the accountant at Becker Co. primarily responsible for handling the Fredericks' account. With respect to the Plastics Recycling transactions, Fredericks testified that he spoke to Steele "about what effect [the investment would] have on [the Fredericks'] estimated tax and things of that nature", but he did not ask Steele "about the economics of the situation." Steele never represented to Fredericks that he was an engineer or expert in plastics recycling. Other than the alleged explanation of the impact the investment would have on the Fredericks' taxes, *534 there is nothing in the record suggesting the exact nature of the advice, if any, that Fredericks received from Steele about the Plastics Recycling transactions.
Cohen is an attorney whom Fredericks hired in October of 1981 to negotiate the settlement of an employment contract. Fredericks asked Cohen whether he was familiar with the Plastics Recycling transactions and whether he could review the SAB Recycling offering memorandum from a legal standpoint. He did not consider Cohen to be an engineer or an expert in plastics recycling. Cohen indicated that he had invested in a 1981 Plastics Recycling transaction, and he agreed to compare the two offering memoranda. Fredericks understood from Cohen that the two transactions were virtually the same and that the investment offered good tax advantages. He did not ask Cohen whether he had received any royalties.
Porter was a licensed engineer and the president and principal stockholder of PDE, a plastics molding company for which Fredericks was a director. Fredericks knew that PDE had been recycling plastic scrap since the late 1970's. After reviewing the SAB Recycling offering memorandum, Fredericks telephoned Porter and asked him if there*535 was any economic value in a machine that recycles polyethylene or one that recycles polystyrene. According to Fredericks, Porter believed that recycling was economically viable depending upon the price of oil. Fredericks did not inform or question Porter about the Plastics Recycling transactions, the Sentinel EPE recycler, or any details of plastics recycling. He did not tell Porter what machine he was investing in; he did not describe the machine to Porter; he did not tell Porter the price of the machine; he did not send Porter a copy of the offering memorandum; and he did not ask Porter if there were any comparable machines already on the market. On cross-examination, Fredericks summed up his conversation with Porter as follows:
Q So, basically, all you asked [Porter] was whether recycling was a--a feasible--a feasible thing, a feasible process.
A As I testified, I asked him is a recycling machine a viable economic entity.
Q Okay. But you didn't go into the specifics of this machine.
A I did not.
We hold that Fredericks' purported reliance on Steele, Cohen, and Porter was not reasonable, not in good faith, nor based on full disclosure. Nothing in the record in docket No. 21847-90*536 suggests the nature of the advice, if any, Fredericks received from Steele, other than the monetary impact the investment would have on his taxes. See
3. The Private Offering Memoranda
Petitioners in very general terms maintain that they reasonably relied upon the offering memoranda and the*537 tax opinion letters appended thereto. However, petitioners' testimony and actions indicate that they did not give due consideration to all of the information set out in the offering memoranda and that they ultimately did not place a great deal of reliance, if any, on the representations therein.
The offering memoranda raised numerous caveats and warnings with respect to the Partnerships, including: (1) The substantial likelihood of audit by the IRS and a likely challenge of the purported value of the recyclers; (2) the general partner's lack of experience in marketing recycling or similar equipment; (3) the lack of an established market for the recyclers; and (4) uncertainties regarding the market prices for virgin resin and the possibility that recycled pellets would not be as marketable as virgin pellets. In addition, the offering memoranda noted a number of conflicts of interest, including Miller's interest in F & G Corp. and his representation of Burstein, PI, and Grant, who was the sole shareholder of ECI Corp. A careful consideration of the materials in the offering memoranda in these cases, especially the discussions of high writeoffs and risk of audit, should have alerted*538 a prudent and reasonable investor to the questionable nature of the promised deductions and credits. See
In each of these consolidated cases the projected tax benefits in the respective offering memoranda exceeded petitioners' respective investments. According to the offering memoranda, for each $ 50,000 investor, the projected first-year tax benefits were investment tax credits in excess of $ 82,600 plus deductions in excess of $ 40,000. Specifically, the projected investment tax credits and deductions for the Partnerships in the first year of the investment for each $ 50,000 investor were as follows:
| IT + BE Credits | Deductions | |
| SAB Recovery | $ 82,639 | $ 40,003 |
| SAB Recycling | 82,639 | 40,037 |
| SAB Reclamation | 83,712 | 40,234 |
As a result of Gollin's gross $ 12,500 investment in SAB Reclamation, he and his wife Harriet claimed an operating loss in the amount of $ 10,025 and investment tax and business energy credits in the amount*539 of $ 20,928. 10 For Fredericks' gross $ 50,000 investment in SAB Recycling, he and his wife Stephanie claimed an operating loss in the amount of $ 39,741 and investment tax and business energy credits in the amount of $ 82,638 on their 1982 return. As a result of Fishbach's one-third interest in ZFH, and ZFH's gross $ 50,000 investment in SAB Recovery in 1981 and gross $ 25,000 investment in SAB Recycling in 1982, on their 1982 return Fishbach and his wife Patricia claimed an operating loss in the amount of $ 7,230 and investment tax and business energy credits in the amount of $ 13,743.
The direct reductions in petitioners' Federal income tax, as a result of the investment tax credits*540 alone, ranged from 165 percent to 167 percent of their cash investments, not taking into consideration any rebated commissions or advance royalty payments. 11 Therefore, after adjustments of withholding, estimated tax, or final payment, like the taxpayers in
*541 Petitioners' reliance upon the Court of Appeals for the Ninth Circuit's partial reversal of our decision in
*542 In the present cases, however, petitioners have not shown that they placed substantial reliance upon the tax opinion letter attached to the offering memoranda. Moreover, the offering memoranda for the Partnerships herein warned prospective investors that the accompanying tax opinion letters were not in final form, and were prepared for the general partner, and that prospective investors should consult their own professional advisers with respect to the tax benefits and tax risks associated with the Partnerships. The tax opinion letters accompanying the SAB Recovery, SAB Recycling, and SAB Reclamation offering memoranda were addressed solely to the general partner and began with the following opening disclaimer: This opinion is provided to
4. Miscellaneous
The parties in these consolidated cases stipulated that the fair market value of a Sentinel EPE recycler in 1981 and 1982 was not in excess of $ 50,000. Notwithstanding this concession, petitioners contend that they were reasonable in claiming credits on their Federal income tax returns based upon each recycler's having a value of $ 1,162,666. In support of this position, petitioners in docket Nos. 16922-90 and 19612-90 submitted into evidence preliminary reports prepared for respondent by Ernest D. Carmagnola (Carmagnola), the president of Professional Plastic Associates. Carmagnola had been retained *544 by the IRS in 1984 to evaluate the Sentinel EPE and EPS recyclers in light of what he described as "the fantastic values placed on the [recyclers] by the owners." Based on limited information available to him at that time, Carmagnola preliminarily estimated that the value of the Sentinel EPE recycler was $ 250,000. However, after additional information became available to him, Carmagnola concluded in a signed affidavit, dated March 16, 1993, that the machines actually had a fair market value of not more than $ 50,000 each in the Fall of 1981 and 1982.
We accord no weight to the Carmagnola reports submitted by petitioners. The projected valuations therein were based on inadequate information, research, and investigation, and were subsequently rejected and discredited by their author. In one preliminary report, Carmagnola states that he has "a serious concern of actual profit" of a Sentinel EPE recycler and that to determine whether the machines actually could be profitable, he required additional information from PI. Carmagnola also indicates that in preparing the report, he did not have information available concerning research and development costs of the machines and that he*545 estimated those costs in his valuations of the machines.
Respondent rejected the Carmagnola reports and considered them unsatisfactory for any purpose, and there is no indication in the records that respondent used them as a basis for any determinations in the notices of deficiency. Even so, counsel for petitioners in docket Nos. 16922-90 and 19612-90 obtained copies of these reports and urge that they support the reasonableness of the values reported on the Gollins' and Fishbachs' returns. Not surprisingly, counsel in those cases did not call Carmagnola to testify, but preferred instead to rely solely upon his preliminary, ill-founded valuation estimates. Carmagnola has not been called to testify in any of the Plastics Recycling cases before us. The Carmagnola reports were a part of the record considered by this Court and reviewed by the Sixth Circuit Court of Appeals in the
Petitioners cite a number of cases in support of their positions, but primarily rely on
This Court declined to sustain the negligence additions to tax in the
In
Neither petitioners nor Becker had any formal education, expertise, or experience in plastics recycling. Neither Cohen, Steele, nor Hertan ever represented that he was expert in plastics recycling and Fredericks and Fishbach had no reason to believe otherwise. *549 The records indicate that none of petitioners or their purported advisers had any personal insight or industry know-how in plastics recycling that would reasonably lead them to believe that the Plastics Recycling transactions would be economically profitable. Although Fredericks served on the board of a plastics molding company, there is no showing in docket No. 21847-90 that this gave him special insight into plastics recycling. Moreover, when he purportedly spoke to Porter about a polyethylene or polystyrene recycler, he sought no advice specifically about the Plastics Recycling transactions or the Sentinel EPE recycler. Similarly, Becker purportedly discussed the transactions with Canno, who apparently was familiar with the plastics industry, but Canno was not hired by Becker to investigate PI and the Sentinel EPE recycler, never saw a Sentinel EPE recycler, and never prepared any kind of formal, written analysis of the venture. Becker and petitioners relied upon representations by insiders to the Plastics Recycling transactions, and neither he nor petitioners hired any independent experts in the field of plastic materials or plastics recycling. Accordingly, we consider petitioners' *550 arguments with respect to the
In
In
In contrast, the Sentinel EPE recycler was priced disproportionately higher than other plastics recycling machines on the market, a fact that should not have eluded a serious investigation by petitioners or their purported advisers. 13 None of petitioners saw a Sentinel EPE recycler prior to investing in the Partnerships. Not only were petitioners not under the impression that the IRS had informally approved of the Plastics Recycling transactions, but the offering memoranda expressly*552 warned of a substantial likelihood of audit and that the purchase price of the recyclers would probably be challenged by the IRS as being in excess of fair market value. In addition, even though PI had obtained patents prior to the Plastics Recycling transactions, PI actually claimed that it had
Petitioners also rely on two recent decisions by the Court of Appeals for the Fifth Circuit that reversed this Court's imposition of the negligence additions to tax in a pair of nonplastics recycling cases:
5. Conclusion as to Negligence
Under the circumstances of these cases, petitioners failed to exercise due care in claiming large deductions and tax credits with respect to the Partnerships on their Federal income tax returns. We hold that petitioners did not reasonably rely upon the offering memoranda, their purported advisers, or in good faith investigate the underlying viability, financial structure, and economics of the Partnership transactions. We are unconvinced by the claim of these experienced and highly sophisticated, able, and successful professionals that they reasonably failed to inquire about their investments and simply relied on the offering circulars and their purported *556 advisers, despite warnings in the offering circulars and explanations by Becker about the limitations of his investigation. In each case these taxpayers knew or should have known better. We hold, upon consideration of the entire records, that petitioners are liable for the negligence additions to tax under the provisions of section 6653(a) for the taxable years at issue. Respondent is sustained on this issue.
B. Section 6659 --Valuation Overstatement
In notices of deficiency, respondent determined that petitioners Gollin and Fredericks were liable for the
In an amendment to answer, respondent asserted that petitioners Fishbach were liable for the
A graduated addition to tax is imposed when an individual has an underpayment of tax that equals or exceeds $ 1,000 and "is attributable to" a valuation overstatement.
Petitioners claimed tax benefits, including an investment tax credit and a business energy credit, *558 based on purported values of $ 1,162,666 for each Sentinel EPE recycler. Petitioners concede that the fair market value of a Sentinel EPE recycler in 1981 and 1982 was not in excess of $ 50,000. Therefore, if disallowance of petitioners' claimed tax benefits is attributable to such valuation overstatements, petitioners are liable for the
Petitioners contend that
1. The Grounds for Petitioners' Underpayments
Petitioners argue that the disallowance of the claimed tax benefits was not "attributable to" a valuation overstatement. According to petitioners, the tax benefits were disallowed because the Partnership transactions lacked economic substance, not because of any valuation overstatements. It follows, petitioners reason, that because the "attributable to" language of
Petitioners' argument rests on the mistaken premise that our*561 holding herein that the Partnership transactions lacked economic substance was separate and independent from the overvaluation of the Sentinel EPE recyclers. To the contrary, in holding that the Partnership transactions lacked economic substance, we relied heavily upon the overvaluation of the recyclers. Overvaluation of the recyclers was an integral factor in regard to: (1) The disallowed tax credits and other benefits in these cases; (2) the underpayments of tax; and (3) our finding that the Partnership transactions lacked economic substance.
Petitioners argue that in
Moreover, a virtually identical argument was recently rejected in
Petitioners' reliance on
*566
Petitioners argue that their concessions of the deficiencies preclude imposition of the
Petitioners' open-ended concessions do not obviate our finding that the Partnership transactions lacked economic substance due to overvaluation of the recyclers. This is not a situation where we have "to decide difficult valuation questions for no reason other than the application of penalties." See
Moreover, concession of the investment tax credit in and of itself does not relieve taxpayers of liability for the
In the present cases, no argument was made and no evidence was presented to the Court to prove that disallowance and concession of the claimed investment tax credits and other tax benefits related to anything other than a valuation overstatement. To the contrary, petitioners each stipulated substantially the same facts concerning the Partnership transactions as we found in
Petitioners' reliance on
*570 We held in
3. Section 6659(e)
Petitioners argue that respondent erroneously failed to waive the
We note initially that petitioners did not request respondent to waive the
However, we do not decide this issue solely on petitioners' failure timely to request waivers, but instead, we have considered the issue on its merits. Petitioners urge that they relied on the respective offering materials and Becker in deciding on the valuation claimed on their tax returns. Fishbach maintains that he relied on Hertan as well. Petitioners contend that such reliance was reasonable, and, therefore, that respondent should have waived the
*573 The offering materials for the Partnerships contained numerous warnings and caveats, including the likelihood that the value placed on the recyclers would be challenged by the IRS as being in excess of fair market value. At trial, Fishbach was unsure if he had read the offering memoranda and speculated that he spent just a short amount of time perusing them and that he flipped through the risk factors. Neither Fishbach nor Gollin sought to resolve the numerous issues raised in the offering memoranda.
Becker possessed no special qualifications or professional skills in the recycling or plastics industries and petitioners had no reason to believe otherwise. Although Fishbach claims that he did not know whether Hertan had any education or experience in plastics recycling, nothing in Hertan's background would indicate such qualifications, and Fishbach conceded that Hertan never said he had such education or experience. Despite these obvious limitations, Becker, Hertan, and petitioners never hired or consulted any plastics engineering or technical experts with respect to the Plastics Recycling transactions. Becker spoke with Canno, who apparently had some knowledge of the plastics industry, *574 but the substance of Canno's purported comments is doubtful, and he had only minimal information about the transaction. At trial, Becker confirmed that in the end he relied exclusively on PI, its personnel, and the offering materials as to the value and purported uniqueness of the machines. Hertan similarly relied on PI personnel and the offering materials, in addition to Becker.
In support of their contention that they acted reasonably, petitioners cite
We hold that petitioners did not have a reasonable basis for the adjusted bases or valuations claimed on their tax returns with respect to their investments in the Partnerships. In these cases, respondent could find that petitioners' respective reliance on the offering materials, Becker, and Hertan was unreasonable. The records in these cases do not establish an abuse of discretion on the part of respondent but support respondent's position. We hold that respondent's refusal to waive the
Long after the trials of these cases, petitioners Gollin and Fishbach each filed a Motion For Leave To File Motion For Decision Ordering Relief From the Negligence Penalty and the Penalty Rate of Interest and To File Supporting Memorandum of Law under Rule 50. Petitioners Gollin and Fishbach also lodged with the Court motions for decision ordering relief from the additions to tax for negligence and from the increased rate of interest, with attachments, and memoranda in support of such motions. Respondent filed objections, with attachments, and memoranda in support thereof, and petitioners thereafter filed reply memoranda. Petitioners Gollin and Fishbach argue that they should be afforded the same settlement that was reached between other taxpayers and the IRS in docket Nos. 10382-86 and 10383-86, each of which was styled
Counsel for petitioners seek to raise a new issue long after the trials in these cases. Resolution of such issue might well require new trials. Such further trials "would be contrary to the established policy of this Court to try all issues raised in a case in one proceeding and to avoid piecemeal and protracted litigation."
Even if petitioners' motions for leave were granted, the *578 arguments set forth in each of petitioners' motions for decision and attached memoranda, lodged with this Court, are invalid and such motions would be denied. Therefore, and for reasons set forth in more detail below, petitioners' motions for leave shall be denied.
Some of our discussion of background and circumstances underlying petitioners' motions is drawn from documents submitted by the parties and findings of this Court in two earlier decisions. See
The
In or about February of 1988, a settlement offer (the Plastics Recycling project settlement offer or the offer) was made available by respondent in all docketed Plastics Recycling cases, and subsequently in all nondocketed cases.
*582 In December 1988, the
*583 Petitioners argue that they are similarly situated to the taxpayer in the
Petitioners contend that under the principle of equality, the Commissioner has a duty of consistency toward similarly situated taxpayers and cannot tax one and not tax another without some rational basis for the difference.
The different tax treatment accorded petitioners and Miller was not arbitrary or irrational. While petitioners and Miller both invested in the Plastics Recycling project, their actions with respect to such investments provide a rational basis for treating them differently. Miller foreclosed any potential liability for increased interest in his cases by making payments prior to December 31, 1984; no interest accrued after that date. In contrast, petitioners made no such payment, and they conceded that the increased rate of interest under
Petitioners argue that
We find that petitioners and Miller were treated equally to the extent they were similarly situated, and differently to the extent they were*586 not. Miller foreclosed the applicability of the
In order to reflect the foregoing,
Footnotes
1. Cases of the following petitioners are consolidated for opinion: Myron and Patricia Fishbach, docket No. 19612-90; and Charles Fredericks, Jr. and Stephanie Fredericks, docket No. 21847-90. These cases were tried and briefed separately.↩
1. The deficiencies in docket No. 16922-90 for taxable years 1979 and 1980 result all or in part from disallowance of investment tax credit carrybacks and business energy credit carrybacks from taxable year 1982.↩
3.
Sec. 6621(c) was repealed by sec. 7721(b) of the Omnibus Budget Reconciliation Act of 1989 (OBRA 89), Pub. L. 101-239, 103 Stat. 2106, 2399, effective for tax returns due after Dec. 31, 1989, OBRA 89 sec. 7721(d), 103 Stat. 2400. The repeal does not affect the instant cases. The annual rate of interest undersec. 6621(c)↩ for interest accruing after Dec. 31, 1984, equals 120 percent of the interest payable under sec. 6601 with respect to any substantial underpayment attributable to tax-motivated transactions.2. The deficiency in docket No. 21847-90 arose in part from respondent's disallowance of certain tax benefits flowing from petitioners Fredericks' investment in B & H Shipping Associates V (B & H Shipping). On May 30, 1991, the parties filed a stipulation of settled issues resolving all of the issues related to the investment in B & H Shipping.↩
4. The notice of deficiency in docket No. 16922-90 lists the additions to tax for negligence for taxable years 1979 and 1980 under sec. 6653(a)(1). For taxable years 1979 and 1980, the addition to tax for negligence was provided for under sec. 6653(a).↩
5. 50 percent of the interest payable with respect to the portion of the underpayment attributable to negligence. Respondent determined that the portion of the underpayment attributable to negligence was $ 9,348 in docket No. 16922-90, $ 11,767 in docket No. 19612-90, and $ 128,880 in docket No. 21847-90.↩
6. The sec. 6661 determination is in the alternative to the
sec. 6659↩ addition to tax.2. The Fishbachs' interest in SAB Recovery and SAB Recycling was acquired through the law firm in which Myron Fishbach was a named partner during 1981 and 1982, Zimmer, Fishbach & Hertan.↩
3. On their 1979 Form 1040X, Amended U.S. Individual Income Tax Return, the Gollins carried back and claimed a total of $ 4,969 in regular investment credits. The source of the additional $ 896 of regular investment credits is unclear from the record in docket No. 16922-90.↩
4. ZFH also acquired an interest in SAB Recovery Associates in 1982, but the record in docket No. 19612-90 does not disclose the size of the interest or how much ZFH paid for it. The record indicates that SAB Recycling Associates was the subject of a separate determination and proceedings, and that a decision has since been entered with respect to that matter. The additions to tax at issue in docket No. 19612-90 stem solely from the Fishbachs' second-tier interests in SAB Recovery and SAB Recycling.↩
5. The $ 7,230 loss and $ 13,743 in credits claimed by the Fishbachs on their 1982 return is generally consistent with a one-third interest in ZFH. The 1982 Form K-1, Partner's Share of Income, Credits, Deductions, etc. issued by SAB Recycling for ZFH reports an ordinary loss in the amount of $ 19,871, and a basis in new recovery property, the Sentinel EPE recyclers, in the amount of $ 206,597. $ 19,871/3 = $ 6,623.66. $ 206,597/3 = $ 68,865.66. Applying the 10 percent investment tax credit and business energy credit computations to $ 68,866 yields a combined credit of $ 13,774 (68,866 x .1 = 6,866.6; 6,877 x 2 = 13,774). The record does not permit more exact computations.↩
6. At trial, Becker was asked, "Did you advise Mr. Fredericks that you would be receiving commissions as a general partner for this investment?" Becker answered, "Yes, I did." However, Becker did refund 7.5 percent of Fredericks' investment, which represented the offeree representative fee.↩
7.
Provizer v. Commissioner , T.C. Memo. 1992-177996 F.2d 1216 (6th Cir. 1993) , concerned the substance of the partnership transaction and also the additions to tax.The following cases concerned the addition to tax for negligence, inter alia:
Grelsamer v. Commissioner , T.C. Memo. 1996-399Zenkel v. Commissioner , T.C. Memo. 1996-398Estate of Busch v. Commissioner , T.C. Memo. 1996-342Spears v. Commissioner , T.C. Memo. 1996-341Stone v. Commissioner , T.C. Memo. 1996-230Reimann v. Commissioner , T.C. Memo. 1996-84Bennett v. Commissioner , T.C. Memo. 1996-14Atkind v. Commissioner , T.C. Memo. 1995-582Triemstra v. Commissioner , T.C. Memo. 1995-581Pace v. Commissioner , T.C. Memo. 1995-580Dworkin v. Commissioner , T.C. Memo. 1995-533Wilson v Commissioner , T.C. Memo. 1995-525Avellini v. Commissioner , T.C. Memo. 1995-489Paulson v. Commissioner , T.C. Memo. 1995-387Zidanich v. Commissioner , T.C. Memo. 1995-382Ramesh v. Commissioner , T.C. Memo. 1995-346Reister v. Commissioner , T.C. Memo. 1995-305Fralich v. Commissioner , T.C. Memo. 1995-257Shapiro v. Commissioner , T.C. Memo. 1995-224Pierce v. Commissioner , T.C. Memo. 1995-223Fine v. Commissioner , T.C. Memo. 1995-222Pearlman v. Commissioner , T.C. Memo. 1995-182Kott v. Commissioner , T.C. Memo. 1995-181Eisenberg v. Commissioner , T.C. Memo. 1995-180Greene v. Commissioner , 88 T.C. 376 (1987)Trost v. Commissioner , 95 T.C. 560 (1990)Farrell v. Commissioner , T.C. Memo. 1996-295Baratelli v. Commissioner , T.C. Memo. 1994-484Estate of Satin v. Commissioner , T.C. Memo. 1994-435Fisher v. Commissioner , T.C. Memo. 1994-434Foam Recycling Associates v. Commissioner , T.C. Memo. 1992-645Madison Recycling Associates v. Commissioner , T.C. Memo. 1992-605↩8. In
Zidanich v. Commissioner , T.C. Memo. 1995-382sec. 6659 addition to tax, but not liable for the negligence additions to tax under sec. 6653(a). As indicated in our opinion, theZidanich case, and theSteinberg case consolidated with it for opinion, involved exceptional circumstances.In
Estate of Satin v. Commissioner, supra Fisher v. Commissioner, supra Provizer v. Commissioner, supra Farrell v. Commissioner, supra Baratelli v. Commissioner, supra ; Zenkel v. Commissioner, supra↩ .9. In an amendment to the answer, respondent asserted that the interest due from petitioner Fishbach under sec. 6653(a)(2) was to be computed on an underpayment of $ 17,445 instead of $ 11,767. However, by order dated Apr. 1, 1994, the burden of proof was placed on petitioners Fishbach "with respect to the negligence issues". The shifting of the burden of proof in respect of sec. 6653(a)(2) was ordered as a sanction under Rule 104(c).↩
10. The Gollins claimed $ 6,391 of the regular investment credit on their 1982 return and carried back the remainder, $ 4,073, to 1979 (an additional $ 896 in regular investment credits was claimed on their amended 1979 return). With respect to the business energy credits, the Gollins carried back $ 6,919 to 1979 and $ 3,545 to 1980.↩
11. Although the record in docket No. 19612-90 does not disclose the amounts of Fishbach's second-tier interests, the projected investment tax and business energy credits for SAB Recovery and SAB Recycling for the first year of the investment, $ 82,639, is 165 percent of the corresponding projected investment amount, $ 50,000.↩
12.
Osterhout v. Commissioner , T.C. Memo. 1993-251Balboa Energy Fund 1981 v. Commissioner , 85 F.3d 634↩ (9th Cir. 1996)13. The Fredericks stipulated that information published prior to the Plastics Recycling transactions indicated that several machines capable of densifying low density materials were already on the market.↩
14. Fredericks purports to have spoken to Porter, a licensed engineer and the president of a plastics molding company that at the time was recycling plastic. However, Porter did not testify at trial, and Fredericks did not establish the extent of Porter's expertise in plastics recycling, if any. Moreover, when Fredericks spoke with Porter by telephone they did not discuss the Plastics Recycling transactions or the Sentinel EPE recyclers.↩
15. Other cases cited by petitioners are inapplicable and distinguishable for the following general, nonexclusive reasons: (1) They involve far less sophisticated, if not unsophisticated, taxpayers; (2) the reasonableness of the respective taxpayers' reliance on expert advice was established in those cases on grounds that do not exist here; and (3) the advice given was within the adviser's area of expertise.↩
16. To the extent that
Heasley v. Commissioner , 902 F.2d 380 (5th Cir. 1990)T.C. Memo. 1988-408 , merely represents an application ofTodd v. Commissioner , 89 T.C. 912 (1987)862 F.2d 540 (5th Cir. 1988) , we consider it distinguishable. To the extent that the reversal in theHeasley case is based on a concept that where an underpayment derives from the disallowance of a transaction for lack of economic substance, the underpayment cannot be attributable to an overvaluation, this Court and the Court of Appeals for the Second Circuit have disagreed. SeeGilman v. Commissioner , 933 F.2d 143, 151↩ (2d Cir. 1991)17. Petitioners' citation of
Heasley v. Commissioner, supra supra note 16 to the effect that the Court of Appeals for the Second Circuit and this Court have not followed theHeasley opinion with respect to the application ofsec. 6659↩ .18. In their posttrial brief, the Gollins referenced the reports prepared by Carmagnola in support of the reasonableness of the claimed valuation. For reasons discussed
supra↩ , we consider the reports prepared by Carmagnola to be unreliable and of no consequence.19. In each of their motions for decision, petitioners state, "After the lead counsel for taxpayers and Respondent had agreed upon the designation of the lead cases,
Respondent's counsel prepared piggyback agreements and offered them to counsel for the taxpayers in this case↩ and to other taxpayers." (Emphasis added.)20. Although the records do not include a settlement offer to petitioners, petitioners have attached to their motions for decision a copy of a settlement offer to another taxpayer with respect to a plastics recycling case, and respondent has not disputed the accuracy of the statement of the plastics recycling settlement offer.↩
21. In each of their motions for decision, petitioners state: "Respondent formulated a standard settlement position
which was extended to all taxpayers having docketed or non-docketed cases in the plastics recycling group,including Petitioner ." (Emphasis added.)In docket No. 16922-90, respondent attached to her objection to petitioners' motion for leave a copy of an Appeals Transmittal Memorandum and Supporting Statement, dated Apr. 26, 1990, which relates that the Gollins were offered and rejected the offer. The Gollins have not disputed the accuracy of its contents.
In docket No. 19612-90, respondent attached to her objection to petitioners' motion for leave a copy of a letter, dated Apr. 19, 1988, extending the offer to petitioners Fishbach in another plastics recycling case, docket No. 34890-87. Also attached to respondent's objection is a copy of the Fishbachs' reply letter, which rejected the offer but stated their desire to stipulate to be bound to the test cases. Respondent states in her objection that docket No. 34890-87 is among the cases in which she made administrative abatements of the negligence additions to tax and increased interest. See
Farrell v. Commissioner , T.C. Memo. 1996-295↩22. Although it is not otherwise a part of the record in the Gollin and Fishbach cases, respondent attached copies of the
Miller↩ closing agreement and disclosure waiver to her objections to petitioners' motion for leave, and petitioners do not dispute the accuracy of the document.
Related
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