ISSUE 35. WHETHER KANTER IS LIABLE FOR SECTION 6661 ADDITIONS TO TAX FOR 1982 THROUGH 1984, AND 1986 THROUGH 1988
OPINION
[1,301] Section 6661(a) provides that, if there is a substantial understatement of income tax for any year, there will be added to the tax an amount equal to 25 percent of the amount of any underpayment attributable to such understatement. See Pallottini v. Commissioner, 90 T.C. 498 (1988). For purposes of this section, a substantial understatement exists if the amount of the understatement for the taxable year exceeds the greater of 10 percent of the tax required to be shown on the return or $ 5,000. See sec. 6661(b)(1).
[1,302] The term "understatement" means the excess of the tax required to be shown on the return over the amount of tax imposed which is shown on the return. Sec. 6661(b)(2)(A). The amount of the understatement 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 or the relevant facts affecting the item's tax treatment are adequately disclosed in the return or in a statement attached thereto. See sec. 6661(b)(2)(B). With respect to tax shelters, the understatement is reduced only if the taxpayer establishes that he reasonably believed that the tax treatment of such item by the taxpayer was more likely than not the proper treatment. See sec. 6661(b)(2)(C)(i). The term "tax shelter" includes a partnership or any other plan or arrangement if the principal purpose of such partnership, entity, plan, or arrangement is the avoidance or evasion of Federal income tax. Sec. 6661(b)(2)(C)(ii).
[1,303] In notices of deficiency for 1982 through 1984 and 1986 through 1988, respondent determined that the Kanters' entire underpayment for each year was a substantial understatement within the meaning of section 6661. Respondent's determination is presumed correct. Kanter had the burden of proving that respondent's determination was erroneous. He failed to do so.
[1,304] In amendments to answers for 1982 through 1984 and 1986 through 1988, respondent asserted the section 6661 addition to tax with respect to any underpayments of tax arising from unreported income not included in the notices of deficiency. Respondent had the burden of proof to the extent that the section 6661 addition to tax had been asserted by amended pleadings. See Rule 142(a).
[1,305] As his Federal income tax returns show, Kanter did not adequately disclose the relevant facts concerning the tax treatment of the various items at issue in these cases. There is and was no substantial authority for his tax treatment of such issues. He had no reason to believe that his treatment of tax shelter items was more likely than not the correct treatment. In this regard, the assignment of income adjustments (Prudential, Century Industries, Hi-Chicago Trust, CMS Investors), Bea Ritch Trusts adjustments, Cashmere adjustments, Schedule E computer leasing adjustments, and the adjustments disallowing losses on sales of notes receivable and stock to Windy City and MAF for nominal consideration are items attributable to tax shelters because they involve entities and arrangements the principal purpose of which was avoidance or evasion of Federal income tax. SeeUnited States v. Dahlstrom, 713 F.2d 1423 (9th Cir. 1983). The evidence affirmatively shows that Kanter did not have substantial authority for failing to report the assigned income at issue or substantial authority for his tax treatment of other items at issue. Therefore, except as otherwise provided in stipulations of settled or conceded issues, we sustain respondent's determination that the entire underpayment of income tax for each of the years 1982 through 1984 and 1986 through 1988 constituted a substantial understatement of tax for which there was no substantial authority or adequate disclosure within the meaning of section 6661. The amounts of the additions to tax under section 6661 can be determined in Rule 155 computations.
ISSUE 36. WHETHER KANTER IS LIABLE FOR SECTION 6621(c) INCREASED INTEREST FOR 1978, 1979, 1980 THROUGH 1984, AND 1986, AND 1987, AND 1988
[1,306] For the year at issue, section 6621(c), increased the interest rate due on a deficiency to 120 percent of the statutory rate (established under section 6601) on any underpayment of tax that exceeds $ 1,000 attributable to "tax motivated transactions", as defined in section 6621(c)(3). A tax-motivated transaction includes, but is not limited to, a valuation overstatement (150 percent or more) under section 6659(c), any loss disallowed under section 465(a), any credit disallowed under section 46(c)(8), any sham transaction, and/or any fraudulent transaction. See sec. 6621(c)(3). Under section 6621(c)(3), tax-motivated transactions also include transactions entered into without the requisite profit motive and which lack economic substance. See Patin v. Commissioner, 88 T.C. 1086 (1987), affd. without published opinion 865 F.2d 1264 (5th Cir. 1989), affd. without published opinion sub nom. Hatheway v. Commissioner, 856 F.2d 186 (4th Cir. 1988), affd. sub nom. Skeen v. Commissioner, 864 F.2d 93 (9th Cir. 1989), affd. sub nom. Gomberg v. Commissioner, 868 F.2d 865 (6th Cir. 1989). Under section 6621(c)(3), tax-motivated transactions also include losses disallowed by reason of invalid debt. See HGA Cinema Trust v. Commissioner, T.C. Memo 1989-370.
[1,307] In notices of deficiency for 1981, 1983, 1984, 1986, and 1987, respondent determined that the Kanters' entire underpayment was a substantial underpayment attributable to tax-motivated transactions within the meaning of section 6621(c). Respondent's determination is presumed correct, and Kanter had the burden of proving that the determinations were erroneous.
[1,308] In the answer to docket No. 1350-87 involving 1982, respondent affirmatively alleged that the entire underpayment was a substantial underpayment attributable to tax-motivated transactions under section 6621(c). In amendments to answers for 1978 through 1984, and 1986 and 1988, respondent affirmatively alleged that the increased underpayments resulting from Kanter's failure to report "kickback" income were attributable to tax-motivated transactions within the meaning of section 6621(c). To the extent that the applicability of the increased interest rate of section 6621(c) has been raised by answer or amendments to answers, respondent bears the burden of proof. See Rule 142(a).
[1,309] This Court has held that an underpayment attributable to the taxpayer's failure to report income that was assigned to a fraudulent or sham trust is an underpayment attributable to tax- motivated transactions. See Kerr v. Commissioner, T.C. Memo 1987-470. Respondent contends that IRA and its subsidiaries, Holding Co. and its subsidiaries, Century Industries, Oyster Bay Associates, the Delta Partnership, the Alpha Partnership, CMS Investors and the Bea Ritch Trusts were fraudulent or sham entities within the meaning of section 6621(c)(3). Therefore, respondent argues that any underpayments arising from Kanter's failure to report his income that he assigned to these entities or that was otherwise reportable as his income even though reported as income by these entities are attributable to tax-motivated transactions within the meaning of section 6621(c). More specifically, respondent argues that underpayments relating to Kanter's failure to report kickback income as set forth in the notices of deficiency and amended answers, consulting income assigned to Century Industries, "bonus payment" income assigned to Holding Co. through Delta, Alpha, and CMS Investors, income earned as trustee of Hi-Chicago Trust and assigned to Holding Co., income assigned to and/or otherwise reported by the Bea Ritch Trusts, and commission income from Equitable Leasing assigned to IRA are underpayments attributable to tax-motivated transactions within the meaning of section 6621(c)(3). We agree with respondent.
[1,310] With respect to 1980, as previously indicated with respect to negligence, Kanter conceded the investment interest expense deduction of $ 26,647 from SLG Partners through K & D Associates and introduced no evidence regarding his liability for additions to tax or the increased interest rate of section 6621(c). The Court has determined that the SLG transaction was a tax-motivated transaction under section 6621(c). See HGA Cinema Trust v. Commissioner, supra.Therefore, any underpayment resulting from this adjustment or from any credits claimed from the SLG transaction for the 1980 year is attributable to tax-motivated transactions within the meaning of section 6621(c).
[1,311] With respect to 1983 and 1986, Kanter introduced no evidence that respondent erred in determining that the underpayments resulting from the Schedule E computer adjustment of $ 83,333 for 1983 and Schedule E interest expense adjustment of $ 50,380 for 1986 were attributable to tax-motivated transactions. Therefore, any underpayments resulting from these adjustments are attributable to tax-motivated transactions within the meaning of section 6621(c).
[1,312] The capital gains and losses adjustment of $ 569,555 for 1983 relates to the sham transaction involving Cashmere. In the Cashmere transaction, Kanter's liability for the increased interest rate is established essentially by the sham nature of the scheme wherein his primary objective was to sell his real estate partnership interests and receive cash therefor while, at the same time, escaping the recognition of gains associated with the negative capital accounts inherent in such interests.
[1,313] With respect to the 1987 capital gains and losses adjustment of $ 3,097,750, included therein is the disallowance of losses claimed on the sale of notes receivable, stock, and partnership interests to Windy City and MAF for nominal consideration. Kanter admitted that the purpose of these sales was to establish losses for tax purposes. As discussed in the disallowance of these losses, the claimed losses were based on sham transactions wholly lacking in economic substance. Consequently, any underpayments resulting from these adjustments are attributable to tax-motivated transactions within the meaning of section 6621(c).
ISSUE 37. WHETHER IRA IS LIABLE FOR THE SECTION 6651(a)(1) ADDITION TO TAX FOR 1980
[1,314] In the notice of deficiency, respondent determined that IRA was liable for an addition to tax under section 6651(a)(1) equal to 15 percent of the deficiency for filing a delinquent return for 1980.
[1,315] Section 6651(a)(1) provides that if there is a failure to file a return on the date prescribed therefor (determined with regard to any extension of time for filing), unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there will be added to the amount required to be shown as tax on such return 5 percent of the amount of such tax if the failure is not for more than 1 month, with an additional 5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate.
[1,316] IRA failed to file timely its Federal income tax return for 1980. Although the due date for IRA's filing of its 1980 return had been extended to September 15, 1981, the return was not received by the Internal Revenue Service until on or about November 21, 1981. See Issue 30. IRA has not shown that such failure to file timely the return was due to reasonable cause and was not due to willful neglect. Therefore, we hold that IRA is liable for the section 6651(a)(1) addition to tax equal to 15 percent of the deficiency for 1980.
ISSUE 38. WHETHER IRA IS LIABLE FOR THE SECTION 6653(a) ADDITIONS TO TAX FOR 1980, AND 1982 THROUGH 1988
[1,317] In the notices of deficiency to IRA for 1980 and 1982 through 1988, respondent determined that all of the underpayments for each year were attributable to negligence or intentional disregard of rules or regulations under section 6653(a).
[1,318] IRA contends that it is not liable for the section 6653(a) addition to tax because it reasonably relied upon the advice of tax professionals, including Kanter and the certified public accountants who maintained its books and prepared its tax returns.
[1,319] Respondent, on the other hand, contends that IRA failed to establish that it is not liable for the section 6653(a) addition to tax.
[1,320] We conclude that IRA is liable for the addition to tax under section 6653(a) for 1980, 1982, 1983, 1984, 1985, 1986, 1987, and 1988, with respect to its underpayments from the equipment leasing transactions adjustments (Issue 22). As previously noted, Mallin, a tax attorney and an individual with considerable experience in the leasing field, brokered the transactions and recommended them to IRA and Kanter. Kanter further testified that, in having IRA invest in these transactions, he relied upon Mallin. However, it is important to note that Mallin was not acting as an outside, disinterested, and independent adviser to IRA, because he was paid a commission by the leasing company based on IRA's cash investment in each transaction. Indeed, during the course of Mallin's testimony, he acknowledged that he was acting as a broker, not as a tax attorney, in brokering these and other leasing transactions. Moreover, the Court did not accept Mallin's conclusory claims regarding the transactions' profit potential and economic substance. Also, no offering memorandum or prospectus was prepared and furnished to IRA with respect to the subject transactions. IRA failed to establish that a reasonable inquiry was made into the merits of the deductions and credits prior to its investment in these transactions. It was not shown that any of IRA's other advisers had knowledge or had been apprised of all the relevant facts. See Collins v. Commissioner, 857 F.2d 1383 (9th Cir. 1988), affg. Dister v. Commissioner, T.C. Memo 1987-217; Zmuda v. Commissioner, 731 F.2d 1417 (9th Cir. 1984). Although reasonable reliance on the advice of professionals may be a defense to negligence, IRA did not show that the reliance in the instant cases was reasonable. See Freytag v. Commissioner, 89 T.C. 849, 888 (1987), affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S. 868, 115 L. Ed. 2d 764, 111 S. Ct. 2631 (1991). Consequently, we sustain respondent's determinations that IRA is liable for the addition to tax for negligence or intentional disregard of rules or regulations under section 6653(a) for 1980, 1983, 1984, 1985, and 1986 on the underpayments from the equipment leasing transaction adjustments. These section 6653(a) additions include (1) an addition to tax under section 6653(a) for 1980, (2) an addition to tax under section 6653(a)(1) and (2) for 1983, 1984, and 1985, and (3) an addition to tax under section 6653(a)(1)(A) and (B) for 1986.
[1,321] We also conclude that IRA failed to establish that it acted reasonably and in good faith in claiming the disallowed 1985 capital losses (Issue 25) from its purported sales of various assets to Kanter and Holding Co. As discussed previously, IRA failed to show that section 267 was inapplicable or that the sales were bona fide. Consequently, we sustain respondent's determination that IRA is liable for the addition to tax under section 6653(a)(1)(A) and (B) for 1985 on the underpayment from the disallowed capital losses.
[1,322] We also conclude that IRA failed to establish that it was not negligent in claiming (1) the disallowed 1987 bad debt deductions (Issue 26), (2) the disallowed 1987 ordinary losses (Issue 27), and (3) the disallowed 1987 capital losses (Issue 28). IRA claimed the bad debt deductions with respect to the promissory notes of Ballard and Lisle. There was no showing that these debts were worthless. Moreover, IRA later pursued collection efforts upon these notes, with the result that it obtained payment from Ballard upon his notes and received Lisle's renewed promise to pay his notes. Also, as to IRA's claimed losses, IRA failed to show a reasonable basis for treating as bona fide its purported sales of various assets to MAF. Consequently, we sustain respondent's determination that IRA is liable for the addition to tax under section 6653(a)(1)(A) and (B) for 1987 on the underpayments from the disallowed losses and bad debt deductions.
[1,323] Lastly, we conclude that IRA failed to establish that it was not negligent in claiming the disallowed 1988 $ 1,073,835 Decision Holdings Form 4797 loss (Issue 23). IRA failed to show that it was reasonable to claim that the TG limited partnership had a basis of $ 1,091,641 in the assets that it transferred to Decision Holdings in a purported section 351 transaction. Consequently, we sustain respondent's determination that IRA is liable for the addition to tax under section 6653(a)(1)(A) and (B) for 1988 on the underpayment from the disallowed Form 4797 loss.
ISSUE 39. WHETHER IRA IS LIABLE FOR THE SECTION 6659(a) ADDITIONS TO TAX FOR 1982 AND 1983
[1,324] Consistent with the previous discussion with respect to Issues 22 and 23, a portion of each of the underpayments in income tax for 1982 and 1983 is attributable to gross overstatements by IRA as to the valuation of computer equipment and the attempt to structure a transaction under section 351 to realize a loss. In both instances, the transactions were factual and legal shams, lacked economic substance, and lacked a profit motive as well as a business purpose. See Rose v. Commissioner, supra. In the section 351 situation, the transactions, under section 357(b) and (c) had no bona fide business purpose, were purposely intended to avoid Federal income tax, and the liabilities to which the properties were subject exceeded the adjusted bases of the properties. IRA presented no meaningful evidence relating to the valuation of the computer equipment nor evidence relating to the inapplicability of section 357(b) and (c) in the section 351 transaction.
[1,325] In our view, the underpayments of taxes shown on IRA's income tax returns for the years in question are attributable to the prohibited conduct; i.e. the deliberate overvaluations. In each of the transactions the indebtedness incurred by IRA/Cedilla for purchase of the equipment greatly exceeded the amounts paid by prior owners of the equipment, and no evidence was presented to establish the reason for such increases in cost. IRA's overvaluations with respect to the computer equipment are inseparable from the transactions' lack of economic substance and profit motive and their sham character. The same rationale applies to the section 351 transaction. Accordingly, we sustain respondent's determination that a portion of the underpayment for each of the years 1982 and 1983 is attributable to a valuation overstatement involving the equipment leasing transactions.
ISSUE 40. WHETHER IRA IS LIABLE FOR THE SECTION 6661 ADDITIONS TO TAX FOR 1983 THROUGH 1988
[1,326] This issue relates to the addition to tax under section 6661 for IRA's understatements of tax attributable to a number of adjustments that we have sustained for 1983 through 1988.
[1,327] In the notices of deficiency issued to IRA for 1983 through 1988, respondent determined that the entire deficiency for each year was a substantial understatement of tax for which IRA was liable for the addition to tax under section 6661(a).
[1,328] IRA contends that it is not liable for the section 6661(a) addition to tax because there was substantial authority for the positions it took with respect to the disallowed items.
[1,329] Respondent, to the contrary, contends that IRA failed to meet its burden of establishing that it was not liable for the section 6661(a) additions.
[1,330] We agree with respondent. IRA failed to establish that substantial authority existed supporting its position on the disallowed equipment leasing transaction items. (Issue 22). In sustaining respondent's disallowance of the credits and deductions claimed by IRA, we note that IRA failed to offer probative evidence (1) that the equipment leasing transactions had economic substance, and (2) that the long-term notes issued were valid recourse indebtedness. Among other things, we did not accept Mallin's conclusory opinions concerning the transactions' profit potential and the reasonably expected residual value of the equipment. Examinations into the economic substance of leasing transactions are inherently factual, and, in conducting the economic substance inquiry, significant objective factors include the reasonableness of the income projections and residual value projections. See Levy v. Commissioner, 91 T.C. 838, 856 (1988). Thus, IRA's reliance on other equipment leasing cases in which taxpayers prevailed is inapposite. An authority is of little relevance if it is distinguishable on its facts from the facts of the case at issue. See sec. 1.6661-3(b), Income Tax Regs.
[1,331] In addition, IRA did not show that (1) the disallowed leasing transaction items were not tax shelter items, and (2) it reasonably believed, at the time its returns were filed, that its treatment of the items was more likely than not the proper treatment. See sec. 1.6661-2(d), Income Tax Regs. Therefore, we sustain respondent's determinations that IRA is liable for additions to tax under section 6661 for 1983 through 1988 on the understatements of tax attributable to the leasing transaction items.
[1,332] Similarly, we conclude that IRA failed to establish that it had substantial authority for its treatment of the disallowed 1985 capital losses (Issue 25). In sustaining respondent's disallowance of the losses, we found that IRA made no showing that section 267 was inapplicable or that the losses were bona fide. Consequently, we sustain respondent's determination that IRA is liable for an addition to tax under section 6661(a) for 1985 on the understatement attributable to the capital loss items.
[1,333] The Court concludes that IRA failed to establish that it had substantial authority for its treatment of (1) the disallowed bad debt deductions (Issue 26), (2) the disallowed ordinary losses (Issue 27), and (3) the disallowed capital losses (Issue 28). As previously discussed, IRA failed to show that the debts, in fact, became worthless during 1987. With respect to the 1987 ordinary and capital loss items, IRA failed to make any showing that (1) the purported sales were bona fide transactions, and/or (2) that section 267 was inapplicable. Moreover, with respect to the purported sales of certain assets made to MAF, IRA also failed to show that (1) the loss items were not tax shelter items, and (2) it reasonably believed that its treatment of the items was more likely than not the proper treatment. Consequently, we sustain respondent's determination that IRA is liable for an addition to tax under section 6661(a) for 1987 on the understatement from the disallowed bad debt deduction, ordinary losses, and capital losses items.
[1,334] Finally, we conclude that IRA failed to establish that it had substantial authority for its treatment of the disallowed 1988 Decision Holdings Form 4797 loss (Issue 23). IRA did not show that the TG limited partnership had an adjusted basis of $ 1,091,641 in the assets it transferred to Decision Holdings. Moreover, IRA did not show that (1) this loss item was not a tax shelter item, and (2) it reasonably believed its treatment of the item was more likely than not the proper treatment. Therefore, we sustain respondent's determination that IRA is liable for an addition to tax under section 6661(a) for 1988 on the understatement attributable to the disallowed Form 4797 loss item.
ISSUE 41. WHETHER IRA IS LIABLE FOR THE SECTION 6662(a) ACCURACY- RELATED PENALTY FOR 1989
[1,335] In the notice of deficiency for 1989, respondent determined that IRA was liable for an accuracy-related penalty of $ 175,780 due to negligence or disregard of rules or regulations and a substantial understatement of tax. IRA had the burden of proving that the imposition of the accuracy-related penalty was erroneous. It failed to do so. Therefore, we sustain respondent's determination.
CONCLUSION
[1,336] To reflect our disposition of the issues in controversy and those settled or conceded by the parties,
[1,337] Decisions in all dockets will be entered under Rule 155.