*The HONORABLE WILLIAM W SCHWARZER, Senior United States

District Judge for the Northern District of California,

sitting by designation.

___________

No. 95-1742

___________

Harold Chakales; *

Linda Carol Chakales, *

Appellants, *

 *

v. * Appeal from the United States

 * Tax Court. 

Commissioner of Internal *

Revenue, *

Appellee. * [PUBLISHED]

___________

Submitted: December 13, 1995

 Filed: March 27, 1996

____________

Before, BOWMAN and LOKEN, Circuit Judges, and SCHWARZER District *

Judge.

____________

SCHWARZER, District Judge.

Taxpayers Harold and Linda Carol Chakales (“Chakales”) appeal

from a decision of the United States Tax Court upholding the

assessment of penalty interest by the Commissioner of Internal

Revenue. Harold Chakales and Linda Carol Chakales v. Commissioner,
68 T.C.M. (CCH) 479 (1994). We have jurisdiction under 26 U.S.C.

§ 7482(a) and affirm.

BACKGROUND 

Chakales was among several thousand taxpayers who participated

in a program operated by First Western Government Securities

(“First Western”) involving straddle transactions of forward

contracts to buy and sell securities issued by the Government

National Mortgage Association and the Federal Home Loan Mortgage

Corporation. The Commissioner’s disallowance of the participants’

resulting tax losses on the ground that the program was a sham was

upheld in Freytag v. Commissioner, 904 F.2d 1011, 1015-17 (5th Cir.

1990), aff’d on other grounds, 501 U.S. 868 (1991). As summarized

by the Fifth Circuit in that case:

First Western’s absolute authority over the pricing and

timing of the transactions that occurred in the selfcontained market of its own making enabled it to achieve

the tax losses desired by its investors with uncanny

accuracy. The Tax Court’s recognition that First

Western’s program made available to its investors an

essentially risk-free opportunity to purchase tax

deductions cannot be labeled clearly erroneous.

Id. at 1016 (citation omitted). 

Chakales does not contest the disallowance of the losses,

conceding that Freytag controls the treatment of his transactions.

He contends, however, that the Tax Court erred in upholding the

Commissioner’s assessment of penalties. The Commissioner

determined that Chakales was liable for a penalty under 26 U.S.C.

§ 6653(a) for negligent underpayment of the tax. In addition,
 The Commissioner assessed section 6621(c) penalty interest 1

in Freytag. The Tax Court upheld the assessment on the ground

that the transactions were a sham. Freytag v. Commissioner, 89

T.C. 849, 886-87 (1987). The court of appeals did not address

the issue in its opinion.

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before the Tax Court, the Commissioner contended that an additional

interest penalty was due under 26 U.S.C. § 6621(c) for a

substantial underpayment of tax due to a tax-motivated transaction.

The Tax Court upheld both assessments.

THE SECTION 6621(c) PENALTY

Section 6621(c) provides for an interest rate of 120 percent

on any “substantial underpayment attributable to any tax motivated

transactions” (i.e., in excess of $1,000), and states in relevant

part: “[T]he term ‘tax motivated transaction’ means . . . any sham

or fraudulent transaction.” 26 U.S.C. § 6621(c)(3)(A)(v). The Tax

Court, basing its determination on the Fifth Circuit’s holding in

Freytag that these transactions were shams, sustained the

assessment of the penalty. 68 T.C.M. at 482. It rejected

1

Chakales’s argument that the penalty cannot be assessed in the

absence of a finding that the taxpayer lacked a profit motive. It

went on, however, to find that Chakales in fact lacked a profit

motive.

We review the Tax Court’s legal conclusions de novo but accept

its findings of fact unless clearly erroneous. Chase v.

Commissioner, 926 F.2d 737, 740 (8th Cir. 1991). “‘A finding is

“clearly erroneous” when although there is evidence to support it,
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the reviewing court on the entire evidence is left with the

definite and firm conviction that a mistake has been committed.’”

Id. (quoting United States v. United States Gypsum Co., 333 U.S.

364, 395 (1948)).

Under the plain language of the statute, a tax motivated

transaction “means . . . [inter alia] any sham . . . transaction.”

26 U.S.C. § 6621(c)(3)(A)(v)(emphasis added). The Commissioner has

authority, therefore, to assess the penalty simply upon a finding

that a transaction was a sham. See Howard v. Commissioner, 931

F.2d 578, 582 (9th Cir. 1991) (affirming a penalty under section

6621(c)(3)(A)(v) where the Tax Court found the underlying

transaction “to be a sham.”). Chakales contends that the

taxpayer’s state of mind is always relevant in the determination of

whether a transaction was tax motivated. He relies principally on

Heasley v. Commissioner, 902 F.2d 380 (5th Cir. 1990). However,

Heasley did not arise under the “sham transaction” provision of

section 6621. In that case the penalty was assessed under the

catch-all provision of section 6621(c)(3)(B) and an IRS regulation

defining a “tax motivated” transaction as one “not engaged in for

profit.” Id. at 385; 26 C.F.R. § 301.6621-2T, Q-4, A-4 (2).

Heasley had invested -- and lost -- a substantial sum in a scheme

represented by his investment adviser as expected to produce future

profits. The court of appeals held that the tax court had erred in

solely considering that the plan had generated only tax deductions

and credits but no profits. It held that “the tax court also

should have considered the Heasleys’ intent when determining

whether the Heasleys did not engage in the transaction for profit.”

Id. at 386. Heasley, therefore, does not address the issue in this
 Chakales’ explanation for the lack of withholding on his 2

annual wages in the two years at issue ($300,000 and $400,000,

respectively) was that “[h]e borrowed from his firm throughout

the year and bonused an appropriate amount at year end, basing

his withholding on December 30 or December 31 on the totality of

facts then known.” Appellant’s Brief at 37.

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case nor do the other decisions cited by Chakales. Section

6621(c)(3)(A)(v) by its terms authorizes the assessment of a

penalty against a taxpayer participating in any sham transaction.

Chakales does not dispute the Commissioner’s disallowance of the

losses based on the characterization of the transactions as sham.

There is no basis for reading a separate state of mind requirement

into the application of the sham test for purposes of section

6621(c)(3)(A)(v). 

Chakales argues further that “[b]ecause this penalty applies

at the investor level, that is the place to examine the

‘motivation.’ A defrauded investor is not subject to a penalty

because he was unsophisticated enough to be victimized.”

Appellant’s Brief at 47. We need not decide the appropriate

application of section 6621(c)(3)(A)(v) to the case of an innocent

victim of a fraudulent scheme who entered it in good faith for

profit. This is not such a case. The Tax Court made specific

findings rejecting Chakales’ assertion of a profit motive. It

found that he was aware of “[t]he raison d’etre of the

program . . . to convert ordinary income into long-term capital

gains and defer the payment of taxes.” 68 T.C.M. at 483. It found

that Chakales had no understanding of the transactions, that he did

not follow his account with First Western but submitted a request

for a tax loss to First Western and had no taxes withheld from his

substantial income from wages, and that he could not explain how 2
 For the taxable year 1981, section 6653(a)(2) provided an 3

addition to tax in the amount of 50 percent of the interest

payable with respect to the portion of the underpayment

attributable to negligence.

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he expected to make a profit by requesting a loss in one year and

an offsetting gain in the next. After reviewing Chakales’ course

of conduct with respect to his investment, the court found that

“[t]he only rational explanation for any of this is that petitioner

entered into these transactions with the primary, if not sole,

objective of obtaining the tax loss.” Id. at 484. That finding is

not clearly erroneous. See Lukens v. Commissioner, 945 F.2d 92,

99-100 (5th Cir. 1991).

THE SECTION 6653 PENALTY

Section 6653 provides that “[i]f any part of any underpayment

. . . is due to negligence . . . there shall be added to the tax an

amount equal to 5 percent of the underpayment.” 26 U.S.C. §

3

6653(a)(1). “[T]he determination of a negligence penalty is

presumptively correct, and the taxpayer bears the burden of proving

that it was improperly imposed.” Chase, 926 F.2d at 740; see also

Freytag, 904 F.2d at 1017. Thus the burden is on the taxpayer to

prove that he did not fail to exercise due care or do what a

reasonable and prudent person would do under similar circumstances.

Goldman v. Commissioner, 39 F.3d 402, 407 (2nd Cir. 1994). “In

addition, because the tax court’s decision involved a factual

determination, it will not be disturbed on appeal unless clearly
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erroneous.” Chase, 926 F.2d at 740. 

The Tax Court found Chakales to have admitted that he did not

understand these transactions which involved forward contracts to

purchase and sell millions of dollars of securities, with ratios of

tax losses to payments from 8:1 to 16:1. 68 T.C.M. at 483. Given

these facts, Chakales “could not merely rely on the documents

supplied by First Western, and further investigation was clearly

mandated. If there had been any serious examination of the program

‘[n]o reasonable person would have expected * * * [the] scheme to

work.’” 68 T.C.M. at 483 (quoting Freytag, 89 T.C. at

889)(internal quotation omitted).

Chakales contends, however, that he reasonably relied on the

advice of experts, to wit, Charles Frederick Marshall and George

Plastiras. Marshall was a broker employed by a securities firm.

He introduced Chakales to the First Western program, presenting him

with the documents which Chakales later completed and sent to First

Western. Chakales knew that Marshall received a commission from

First Western for selling the program to him. With respect to

Marshall, the Tax Court held that reliance on “the promoter’s

statements concerning the bona fides of these transactions . . .

‘is not the type of activity which will overcome the addition to

tax for negligence.’” 68 T.C.M. at 483 (quoting Rybak v.

Commissioner, 91 T.C. 524, 565 (1988)). See Goldman, 39 F.3d at

408 (reliance on advice from person who signed the limited

partnership agreement at issue as the partnership’s sales

representative was unreasonable).
-8-

Plastiras was an experienced tax attorney and accountant who

had represented Chakales since 1964 in various business and estate

matters, including their tax aspects. At Chakales’ request,

Plastiras met with him and Marshall late one afternoon to discuss

the First Western program, including the risks involved and whether

it had economic reality. He testified that he received First

Western’s materials, had lawyers in his firm research them and

arrive at their own opinion, and received from one of his partners

a hand-written office memorandum respecting the securities aspect

of the investment. Plastiras made no investigation of First

Western; as he put it, “I am just totally unaware about First

Western. Forgive me.” 

Chakales’ testimony described the advice he received from

Plastiras as follows:

Q. [D]id you retain his firm to render those opinions or

that advice?

A. Yes.

Q. And what did he tell you the advice of his firm was?

A. That it sounded like this was a very legitimate firm,

and that there was an opportunity to make some money.

Q. And what did he tell you about the tax opinion that

[Marshall gave to you]? . . .

A. He thought that the tax opinion from Arthur Andersen

was reasonable.

Q. The tax opinion from Arthur Andersen?

A. Well, whatever it was. I am not sure. That he

thought that this was a reasonable investment, as a taxpayer.
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Q. Did he give you an opinion about the tax treatment of

the transactions? 

A. What do you mean by tax -- an opinion as to tax

treatment?

Q. You gave him three documents . . .

A. One was . . . a legal opinion from a law firm.

Q. What was the legal opinion from the law firm about?

A. Maybe that was the tax - - that was about the

securities, I thought. I may be a little confused.

Q. And what did he tell you about that legal opinion

from the law firm?

A. That he didn’t know the law firm, and that his law

firm looked over it and thought that it was reasonable . . .

[and that it] [c]oncurred with their opinion.

(Joint Appendix 182-84.)

The relevant testimony of Plastiras was as follows:

Q. And what did you advise him or did you give him any

advice as to whether or not this transaction had economic

substance in reality? . . .

A. Yes. In our judgment, it had economic risk, and that

he could lose considerable amount of money. I was very much

concerned more about the loss of money than the gain. I

didn’t want him to lose any money.
 Plastiras did not prepare Chakales’ tax returns, and there 4

is no evidence that Chakales received or relied on advice from

his tax accountants in claiming the disallowed losses.

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(Joint Appendix 161-62.)4

The Tax Court found that Chakales did not hire Plastiras to

investigate First Western, that when Plastiras’ partner raised

concerns they were not followed up, and that Plastiras, like

Chakales, simply relied on Marshall. 68 T.C.M. at 483.

In United States v. Boyle, 469 U.S. 241, 251 (1985), the

Supreme Court laid down the controlling principle:

When an accountant or attorney advises a taxpayer on a

matter of tax law, . . . it is reasonable for the

taxpayer to rely on that advice. Most taxpayers are not

competent to discern error in the substantive advice of

an accountant or attorney. To require the taxpayer to

challenge the attorney, to seek a “second opinion,” or to

try to monitor counsel on the provisions of the Code

himself would nullify the very purpose of seeking the

advice of a presumed expert in the first place.

The underlying premise is that a taxpayer may reasonably rely on

advice when that advice involves the application of the attorney’s

or accountant’s relevant expertise. That is not what occurred in

this case. The “advice” Plastiras gave, on which Chakales now

claims to have relied, was little more than a generalized statement

that he could lose money on the transaction. Chakales himself was

vague at best about just what “advice” he had received from

Plastiras. See Howard, 931 F.2d at 582 (“Where no reliable

evidence exists in the record suggesting the nature of any advice
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given, a finding of negligence is not erroneous.”). There is,

moreover, no evidence that Plastiras researched the tax aspects of

the transaction, much less that he investigated First Western or

the manner in which the program operated. See Leonhart v.

Commissioner, 414 F.2d 749, 750 (4th Cir. 1969)(“[T]o escape the

penalty [on the ground of good faith reliance on the advice of an

accountant] taxpayers must be able to show that the accountant

reached his decisions independently after being fully apprised of

the circumstances of the transactions.”) Cf. Chamberlain v.

Commissioner, 66 F.3d 729, 733 (5th Cir. 1995)(reversing penalty

assessment where “[t]he [tax] expert advised that there was ‘a good

faith, supportable position’ concerning the deductibility of the

loss.”), reh’g denied.

The Tax Court’s factual findings are not clearly erroneous and

its conclusion that Chakales failed to carry his burden of proving

that he exercised due care was not error. 

Affirmed.

A true copy.

Attest:

CLERK, U.S. COURT OF APPEALS, EIGHTH CIRCUIT.