T.C. Memo. 1995-605

UNITED STATES TAX COURT

UNITED CIRCUITS, INC., Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 20548-94. Filed December 26, 1995.

Gino Pulito, for petitioner. 

John E. Budde, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

COHEN, Judge: Respondent determined deficiencies of $68,587

and $33,638 in petitioner's 1989 and 1990 Federal income taxes,

respectively, and accuracy related penalties of $9,386 and $55

under section 6662(a) for 1989 and 1990, respectively. Unless

otherwise indicated, all section references are to the Internal

Revenue Code in effect for the years in issue, and all Rule

references are to the Tax Court Rules of Practice and Procedure.
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After concessions by the parties, the only issues remaining

for decision are whether petitioner is liable for the 1989 and

1990 accuracy related penalties for negligence and for a 

substantial understatement of income tax.

FINDINGS OF FACT

Some of the facts have been stipulated, and the stipulated

facts are incorporated in our findings by this reference. 

Petitioner had its principal place of business in Ohio at the

time the petition was filed. During the years in issue,

petitioner was in the business of manufacturing circuit boards.

United Circuits, Inc. (UCI), was owned by Frank Schubert

(Schubert) and Gary Jump (Jump). Schubert, the president of UCI, 

was primarily responsible for overseeing the manufacturing

process and ensuring that the waste produced from the

manufacturing process was in compliance with Environmental

Protection Agency standards. Schubert's education and prior work

experience were in engineering.

Jump was the vice president and general manager of UCI. 

Jump had various responsibilities that included reviewing UCI

financial information, making decisions about equipment

purchases, and working with Schubert on manufacturing matters. 

Jump received a degree in marketing.

UCI employed Davidson Audit Company (DAC) to perform

accounting functions and to prepare UCI's financial statements

and tax returns. Eleanor Northcutt (Northcutt), an employee of
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DAC, was responsible for the UCI account. Northcutt had been

employed by DAC since 1965 and had handled the UCI account since

UCI began business. Northcutt was a high school and a business

school graduate. She took 32 to 48 hours of continuing education

courses a year that were offered by the International Society of

Public Accountants. Northcutt did not have a public accountant

license. When Northcutt was presented with an accounting issue

about which she was uncertain, she would research the issue

herself and then make a decision as to how she felt the issue

should be treated.

Every month, Jump took UCI ledgers and invoices to

Northcutt. Northcutt would have her clerk prepare monthly

financial statements for UCI based on the ledgers and invoices. 

Northcutt reviewed the monthly financial statements after the

clerk completed them and before they were given to UCI.

Because the manufacturing processes used by UCI corroded its

equipment, periodic replacement of the equipment was necessary. 

Prior to the years in issue, UCI purchased equipment outright and

depreciated it for tax purposes.

During 1988, Jump was contacted by Equitable Lomas Leasing

Corp. (Lomas), a company that offered leases on equipment that

Jump was interested in purchasing. Lomas told Jump that there

were tax advantages of leasing the equipment instead of

purchasing it. Lomas advised Jump that, if the equipment lease

were for a duration of at least 1 year, the lease would be
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"legitimate". Jump contacted Northcutt about the equipment

acquisitions, and they discussed the possibility of leasing the

equipment. Jump specifically asked whether a 1-year lease was a

"legitimate" lease. Northcutt researched the issue of lease

duration and told Jump that 1-year leases would not be a problem

as long as they had monthly payments and they were set up as

leases or intended as leases.

During 1989 and 1990, UCI acquired the equipment and made

payments as follows:

 Asset 1989 Payments 1990 Payments

Voss level machine $ 38,750 $11,250

Drill 66,840 12,368

Etcher 26,220 26,221

Filter press 9,295

Air compressor 7,086

Total $141,105 $56,925

The document that conveyed the Voss level machine equipment

to UCI consisted of a typed payment schedule on a form that had

the preprinted words "Purchase Order" on the top of the form. 

The words "Lease Payments as Follows" were typed below "Purchase

Order". The agreement required four payments of $5,000 and eight

payments of $3,750, for a total of $50,000, with a $1.00 buy out

option. The agreement did not contain a provision for the return

of the equipment to the lessor. The invoice was signed by Jump

and dated April 28, 1989.

The drill was conveyed on a Lomas form titled "Master

Equipment Lease Agreement". The agreement consisted of a deposit
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and advance payment of $32,736.16, followed by eight monthly

payments of $5,684.04, for a total of $78,208, with a $1,000 buy

out option at the end of the 8 months. UCI exercised the buy out

option. The lease was signed by Schubert and dated June 27,

1989.

UCI was sent an invoice for the etcher by the supplier. The

terms were 50 percent down and 50 percent net 30 days after

shipment. UCI paid with two $26,220.50 checks dated November 9,

1989, and June 21, 1990, for a total of $52,441. The invoices

did not contain a provision for the return of the equipment to

the lessor or a buy out option. The checks were signed by Jump,

and the invoice was dated October 17, 1989.

The filter press was acquired on a series of invoices from

Jim's Plating Supply, Inc. There were a total of seven monthly

invoices, each one requesting a payment of $1,168.13. The

invoices did not contain a buy out option or a provision to

return the equipment to the lessor. The invoices were dated June

through December 1989.

The air compressor was acquired on a Compu Rent lease

agreement that required an advance payment of $1,574.60 and 10

monthly payments of $787.30. The agreement did not contain a buy

out provision. The agreement was signed by Jump and dated

May 15, 1990.

UCI recorded the payments for the equipment under "Lease

Expense" on its ledgers. The useful life of the equipment
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acquired as described above was substantially greater than the

duration of the purported leases.

Northcutt's clerk prepared UCI's 1989 and 1990 tax returns

based on the ledgers and invoices provided by UCI. Northcutt did

not review the purported lease transactions that were entered

into by UCI. Neither Northcutt nor her clerk verified the lease

expenses as part of UCI's return preparation. Petitioner

deducted the payments for the asset acquisitions as "Lease

Expense" on its 1989 and 1990 tax returns in the aggregate

amounts of $141,105 and $56,925, respectively. Northcutt

reviewed and checked the returns before sending them to UCI for

signature. Jump and Schubert each spent 5 to 10 minutes

reviewing the Federal income tax returns after they were received

from Northcutt. Schubert, as president of UCI, signed the

returns in both 1989 and 1990.

OPINION

Respondent determined that the lease expenses claimed by

petitioner were capital expenses and disallowed the deductions. 

Petitioner has conceded the $68,587 and $33,638 deficiencies for

1989 and 1990, respectively. Petitioner argues, however, that it

is not liable for the accuracy related penalties because there

was substantial authority for its position on its tax returns and

because petitioner's reliance on its accountant was reasonable

and in good faith. Respondent contends that there is no

substantial authority for petitioner's position on its tax
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returns and that petitioner's accountant was not qualified to

render tax advice. Petitioner bears the burden of proving that

respondent's determination is erroneous. Rule 142(a); INDOPCO,

Inc. v. Commissioner, 503 U.S. 79, 84 (1992); Bixby v.

Commissioner, 58 T.C. 757, 791 (1972).

Section 6662(a) imposes an accuracy related penalty of

20 percent on any portion of an underpayment of tax that is

attributable to items set forth in section 6662(b). Section

6662(b)(2) specifies as one of those items "Any substantial

understatement of income tax." An understatement is substantial

if it exceeds the greater of 10 percent of the tax required to be

shown on the return or $10,000. Sec. 6662(d)(1)(A) and (B). In

calculating understatements under section 6662(b)(2), items for

which there was substantial authority are not to be considered. 

Sec. 6662(d)(2)(B)(i). To determine whether the treatment of any

portion of an understatement is supported by substantial

authority, the weight of authorities in support of the taxpayer's

position must be substantial in relation to the weight of

authorities supporting contrary positions. Antonides v.

Commissioner, 91 T.C. 686, 700-704 (1988), affd. 893 F.2d 656

(4th Cir. 1990); sec. 1.6662-4(d)(3), Income Tax Regs.

Petitioner argues that the weight of authorities supports

its position that the equipment was acquired by lease and not

acquired in a disguised sale. Petitioner relies on Revenue

Ruling 55-540, 1955-2 C.B. 39, and Benton v. Commissioner, 197
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F.2d 745 (5th Cir. 1952), revg. a Memorandum Opinion of this

Court dated Sept. 20, 1950, as authorities to support its

position. Petitioner quotes Revenue Ruling 55-540, 1955-2 C.B.

at 41, as follows:

Whether an agreement, which in form is a lease, is in

substance a conditional sales contract depends upon the

intent of the parties as evidenced by the provisions of

the agreement, read in the light of the facts and

circumstances existing at the time the agreement was

executed. In ascertaining such intent no single test,

or any special combination of tests, is absolutely

determinative. No general rule, applicable to all

cases, can be laid down. Each case must be decided in

the light of its particular facts. * * *

Petitioner concludes that, because there is no general rule on

how to treat these arrangements, there is substantial authority

to treat them as petitioner did on its returns. However,

petitioner's recitation of Revenue Ruling 55-540 is incomplete. 

The ruling sets forth an "economic" test and continues as

follows:

However, from the decisions cited below, it would

appear that in the absence of compelling persuasive

factors of contrary implication an intent warranting

treatment of a transaction for tax purposes as a

purchase and sale rather than as a lease or rental

agreement may in general be said to exist if, for

example, one or more of the following conditions are

present: [Id. at 41.]

The conditions following in the ruling that would indicate a

sale include facts where: The lessee will acquire title upon the

payment of a stated amount of "rentals", which under the contract

he is required to make; the total amount that the lessee is

required to pay for a relatively short period of use constitutes
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an inordinately large proportion of the total sum required to be

paid to secure the transfer of the title; and the property may be

acquired under a purchase option at a price that is nominal in

relation to the value of the property at the time when the option

may be exercised, as determined at the time of entering into the

original agreement, or at a price that is a relatively small

amount when compared with the total payments that are required to

be made.

The facts in this case fit squarely within the conditions

set forth in the ruling: the terms of the leases were

substantially less than the life of the equipment, and UCI owned

the equipment outright, either after a maximum of 10 payments or

after exercising a nominal buy out option. Rather than

supporting petitioner's position, Revenue Ruling 55-540 is

contrary to petitioner's position.

Petitioner relies on Benton v. Commissioner, supra, to

support deducting all payments under short-term leases. In

Benton, the lease was for the purchase of automobiles to be used

as taxicabs. The 1945 lease required 10 payments of $5,000 with

an option to purchase the automobiles for $35,000 at the end of

the 10 months. The Court of Appeals upheld the leases stating

that, when the intent of the parties to a contract is determined,

it must be determined in light of the facts and circumstances as

they existed at the time the parties entered into the contract.
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At the time the "leases" in dispute here were entered into,

UCI intended to keep the equipment permanently. Northcutt

testified at trial: "United Circuits was buying some equipment

and we [Jump and Northcutt] discussed the possibility of a lease

against depreciating it". (Emphasis added.) The documents

transferring the equipment either had no provision for the return

of the equipment to the "lessors" at the end of the required

payments or the agreements offered a nominal buy out. Taking

into account all of the relevant facts and circumstances,

including the intent of the parties to the agreement at the time

of the agreements, we conclude that agreements have the legal

effect of a contract for sale. Benton is distinguishable and

does not represent authority for petitioner's position.

Petitioner has failed to present any authority that supports

petitioner's position on its tax returns. Under either the

economic test of the revenue ruling or the intent test of Benton

applied to the facts, the transactions were sales and not leases. 

Accordingly, petitioner cannot rely on the substantial authority

exception to the substantial understatement penalty to avoid

liability.

Petitioner also argues that it reasonably and in good faith

relied on Northcutt, its accountant, to prepare its returns and,

therefore, it should not be liable for the accuracy related

penalty. The reasonable cause and good faith exception in

section 6664(c) applies to both the substantial understatement
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and negligence penalties in section 6662(a) and (b). Section

1.6664-4, Income Tax Regs., states:

Reasonable cause and good faith exception to section

6662 penalties.--(a) In general. No penalty may be

imposed under section 6662 with respect to an portion

of an underpayment upon a showing by the taxpayer that

there was reasonable cause for, and the taxpayer acted

in good faith with respect to, such portion. * * *

(b) Facts and circumstances taken into account.--

(1) In general. The determination of whether a

taxpayer acted with reasonable cause and in good faith

is made on a case-by-case basis, taking into account

all pertinent facts and circumstances. The most

important factor is the extent of the taxpayer's effort

to assess the taxpayer's proper liability. * * *

Reliance on * * * the advice of a professional (such as

an appraiser, attorney or accountant) does not

necessarily demonstrate reasonable cause and good

faith. Similarly, reasonable cause and good faith is

not necessarily indicated by reliance on facts that,

unknown to the taxpayer, are incorrect. * * *

As a general rule, the responsibility of filing an accurate

return cannot be shifted by the taxpayer to a return preparer. 

Metra Chem Corp. v. Commissioner, 88 T.C. 654, 662 (1987). 

However, under certain circumstances, the taxpayer has been able

to avoid the imposition of a penalty if there was good faith

reliance by the taxpayer on the advice of a competent adviser. 

Jackson v. Commissioner, 86 T.C. 492, 539-540 (1986), affd. 864

F.2d 1521 (10th Cir. 1989). To show good faith reliance on the

advice of a competent adviser, the taxpayer must at least

establish: (1) That he or she provided the return preparer with

complete and accurate information; (2) that an incorrect return

was a result of the preparer's mistakes; and (3) that the
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taxpayer believed in good faith that he was relying on the advice

of a competent return preparer. Metra Chem Corp. v.

Commissioner, supra.

Petitioner relies on section 1.6664-4(b)(2), Example (l),

Income Tax Regs., to establish good faith reliance:

A, an individual calendar year taxpayer, engages B, a

tax professional, to give him advice concerning the

deductibility of certain state and local taxes. A

provides B with full details concerning the taxes at

issue. B advises A that the taxes are fully

deductible. A, in preparing his own tax return, claims

a deduction for the taxes. Under these facts, A is

considered to have demonstrated good faith by seeking

the advice of a tax professional, and to have shown

reasonable cause for any underpayment attributable to

the deduction claimed for the taxes. However, if A had

sought advice from someone that he knew, or should have

known, lacked knowledge in federal income taxation, A

would not be considered to have shown reasonable cause

or to have acted in good faith.

Petitioner argues that it is not liable for the penalty

because the facts in the instant case are the same as the facts

in the example. Petitioner's argument, however, is contradicted

by the evidence. Jump did not provide Northcutt with full

details or complete and accurate information concerning the

transactions in issue. Northcutt testified that she did not see

the agreements for the equipment acquisitions entered into by

UCI.

In addition, Jump relied on Northcutt for “accounting”

advice rather than for “tax” advice. Jump testified:

Q In giving it [the question about the leases] to

her, did you anticipate she would render tax advice?
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A I guess we were looking at it more as

accounting advice than strictly tax advice.

Q So your reliance on Ms. Northcutt for these

lease expenses goes to the question of accounting as

opposed to tax return preparation?

A Having never been involved in an audit or

anything, we're more aware of it now but at the time,

no, we were concerned with accounting and the company. 

We really didn't give much thought to being audited or

the IRS. We do now.

Northcutt’s return preparation consisted of transferring the

information in petitioner's ledgers to an income tax form without

verifying the validity of the entries in the ledger. Jump did

not inquire about the tax consequences of the transactions

entered into by petitioners and did not receive advice on the tax

consequences. Jump, by his own admission, did not rely on

Northcutt to render tax advice. Moreover, Jump did not follow

her advice as to the characteristics of a “legitimate” lease,

because two of the five purported leases’ payment terms were for

a duration of less than 1 year. Petitioner has failed to

establish good faith reliance on the advice of a competent tax

adviser.

Respondent also determined that petitioner was liable for an

accuracy related penalty because the understatement was due to

negligence. Petitioner argues that it is not liable for the

negligence penalty because it relied on its accountant. For the

reasons set forth above, we are not persuaded by petitioner's

argument.
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Petitioner has failed to meet its burden of proof to avoid

the accuracy related penalties. Accordingly, respondent's

determination will be sustained.

Decision will be entered

for respondent.