TAX COURT OPINION

Case: Phyllis Kovnat and Estate of Samuel Kovnat, Deceased, Phyllis Kovnat, Executor
Docket Number: 6597-12
Judge: Marvel
Opinion Type: bench
Filed: 06/30/2014
Pages: 14

SYM UNITED STATES TAX COURT WASHINGTON, DC 20217 PHYLLIS KOVNAT AND ESTATE OF SAMUEL KOVNAT, DECEASED, PHYLLIS KOVNAT, EXECUTOR, Petitioner(s), v. ) ) ) ) ) ) ) Docket No. 6597-12 COMMISSIONER OF INTERNAL REVENUE, Respondent. ) ) ) ORD ER Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it is ORDERED that the Clerk of the Court shall transmit to petitioners and to respondent a copy of the pages of the transcript of the proceedings in the above case before Judge L. Paige Marvel at Hartford, Connecticut, on May 22, 2014, containing the Court's oral findings of fact and opinion rendered at the trial session at which this case was heard. In accordance with the Court's oral findings of fact and opinion, decision will be entered for respondent. (Signed) L. Paige Marvel Judge Dated: Washington, D.C. June 30, 2014 SERVED Jun 30 2014 Capital Reporting Company 3 1 Bench Opinion by Judge L. Paige Marvel 2 May 22, 2014 3 Phyllis Kovnat and Estate of Samuel Kovnat, Deceased, 4 Phyllis Kovnat, Executor v. Commissioner 5 Docket No. 6597-12 6 THE COURT: The Court has decided to render 7 oral findings of fact and opinion in this case, and 8 9 the following represents the Court's oral findings of -- fact and opinion. The oral findings of fact and 10 opinion shall not be relied upon as precedent in any 11 other case. 12 This bench opinion is made pursuant to the 13 authority granted by section 7459(b) of the Internal 14 Revenue Code of 1986 (Code) as amended and Rule 152 15 of the Tax Court Rules of Practice and Procedure. 16 Hereinafter in this bench opinion, unless otherwise 17 indicated, section references are to the Code and 18 Rule references are to the Tax Court Rules of 19 Practice and Procedure. Some monetary amounts have 20 been rounded to the nearest dollar. 21 Robert J. Percy appeared on behalf of 22 petitioners. John Aletta appeared on behalf of 23 respondent. This case arises from a notice of 24 deficiency dated December 8, 2011, that the 25 respondent mailed to petitioners at their last known (866) 448 - DEPO www.CapitalReportingCompany.com 2014 Capital Reporting Company 4 1 address. In the notice of deficiency, respondent 2 disallowed $102,236 of itemized deductions (including 3 4 5 6 a $91,000 theft loss deduction and a $11,209 state and local tax deduction) that petitioners claimed on the Schedule A, Itemized Deductions, of their 2006 joint Federal income tax return; disallowed a $4,400 7 deduction for legal and professional service expenses 8 9 claimed on the Schedule C, Profit Or Loss From Business, allowed a $3,000 capital loss in 10 lieu of the $91,000 theft loss that respondent 11 disallowed; made some computational adjustments, and 12 13 determined that petitioners were liable for a Federal income tax deficiency of $29,079, and an accuracy- 14 related penalty under section 6662 of $5,816. 15 Petitioners have stipulated to the adjustments 16 disallowing the Schedule C legal and professional 17 18 service expense deduction and the Schedule A state and local tax deduction and now contest only the 19 disallowance of their Schedule A theft loss deduction 20 and the related capital loss allowance, and the section 21 6662 penalty. We must decide therefore whether 22 petitioners have proved that they sustained a theft 23 24 25 loss in 2006, and whether they are liable for the section 6662 accuracy-related penalty. FINDINGS OF FACT. (866) 448 - DEPO www.CapitalReportingCompany.com 2014 Capital Reporting Company The parties have stipulated some of the 5 relevant facts, which we incorporate herein by this reference. We also find facts on the basis of the stipulated exhibits, and to the extent that we find it credible and relevant, sworn testimony. 1 2 3 4 5 6 Petitioner, Phyllis Kovnat, resided in Connecticut 7 when she petitioned the Court on behalf of herself 8 9 and the Estate of Samuel Kovnat. At all relevant times, Advest, Inc. 10 (Advest) was a broker-dealer registered under the 11 Securities Exchange Act of 1934 with the New York 12 Stock Exchange, the National Association of 13 Securities Dealers, and all fifty states. In 1999 14 petitioners opened a brokerage trading account with 15 Advest that was subject to a margin account. Daniel 16 S. Spring was a registered representative of Advest 17 who handled transactions involving petitioners' 18 brokerage account at Advest. 19 In 2002 petitioners purchased a publicly 20 traded real estate investment trust (REIT) known as 21 Apex Mortgage (Apex) with funds provided under their 22 margin agreement with Advest. Shortly thereafter the 23 market value of Apex decreased and petitioners 24 purchased more shares of Apex on the recommendation 25 of Mr. Spring. The market value of Apex continued to (866) 448 - DEPO www.CapitalReportingCompany.com 2014 Capital Reporting Company 1 deteriorate and in late 2002 petitioners' shares in 6 2 Apex were sold at a loss. 3 In 2005 petitioners filed a claim against 4 Advest and Mr. Spring with the National Association 5 of Securities Dealers. In their claim petitioners 6 alleged that they made the initial and subsequent 7 8 investments in Apex on the basis of recommendations from Mr. Spring. Petitioners also allege that their 9 Apex investments steadily lost value and petitioners 10 were eventually subjected to several margin calls 11 that required them to liquidate investments to 12 satisfy their margin debt. 13 Petitioners asserted in their claim that 14 Mr. Spring breached his fiduciary duty to 15 petitioners, churned their account, misrepresented 16 material facts in recommending the Apex investments, 17 and made unsuitable investment recommendations. 18 Petitioners also seesm that Advest C|RiMfD failed to 19 adequately supervise Mr. Spring. Petitioners claimed 20 damages, costs and reasonable attorney's fees. 21 Advest and Mr. Spring filed an answer to 22 petitioners' claim that generally denied any 23 24 liability on their part. The answer also alleged that Mr. Kovnat, who was the primary contact for 25 petitioners' account, was an experienced and (866) 448 - DEPO www.CapitalReportingCompany.com 2014 Capital Reporting Company 7 1 2 3 sophisticated investor, that Mr. Spring's recommendations were suitable to petitioners' stated investment objectives, and that the losses in 4 petitioners' account were the result of market and 5 6 7 8 9 investment risks of which petitioners were aware. In 2006 petitioners settled their claim through the execution of a general release and settlement agreement. Pursuant to the release and settlement agreement, Advest paid petitioners $30,000 10 by issuing a check to petitioners' attorney. 11 12 By letter dated February 6, 2007, a company called Fraud Recovery Group, Inc. (FRG) solicited £ 13 petitioners and offered to assert a tax claim on A 14 15 their behalf for the unrecouped portion of their investment loss. Petitioners contacted Toby Elsass 16 and spoke with him about the possibility of claiming 17 a tax loss. Shortly thereafter petitioners agreed to 18 work with FRG for a fee equal to a percentage of the 19 refund claimed on their Federal income tax return for 20 2006, which FRG would prepare. 21 FRG prepared petitioners' 2006 tax returns. 22 On Schedule A of petitioners' 2006 Federal income tax 23 return, FRG reported a $91,000 theft loss with 24 respect to the unrecouped portion of petitioners' 25 Advest account loss. The return also claimed a (866) 448 - DEPO www.CapitalReportingCompany.com 2014 Capital Reporting Company 1 Schedule A deduction for state and local taxes and a 2 Schedule C deduction for legal and professional fees. 8 3 Mr. Kovnat dealt with Mr. Elsass and supplied 4 documents and information to FRG to be used in 5 preparing the 2006 returns. Mr. Kovnat died on 6 February 24, 2012. 7 In 2010 the Department of Justice sued Mr. 8 Elsass and FRG alleging that they had engaged in the 9 promotion of a theft loss scheme and requested a 10 11 permanent injunction and related relief. On October 17, 2013, the United States District Court for the 12 Southern District of Ohio issued its judgment in the case. 13 14 ANALYSIS 15 I. Burden of Proof. 16 Generally, the Commissioner's determination 17 of a deficiency is presumed correct, and the taxpayer 18 bears the burden of proving that the determination is 19 improper. Rule 142(a)(1); Welch v. Helvering, 290 20 U.S. 111, 115 (1933). However, under section 21 7491(a)(1), if a taxpayer produces credible evidence 22 with respect to any factual issue relevant to 23 ascertaining the taxpayer's liability for any tax 24 imposed by subtitle A or B of the Code and satisfies 25 the requirements of section 7491(a)(2), the burden of (866) 448 - DEPO www.CapitalReportingCompany.com 2014 Capital Reporting Company 1 proof on any such issue shifts to the Commissioner. 2 Petitioners have not proven that they have satisfied 3 the requirements of section 7491(a) so the burden of 9 4 proof remains on them. 5 6 II. Theft loss under Section 165. Section 165 erally authorizes a 7 deduction for losses resulting from theft for the 8 year in which the taxpayer discovers the loss. 9 Section 165(a),(c) and (e). In order to claim a 10 11 12 theft loss deduction, the taxpayer must prove (1) that a theft actually occurred under the law of the jurisdiction wherein the alleged loss occurred, 13 Monteleone v. Commissioner, 34 T.C. 688, 692 (1960), 14 15 (2) the amount of the loss, Gerstell v. Commissioner, 46 T.C. 161, 175 (1966), and (3) the date the 16 taxpayer discovered the loss, sec. 165(e); McKinley 17 18 v. Commissioner, 34 T.C. 59, 63 (1960). The term "theft" under Section 165 has a 19 general and broad meaning that includes any criminal 20 appropriation of another's property, including theft 21 by swindling, false pretenses, and other forms of 22 guile. Edwards v. Bromberg, 232 F.2d 107, 110, (5th 23 Cir. 1956); see also sec. 1.165-8(d), Income Tax 24 Regs. Generally the law of the jurisdiction where the 25 taxpayer sustained the loss governs whether a theft (866) 448 - DEPO www.CapitalReportingCompany.com 2014 Capital Reporting Company 10 1 has occurred under section 165. Bellis v. 2 Commissioner, 540 F.2d 448, 449 (9th Cir. 1976), 3 m 61 T.C. 354 (1973). A A violation of t A 4 Federal criminal statute may also establish that a 5 6 7 8 9 10 11 theft occurred for purposes of section 165. Nichols v. Commissioner, 43 T.C. 842, 884-885 (1965). Petitioners have failed to prove that their losses related to their investment in Apex were caused by a theft under Connecticut or Federal law. Instead, petitioners' loss appears to be a capital loss, and Mr. Spring's actions appear to be negligent 12 at worst. The closest petitioners come to asserting 13 any criminal activity by Mr. Spring is their 14 allegation that Mr. Spring engaged in churning. 15 However, petitioners have failed to show that their 16 losses related to any churning activity, and they 17 18 have not cited any authority to support their contention that churning is theft under Connecticut 19 or Federal law. See Rule 142(a). Accordingly, we 20 sustain respondent's disallowance of petitioners' 21 22 23 theft loss deduction. III. Section 6662 Accuracy- Related Penalty. The Commissioner bears the burden of 24 production with respect to a taxpayer's liability for 25 penalties and must produce sufficient evidence (866) 448 - DEPO www.CapitalReportingCompany.com 2014 Capital Reporting Company 11 1 indicating that it is appropriate to impose the 2 penalty. See section 7491(c); Higbee v. 3 Commissioner, 116 T.C. 438, 446 (2001). Once the 4 Commissioner carries the burden of production, the 5 6 7 8 9 10 taxpayer must come forward with persuasive evidence that the Commissioner's determination is incorrect, or that the taxpayer had reasonable cause or substantial authority for the position. See Higbee v. Commissioner, 116 T.C. at 446-447. Section 6662(a) and (b)(1) authorizes the 11 Commissioner to impose a 20 percent penalty on any 12 underpayment of tax that is attributable to, among 13 other things, negligence or disregard of rules or 14 15 regulations. The term "negligence" includes any failure to make a reasonable attempt to comply with 16 the provisions of the Internal Revenue laws, and the 17 18 term "disregard" includes any careless, reckless, or intentional disregard. Section 6662(c); sec. 1.6662- 19 3(b)(1) and (2), Income Tax Regs. 'Negligence' also 20 includes any failure by the taxpayer to keep adequate 21 books and records or to substantiate items properly." 22 Sec. 1.6662-3(b)(1) Income Tax Regs. Disregard of 23 rules or regulations "is 'careless' if the taxpayer dct6 A 24 not exercise reasonable diligence to determine the 25 correctness of a return position" and "is 'reckless' if (866) 448 - DEPO www.CapitalReportingCompany.com 2014 Capital Reporting Company 1 the taxpayer makes little or no effort to determine 12 2 whether a rule or regulation exists, under 3 circumstances which demonstrate a substantial 4 deviation from the standard of conduct that a 5 reasonable person would observe." Sec. 1.6662- 6 3(b)(2), Income Tax Regs; see also Neely v. 7 Commissioner, 85 T.C. 934, 947 (1985). 8 The accuracy-related penalty does not apply 9 with respect to any portion of the underpayment for 10 which the taxpayer shows that there was reasonable 11 cause and that he or she acted in good faith. 12 Section 6664(c)(1). The decision as to whether a 13 14 taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into 15 account all of the pertinent facts and circumstances. 16 See sec. 1.6664-4(b)(1), Income Tax Regs. 17 18 "Circumstances that may indicate reasonable cause and good faith include an honest misunderstanding of fact 19 or law that is reasonable in light of all the facts 20 and circumstances, including the experience, 21 knowledge, and education of the taxpayer." Id. 22 Reliance on a tax professional demonstrates 23 reasonable cause when (1) a taxpayer selects a 24 competent tax advisor, (2) supplies the advisor with 25 all relevant information, and (3) relies in good (866) 448 - DEPO www.CapitalReportingCompany.com 2014 Capital Reporting Company 13 1 faith on the advisor's professional judgment. See 2 Neonatology Assocs. P.A. v. Commissioner, 115 T.C. 3 4 5 6 43, 99 (2000), aff'd, 299 F.3d 221 (3d Cir. 2002). Petitioners concede that they claimed several erroneous deductions on their 2006 return, and we have also concluded that they were not 7 entitled to claim a theft loss deduction. 8 Accordingly, respondent has satisfied his burden of Pt'DhuCt 9 dence showing that petitioners are liable 10 for an accuracy-related penalty under section 6662(a) 11 12 13 for an underpayment of tax attributable to negligence or disregard of rules or regulations. Petitioners have not produced any credible 14 evidence showing that (1) they investigated the 15 credentials of FRG or Mr. Elsass, (2) they obtained 16 any independent advice regarding the appropriateness 17 of claiming a theft loss for what appeared, with the 18 benefit of hindsight, to be a bad investment 19 recommendation, (3) they reasonably believed that FRG 20 would honestly and competently prepare their return, 21 or (4) they supplied all of the relevant information 22 to FRG. Accordingly, petitioners have not proven 23 that they reasonably relied in good faith on a 24 competent professional advisor, or that they 25 otherwise had reasonable cause for the reporting (866) 448 - DEPO www.CapitalReportingCompany.com 2014 Capital Reporting Company 14 1 mistakes on their 2006 return. We sustain 2 3 4 respondent's determination that petitioners are liable for a section 6662(a) penalty for an underpayment of tax attributable to negligence or 5 disregard of rules or regulations. 6 7 In conclusion, while we are sympathetic to the unfortunate circumstances that generated 8 petitioners' investment loss, petitioners have not 9 offered us any credible evidence that a theft gave 10 11 12 13 14 rise to the loss. We also regret that we must conclude that petitioners are liable for the section 6662 penalty but the evidentiary record leads us with |(cid:16)254AVKS no choice. Petitioners did not investigate the credentials of FRG, which was apparently preying on 15 people who had suffered investment losses, and 16 petitioners did not obtain any independent opinion 17 regarding their ability to claim a theft loss. The 18 only opinion they apparently received was that of 19 FRG, which was preparing tax returns claiming theft 20 losses for what appeared to be investment losses 21 22 created by market conditions and bad advice, at a time when FRG was earning substantial fees based on 23 the size of the refunds claimed. 24 25 We have considered the parties' rema1ning arguments and, to the extent not discussed above, (866) 448 - DEPO www.CapitalReportingCompany.com 2014 Capital Reporting Company 1 conclude that those arguments are irrelevant, moot or 15 2 without merit. To reflect the foregoing, decision will be entered for respondent. This concludes the Court's oral findings of fact and opinion. (Whereupon, at 9:35 a.m., the above entitled matter was concluded) 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 (866) 448 - DEPO www.CapitalReportingCompany.com 2014