Case Name: Anton Zabolotny and Bernel Zabolotny, Petitioners v. Commissioner of Internal Revenue, Respondent
Court: United States Tax Court
Jurisdiction: United States
Decision Date: 1991-09-30
Citations: 97 T.C. 385
Docket Number: Docket No. 4844-87
Parties: Anton Zabolotny and Bernel Zabolotny, Petitioners v. Commissioner of Internal Revenue, Respondent
Judges: Nims, Chabot, Parker, Shields, Hamblen, Cohen, Jacobs, Gerber, Wright, Wells, and Whalen, JJ., agree with the majority opinion.
Reporter: Reports of the Tax Court of the United States
Volume: 97
Pages: 385–425

Head Matter:
Anton Zabolotny and Bernel Zabolotny, Petitioners v. Commissioner of Internal Revenue, Respondent
Docket No. 4844-87.
Filed September 30, 1991.
Jill S. Rolek, for the petitioners.
William I. Miller and Judith M. Picken, for the respondent.

Opinion:
DRENNEN, Judge:
In notices of deficiency issued to both petitioners, respondent determined identical deficiencies in each of the petitioners' Federal excise taxes as follows:
Anton Zabolotny
Year
1981
1982
1983
1984
1985
1986
First-tier (initial) deficiency $324,095.75 324,095.75 324,095.75 324,095.75 324,095.75 324,095.75
Additions to tax sec. 6651 $81,023.94 81,023.94 81,023.94 81,023.94 64,819.15
For taxable year ended November 26, 1986, respondent determined a second-tier deficiency of $6,481,915.
Bemel Zabolotny
First-tier (initial) deficiency
Additions to tax
Year
1981
1982
1983
1984
1985
1986
$324,095.75
324,095.75
324,095.75
324,095.75
324,095.75
324,095.75
sec. 6651
$81,023.94
81,023.94
81,023.94
81,023.94
64,819.15
For taxable year ended November 26, 1986, respondent determined a second-tier deficiency of $6,481,915.
The issues presented for our consideration all involve whether a sale of real estate by petitioners to an employee stock ownership plan was a prohibited transaction giving rise to an excise tax under the Employee Retirement Income Security Act of 1974 (ERISA), Pub. L. 93-406, 88 Stat. 829. More specifically, the issues are: (1) Whether petitioners are disqualified persons under section 4975(e)(2); (2) whether the sale of certain real property by petitioners to an employee stock ownership plan is a prohibited transaction described in section 4975(c); (3) whether the sale of certain real property by petitioners to an employee stock ownership plan is exempt from excise tax under section 4975(d)(13); (4) whether the sale of real property by petitioners was simultaneously corrected pursuant to section 4975(f)(5); and (5) whether an addition to tax under section 6651(a)(1) for failure to file excise tax returns is applicable.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulation of facts and the accompanying exhibits are incorporated herein by this reference.
Petitioners Anton and Bernel Zabolotny are husband and wife. They filed timely joint income tax returns for each of the years 1981 through 1986. At the time the petition in this case was filed, petitioners' legal residence was Killdeer, North Dakota. Before May 20, 1981, petitioners had been engaged in farming operations on 1,205 acres of land which they owned in Billings County and McKenzie County in western North Dakota. During the 1970s petitioners and other neighboring farmers discovered oil on their farm properties. In 1977, petitioners entered into various lease arrangements with Gulf Oil Corp. with respect to the mineral rights to their property. The oil production royalty rights on the property produced revenue in excess of $1 million to $1.5 million annually.
On May 20, 1981, Anton and Bernel Zabolotny and their son, Larry Zabolotny, incorporated petitioners' farming operation under the name Zabolotny Farms, Inc. (Farms, Inc.), in the State of North Dakota. On the date of incorporation, Farms, Inc., issued 670 shares of its stock to both Anton and Bernel Zabolotny, which were the only shares issued as of that date. Starting on April 30, 1982, Anton and Bernel Zabolotny began to gradually transfer their stock in Farms, Inc., such that their overall percentage ownership of the corporation declined progressively to a combined total ownership of 6.97 percent of the stock of the corporation in 1985. The initial directors of Farms, Inc., were Anton Zabolotny, Bernel Zabolotny, and Larry Zabolotny. The officers of the corporation during all the years at issue were Anton Zabolotny, president; Larry Zabolotny, vice president; and Bernel Zabolotny, secretary-treasurer.
On May 20, 1981, Farms, Inc., adopted the Zabolotny Farms, Inc., employee stock ownership plan (ESOP). Petitioners were the initial plan participants. Anton Zabolotny was named as trustee of the ESOP on May 20, 1981, and remained such during all years at issue. A determination letter for the ESOP was requested of the District Director of Internal Revenue on July 21, 1981. On February 1, 1982, a favorable letter was issued which determined that the ESOP was a qualified trust under section 401(a).
In their decision to adopt the ESOP, petitioners relied on the research and tax advice given to them by two practicing Icertified public accountants, John Henss and David lEckroth. Mr. Henss has a law degree and has been a (member of a public accounting firm located in Des Moines, Iowa, since 1972. Mr. Henss was responsible for analyzing the feasibility of petitioners' ESOP prior to its creation, drafting the documents creating the ESOP, compiling the annual financial statements of income for the trust, and administering the ESOP. Mr. Eckroth, with the public accounting firm Pucklich & Eckroth, performed much of the other accounting work for petitioners as individuals, for Farms, Inc., and for the ESOP.
On May 20, 1981, the ESOP purchased from petitioners three tracts of farm land located in McKenzie County and Billings County, North Dakota, together with the mineral rights in the land, in exchange for a joint and survivor private annuity plan established by the ESOP for the benefit of petitioners. This was the same property on which petitioners had been conducting their cattle and wheat farming operations. These three tracts were transferred by petitioners for $6,481,915, which was the approximate present value of future payments to petitioners under the joint and survivor private annuity plan established by the ESOP to be paid to petitioners. It has been stipulated that this purchase price represented adequate consideration and we so find. Annual payments under the joint and survivor arrangement between petitioners and the ESOP were in the amount of $478,615 per year payable on January 1 of each year for the lives of petitioners. Petitioners did not attempt to secure a special exemption from the Secretary of Labor for the sale of the property to the ESOP.
After the purchase of the three tracts from petitioners, on December 31, 1982, the ESOP purchased an additional 568.5 acres of real property located in Dunn County, North Dakota, from Albert Keller and Linda Keller, bringing the plan's total real estate holdings in western North Dakota to 1,773.5 acres. All of that property was located in an area which is sparsely populated. Petitioners introduced evidence to indicate that at the time the plan went into effect, a federally funded gasification plant was to be constructed close to the property which is the subject of this litigation. That plant was supposed to produce substantial Federal funding, but the funding apparently never materialized nor was that plant ever constructed. There was little or no industrial or residential development in western North Dakota at the time the ESOP purchased the property from petitioners.
On May 20, 1983, Anton Zabolotny, as trustee for the ESOP, entered into a 5-year lease of the surface of the 1.773.5 acres of farm ranch land to Farms, Inc. The ESOP retained the mineral rights. Farms, Inc., was actively engaged in farming the surface rights to the real property. The farming operation was diversified in that both cattle and grain operations were sustained.
The ESOP realized cumulative net income from all sources totaling $4,634,189 during the years ended April 30, 1982, 1983, 1984, and 1985.
The two certified public accountants involved in this case, Mr. Henss and Mr. Eckroth, led petitioners to believe that no taxable event was created by the above transactions for which any Federal excise tax returns would be required to be filed.
On November 21, 1986, respondent issued a notice of deficiency to each petitioner, in the amounts set forth above, determining an excise tax pursuant to section 4975(a). According to the explanation of adjustments attached to the notices of deficiency, the excise tax is on the sale of real property owned by petitioners to the Zabolotny Farms, Inc., employee stock ownership plan which took place on May 20, 1981. Respondent deems that sale to be a prohibited transaction for purposes of the section 4975(a) excise tax which is not excused by any applicable exception.
OPINION
Section 4975, as added to the Internal Revenue Code by Title II of the Employee Retirement Income Security Act of 1974. imposes an excise tax on prohibited transactions. It provides that the tax shall be paid by any disqualified person who participates in a prohibited transaction. The tax is imposed at two levels. Section 4975(a) provides for a mandatory initial tax equal to 5 percent of the amount involved with respect to the prohibited transaction. Section 4975(b) imposes an additional tax equal to 100 percent of the amount involved, if the prohibited transaction is not timely corrected. Section 4975(c)(1)(A) provides that, for purposes of the section 4975(a) excise tax, "prohibited transaction" means "any direct or indirect sale or exchange, or leasing, of any property between a plan and a disqualified person."
Section 4975(e)(1) defines "plan" as a trust described in section 401(a). Since the parties here stipulated that the ESOP is such a trust, the first issue for our consideration is whether petitioners were "disqualified persons." Section 4975(e)(2) defines "disqualified person" in terms of certain relationships a person has with a plan. Those relationships include fiduciary, sec. 4975(e)(2)(A); an owner of 50 percent or more of a corporation any of whose employees are covered by the plan, sec. 4975(e)(2)(E); a member of the family of any individual described within certain paragraphs in section 4975(e)(2), sec. 4975(e)(2)(F); and any officer or director of a corporation which, among other things, has employees covered by the plan, sec. 4975(e)(2)(H).
Petitioner Anton Zabolotny was a disqualified person as described in section 4975(e)(2)(A), (E), and (H). As a trustee for the plan he had discretionary authority to manage the plan and was thus a fiduciary as described in section 4975(e)(3), thus bringing him within section 4975(e)(2)(A). He was also a 50-percent shareholder of Farms, Inc., which was the corporation whose employees initially participated in the plan, thus bringing him within section 4975(e)(2)(E). Finally, as an officer of Farms, Inc., he falls within section 4975(e)(2)(H). Bernel, like Anton, as an officer and initial 50-percent shareholder of Farms, Inc., falls within section 4975(e)(2)(E) and (H). She is also, as Anton's wife, a family member as described in section 4975(e)(2)(F).
Since petitioners are disqualified persons, the sale of their property to the ESOP was a prohibited transaction under section 4975(c) unless the transaction satisfied an exemption as specified in section 4975(d). Petitioners argue that the transactions qualify for such an exemption under section 4975(d)(13). That section provides that the prohibited transaction restrictions of section 4975(c) shall not apply to any transaction which is exempt from section 406 of ERISA by reason of the exemptions within section 408(e) of ERISA. Section 408(e) of ERISA provides that the prohibitions of section 406 of ERISA shall not apply to the acquisition, sale, or lease by a plan of qualifying employer real property as defined in section 407(d)(4) of ERISA. Section 408(e) of ERISA also provides that, to be exempt, such acquisition, sale, or lease, must be for adequate consideration, no commission must be charged for arranging such transaction, and the plan involved must be an eligible individual account plan as defined in section 407(d)(3) of ERISA. There is no dispute that the latter requirements have been satisfied, but it remains to be decided whether the subject property constituted qualifying employer real property under section 407(d)(4) of ERISA.
Section 407(d)(4) of ERISA defines "qualifying employer real property" as parcels of "employer real property" if a substantial number of parcels are dispersed geographically. In addition, each parcel of real property and the improvements on it must be suitable, or adaptable without undue expense, for more them one use. ERISA sec. 407(d)(4)(A) and (B). To qualify under section 407(d)(4) of ERISA, the subject property must first qualify as "employer real property." According to section 407(d)(2) employer real property means "real property which is leased to an employer of employees covered under the plan." ERISA sec. 407(d)(2). Farms, Inc., is such an employer, but the ESOP leased only the surface rights of the property it acquired from petitioners back to Farms, Inc. The mineral rights remained under lease to Gulf Oil. The lease from the ESOP to Farms, Inc., was called a farm lease. It was limited to "agricultural purposes" and was subject to any underlying mineral rights together with appropriate easements for access to such minerals. Nevertheless petitioners argue that this lease qualifies the land under section 407(d)(4) of ERISA.
Respondent argues that only the portion of the subject property attributable to the surface rights can be considered employer real property under the statutory definition. In other words, only that fraction of the property's market value attributable to the surface rights is employer real property which might qualify under section 407(d)(4) of ERISA and thus for exemption. Petitioners concede that mineral rights are separate from surface rights but argue that the lease to Gulf Oil brings the mineral rights within the "employer real property" definition as real property leased to an employer of employees covered by the plan and thus exempt from ERISA section 407(d)(2). Petitioners support this argument by reading section 407(d)(4)(C) of ERISA into section 407(d)(2) of ERISA. The former paragraph, which is part of the definition of qualifying employer real property, states that employer red. property will qualify "even if such property is leased to one lessee." ERISA sec. 407(d)(4)(C). To petitioners, that language indicates that real property does not have to be leased solely to an employer of employees covered by the plan to satisfy the definitional requirements of employer real property.
The plain language of the statute does not support petitioners' interpretation of section 407(d)(2) of ERISA. Section 407(d)(2) of ERISA provides that employer real property is property leased to an employer of employees covered by the plan. ERISA sec. 407(d)(2). Here, only the surface rights were leaséd to Farms, Inc., and therefore only the surface rights can possibly be ERISA section 407(d)(2) employer real property. Therefore, the mineral rights do not qualify as employer real property as defined in ERISA section 407(d)(2) because they were not leased to Farms, Inc., the employer. However, since the surface rights leased back to Farms, Inc., by the ESOP could be employer reeil property, we must look further to determine if that portion of the property (the surface rights) is qualifying employer real property, making it eligible for the ERISA section 408(e) exemption from the ERISA prohibited transaction provisions and thus eligible for the section 4975(d)(13) exemption. Employer real property will be considered qualifying employer real property if a substantial number of parcels are dispersed geographically, ERISA sec. 407(d)(4)(A), and if each parcel of the real property and improvements thereon are suitable for more than one use, ERISA sec. 407(d)(4)(B). Petitioners argue that geographic dispersion is in fact met because the property purchased from petitioners by the ESOP was dispersed vertically in that it includes both surface and subsurface rights. Petitioners insist that the term "geographically" differs from the term "topographic" because "geographically" refers to a cross-section of the earth whereas "topographic" refers merely to surface configurations. Petitioners argue that respondent seeks to narrow the definition of the term "geographic" to include only the surface rights of the property purchased by the ESOP.
Petitioners cite Lambos v. Commissioner, 88 T.C. 1440 (1987), together with Webster's Dictionary, for the proposition that the term "dispersed geographically" looks to a physical cross-section of any piece of real property. In Lambos, taxpayers engaged in a prohibited transaction with a plan and were trying to escape the application of the section 4975(a) excise tax through the section 4975(d)(13) exemption. There, we did not deem three fast food restaurants located in the same county to be dispersed geographically for purposes of section 407(d)(4)(A) of ERISA. We stated:
The Conference report is clear that the geographic dispersion standard (sec. 407(d)(4)(A), ERISA) codified as part of the qualifying employer real property definition are intended to safeguard plan investments against adverse economic conditions peculiar to one area. Geographic dispersement, in the context of congressional intent patently obvious in the ERISA provisions and committee reports, connotes a wide spread range or distribution in varied directions and locations. [88 T.C. at 1449.]
The Lambos opinion went on to analyze the economic similarity of the three parcels as insufficient to satisfy geographic dispersement. We can find nothing in Lambos to support petitioners' argument that geographic dispersion includes or implies an analysis of various subsurface rights attendant to any specific piece of real property.
The phrase "dispersed geographically" is used in ERISA section 407(d)(4) without definition. There are no regulations on this point. However, the legislative history from ERISA states:
the plan might acquire and lease to the employer multipurpose buildings which are located in different geographical areas. It is intended that the geographic dispersion be sufficient so that adverse economic conditions peculiar to one area would not significantly affect the economic status of the plan as a whole. All of the qualifying real property may be leased to one lessee, which may be the employer or an affiliate of the employer. [H. Rept. 93-1280 (Conf.), at 318 (1974), 1974-3 C.B. 415, 479.]
In expressing concern about "adverse economic conditions" specific to a given area, this excerpt from the legislative history indicates that Congress intended that term to require a number of parcels located in "different geographical areas." Thus, the word "geographically" was more likely than not used in ERISA to mean simply "on a regional basis," as argued by respondent. To read a more technical explanation into the definition of that term seems to go outside the scope of congressional intent. Furthermore, if petitioners' argument were accepted it could conceivably mean that all real property by virtue of separate vertical property interests is geographically dispersed. This would leave the entire statutory provision virtually meaningless.
Lambos, as well as the portion of the legislative history excerpted above, highlights the fact that the primary rationale for the geographic dispersement requirement is to protect the plan from adverse economic conditions peculiar to one area. Here, the properties are located in identical geographic environments. We see nothing in the record to differentiate between the pieces of property sold to the ESOP. All the properties are located in the sparsely populated Badlands of western North Dakota and the record shows that the overall farming operations conducted there were not profitable. Moreover, oil production was responsible for all of the income associated with the subject properties.
Petitioners also look towards the multiple uses of the property as giving rise to geographic dispersion. In this connection, petitioners discuss the use of surface rights for the farming operations and the use of subsurface rights for oil extraction as geographically dispersed endeavors. Petitioners argue that the functional aspects attendant to the subject property exposed it to separate economic pressures, thus satisfying the need for required economic protection outlined in the legislative history. We agree with respondent that this argument confuses geographic dispersion with multiple use, which is a separate requirement for real property to be deemed qualified employer real property. The requirements are stated in the disjunctive. Rutland v. Commissioner, 89 T.C. 1137, 1148 (1987). We recognize that section 407(d)(4)(B) of ERISA requires that employer real property be subject to more than one use in order to be characterized as qualified employer real property. However, given our finding that petitioners have not satisfied the geographic dispersion requirement, the subject property cannot be qualified employer real property. Therefore, an examination of section 407(d)(4)(B) of ERISA is unnecessary.
Petitioners also urge us not to characterize this transaction as a prohibited transaction because it was in accord with the "prudent man rule" of section 404(a)(1) of ERISA. We recently rejected such an argument in Rutland v. Commissioner, supra. In that case an ESOP purchased real property from the plan participants. Taxpayers argued that they should not be subjected to the excise tax under section 4975(a) for equitable reasons. We flatly rejected that claim and the claim that the plan was improved by the purchase:
In our view, such claims are not relevant in deciding whether the petitioners are hable for the excise taxes in issue. The language and legislative history of ERISA indicate a congressional intention to create, in section 4975(c)(1), a blanket prohibition against certain transactions, regardless of whether the transaction was entered into prudently or in good faith or whether the plan benefited as a result. [Rutland v. Commissioner, 89 T.C. at 1146.]
In light of Rutland, it seems clear that the legislative framework must be complied with in order to fall within the narrow range of exceptions within the prohibited transactions arena.
Rutland drew from Leib v. Commissioner, 88 T.C. 1474 (1987), which contained an extensive review of the legislative and judicial concerns surrounding the per se restrictions in the prohibited transaction provisions. As set forth in Leib, the underlying rationale for those restrictions was a congressional assumption that certain transactions between certain parties are inherently suspicious and should be disallowed ab initio:
The language and statutory framework of section 4975 indicate an intent to create, in section 4975(c)(1), a blanket prohibition against certain transactions, regardless of how prudent the transaction or whether the plan benefited therefrom, unless the transaction came within a statutory exemption or an administrative exemption had been granted. [Leib v. Commissioner, 88 T.C. at 1479.]
In light of Rutland, Leib, and the plain language of the statutes, we find it difficult to condone a transaction which clearly falls outside the narrowly carved statutory exceptions to the prohibited transaction provisions. With respect to the mineral rights, we determine that the subject transaction does not concern employer real property because those rights were not leased to Farms, Inc. Sec. 407(d)(2), ERISA. With respect to the farm lease, we determine that the property involved is not qualifying employer real property because such properties are not dispersed geographically. Sec. 407(d)(4)(A), ERISA. Consequently, the subject sale of properties to the ESOP is not exempt by section 4975(d)(Í3) because those sales do not concern qualifying employer real property as defined in section 407(d)(4) of ERISA as required by section 408(e) of ERISA.
We note, as does respondent, that petitioners could have avoided this litigation through a successful application for a special exemption pursuant to section 4975(c)(2). That section provides for a special exemption procedure by which the Secretary of the Treasury, after consultation and coordination with the Secretary of Labor, may grant a conditional or unconditional exemption from the section 4975(a) excise tax on a disqualified person. Sec. 4975(c)(2). Apparently, petitioners did not avail themselves of this exemption procedure, and cannot now seek its protection.
Finally, petitioners argue that the subject transaction, even if prohibited, was simultaneously corrected and therefore falls outside the reach of the section 4975(a) excise tax. The excise tax on prohibited transactions is imposed for each year (or part thereof) in the taxable period. Sec. 4975(a). The taxable period is the period beginning with the date on which the prohibited transaction occurs and ending on the earliest of three dates, including the date on which correction of the prohibited transaction is completed. Sec. 4975(f)(2). Section 4975(f)(5) defines "correction" as "undoing the transaction to the extent possible, but in any case placing the plan in a financial position not worse than that in which it would be if the disqualified person were acting under the highest fiduciary standards." Sec. 4975(f)(5).
For further guidance on the term "correction" we turn to section 53.4941(e)-l, Foundation Excise Tax Regs., which is controlling to the extent such regulation describes terms appearing in both sections 4941(e) and 4975(f). Section 53.4941(e)-l(c)(l), Foundation Excise Tax Regs., provides that "Correction shall be accomplished by undoing the transaction which constituted the act of self-dealing to the extent possible, but in no case shall the resulting financial position of the private foundation be worse than that which it would be if the disqualified person were dealing under the highest fiduciary standards." Sec. 53.4941(e)-l(c)(l), Foundation Excise Tax Regs.
Petitioners argue that correction occurred simultaneously on the purchase date. They support this argument with a citation of the second portion of section 4975(f)(5), which requires that the plan be placed "in a financial position not worse than that in which it would be if the disqualified person were acting under the highest fiduciary standards." Sec. 4975(f)(5). They argue that, since the plan made a substantial profit on the transaction, those fiduciary standards were satisfied and the transaction was immediately corrected, thus ending the taxable period on the date of the prohibited transaction.
We cannot agree with petitioners' reading of section 4975(f)(5). The language of the statute and the applicable regulations clearly look to some affirmative act to effect a correction, rather than to the financial success of the prohibited transaction. In other words, a transaction will not be deemed corrected simply because it turns out to be a good deal. The statute and the regulations look first to rescission of the transaction where possible. Here we are presented with no evidence which would show that rescission is in any way not feasible, such as a previous sale of the property by the plan to a third party. Hence, petitioners have yet to correct the subject transaction. To hold otherwise would effectively subvert the strict statutory guidelines presented by the prohibited transaction provisions. As we have noted previously, see Rutland v. Commissioner, supra; Leib v. Commissioner, supra, section 4975(a) levies an excise tax on certain transactions regardless of how prudent the transaction or whether the plan benefited therefrom.
The subject transactions have yet to be corrected within the meaning of section 4975(f)(5). We do not have before us the issue of what it will be necessary for petitioners to do to correct the transaction. The issue before us is whether the sale of the property by petitioners to the ESOP was a prohibited transaction within the meaning of section 4975 as determined by respondent. We hold that it was. Consequently, the first-tier excise tax under section 4975(a) was properly determined, except for an error in computation which counsel for respondent conceded on opening statement. The second-tier tax under section 4975(b) was also properly determined, unless the transaction is "corrected" within the provisions of the law. See Adams v. Commissioner, 70 T.C. 373, supplemented 70 T.C. 446 (1978), supplemented 72 T.C. 81 (1979), affd. without published opinion 688 F.2d 815 (2d Cir. 1982).
Petitioners in their petition claimed error in respondent's determination of additions to tax under section 6651(a)(1) for failure to file excise tax returns. Section 6651(a)(1) imposes an addition to tax for the failure to file a required return "unless it is shown that such failure is due to reasonable cause and not due to willful neglect." To avoid the addition to tax, the taxpayer must establish both (1) that the failure to file was due to "reasonable cause," and (2) that the failure did not result from "willful neglect." Sec. 6651(a); United States v. Boyle, 469 U.S. 241, 245 (1985).
In general, a taxpayer's duty to file a return when due is a personal, nondelegable duty. Thus, reliance upon an accountant to file is ordinarily no excuse for filing a return beyond the due date. See Logan Lumber Co. v. Commissioner, 365 F.2d 846, 854 (5th Cir. 1966), affg. on this issue a Memorandum Opinion of this Court. However, the Supreme Court has distinguished the case in which a taxpayer reasonably relies on the substantive tax advice of an accountant or attorney that no return need be filed.
When an accountant or attorney advises a taxpayer on a matter of tax law, such as whether a liability exists, 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. [United States v. Boyle, 469 U.S. at 251.]
Similarly, this Court has held that reasonable cause within the meaning of section 6651(a)(1) can be shown by proof that the taxpayer supplied all relevant information to a competent tax adviser and relied in good faith on the incorrect advice of the adviser that no return was required to be filed. Marprowear Profit-Sharing Trust v. Commissioner, 74 T.C. 1086, 1096-1097 (1980); Coldwater Seafood Corp. v. Commissioner, 69 T.C. 966, 974 (1978); West Coast Ice Co. v. Commissioner, 49 T.C. 345, 351 (1968); Amo Realty Co. v. Commissioner, 24 T.C. 812, 817 (1955).
This case can be distinguished from United States v. Boyle, supra, because in that case petitioner was aware that an estate tax return had to be filed but he relied on his tax adviser to file it on time. In this case, petitioners relied on the advice of their tax adviser that no taxable transaction had occurred which would require that a tax return be filed.
We find that petitioners have demonstrated reasonable cause sufficient to excuse their failure to file excise tax returns for the years in issue. Although neither party directly argued this issue in their briefs, petitioners presented the testimony of one of their accountants, John Henss, who has a law degree and expertise in the area of employee stock ownership plans. Mr. Henss testified that petitioners relied upon his advice that their sale of property to the employee stock ownership plan was not a prohibited transaction that would give rise to tax under section 4975. Respondent did not contradict Mr. Henss' testimony on this point. Rather, the testimony of respondent's only witness, an I.R.S. agent, indicates that both of the accountants involved in petitioners' case, Mr. Eckroth and Mr. Henss, believed that petitioners' sale of property to the ESOP would not be a prohibited transaction under section 4975, that they advised petitioners with regard to their legal conclusion, and that petitioners relied on their advice by selling the property to the ESOP. Petitioners, who for years made their living as farmers, were not versed in tax matters, especially the law involving employee stock ownership plans and prohibited transactions, which is very complex. Lambos v. Commissioner, 88 T.C. 1440, 1445 (1987). In light of the complexity of this area of tax law, petitioners' accountants' advice that there was no taxable event under section 4975 was not so clearly wrong as to permit an inference that petitioners, in relying on Mr. Henss' and Mr. Eckroth's advice, were negligent or that they deliberately disregarded the law. Marprowear Profit-Sharing Trust v. Commissioner, 74 T.C. 1086, 1096-1097 (1980); Coldwater Seafood Corp. v. Commissioner, 69 T.C. 966, 971, 974 (1978). Accordingly, we hold that petitioners' failure to file excise tax returns was due to reasonable cause and not to willful neglect within the meaning of section 6651(a)(1).
To reflect the foregoing,
Decision will be entered under Rule 155.
Reviewed by the Court.
Nims, Chabot, Parker, Shields, Hamblen, Cohen, Jacobs, Gerber, Wright, Wells, and Whalen, JJ., agree with the majority opinion.
HALPERN, J., dissents.
Unless otherwise indicated, all section references are to the Internal Revenue Code as amended and in effect for the years in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.
This is the figure that appeared on the front page of both notices of deficiency. The computations attached to the notices both used the figure $81,023.94 for the additions to tax for 1985, as did respondent in his brief. No explanation was given for this discrepancy.
All references to ERISA refer to the Employee Retirement Income Security Act of 1974, Pub. L. 93-406, 88 Stat. 829, 29 U.S.C. sec. 1001 (1988).
Although the parties have stipulated May 20, 1981, as the incorporation date, we note that the certificate of incorporation of Zabolotny Farms, Inc., indicates an incorporation date of Nov. 3, 1981.
Title I of the Employee Retirement Income Security Act of 1974, Pub. L. 93-406, 88 Stat. 832, sets forth the guidelines of standards governing the establishment and operation of pension plans and also establishes general standards of conduct for plan fiduciaries. Title II of ERISA, 88 Stat. 898, specifically amends the Internal Revenue Code of 1954.
(2) Disqualified person. — For purposes of this section, the term "disqualified person" means a person who is—
(A) a fiduciary;
(B) a person providing services to the plan;
(C) an employer any of whose employees are covered by the plan;
(D) an employee organization any of whose members are covered by the plan;
(E) an owner, direct or indirect, of 50 percent or more of—
(i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of a corporation,
(ii) the capital interest or the profits interest of a partnership, or
(iii) the beneficial interest of a trust or unincorporated enterprise,
which is an employer or an employee organization described in subparagraph (C) or (D);
(F) a member of the family (as defined in paragraph (6)) of any individual described in subparagraph (A), (B), (C), or (E);
(G) a corporation, partnership, or trust or estate of which (or in which) 50 percent or more of—
(i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of such corporation,
(ii) the capital interest or profits interest of such partnership, or
(iii) the beneficial interest of such trust or estate, is owned directly or indirectly, or held by persons described in subparagraph (A), (B), (C), (D), or (E);
(H) an officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10 percent or more shareholder, or a highly compensated employee (earning 10 percent or more of the yearly wages of an employer) of a person described in subparagraph (C), (D), (E), or (G); or
(I) a 10 percent or more (in capital- or profits) partner or joint venturer of a person described in subparagraph (C), (D), (E), or (G).
(3) Fiduciary. — For purposes of this section, the term "fiduciary" means any person who— (A) exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets.
While some of the sections of ERISA were carried over to the Internal Revenue Code, all sections were not. I.R.C. section numbers will be used where appropriate.
Sec. 406 of ERISA, like sec. 4975(c) of the Internal Revenue Code, defines certain prohibited transactions for purposes of ERISA.
See Adams v. Commissioner, 70 T.C. 373, supplemented 70 T.C. 446 (1978), supplemented 72 T.C. 81 (1979), affd. without published opinion 688 F.2d 815 (2d Cir. 1982).
This appears to be a harsh result in this case because the amounts are so large. However, the legislative history and the language used by Congress suggests that violation of the prohibitions in the law were intended to be treated harshly. To lessen the burden somewhat "corrections" were provided; but petitioners do not appear to have made any effort to correct the transactions here. This Court has decided three cases involving ERISA, Rutland v. Commissioner, 89 T.C. 1137 (1987), Leib v. Commissioner, 88 T.C. 1474 (1987), and Lambos v. Commissioner, 88 T.C. 1440 (1987), none of which can be readily distinguished from this case, in principle at least, and all of which require the conclusion we reach here unless distinguished or overruled. We think the opinions in each of those cases properly applied the law as written by Congress and we find no reason for departing from them now.
We also note that respondent, in his first brief, appears to acknowledge petitioners' reliance on their accountants' advice. On pages 45 and 46 respondent states that:
There was testimony to show that petitioners in this case relied on the advice of David Eckroth, their accountant, and John Henss, a second accountant who was recommended to them by Mr. Eckroth. Even if petitioners were misled into thinking the transactions were permissible, this is no defense. There is no knowledge requirement included in the excise tax provisions.