Opinion ID: 167170
Heading Depth: 2
Heading Rank: 3

Heading: The Van Scotens' Federal Tax Claims and the Instant Litigation

Text: 27 On June 10, 1991, the Van Scotens filed a joint Federal income tax return for 1990, on which they reported the following: 28 Wage income $46,162 Interest income 29 Pension and annuity income 8,422 Loss from DSBS 87-C (148,390) IRA contribution (2,000) Adjusted gross income (95,777) Tax liability 842 Overpayment 3,771 29 R. Ex. 24-R. 30 Upon filing their 1990 return, the Van Scotens also filed a Form 1045, Application for Tentative Refund. On this form, the Van Scotens claimed a loss carry-back from 1990 in the amount of $102,228. The Van Scotens reported the following after application of the loss carry-back to the respective taxable years: 31 1987 1988 1989 AGI on return $49,726 $38,967 $40,889 Tax liability on return 5,949 3,529 3,549 Correct tax liability -0- -0- -0- Overpayment 5,949 3,529 3,549 32 R. Ex. 24-R. 33 As planned, the 1990 return and the Form 1045 were prepared by individuals affiliated with the Hoyt organization. The refund and tentative refunds requested by the Van Scotens with respect to the 1990 return and the carry-back years totaled $16,798. The Van Scotens remitted two payments to the Hoyt organization during 1991 in the amounts of $7,000 and $9,750. 34 In January 1992, before the Van Scotens signed their 1991 return, the Commissioner mailed Hoyt investors, including the Van Scotens, a letter regarding the application of 26 U.S.C. § 469 (relating to passive activity loss limitations). 4 That same month, Mr. Hoyt mailed a letter to investors, including the Van Scotens, setting forth arguments that Hoyt investors materially participated in their partnerships within the meaning of § 469. In this letter, Mr. Hoyt stated that the Commissioner's assertions in the preceding letter were incorrect, and that the investors should do what was necessary to participate in their investment at least 100 or 500 hours per year, depending upon the circumstances, in order to meet § 469 requirements. Mr. Hoyt stated that the time investors spent in recruiting new investors, as well as reading and thinking about these letters, would count toward the material participation hourly requirements. R. Ex. 480-P. Finally, in this letter Mr. Hoyt emphasized that [t]he position of your partnership is that it is not a tax shelter, because tax shelters are never recognized for Federal income tax purposes. Id. 35 By letter dated February 11, 1992, the Commissioner replied to the assertions made by Mr. Hoyt. The Commissioner explained that: Mr. Hoyt's letter contained misleading and/or inaccurate premises; Mr. Hoyt was relying on provisions that Treas. Reg. § 1.269-5T(b)(2) specifically excluded from being taken into account; [c]ontrary to Mr. Hoyt's statement, time spent reading and thinking about issues should not be considered as material participation hours for 1992; and confused partners should consult with an independent accountant or attorney. R. Ex. 17-R at 2. The Commissioner also attached to its letter excerpts from Treas. Reg. § 1.269-5T(f)(2)(ii) specifically stating that work done by individuals as investors, e.g., studying and analyzing financial statements and considering proposals from the day-to-day managers, did not count towards the material participation requirements. Id. at 3-4. 36 In addition to the above correspondence, the Van Scotens received a letter dated February 3, 1992 that informed them that the Commissioner was beginning an examination of DSBS 87-C with respect to its taxable year ending in 1990. When the Van Scotens received any correspondence from the Commissioner, they mailed or faxed copies to the Hoyt organization but neither took further action nor sought independent advice concerning the information they received. 37 The Van Scotens filed a joint Federal income tax return for taxable year 1991, the year in issue, reporting the following: 38 Wage income $51,362 Interest income 71 State tax refunds 1,433 Loss from DSBS 87-C (45,510) Farm income 22,199 IRA contribution (2,000) Self-employment tax deduction (240) Adjusted gross income 27,315 Tax liability 1,798 Overpayment 2,471 39 R. Ex. 1-J at 2, 4. 40 A statement included with the return, separately signed by the Van Scotens, represented that the Van Scotens materially participated in DSBS 87-C activities. On the blank line following [t]he numbers [sic] of hours we spent working in our business activity in 1991 was, the Van Scotens filled in all that was needed to be done. Id. at 3. The 1991 return was prepared by one of Mr. Hoyt's tax preparation services and was signed by Mr. Hoyt on April 10, 1992. The Van Scotens signed the return on April 14, 1992. 41 Mr. Van Scoten did not know how the Hoyt partnership related items were derived; he knew only that Mr. Hoyt or a member of his organization had entered the items on the returns. He assumed the items were correct. Mr. Van Scoten did not question the amounts shown on the return, and the Van Scotens did not have the returns checked by an independent tax advisor before signing them. The Van Scotens remitted two payments to the Hoyt organization during 1992 in the amounts of $3,000 and $1,250. 42 Following the 1993 cattle count, on May 1, 1995, the Commissioner issued a Notice of Final Partnership Administrative Adjustment (FPAA) to the Van Scotens with respect to DSBS 87-C that reflected the disallowance of various deductions claimed on the partnership's return for the 1991 taxable year. Because a timely petition to the Tax Court was not filed in response to the FPAA issued for DSBS 87-C, the Commissioner made a computational adjustment against all DSBS 87-C partners with respect to the FPAA. The computational adjustments changed the Van Scotens' 1991 claimed DSBS 87-C loss of $45,510 to income of $4,998 and disallowed the Hoyt partnership-related IRA contribution deduction of $2,000, resulting in additional computational adjustments to the Van Scotens' itemized deductions and self-employment tax deduction. This changed the Van Scotens' 1991 tax liability to $16,479, an increase of $14,681 above the Van Scotens' reported tax liability of $1,798. 43 The Commissioner also determined that $14,359 of the underpayment resulting from the DSBS 87-C computational adjustment was due to the Van Scotens' negligence in claiming the $45,510 DSBS 87-C loss. Consequently, pursuant to I.R.C. § 6662(a), the Commissioner assessed an accuracy-related penalty of $2,872. 44 The Van Scotens petitioned the Tax Court for a redetermination of the § 6662(a) penalty assessed by the Commissioner. After a trial, the Tax Court entered a final decision for the Commissioner, sustaining its negligence determination and rejecting the Van Scotens' argument that they should be relieved from paying a penalty because they showed reasonable cause and acted in good faith in claiming the DSBS 87-C loss. 45 On appeal, the Van Scotens argue that the Tax Court erred in upholding the Commissioner's negligence determination for the following reasons: (1) it failed to consider numerous relevant and undisputed facts favorable to them; (2) they were not negligent because they reasonably relied on the advice of Mr. Hoyt, his organization's tax professionals, and Edward; (3) they were not negligent because they reasonably relied on the Bales decision; (4) they were not negligent because they actively monitored their investment; (5) the Tax Court applied an improper negligence standard; (6) it improperly determined that the Hoyt partnerships were abusive tax shelters; and (7) Mr. Hoyt's fraud caused them to have an honest misunderstanding of fact.