Court Opinion

ID: 4336867
Source: CourtListenerOpinion
Date Created: 2018-11-14 03:03:09.395097+00
Date Added: 2024-06-11T14:47:15.162071
License: Public Domain

T.C. Memo. 2007-361

                      UNITED STATES TAX COURT

          WILLIAM R. AND BETTY O. BASS, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

     Docket No. 19207-06.             Filed December 5, 2007.

     William R. and Betty O. Bass, pro se.

     James H. Brunson III, for respondent.

             MEMORANDUM FINDINGS OF FACT AND OPINION

     COHEN, Judge:   In an “affected items” notice of deficiency

sent June 19, 2006, respondent determined that petitioners are

liable for additions to tax for 1982 as follows:
                                  - 2 -

                                 Additions to Tax
     Year      Sec. 6653(a)(1)      Sec. 6653(a)(2)      Sec. 6661

     1982           $351                  *               $1,755

     *    50 percent of the interest on $7,020.

The notice also included a statement that interest would accrue

and be assessed at 120 percent of the underpayment rate in

accordance with section 6621(c).     The additions to tax resulted

from a final partnership proceeding involving a jojoba plant

venture known as Cal-Neva Partners (Cal-Neva).        Unless otherwise

indicated, all section references are to the Internal Revenue

Code in effect for the year in issue, and all Rule references are

to the Tax Court Rules of Practice and Procedure.

                           FINDINGS OF FACT

     Petitioners resided in Georgia at the time that they filed

their petition.    In 1982, William R. Bass (petitioner) was

employed by Lockheed Corp. as an accountant, and Betty O. Bass

was employed by the Institute of Basic Youth Conflict as a

typist.

     On or about December 23, 1982, petitioners paid $5,000 for a

limited partnership interest in Cal-Neva.     The $5,000 was paid in

reliance on representations by two persons associated with Cal-

Neva whom petitioner met during a business trip to Nevada.

Petitioner did not consult any independent persons regarding the

viability of the jojoba plant venture or the claimed tax
                                - 3 -

consequences related to the venture, and he relied solely on

promoters who had no known experience in jojoba plant farming.

     Petitioner prepared a joint 1982 Form 1040, U.S. Individual

Income Tax Return.    As a result of losses claimed, petitioners

requested a refund of $3,742.07, which had been paid by

withholding and estimated tax payments.    On Schedule C, Profit or

(Loss) From Business or Profession, petitioner reported his

business as Bass Enterprises, with gross receipts of $444.30 and

a net loss of $25,827.79.    Among the items shown as constituting

the loss was a “Write-off of Farming Venture $13,150".

Petitioner did not have a Schedule K-1, Partner’s Share of

Income, Credits, Deductions, etc., from Cal-Neva when he filed

the 1982 return.   The amount that petitioner deducted on

Schedule C was his estimate of the amount to be claimed based on

his conversations with the promoters of Cal-Neva at the time that

he paid the $5,000.

     On February 11, 1987, a Notice of Final Partnership

Administrative Adjustment was sent to petitioners as a partner in

Cal-Neva.   In the notice, research and development expenses of

$193,150 and amortization of organizational costs of $42 were

disallowed to Cal-Neva.    A petition on behalf of Cal-Neva was

filed by Yolanda J. Benham (Benham), tax matters partner, as

docket No. 6594-87.    On October 18, 1993, the parties in docket

No. 6594-87 filed a Stipulation to be Bound setting forth their
                                - 4 -

agreement that the outcome of the Cal-Neva case was to be

determined in accordance with the outcome of Utah Jojoba I

Research v. Commissioner, docket No. 7619-90.    On January 5,

1998, the Court’s opinion in Utah Jojoba I Research v.

Commissioner, T.C. Memo. 1998-6 (Utah Jojoba I Research), was

filed, and, pursuant to that opinion, a decision sustaining

respondent’s adjustments was entered on January 8, 1998, in that

case.

     At the time the decision in Utah Jojoba I Research became

final, the tax matters partner in the Cal-Neva case, Benham,

could not be located.   Ultimately, respondent filed a Motion for

Entry of Decision in accordance with the Stipulation to be Bound.

By order dated February 1, 2005, the partners of Cal-Neva were

directed to show cause why respondent’s Motion for Entry of

Decision should not be granted.   No response to the Court’s order

was received.    Decision in the Cal-Neva case, docket No. 6594-87,

was entered April 11, 2005.   A copy of the decision was served on

petitioner.   The decision in docket No. 6594-87 became final

July 11, 2005.   The notice in the instant case was sent June 19,

2006, within 1 year of finality of the partnership proceeding.

The additions to tax in issue here were based on $7,020, which

the Internal Revenue Service (IRS) determined to be the

deficiency in income tax attributable to the Cal-Neva deductions

claimed by petitioners on Schedule C of their 1982 return.
                                - 5 -

Because miscellaneous deductions were not identified on

Schedule C as attributable to Cal-Neva or to some other activity

on the part of petitioners, the IRS estimated disallowed amounts

as 50 percent of the miscellaneous expenses shown on Schedule C.

Thus, the adjustment on which the additions to tax were

calculated totaled $14,783.69, including the $13,150 attributable

to Cal-Neva.

                               OPINION

     Petitioners contend that they were not negligent and that

the additions to tax are inappropriate in this case.    They also

assert that the tax on which the additions to tax are computed

was overstated because of the manner in which the disallowed

expenses attributable to Cal-Neva were determined, because items

above and beyond $13,150 were not related to Cal-Neva but to

other activities in which petitioner engaged.    We accept

petitioner’s testimony in this regard.    Our findings, however,

are otherwise sparse.    Petitioner provided no details concerning

the partnership.    His testimony at trial as to the extent of his

investigation of Cal-Neva consisted of the following:

          I don’t recall exactly how the investment
     possibility came into being. I don’t know whether it
     was a phone call, letter, or what, but anyway, we were
     contacted regarding the investment.

            Since I grew up on a farm, I thought that it had
     some   potential. I combined a trip to Nevada to meet
     with   them with a trip by my employer, and I did meet
     with   them. They seemed to be honest people. He had
     been   in the airline industry, and she had worked as an
                               - 6 -

     attorney. I don’t know whether exactly she was a
     practicing attorney or what.

          But they seemed to be people that understood
     enough about the investment, and that it was viable,
     and so I know at some point, having some knowledge of
     taxes on some of the past investments, I thought it
     would be a viable investment.

          So I did enter into the investment, and paid the
     $5,000 initial investment amount, and the rest was
     financed, and interest payments were made for several
     years, five or six years, and ultimately the
     partnership went under.

          Of course, if I had known that at the beginning, I
     definitely would not have been involved in it,
     especially since it looks like it was creating a
     problem from the standpoint of taxability. But at the
     time, it seemed to me that it was not an unusual
     investment to make.

          And so after doing the limited amount of checking
     that I was able to do without spending days and days, I
     guess, in the area where they resided. I think it was
     during that time that they subsequently moved to
     Hawaii.

          So my investigating from a due diligence to me was
     sufficient to let me know that it was a viable
     investment and it would stand up from a tax standpoint,
     and so that’s basically my statement and my testimony
     in that regard.

     In other reported cases, notably the opinion in Utah

Jojoba I Research, the programs concerning Jojoba plants are

described in detail.   As summarized in Lopez v. Commissioner,

T.C. Memo. 2001-278, affd. 92 Fed. Appx. 571 (9th Cir. 2004):

     In the decided case, this Court held that the
     partnerships did not directly or indirectly engage in
     research or experimentation and that the partnerships
     lacked a realistic prospect of entering into a trade or
     business. In upholding respondent’s disallowance of
     research and experimental expenditures, the Court found
                                 - 7 -

     that the agreements between the partnerships and the
     proposed research and development contractor, U.S. Agri
     Research & Development Corp. (U.S. Agri), had been
     designed and entered into solely to provide a mechanism
     to disguise the capital contributions of limited
     partners as currently deductible expenditures. The
     Court stated that the activities of the partnerships
     were “another example of efforts by promoters and
     investors in the early 1980's to reduce the cost of
     commencing and engaging in the farming of jojoba by
     claiming, inaccurately, that capital expenditures in
     jojoba plantations might be treated as research or
     experimental expenditures for purposes of claiming
     deductions under section 174.” * * * [Fn. ref.
     omitted.]

More details concerning the partnerships and the investors are

found in the records and in the opinions in other cases in which

we have sustained additions to tax arising out of investments in

the jojoba plant partnerships.    As the Court stated in Kellen v.

Commissioner, T.C. Memo. 2002-19:

          We have decided many jojoba cases involving
     additions to tax for negligence and substantial
     understatement of tax liability. 15/ We have found the
     taxpayers liable for additions to tax for negligence in
     all of those cases; likewise, we have found the
     taxpayers liable for the addition to tax for
     substantial understatement of tax liability in all of
     those cases that have presented that issue.
     __________________
          15/ See, e.g., Lopez v. Commissioner, T.C. Memo.
     2001-278; Christensen v. Commissioner, T.C. Memo. 2001-
     185; Serfustini v. Commissioner, T.C. Memo. 2001-183;
     Carmena v. Commissioner, T.C. Memo. 2001-177; Nilsen v.
     Commissioner, T.C. Memo. 2001-163; Ruggiero v.
     Commissioner, T.C. Memo. 2001-162; Robnett v.
     Commissioner, T.C. Memo. 2001-17; Harvey v.
     Commissioner, T.C. Memo. 2001-16; Hunt v. Commissioner,
     T.C. Memo. 2001-15; Fawson v. Commissioner, T.C. Memo.
     2000-195; Downs v. Commissioner, T.C. Memo. 2000-155;
     Glassley v. Commissioner, T.C. Memo. 1996-206;
     Stankevich v. Commissioner, T.C. Memo. 1992-458.
                               - 8 -

     In Lopez v. Commissioner, supra, as in this case, the

partnership in which the taxpayers invested had signed a

Stipulation to be Bound by the outcome of Utah Jojoba I Research.

Petitioners have not shown any facts that would distinguish this

case from the others involving jojoba plant ventures.

     Section 6653(a)(1) imposes an addition to tax in an amount

equal to 5 percent of the underpayment of tax if any part of the

underpayment is due to negligence or intentional disregard of

rules or regulations.   Section 6653(a)(2) imposes another

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

due on the portion of the underpayment attributable to negligence

or intentional disregard of rules or regulations.

     Negligence is defined as the failure to exercise the due

care that a reasonable and ordinarily prudent person would

exercise under like circumstances.     See Anderson v. Commissioner,

62 F.3d 1266, 1271 (10th Cir. 1995), affg. T.C. Memo. 1993-607;

Neely v. Commissioner, 85 T.C. 934, 947 (1985).     The focus of

inquiry is the reasonableness of the taxpayer’s actions in light

of the taxpayer’s experience and the nature of the investment.

See Henry Schwartz Corp. v. Commissioner, 60 T.C. 728, 740

(1973); see also Sacks v. Commissioner, 82 F.3d 918, 920 (9th

Cir. 1996) (whether a taxpayer is negligent in claiming a tax

deduction “depends upon both the legitimacy of the underlying

investment, and due care in the claiming of the deduction.”),
                                - 9 -

affg. T.C. Memo. 1994-217; Turner v. Commissioner, T.C. Memo.

1995-363.   In this regard, the determination of negligence is

highly factual.

     In his testimony quoted above, petitioner indicated that he

spent very little time investigating the viability of an

investment in jojoba farming or the likely tax treatment of that

investment, relying on his experience in similar investments.    He

offered in evidence at trial tax returns from earlier years on

which he had deducted various partnership losses.    Among the

papers that he presented, however, was a decision where this

Court determined that he owed a deficiency and a negligence

addition to tax for 1981.   Petitioner’s experience is not

persuasive evidence that he was qualified to assess the viability

and the proper treatment of the Cal-Neva partnership, relying

solely on the promoters.    Based on the limited effort described

by petitioner and consistent with all opinions in similar cases,

we conclude that petitioners failed to exercise reasonable care

and are liable for the additions to tax for negligence.

     Section 6661(a), as amended by the Omnibus Budget

Reconciliation Act of 1986, Pub. L. 99-509, sec. 8002, 100 Stat.

1951, provides for an addition to tax of 25 percent of the amount

of any underpayment attributable to a substantial understatement

of income tax for the taxable year.     A substantial understatement

of income tax exists if the amount of the understatement exceeds
                               - 10 -

the greater of 10 percent of the tax required to be shown on the

return, or $5,000.   Sec. 6661(b)(1)(A).   Generally, the amount of

an understatement is reduced by the portion of the understatement

that the taxpayer shows is attributable to either (1) the tax

treatment of any item for which there was substantial authority,

or (2) the tax treatment of any items with respect to which the

relevant facts were adequately disclosed on the return.      Sec.

6661(b)(2)(B).    If an understatement is attributable to a tax

shelter item, however, different standards apply.    First, in

addition to showing the existence of substantial authority, a

taxpayer must show that he reasonably believed that the tax

treatment claimed was more likely than not proper.    Sec.

6661(b)(2)(C)(i)(II).   Second, disclosure, whether or not

otherwise adequate, will not reduce the amount of the

understatement.   Sec. 6661(b)(2)(C)(i)(I).

     Substantial authority exists when “the weight of the

authorities supporting the treatment is substantial in relation

to the weight of authorities supporting contrary positions.”

Sec. 1.6661-3(b)(1), Income Tax Regs.    Petitioner has failed to

show that substantial authority existed for the tax treatment of

the Cal-Neva loss on his 1982 return.

     Petitioner has not satisfied any of the conditions for

avoiding application of the section 6661 addition to tax.      His

inclusion of the loss on Schedule C without identification of the
                               - 11 -

Cal-Neva partnership does not constitute adequate disclosure.

Accepting his testimony and concluding that the correct amount of

the underpayment should have been calculated based on $13,150 in

disallowed losses rather than $14,783.69, the underpayment would

still be substantial for purposes of section 6661.

     Petitioners have made several arguments that we address

briefly.    First, in their answering brief, petitioners argue for

the first time that the notice in this case was sent after the

expiration of the period of limitations.     In this context,

however, the period of limitations was suspended during the time

that the partnership action was pending and for 1 year

thereafter.   Sec. 6229(d).   The decision in the partnership

action did not become final until the expiration of the time for

filing a notice of appeal, which was 90 days after entry of the

decision.   Secs. 7481(a)(1), 7483.     Thus, the notice in this case

was sent approximately 3 weeks before the expiration of the

period of limitations.

     Second, petitioners argue that the underpayment should be

further reduced by allowance of $5,000 as their out-of-pocket

expenses in relation to the Cal-Neva investment.     There is no

authority, however, that would allow them to deduct their out-of-

pocket amounts in the year of the investments.     See, e.g., Marine

v. Commissioner, 92 T.C. 958, 974-980 (1989), affd. without
                              - 12 -

published opinion 921 F.2d 280 (9th Cir. 1991); Viehweg v.

Commissioner, 90 T.C. 1248, 1253-1255 (1988).

     Third, following up on an inquiry made by the Court to

respondent’s counsel at the time of trial, petitioners assert

that section 7491(c) should impose on respondent the burden of

production with respect to the additions to tax in this case.

That section applies to examinations commenced after July 22,

1998.   Internal Revenue Service Restructuring and Reform Act of

1998, Pub. L. 105-206, sec. 3001(c), 112 Stat. 685, 727.

Respondent contends that the affected items in this case are

merely a continuation of the proceeding commenced with respect to

the partnership long before the effective date of section

7491(c).   Under the circumstances of this case, it is arguable

that an examination of petitioners’ return commenced after that

effective date, because, due to petitioners’ failure to attach a

Schedule K-1, the disallowed deductions were determined only

after examining petitioners’ Schedule C.   This is not the normal

proceeding in which adjustments based on the partnership

proceeding and Schedules K-1 are automatically made and assessed

with respect to the individual partners.   We offer no opinion,

however, about whether the determination of additions to tax as

affected items resulting from a partnership examination is a

separate examination for purposes of the effective date of

section 7491, and we need not decide whether the circumstances of
                              - 13 -

this case would lead to the conclusion that examination of

petitioners’ Schedule C was a separate examination.    The record

in this case supports the application of the additions to tax

without regard to the burden of production.    If the burden of

production were on respondent, it would be satisfied in this case

by the tax return, petitioner’s testimony, and other evidence in

the record.

     Petitioners also ask that we reduce the amount of tax that

was assessed after the partnership-level proceedings became

final, which is not a part of the determination in the statutory

notice in this case.   That assessment was a computational

adjustment that the Commissioner is permitted to assess against

the partner without issuing a notice of deficiency.    Secs. 6225,

6230(a)(1); N.C.F. Energy Partners v. Commissioner, 89 T.C. 741,

744 (1987); Maxwell v. Commissioner, 87 T.C. 783, 792 n.7 (1986).

We have no jurisdiction in this case over that computational

adjustment.   For purposes of the additions to tax, however, we

are satisfied by the evidence in this case that the correct

amount of the underpayment is less than the amount assessed and

that the correct amount should be used in computing the additions

to tax.   That amount will be computed by determining the tax

based on disallowance of the sum of $13,150.

     Finally, petitioners assert that the investment in Cal-Neva

was not a “tax-motivated transaction” for purposes of section
                                - 14 -

6621(c).     The increased rate of interest under section 6621(c) is

120 percent of the statutory rate imposed on underpayments under

section 6601 if the underpayment exceeds $1,000 and is

attributable to a tax-motivated transaction (as defined in

section 6621(c)(3)).     The increased interest is effective only

with respect to interest accruing after December 31, 1984,

notwithstanding that the transaction was entered into before that

date.     Solowiejczyk v. Commissioner, 85 T.C. 552 (1985), affd.

per curiam without published opinion 795 F.2d 1005 (2d Cir.

1986).

        This Court generally does not have jurisdiction to review

assessment of section 6621(c) tax-motivated interest in affected

item proceedings, even though the tax-motivated interest is an

affected item that requires a partner-level determination.     See

White v. Commissioner, 95 T.C. 209 (1990); Korchak v.

Commissioner, T.C. Memo. 2005-244; see also Ertz v. Commissioner,

T.C. Memo. 2007-15.     A narrow exception to this rule applies if a

taxpayer has paid the assessed tax-motivated interest and

subsequently invokes the overpayment jurisdiction of this Court

under section 6512(b).     See Barton v. Commissioner, 97 T.C. 548

(1991).     Petitioners do not claim that they have paid the

interest.
                              - 15 -

     Petitioners nevertheless argue that this Court has

jurisdiction to review interest assessments under section

6621(c)(4).   Section 6621(c)(4) provides as follows:

          (4) Jurisdiction of Tax Court.–-In the case of any
     proceeding in the Tax Court for a redetermination of a
     deficiency, the Tax Court shall also have jurisdiction
     to determine the portion (if any) of such deficiency
     which is a substantial underpayment attributable to tax
     motivated transactions.

Respondent presumably determined that the underlying deficiency

in this case was a substantial underpayment attributable to a

tax-motivated transaction.   As explained above, this Court does

not have jurisdiction to review the underlying deficiency.

Because the underlying deficiency is not before this Court,

section 6621(c)(4) cannot confer jurisdiction to determine what

portion of such underlying deficiency is attributable to a tax-

motivated transaction.   Although each addition to tax at issue in

this case is a “deficiency” within the meaning of section

6621(c)(4), section 6621(c)(2) excludes additions to tax from the

definition of “substantial underpayment attributable to tax

motivated transactions”, thereby precluding review under section

6621(c)(4).   White v. Commissioner, supra at 216; see Robnett v.

Commissioner, T.C. Memo. 2001-17; Hunt v. Commissioner, T.C.

Memo. 2001-15 (both involving jojoba venture partnerships).

     We have considered the other arguments of the parties, and

they are either irrelevant to our decision or lacking in merit.
                             - 16 -

To take account of the necessary recomputation of the additions

to tax,

                                        Decision will be entered

                                   under Rule 155.