Court Opinion

ID: 9839677
Source: CourtListenerOpinion
Date Created: 2023-09-13 19:02:57.783879+00
Date Added: 2024-06-11T09:38:24.586131
License: Public Domain

United States Tax Court

                               T.C. Memo. 2023-116

  JOHN R. JOHNSON AND ESTATE OF JUDITH E. JOHNSON,
DECEASED, JOHN R. JOHNSON, PERSONAL REPRESENTATIVE,
                      Petitioners

                                           v.

               COMMISSIONER OF INTERNAL REVENUE,
                           Respondent

                                     —————

Docket No. 12676-20.                                    Filed September 13, 2023.

                                     —————

Luke R. Gordon and Martin J. Martelle, for petitioners.

Gregory M. Hahn, Logan M. Westerman, and Scott W. Forbord, for
respondent.

         MEMORANDUM FINDINGS OF FACT AND OPINION

      NEGA, Judge: Respondent determined deficiencies in John R.
and Judith E. Johnson’s income tax and accuracy-related penalties for
2015, 2016, 2017, and 2018 as follows:

            Year                       Deficiency               § 6662(a) 1 penalty
            2015                        $658,034                    $131,606.80
            2016                         237,300                      47,460.00
            2017                          36,949                        7,389.80
            2018                          50,417                      10,083.40

        1 Unless otherwise indicated, statutory references are to the Internal Revenue

Code, Title 26 U.S.C., in effect at all relevant times, regulation references are to the
Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times, and
Rule references are to the Tax Court Rules of Practice and Procedure.

                                 Served 09/13/23
                                           2

[*2] After concessions, 2 the only remaining issue for decision is the
applicability of section 6662(a) accuracy-related penalties for
underpayments due to negligence, disregard of rules or regulations,
and/or substantial understatements of income tax. Petitioners argue
that they qualify for the reasonable cause and good faith exception found
in section 6664(c)(1).

                              FINDINGS OF FACT

      Some of the facts are stipulated and are so found. The Stipulation
of Facts and the attached Exhibits are incorporated herein by this
reference. When the Petition was timely filed, John R. and Judith E.
Johnson resided in Alaska.

       Petitioner John R. Johnson filed joint tax returns with his wife,
Judith E. Johnson, for the years at issue. Since the time of filing the
Petition, Judith E. Johnson has passed away. Mr. Johnson is authorized
to represent the estate of Judith E. Johnson in this case.

       Mr. Johnson has been engaged in the business of buying, selling,
and leasing real estate for more than 50 years. In 2006 he purchased
the Lawton Hotel property for $4,126,005. This purchase price was
allocated to the Johnsons’ cost bases as follows:

                  Lawton Best Western (building)           $1,754,500
                  Lawton Extended Stay (building)             365,750
                  Furniture and fixtures                      629,750
                  Restaurant equipment                        400,000
                  Office equipment                            180,000
                  Roadside sign                                75,000
                  Vehicles                                     15,000
                  Land                                        650,000
                  Franchise fee                                56,005

       The Johnsons improperly claimed depreciation deductions from
2006 to 2013 amounting to 100% of the value of the commercial
buildings (Lawton Best Western and Lawton Extended Stay) on the
Lawton hotel property.    They accomplished this by applying a

         2 Petitioners have conceded all issues related to the underlying deficiencies as

set out in the notice of deficiency.
                                      3

[*3] seven-year depreciation period to the commercial buildings, which
should have been subject to a 39-year depreciation period. This
amounted to a total depreciation deduction of $2,120,250 between 2006
and 2013, while the correct method would have yielded a total deduction
over that period of only $595,811. The correct 39-year depreciation
period would have produced a deduction of $54,364 for each full year.
The method the Johnsons actually used produced a deduction of
$519,249 for 2007 alone with deductions for other years varying between
$94,563 and $370,832 according to the MACRS 3 seven-year method.
They sold the Lawton Hotel property in 2016 for $5 million.

       For 2015 the Johnsons properly claimed a home mortgage
interest deduction of $44,806 on Schedule A, Itemized Deductions. They
also claimed the same $44,806 on Schedule E, Supplemental Income and
Loss, as mortgage interest related to a commercial property in Valdez,
Alaska. Also in 2015 they misreported their Social Security income as
$30,813 instead of $35,492 as shown on their SSA–1099, Social Security
Benefit Statement.

       Furthermore, for 2015 the Johnsons claimed a charitable
contributions deduction of $152,500. They attached an incomplete Form
8283, Noncash Charitable Contributions, specifying that $2,500 of this
deduction was attributable to a donation of fencing to Ka Hale Pomaikai,
a rehabilitation center in Hawaii, and $150,000 to the donation of a
building to the Elgin Opera House in Oregon. They did not obtain a
qualified appraisal for the donation of the building. The recipient of the
building did not sign the Form 8283. They did not submit a
contemporaneous written acknowledgment or receipt from either
recipient as part of the 2015 return or at trial. The portions of Form
8283 that call for the signature of an appraiser and the signature of a
representative of the Elgin Opera House were left blank. The submitted
form describes the donated property as “Building” without any further
identifying information and describes the condition of the property as
“Good used.”

       Because of the Johnsons’ improper depreciation deductions
claimed between 2006 and 2013, respondent made a section 481 method
of accounting adjustment for 2015 of $1,969,976. Since the depreciation
adjustment affected their basis in the Lawton Hotel property at the time
of sale in 2016, respondent adjusted the amount of gain that they

       3 Modified Accelerated Cost Recovery System. See I.R.S. Pub. 946, How to

Depreciate Property.
                                       4

[*4] realized on the 2016 disposition of the Lawton Hotel. Respondent
also proposed a number of adjustments as appropriate for the other
mistakes on their returns for tax years 2015–18. Petitioners concede
the correctness of these adjustments other than the accuracy-related
penalties. On October 29, 2020, the Johnsons timely filed a Petition
with this Court disputing the notice of deficiency issued on July 27,
2020. 4

                                 OPINION

I.    Burden of Proof

       Respondent bears the burden of production with respect to
petitioners’ liability for section 6662 penalties and must produce
sufficient evidence indicating that it is appropriate to impose them. See
§ 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446 (2001). If this
initial burden is met, petitioners have the burden to show by a
preponderance of the evidence that they meet the requirements of the
reasonable cause and good faith exception to accuracy-related penalties.
Higbee, 116 T.C. at 446.

II.   Analysis

       Section 6662(a) imposes a 20% accuracy-related penalty on the
portion of an underpayment of tax attributable to any of the reasons
listed in section 6662(b), including negligence or disregard of rules or
regulations or a substantial understatement of income tax. Negligence
“includes any failure to make a reasonable attempt to comply with the
provisions of this title.” § 6662(c). Disregard includes careless, reckless,
or intentional disregard. Id. If the taxpayer shows that there is
reasonable cause for any portion of an underpayment, and the taxpayer
acted in good faith with respect to that portion, no accuracy-related
penalty may be imposed on that portion of the underpayment.
§ 6664(c)(1).

       Section 6751(b)(1) requires that all penalties receive written
supervisory approval. The parties have stipulated that the individual
who made the penalty determination obtained supervisory approval.
We accept the parties’ stipulation and, on the record before us, conclude
that the managerial approval satisfied section 6751(b)(1).

      4 The Petition was postmarked October 23, 2020.   See § 7502.
                                       5

[*5] With respect to the section 6662(a) penalties, respondent has met
his initial burden of production. Section 6662(a) and (b)(1) penalties are
applicable to any portion of an underpayment for which the taxpayer is
negligent or disregards rules and/or regulations. These penalties also
apply when taxpayers substantially understate their income tax—
defined as understating the tax by more than 10% of the tax required to
be shown on the return. § 6662(b)(2), (d)(1)(A). Respondent has
established negligence and disregard of the rules and regulations with
respect to the entire underpayment for each year at issue for reasons
including, but not limited to, using an improper depreciation method,
inaccurately reporting Social Security income, claiming duplicate
mortgage interest deductions, and lacking proper substantiation and
qualified appraisals for the charitable contributions. In addition,
assuming Rule 155 computations confirm substantial understatements
of income tax for the years at issue, respondent has met his burden of
producing evidence that the petitioners substantially understated their
income tax within the meaning of section 6662(b)(2). The amount of tax
shown by the Johnsons for each year and the amount of tax required to
be shown for each year as stated in the notice of deficiency are as
follows: 5

       Year            Tax Shown on        Tax Required to Be   Understatement
                          Return            Shown on Return      Percentage 6
       2015                   0                 $658,034              100%
       2016                $31,371               268,671              88.3%
       2017                228,760               265,709              13.9%
       2018                218,502               268,919              18.7%

Since the understatement was more than 10% of the tax required to be
shown for each year, respondent has met his burden of production for
showing that the section 6662(a) accuracy-related penalties properly
apply. In the alternative respondent has met his burden of production
by showing that the Johnsons were negligent and in disregard of rules
and regulations, giving rise to the section 6662(a) accuracy-related
penalties.

       5 These numbers are subject to change under Rule 155 computations.

       6 If this percentage exceeds 10%, the understatement is substantial.   See
§ 6662(d)(1)(A).
                                     6

[*6]   A.    Threshold Availability of Reasonable Cause Defense for
             Charitable Contribution Deductions

       Respondent argues that under section 6664(c)(3), the reasonable
cause and good faith defense is unavailable with respect to the
disallowed charitable contribution deductions. We disagree. Section
6664(c)(3) disallows the reasonable cause defense for a charitable
contribution deduction as long as the contributed property is
substantially or grossly overvalued—defined as valuing the property in
excess of 150% or 200% of its accurate value. § 6662(e), (h). Since no
evidence has been introduced about the correct valuation of the
contributed property, we are unable to conclude that the property was
substantially or grossly overvalued. Accordingly, section 6664(c)(3) does
not apply, and the reasonable cause and good faith defense in section
6664(c)(1) is available to petitioners with respect to the penalties arising
from the denied charitable contribution deductions for 2015.

       B.    Analysis of Reasonable Cause Defense

        Petitioners’ sole argument against the application of
section 6662(a) accuracy-related penalties is that petitioners relied on
their certified public accountant (CPA) and should qualify for the
reasonable cause and good faith exception laid out in section 6664(c)(1).
Reasonable cause requires that the taxpayer exercise ordinary business
care and prudence as to the disputed item. See Neonatology Assocs., P.A.
v. Commissioner, 115 T.C. 43, 98 (2000), aff’d, 299 F.3d 221 (3d Cir.
2002); see also United States v. Boyle, 469 U.S. 241, 251 (1985). The
determination of reasonable cause must be “made on a case-by-case
basis, taking into account all pertinent facts and circumstances.” Treas.
Reg. § 1.6664-4(b)(1). The most important factor in this determination
is the “extent of the taxpayer’s effort to assess the taxpayer’s proper tax
liability.” Id. Reasonable reliance on the advice of an independent,
competent professional as to the tax treatment of an item may meet the
requirement of ordinary business care and prudence. See id. para. (c).
The taxpayer’s education and business experience are relevant to the
determination of whether the taxpayer’s reliance on professional advice
was reasonable and in good faith. Id. subpara. (1). In order for a
taxpayer to reasonably rely on advice of a professional, the taxpayer
must prove (1) the adviser was a competent professional who had
sufficient expertise to justify reliance, (2) the taxpayer provided all
necessary and accurate information to the adviser, and (3) the taxpayer
actually relied in good faith on the adviser’s judgment. Neonatology
Assocs., P.A., 115 T.C. at 99.
                                     7

[*7] Petitioners satisfy each of the first two prongs of the test laid out
in Neonatology.     Their CPA was a competent professional and
petitioners provided her with all necessary and accurate information.
Mr. Johnson testified about limited use of handwritten notes related to
cash donations to charitable organizations but supplemented those
notes with phone calls and appropriate documentation for all items
other than the cash donations. The third prong requires that the
taxpayers reasonably relied in good faith on the advice of a tax
professional. In order for such reliance to exist, petitioners would first
have to establish that their CPA communicated something constituting
advice. See Treas. Reg. § 1.6664-4(c)(2).

       Petitioners presented no evidence that their CPA told them that
the seven-year depreciation schedule was applicable to commercial
buildings or that the mortgage interest deduction could be claimed
twice. Petitioners also failed to show that their CPA advised them that
the county assessor’s valuation would suffice instead of a qualified
appraisal for the building donated to the Elgin Opera House. When
asked whether she advised Mr. Johnson that the charitable contribution
deduction could be claimed using the county assessor’s valuation instead
of a qualified appraisal, petitioners’ CPA testified that she “never had
that discussion with [Mr. Johnson.]” Petitioners cannot claim to have
reasonably relied on advice which was never given. In addition, Mr.
Johnson was not credible when he definitively stated: “We thoroughly
discussed the tests” related to the donation of the building to the Elgin
Opera House. This was decidedly in contrast with his immediately
following statement that details about the donation were “[t]oo far to
remember.” Petitioners have failed to meet their burden of establishing
that they received any advice about the propriety of claiming a
charitable contribution deduction over $5,000 without a qualified
appraisal or any advice concerning the proper tax treatment of any of
the understatements. See Woodsum v. Commissioner, 136 T.C. 585,
593–94 (2011).

       Failing to show that they received any advice about the correct
tax treatment of any of the items noted in the deficiency, petitioners’ last
remaining contention is that they are entitled to the reasonable cause
and good faith exception merely because their CPA prepared the
returns. “The mere fact that a certified public accountant has prepared
a tax return does not mean that he or she has opined on any or all of the
items reported therein.” Neonatology Assocs., P.A., 115 T.C. at 100.
Taxpayers have a nondelegable duty to review the return for accuracy
before filing. See Metra Chem Corp. v. Commissioner, 88 T.C. 654, 662
                                         8

[*8] (1987). We are unpersuaded that Mr. Johnson—a sophisticated
participant in real estate transactions—would have missed the
duplicate interest deductions, the grossly overstated depreciation, or the
lack of a qualified appraisal if he had conducted even a cursory review
of the returns. 7 See, e.g., Schweizer v. Commissioner, T.C. Memo. 2022-
102, at *11 (finding defective Form 8283 lacking qualified appraisal);
Chiarelli v. Commissioner, T.C. Memo. 2021-27, at *22 (finding
sophisticated taxpayer unable to escape accuracy-related penalties by
blaming CPA); Langston v. Commissioner, T.C. Memo. 2019-19,
at *16–18, aff’d, 827 F. App’x 900 (10th Cir. 2020). Mr. Johnson later
claimed that depreciation schedules are incomprehensible numbers of
which he has no understanding. We find that Mr. Johnson’s self-serving
testimony as to this issue lacked credibility. Petitioners have failed to
carry their burden of establishing reasonable cause.

       Accordingly, we sustain respondent’s determination that
petitioners are liable for the section 6662(a) accuracy-related penalties
for 2015, 2016, 2017, and 2018 as laid out in the notice of deficiency.

       We have considered all of the arguments made by the parties and,
to the extent they are not addressed herein, we find them to be moot,
irrelevant, or without merit.

       To reflect the foregoing,

       Decision will be entered under Rule 155.

        7 For instance, at trial Mr. Johnson made repeated unprompted references to

section 1031 and indicated his awareness of substantive tax provisions that bear upon
real estate investing. He elected to conduct most of his transactions with minimal
involvement of counsel—choosing instead to rely on his own expertise about the
substance and tax implications of his transactions.