Lincir v. Commissioner

MEMORANDUM FINDINGS OF FACT AND OPINION

DAWSON, JUDGE: This case was assigned to Chief Special Trial Judge Peter J. Panuthos pursuant to the provisions of section 7443A(b)(4) and Rules 180, 181, and 183. ¹ The Court agrees with and adopts the opinion of the Special Trial Judge, which is set forth below.

OPINION OF THE SPECIAL TRIAL JUDGE

PANUTHOS, CHIEF SPECIAL TRIAL JUDGE: Respondent determined deficiencies in and additions to petitioners' Federal income taxes as follows:

Respondent also determined that, once the deficiencies are determined, petitioners are liable for increased interest on underpayments attributable to a tax-motivated transaction as defined in section 6621(c).

The deficiencies in this case result from respondent's disallowance of certain losses. The losses include those attributable to petitioners' participation in the "Arbitrage and Carry" gold trading promoted by Futures Trading, Inc. (FTI). The losses also include those attributable to petitioners' participation in the Treasury bill (T-bill) option and stock forward transactions promoted by Merit Securities, Inc. (Merit), a company that is related to FTI.

The parties have stipulated that --

   All adjustments * * * relating to the T-Bill Options and the

   Stock Forward Contracts programs promoted by Merit shall be

   redetermined in the same manner as comparable adjustments in

   Rivera v. Commissioner, Tax Court Docket Nos. 41343-85 and

22921-86 ("CONTROLLING CASES").

The above-mentioned "controlling cases" are two of seven consolidated cases reported as Leema Enterprises, Inc. v. Commissioner, T.C. Memo 1999-18. Therein we addressed issues *117 concerning the Merit T-bill and stock forward trades and held that --

   the Merit markets lacked economic substance. Although the form

   appeared as markets for particular financial instruments, the



   substance was the creation of straddles to generate loss

   deductions without corresponding economic losses. * * * In

   short, the Merit trades * * * cannot support the losses claimed.

We alternatively held that, even if the transactions had substance, the individual Merit investors' "primary objective was obtaining tax benefits", and thus they "failed to meet the statutory requirements for deducting the losses at issue".

Our holding in Leema Enterprises, Inc., accordingly disposes of the Merit T-bill and stock forward losses at issue here. For the reasons stated therein, those losses are not allowed in this case.

The parties have also entered into a "Second Stipulation of Facts" wherein they agreed "that all transactions involving the Arbitrage and Carry ('A/C') program promoted by Futures Trading, Inc. ('FTI') will be ignored for Federal income tax purposes". ^2*118 This second stipulation resolved other issues concerning the deficiencies at issue.

After additional concessions, ^3*119 the issues remaining for decision are: (1) Whether petitioners are liable for additions to tax for negligence or intentional disregard of rules or regulations pursuant to section 6653(a) (or pursuant to section 6653(a)(1) and (2) for the years 1981 and 1982); (2) whether petitioners are liable for increased interest on underpayments attributable to a tax- motivated transaction pursuant to section 6621(c); and (3) whether petitioners are liable for the addition to tax imposed under section 6661 for making a substantial understatement for the year 1982.

FINDINGS OF FACT

The parties filed two stipulations of settlement of tax shelter adjustments, a first stipulation of facts with attached exhibits, a second stipulation of facts, and a third stipulation of facts, with more attached exhibits. The facts reflected are so found, and, by this reference, are incorporated herein. Additionally, the "controlling cases", reported as Leema Enterprises, Inc. v. Commissioner, supra, are incorporated by this reference.

Petitioners Tom I. Lincir and Diane C. Lincir were married and resided in San Pedro, California, when their petition was filed. They were divorced in 1993. Petitioners are high school graduates. Mr. Lincir has taken some junior college classes and is trained as a metalworker. After graduating from high school, Mrs. Lincir took some junior college courses in bookkeeping.

Between 1975 and 1982, petitioners operated two successful physical-fitness *120 businesses. One, Sta-Slim Products, engaged in manufacturing light exercise items, and the other, Ivanko Barbell Co., engaged in the importation and sale of weightlifting equipment. Mr. Lincir was involved in every aspect of the businesses, while Mrs. Lincir handled the accounts payable and ran the office side of the businesses. By 1982, sales of the two companies totaled more than $ 4 million annually.

Between 1976 and 1980, Mr. Lincir was also involved in dealing in coins and precious metals. He attended weekly seminars that had been formed to discuss investing in precious metals.

Mr. Lincir additionally invested in real estate. One of his associates in an apartment house venture introduced Mr. Lincir to an accountant named Robert Schenkman, a specialist in real estate. Mr. Schenkman became petitioners' accountant. He assisted Mr. Lincir with incorporating petitioners' businesses, establishing a system for payroll taxes, and preparing petitioners' Federal income tax returns. Mr. Schenkman helped petitioners to establish a retirement program, which invested its assets in gold.

Mr. Schenkman also provided Mr. Lincir with information about the FTI/Merit promotions. Mr. Schenkman worked *121 with a representative of FTI, Rusty London, "more or less * * * as a team" concerning FTI/Merit and its clients. Mr. Schenkman billed Mr. London for the time Mr. Schenkman expended in lining up clients for FTI/Merit. Mr. Schenkman routinely disclosed to his clients this financial arrangement with Mr. London.

Mr. Schenkman explained to Mr. Lincir that, for tax purposes, the FTI/Merit program would generate gains in the form of long-term capital gains, and losses as ordinary losses. Mr. Lincir shared this knowledge with Mrs. Lincir. Mr. Schenkman also provided Mr. Lincir with a private placement memorandum about the FTI/Merit program. Mr. Lincir tried to read this document but did not understand it. ⁴

Mr. Lincir assumed that Mr. *122 Schenkman profited in some way from the business generated by referring clients to FTI/Merit. Mr. Lincir did not know the particulars of such arrangements, however, and he had no knowledge of whether FTI/Merit compensated Mr. Schenkman directly.

In 1978, Mr. Lincir invested approximately $ 225,000 in the FTI/Merit programs. FTI/Merit provided information concerning the tax ramifications of Mr. Lincir's investments directly to Mr. Schenkman; that information was not provided to Mr. Lincir first. Mr. Schenkman told petitioners that the deductions generated by the FTI/Merit program were in accordance with the tax laws.

The following table is derived from petitioners' Federal income tax returns for the years at issue. The table compares petitioners' salary income from their businesses with their "supplemental" losses from FTI/Merit reported on their Schedules 4797, Supplemental Schedule of Gains and Losses:

The large losses did not concern Mr. Lincir; he had "total confidence" in Mr. Schenkman and felt that bigger gains would come later, because that was *123 the way the program was described.

Mr. Schenkman proposed other investment opportunities to petitioners, but they did not accept any such investment recommendations.

OPINION

1. ADDITIONS TO TAX UNDER SECTIONS 6653(a) AND 6653(a)(1) AND (2)

Section 6653(a) (and, beginning with taxable year 1981, section 6653(a)(1)) provides for an addition to tax equal to 5 percent of any underpayment if any part of the underpayment is due to negligence or intentional disregard of rules and regulations. Section 6653(a)(2) (beginning with the tax year 1981) provides for an addition to tax equal to 50 percent of the interest payable on the deficiency with respect to the portion of the underpayment which is attributable to negligence or intentional disregard of rules and regulations.

Negligence under sections 6653(a) and 6653(a)(1) and (2) is the lack of due care or the failure to act as a reasonable person would act under the same circumstances where there is a legal duty to act. See Neely v. Commissioner, 85 T.C. 934, 947 (1985). Petitioners bear the burden of proving that no part of the underpayments for the years at issue is due to negligence or intentional disregard of rules and regulations. See Rule *124 142(a); Bixby v. Commissioner, 58 T.C. 757 (1972).

In this case, the high writeoffs generated by the FTI/Merit programs were reflected as consistent annual losses of hundreds of thousands of dollars. The losses approached, and often exceeded, petitioners' income from their two businesses. Write-offs of this magnitude should have alerted petitioners that their deductions were, at best, questionable. See Collins v. Commissioner, 857 F.2d 1383, 1386 (9th Cir. 1988), affg. Dister v. Commissioner, T.C. Memo 1987-217. In such cases, taxpayers have a duty to show that they made reasonable inquiry into the validity of the investment plans that generated such deductions. See Zmuda v. Commissioner, 731 F.2d 1417, 1422, 1423 (9th Cir. 1984), affg. 79 T.C. 714 (1982).

Petitioners have not made such a showing. Their reliance upon the advice of Mr. Schenkman did not constitute a "reasonable inquiry". An accountant's advice cannot shield taxpayers from liability for the negligence penalties when the accountant lacks knowledge of pertinent facts relating to the venture as to which the taxpayers are seeking advice. See Collins v. Commissioner, supra.Petitioners have not demonstrated that Mr. Schenkman *125 possessed sufficient expertise to advise them about the gold trading or financial instruments involved in the FTI/Merit programs. To the contrary, Mr. Schenkman has conceded that he was not a specialist in gold trading or financial instruments. He has stated that he merely "tried to lay out what the tax consequences would be based on the information given to me by the promoter". Mr. Lincir had substantial exposure to the practices of precious metal trading. He knew, or should have known, of Mr. Schenkman's relative lack of experience.

Moreover, it was not reasonable for petitioners to base substantial tax losses solely upon the advice of a tax adviser who has an economic interest in promoting the investment. Investors instead have a duty to consult with competent advisers who are independent of the program, or they must otherwise examine the validity of the program. See Marine v. Commissioner, 92 T.C. 958, 993 (1989), affd. without published opinion 921 F.2d 280 (9th Cir. 1991). Mr. Schenkman was not independent of the FTI/Merit programs. He instead stood to profit from the business generated by getting his clients into the FTI/Merit programs, and he routinely advised his clients of *126 that fact. Mr. Lincir concededly knew that, in some fashion, Mr. Schenkman would earn additional income by getting his clients into the program.

We do not accept the notion that petitioners are naive and trusting individuals who were led astray by bad tax advice. Petitioners have developed and maintained two successful businesses. These businesses have generated millions of dollars in sales and annual incomes for petitioners in the hundreds of thousands of dollars. Moreover, in addition to being a successful businessman, Mr. Lincir participated in precious metal trading and real estate ventures. We conclude that petitioners possessed enough experience and knowledge of business to have known that they should have evaluated the substantial tax deductions at issue more carefully.

On the record before us, petitioners have failed to show that we should reject respondent's determined additions to tax for negligence.

2. SECTION 6621(c) ADDITIONAL INTEREST

Section 6621(c) (formerly section 6621(d)) provides for an increase in the interest rate where there is a substantial underpayment (i.e., one that exceeds $ 1,000) in any taxable year in which the understatement is "attributable to 1 or more *127 tax motivated transactions". Petitioners bear the burden of proof as to this issue. See Rule 142(a); Boyd v. Commissioner, 101 T.C. 365, 373 (1993).

In Seykota v. Commissioner, T.C. Memo 1991-234, supplemented by T.C. Memo 1991-541, we found that the FTI/Merit transactions were tax-motivated transactions within the meaning of section 6621(c). We again made the same finding with respect to the Merit T-bill and stock forward trades in Leema Enterprises, Inc. v. Commissioner, T.C. Memo 1999-18. Petitioners have presented no evidence to show that these findings should not apply to them. Accordingly, the additional interest imposed by section 6621(c) is applicable to petitioners. ⁵

3. SUBSTANTIAL UNDERSTATEMENT *128 OF TAX UNDER SECTION 6661

Respondent has determined additions to tax under section 6661 for 1982. For returns due after December 31, 1982 (but before January 1, 1990), section 6661 provides for an addition to tax equal to 25 percent of the amount of any underpayment attributable to a substantial understatement. An understatement is "substantial" when the understatement for the taxable year exceeds the greater of (1) 10 percent of the tax required to be shown on the return or (2) $ 5,000. The understatement is reduced to the extent that the taxpayer (1) has adequately disclosed his or her position, or (2) has substantial authority for the tax treatment of an item. See sec. 6661; sec. 1.6661-6(a), Income Tax Regs. Petitioners again bear the burden of showing that they are not subject to the addition to tax determined by respondent. See Rule 142(a); Cochrane v. Commissioner, 107 T.C. 18, 29 (1996).

Petitioners presented no evidence to show that respondent erroneously determined the addition to tax under section 6661. Accordingly, we hold that petitioners are liable for the addition to tax under section 6661. Their concessions with respect to the deficiencies at issue show that their understatement *129 for 1982 exceeds the greater of $ 5,000 or 10 percent of the tax required to be shown on their return for 1982. Respondent determined that all of petitioners' 1982 underpayment is attributable to that substantial understatement. Because petitioners have not disputed this determination, we so hold.

In view of the foregoing,

Decision will be entered under Rule 155.