1990 Tax Ct. Memo LEXIS 695 | Tax Ct. | 1990
1990 Tax Ct. Memo LEXIS 695">*695
*2005 MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined the following deficiencies and additions 2 to petitioners' Federal income tax:
Petitioners/Rogers - Dkt. No. 27353-86 | |||
Additions to Tax | |||
Year | Deficiency | Sec. 6653(a) 3 | Sec. 6659 |
1979 | $ 2,499.00 | $ 124.95 | $ 749.70 |
1980 | 2,546.00 | 127.80 | 763.80 |
1981 | 2,500.00 | * 125.00 | 750.00 |
1982 | 7,218.00 | 2,165.40 |
Petitioners/Moss - Dkt. No. 43568-86 | |||
Additions to Tax | |||
Year | Deficiency | Sec. 6659 | Sec. 6661 |
1982 | $ 15,310.00 | $ 3,900.00 | $ 231.00 |
Petitioners/Morgan-Dkt. No. 44611-86 | ||||
Additions to the Tax | ||||
Year | Deficiency | Sec. 6653(a) | Sec. 6659 | Sec. 6661 |
1982 | $ 15,573.00 | $ 778.65 * | $ 3,900.00 | $ 257.30 |
1983 | 394.00 | 19.70 | -- | -- |
Petitioners/Johnson-Dkt. No. 4215-87 | ||||
Additions to Tax | ||||
Year | Deficiency | Sec. 6653(a) | Sec. 6659 | Sec. 6661 |
1979 | $ 2,658.00 | $ 132.90 | $ 797.40 | $ -- |
1982 | 12,388.17 | 619.41 * | 3,102.60 | 511.54 |
Petitioners/McEvoy-Dkt. No. 4317-87 | ||||
Additions to the Tax | ||||
Year | Deficiency | Sec. 6653(a) | Sec. 6659 | Sec. 6661 |
1982 | $ 14,181.92 | $ 709.10 * | $ 3,698.40 | $ 463.48 |
1983 | 987.00 | 49.35 | -- | -- |
Petitioners/Ridgeway-Dkt. No. 25670-87 | |||
Additions to Tax | |||
Year | Deficiency | Sec. 6653(a) | Sec. 6659 |
1979 | $ 8,912.00 | $ 445.60 | $ 2,673.60 |
1982 | 18,155.53 | 907.78 * | 1,285.50 |
The issues in these consolidated cases involve petitioners' leases of energy management devices from O.E.C. Leasing Corporation (OEC). 4 Because petitioners have conceded the correctness of the income tax portion of the deficiency, the remaining issues are: (1) Whether some 5 petitioners are liable for the additions to tax for negligence,
1990 Tax Ct. Memo LEXIS 695">*701 FINDINGS OF FACT
The stipulation of facts and attached exhibits are incorporated herein by this reference. Respondent determined, in the notices of deficiency, that petitioners 6 were not entitled to their claimed investment tax and energy credits and deductions in connection with a leasing transaction involving energy equipment. Petitioners have conceded that they are not entitled to the credits and deductions, but continue to contest the applicability of the additions to tax and increased interest.
At least one of each set of petitioners attended a meeting during the late fall of 1982, conducted by J. Wayne Collins (Collins), who was a representative and agent of OEC. Most petitioners were aware or believed that Collins would receive a commission or some income for his part in inducing "investment" 1990 Tax Ct. Memo LEXIS 695">*702 in the OEC transaction. The purpose of the meeting was to promote or solicit participation in a leasing program. Under that program individuals were to lease an energy system (system) which controlled energy devices to save money on utility bills. The systems were to be installed with end-user establishments, which would be obligated to pay a portion of their energy savings back to the lessee and lessor. OEC was to purchase the systems for lease to investing participants. The participants, in turn, would operate their own leasing business and lease the system to the end user. Petitioners attended the meeting based upon the recommendation of their accountant, Chandler Russell (Russell). Russell prepared the 1982 returns of all petitioners before the Court, and in some cases he had prepared prior year tax returns. In some instances, Russell had provided investment and tax advice to petitioners in years prior to 1982.
At the meeting, petitioners received promotional materials concerning the leasing program, the system, a tax opinion which had been prepared for OEC, and projections regarding the leasing program. The tax opinion indicated that the terms of the transaction were1990 Tax Ct. Memo LEXIS 695">*703 highly unusual and not indicative of typical transactions in the energy savings field. The tax opinion also indicated that it was essential that "investors" be independent from OEC (not a partner or joint venturer) and that they be engaged in the operation of a business in order obtain the benefit of the income and energy credits. The promotional materials alerted "investors," that as a lessee of a system, they would be responsible for marketing, installation, and maintenance of the system.
The materials highlighted the "tax writeoff and cash benefit" and the main promotional brochure (which explained the program) featured the following chart preceding the text:
ENERGY CONTROL SYSTEMS | ||||
EQUIPMENT LEASING PROGRAM | ||||
FIRST YEAR ESTIMATED TAX WRITEOFF AND CASH BENEFITS | ||||
ASSUMING 50% BRACKET TAXPAYER | ||||
SYSTEM 1 | SYSTEM 2 | |||
COST BASIS of | ||||
Energy Control System | $ 65,000 | $ 175,000 | ||
Advanced guaranteed | ||||
rental payment | $ 5,000 | $ 15,000 | ||
TAX BENEFITS | ||||
Investment tax | ||||
credit-10% of Cost | $ 6,500 | $ 17,500 | ||
Energy Tax | ||||
credit-10% of Cost | 6,500 | 17,500 | ||
Total Tax Credits | $ 13,000 | $ 35,000 | ||
Tax Savings (50%) | ||||
on advanced guaranteed | ||||
rental payment | 2,500 | 7,500 | ||
Total Tax Benefits in | ||||
Year of Acquisition | $ 15,500 | $ 42,500 | ||
Positive Cash Benefit | ||||
for Year of Acquisition | $ 10,500 | $ 27,500 |
SYSTEM 3 | ||
COST BASIS of | ||
Energy Control System | $ 280,000 | |
Advanced guaranteed | ||
rental payment | $ 25,000 | |
TAX BENEFITS | ||
Investment tax | ||
credit-10% of Cost | $ 28,000 | |
Energy Tax | ||
credit-10% of Cost | 28,000 | |
Total Tax Credits | $ 56,000 | |
Tax Savings (50%) | ||
on advanced guaranteed | ||
rental payment | 12,500 | |
Total Tax Benefits in | ||
Year of Acquisition | $ 68,500 | |
Positive Cash Benefit | ||
for Year of Acquisition | $ 43,500 |
Does not include: (1) any first-year service income from energy savings.
(2) initial location fee, if service company is retained.
(3) any state or local tax impositions.
These projections were prepared by the Lessor. They represent an estimate of certain tax and economic benefits. Each Lessee is advised to consult with his own professional tax advisor with respect to these illustrations.
Petitioners relied upon the representations contained in the promotional materials. Petitioners were aware of the tax benefits. Petitioners did not consult with experts in the field of energy management equipment leasing prior to investing in the OEC transaction. None of petitioners had expertise in energy management equipment or the leasing of1990 Tax Ct. Memo LEXIS 695">*705 the same prior to their "investment."
Petitioners also relied upon Russell, who held himself out as a specialist in tax and investment advice. Russell limited his advice to the tax aspects of investments. His partner, who was not involved in this matter, provided advice about general business aspects concerning investments. Russell spent about 40 to 80 hours reviewing the promotional materials that had been given to petitioners. Russell attended the meeting with Collins. Russell analyzed the promotional materials with respect to the tax aspects and financial profitability. Russell had no expertise in the energy field, no engineering background, and no specialized expertise in the operation or appraisal of energy saving devices. Russell relied upon OEC for all factual representations in the promotional material. Russell recommended petitioners' involvement in the program.
The mechanics of the OEC transaction are identical in most respects to the transactions described in
End User: | 50 percent |
Service Company: | 7.5 percent |
Lessor (OEC): | 31.88 percent |
Lessee: | 10.62 percent |
The end users were not required to make any payments, other than sharing energy savings, in connection with their use of the devices. Prior to installation, the service company would conduct an "energy audit" to determine a suitable end-user location. The investor would also pay initial amounts for the first year's rental and an installation charge. The investor/lessee claimed tax deductions for advanced rental1990 Tax Ct. Memo LEXIS 695">*707 and installation charges, and investment tax credits under section 48(d), based on the purchase price OEC paid for the units.
The units themselves are electronic devices designed to regulate oil, gas, steam, and electrical usage, thereby conserving energy to the end user. During 1982 there were a number of such devices on the market. The cost of such a system is based upon its capabilities and the number of *2008 functions it can perform. The report prepared by respondent's expert 7 explains these factors in greater detail, reflecting the complexity of the device.
The energy management system market is a large market, heavily advertised in the trade. During 1982, a unit comparable to the Energy Management Systems (EMS) 1990 Tax Ct. Memo LEXIS 695">*708 I, II, and III could have been purchased for approximately $ 1,500, $ 1,600, and $ 4,800, respectively. The fair market value, during 1982, of the EMS I, II, and III is $ 1,500, $ 1,600, and $ 4,800, respectively. The 1982 promotional materials provided to petitioners contained the statement that the value of the EMS I, II, and III was $ 65,000, $ 175,000, and $ 280,000, respectively.
The ultimate profitability (without considering tax benefits) of the venture to OEC and its lessees was dependent upon a number of factors, including the initial advanced rental and installation expenditures, annual energy bill, actual cost savings to the end user, the rate of inflation for energy costs, and useful physical and economic life of the equipment. For example, the advanced rental for an EMS III was $ 25,000 per unit, while installation was $ 2,150. The minimum annual energy bill that would justify use of the EMS III was $ 90,000. Based on a 1982 Department of Energy (DOE) report, energy costs were forecast to increase, on the average, 3.8 percent (electricity - 2.0 percent, gas - 9.1 percent, oil - 4.3 percent). This is a weighted average for the typical industrial/commercial fuel1990 Tax Ct. Memo LEXIS 695">*709 combination. Considering a 7-percent inflation rate, the annual rate of energy cost increase would be 10.8 percent. DOE reports for earlier periods had projected cost increases of some 20 percent. The percentages and relative figures for EMS I and II units are substantially similar.
Actual energy savings to a particular end user may vary significantly, depending on physical characteristics of the facility and energy conservation measures which may have been employed prior to installation of an energy management system. Industry reports predicted 5 to 12-percent savings with a maximum of approximately 20 percent. Actual savings are often less than projected. We agree with respondent's expert that 10 percent is a reasonable assumption.
Optimistic estimates of the engineering useful life of these units is 20 to 25 years. Engineering or physical useful life is the length of time the unit may remain operational with normal repairs. The units in question were warranted for only 1 year. Electronic equipment is also subject to obsolescence (economic useful life); while the unit is still operative, it may nonetheless be more cost-effective to replace it with newer, more efficient1990 Tax Ct. Memo LEXIS 695">*710 technology. These units are also subject to obsolescence or failure of the underlying climate control units (central heating or air-conditioning units). When these are replaced, the new units often incorporate internal energy management control systems. These devices have a useful life of approximately 10 years.
Using these assumptions, one can obtain projected cash flows for the lease of an EMS unit. Discounting this future cash flow to present value, to take into account the time value of money, is a way that has been used to measure the economic viability of these transactions. See
1990 Tax Ct. Memo LEXIS 695">*712 Under the terms of an OEC lease concerning energy minders an investor would experience negative cash flow, negative net present value of cash flow, and negative *2009 internal rate of return, as follows:
Item | EMS I | EMS II | EMS III |
Negative cash flow | $ 2,043.00 | $ 3,829.00 | $ 7,769.00 |
Negative net present | |||
value of cash flow | 3,366.00 | 8,181.00 | 13,959.00 |
Negative internal | |||
rate of return | 7.8% | 5.4% | 6.9% |
Petitioners/Rogers resided in Atlanta, Georgia, when the petition was filed in this case. Petitioner-husband/Rogers (Rogers) attended the OEC informational meeting. Rogers had been either a partner or sole proprietor of a photography business for 12 years as of 1982. Rogers was familiar with photography before he engaged in that business. Rogers' educational background was the equivalent of the completion of one year of college. For 1982, Rogers reported the income and deductions of his photography business on a Schedule C, entitled "Profit or (Loss) From Business or Profession." Rogers in 1982 invested $ 5,250 ($ 5,000 of which was claimed as rent and $ 250 as an installation fee), all of which was claimed1990 Tax Ct. Memo LEXIS 695">*713 as deductions and a loss for 1982. Rogers reported his OEC activity as his leasing business involving energy devices on a Schedule C, entitled "Profit or (Loss) From Business or Profession." In addition to the $ 5,250 loss claimed for 1982, Rogers also claimed credits against tax in the total amount of $ 13,000. The credits against tax were for the investment tax credit ($ 6,500) and the energy credit ($ 6,500), each of which represented 10 percent of $ 65,000, the purported value of the system leased by Rogers. The combination of the OEC loss and credits generated a reduction in petitioners/Rogers' 1982 tax liability, along with a small refund of some withheld tax. The investment tax and energy credits generated refunds of most of the Federal income tax that had been paid by petitioners/Rogers for their 1979, 1980, and 1981 taxable years.
Rogers did not understand the details of the OEC leasing transaction and he believed that he had purchased, rather than leased, a system. Rogers believed that the $ 5,000 "was for the purchase of the unit." Rogers had no expertise concerning the system or its value and relied upon the promotional material and Russell's recommendation concerning1990 Tax Ct. Memo LEXIS 695">*714 the tax aspects and potential for profit. Rogers did not know whether the system he allegedly leased had been installed with an end user or the name of his end user, if any, prior to the end of 1982.
Rogers did not take many steps to determine if the EMS unit allegedly leased had been received by an end user. Rogers did not receive any money or revenue from his OEC "investment." Rogers spent little, if any, time and effort on the energy management equipment leasing transaction and he made no independent investigation into the value of a system.
Rogers, presumably 9 subsequent to 1982, filed for relief regarding his involvement in the OEC transaction under the Witness and Victim Protection Act of 1982.
Petitioners/Moss resided1990 Tax Ct. Memo LEXIS 695">*715 in Malibu, California, at the time the petition was filed in their case. Petitioner-wife/Moss (Moss) attended the informational meeting, during the late fall of 1982, conducted by Collins. At the meeting, Moss received the promotional materials. Moss had been a bookkeeper prior to becoming involved in the OEC transaction in 1982. Moss' husband was in the insurance business during the same period. Petitioners/Moss, during 1982, invested $ 5,250 ($ 5,000 of which was claimed as rent and $ 250 as an installation fee), all of which was claimed as deductions and a loss for 1982. Petitioners/Moss reported their OEC activity as a leasing business involving energy devices on a Schedule C, entitled "Profit or (Loss) From Business or Profession." In addition to the $ 5,250 loss claimed for 1982, petitioners/Moss also claimed credits against tax in the total amount of $ 13,000. The credits against tax were for the investment tax credit ($ 6,500) and the energy credit ($ 6,500), each of which was based upon 10 percent of $ 65,000, the purported value of the system leased by petitioners/Moss. The $ 13,000 in tax credits reduced petitioners/Moss' tax liability for 1982 from $ 13,846 to $ 1990 Tax Ct. Memo LEXIS 695">*716 846, thereby permitting a $ 30,643 refund of tax withheld from Moss' husband's $ 111,401 compensation from Pennsylvania Life Insurance Company.
Moss did not understand the details of the OEC leasing transaction and believed that she had purchased, rather than leased, a system. Petitioners/Moss had no expertise concerning the system or its value and relied upon the promotional material and Russell's recommendation concerning the tax aspects and potential for profit. Moss did not know whether the system allegedly leased had been installed with an end user or the name of her end user, if any, prior to the end of 1982.
Petitioners/Moss did not take many steps to determine if the system allegedly leased had been received by an end user. Petitioners/Moss did not receive any money or revenue from their OEC "investment." Moss spent little, if any, time and effort on the energy management equipment leasing transaction, and she made no independent investigation into the value of a system.
*2010 Petitioners/Moss, presumably subsequent to 1982, filed for relief regarding involvement in the OEC transaction under the Witness and Victim Protection Act of 1982.
1990 Tax Ct. Memo LEXIS 695">*717 Petitioners/Morgan resided outside the United States in Mississauga, Ontario, Canada, at the time the petition was filed in their case. Petitioner-husband/Morgan (Morgan) had a college degree in business administration and has been a businessman since 1955. He had no expertise in energy devices and realized that Russell's expertise and advice concerned the tax and financial aspects of the OEC transaction with the assumption that the factual basis stated in the promotional materials was correct. Russell was petitioners/Morgan's accountant and he regularly prepared their income tax returns.
Morgan attended the informational meeting, during the late fall of 1982, conducted by Collins. At the meeting, Morgan received the promotional materials. Morgan was employed by A. L. Williams Insurance Agency as president of their Canadian operation during and prior to his involvement in the OEC transaction in 1982. Morgan's wife was also employed in the insurance business during the same period. Petitioners/Morgan, during 1982, invested $ 5,250 ($ 5,000 of which was claimed as rent and $ 250 as an installation fee), all of which was claimed as deductions and a loss for 1982. Petitioners/Morgan1990 Tax Ct. Memo LEXIS 695">*718 reported their OEC activity as a leasing business involving energy devices on a Schedule C, entitled "Profit or (Loss) From Business or Profession." In addition to the $ 5,250 loss claimed for 1982, petitioners/Morgan also claimed credits against tax in the total amount of $ 13,000. The credits against tax were for the investment tax credit ($ 6,500) and the energy credit ($ 6,500), each of which was based upon 10 percent of $ 65,000, the purported value of the system leased by petitioners/Morgan. The $ 13,000 in tax credits reduced petitioners/Morgans' tax liability for 1982 from $ 20,888 to $ 7,888, thereby permitting a $ 16,528 refund of tax withheld from the Morgans' $ 97,009 compensation from Pennsylvania Life Insurance Company and A. L. Williams Insurance Agency. For 1983 petitioners/Morgan deducted an additional $ 895 on a Schedule C for insurance ($ 145) and installation ($ 750).
Morgan did not generally understand the details of the OEC leasing transaction. Morgan had no expertise concerning the system or its value and relied upon the promotional material and Russell's recommendation concerning the tax aspects and potential for profit. Morgan did not know whether the1990 Tax Ct. Memo LEXIS 695">*719 system allegedly leased had been installed with an end user or the name of his end user, if any, prior to the end of 1982. Petitioners/Morgan did not pay the installation fee until 1983, in which year they claimed said amount as a deduction on their Schedule C.
Petitioners/Morgan did not receive any money or revenue from the OEC transaction. Morgan spent little time and effort on the energy management equipment leasing transaction and he made no independent investigation into the value of a system.
Petitioners/Morgan, presumably subsequent to 1982, filed for relief regarding involvement in the OEC transaction under the Witness and Victim Protection Act of 1982.
Petitioners/Johnson resided in Roswell, Georgia, at the time the petition was filed in their case. Petitioner-husband/Johnson (Johnson) had a college degree in history and was a vice president of sales for Spectra Scan, a company providing diagnostic imaging services to primary care physicians. He had no expertise in energy devices and realized that Russell's expertise and advice concerned the tax and financial aspects of the OEC transaction with the assumption that the factual1990 Tax Ct. Memo LEXIS 695">*720 basis stated in the promotional materials was correct. Russell was petitioners/Johnsons' accountant and he regularly prepared their income tax returns.
Johnson attended the informational meeting, during the late fall of 1982, conducted by Collins. At the meeting, Johnson received the promotional materials. Johnson read the materials and was familiar with the details of the leasing transaction. Petitioners/Johnson, during 1982, invested $ 5,250 ($ 5,000 of which was claimed as rent and $ 250 as an installation fee), all of which was claimed as deductions and a loss for 1982. Petitioners/Johnson reported their OEC activity as a leasing business involving energy devices on a Schedule C, entitled "Profit or (Loss) From Business or Profession." In addition to the $ 5,250 loss claimed for 1982, petitioners/Johnson also claimed credits against tax in the total amount of $ 13,000. The credits against tax were for the investment tax credit ($ 6,500) and the energy credit ($ 6,500), each of which was based upon 10 percent of $ 65,000, the purported value of the system leased by petitioners/Johnson. The $ 13,000 in tax credits reduced petitioners/Johnsons' tax liability for 1982 from1990 Tax Ct. Memo LEXIS 695">*721 $ 11,011 to zero, thereby permitting a $ 11,158 refund of tax withheld from Johnson's $ 71,758.18 compensation from his wages for 1982. The remaining $ 2,658 in credits was carried back to petitioners/Johnsons' 1979 taxable year, which generated an additional refund of tax paid in connection with 1979 income in the amount of $ 2,658.
Johnson had no expertise concerning the system or its value and relied upon the promotional material and Russell's recommendation concerning the tax aspects and potential for profit. Johnson did not know whether the system allegedly *2011 leased had been installed with an end user or the name of his end user, if any, prior to the end of 1982.
Petitioners/Johnson did not receive any money or revenue from the OEC transaction. Johnson spent little time and effort on the energy management equipment leasing transaction, and he made no independent investigation into the value of a system.
Petitioners/Johnson, presumably subsequent to 1982, filed for relief regarding involvement in the OEC transaction under the Witness and Victim Protection Act of 1982.
Petitioners/McEvoy resided in Dunwoody, Georgia, at the time the petition1990 Tax Ct. Memo LEXIS 695">*722 was filed in their case. Petitioner-husband/McEvoy (McEvoy) had been a pilot in the United States Air Force and, since 1973, he was a pilot employed by Delta Air Lines. He had no expertise in energy devices and realized that Russell's expertise and advice concerned the tax and financial aspects of the OEC transaction with the assumption that the factual basis stated in the promotional materials was correct. Russell was petitioners/McEvoys' accountant and he prepared their 1982 and subsequent income tax returns.
McEvoy attended the informational meeting, during the late fall of 1982, conducted by Collins. At the meeting, McEvoy received the promotional materials. Petitioners/McEvoy, during 1982, invested $ 5,250 ($ 5,000 of which was claimed as rent and $ 250 as an installation fee), all of which was claimed as deductions and a loss for 1982. Petitioners/McEvoy reported their OEC activity as a leasing business involving energy devices on a Schedule C, entitled "Profit or (Loss) From Business or Profession." In addition to the $ 5,250 loss claimed for 1982, petitioners/McEvoy also claimed credits against tax in the total amount of $ 13,000. The credits against tax were for the1990 Tax Ct. Memo LEXIS 695">*723 investment tax credit ($ 6,500) and the energy credit ($ 6,500), each of which was based upon 10 percent of $ 65,000, the purported value of the system leased by petitioners/McEvoy. Twelve thousand three hundred twenty-eight dollars of the $ 13,000 in tax credits reduced petitioners/McEvoys' income tax liability for 1982 from $ 12,328 to zero, thereby permitting a $ 10,832 refund of tax withheld from McEvoys' $ 72,507 in compensation from his wages for 1982. An additional $ 672 in income tax credits was carried forward to petitioners/McEvoys' 1983 taxable year, which generated an additional refund of tax paid in connection with 1983 income in the amount of $ 672. Petitioners/McEvoy also claimed an $ 895 loss from the OEC activity for 1983 comprised of $ 145 insurance and $ 750 installation expenses. No income was reported in 1982 or 1983 from the OEC leasing transaction.
McEvoy had no expertise concerning the system or its value and relied upon the promotional material and Russell's recommendation *2012 concerning the tax aspects and potential for profit. McEvoy did not know whether the system allegedly leased had been installed with an end user or the name of his end user, if any, 1990 Tax Ct. Memo LEXIS 695">*724 prior to the end of 1982.
McEvoy spent little time and effort on the energy management equipment leasing transaction, and he made no independent investigation into the value of a system.
Petitioners/McEvoy, presumably subsequent to 1982, filed for relief regarding involvement in the OEC transaction under the Witness and Victim Protection Act of 1982.
Petitioners/Ridgeway resided in Stone Mountain, Georgia, at the time the petition was filed in their case. Petitioner-husband/Ridgeway (Ridgeway) is a computer programmer and had been an officer of Con Data Corporation for 18 years. He had no expertise in energy devices and realized that Russell's expertise and advice concerned the tax and financial aspects of the OEC transaction with the assumption that the factual basis stated in the promotional materials was correct. Ridgeway did not understand all aspects of the leasing transaction. Russell was petitioners/Ridgeways' accountant and he prepared their 1982 income tax return.
Ridgeway attended the informational meeting, during the late fall of 1982, conducted by Collins. At the meeting, Ridgeway received the promotional materials. Petitioners/Ridgeway, 1990 Tax Ct. Memo LEXIS 695">*725 during 1982, invested $ 5,250 ($ 5,000 of which was claimed as a rental fee and $ 250 as an installation fee), all of which was claimed as deductions and a loss for 1982. Petitioners/Ridgeway reported their OEC activity on a Schedule C, entitled "Supplemental Income Schedule." In addition to the $ 5,250 loss claimed for 1982, petitioners/Ridgeway also claimed credits against tax in the total amount of $ 13,000. The credits against tax were for the investment tax credit ($ 6,500) and the energy credit ($ 6,500), each of which was based upon 10 percent of $ 65,000, the purported value of the system leased by petitioners/Ridgeway. A combination of deductions and credits reduced petitioners/Ridgeway's 1982 income tax liability $ 4,285, which assisted in generating a $ 24,776 refund of tax withheld from petitioners/Ridgeways' $ 90,000 in compensation from wages for 1982. An additional $ 8,912 was carried back to petitioners/Ridgeways' 1979 taxable year, generating additional refunds. No income was reported in 1982 from the OEC leasing transaction.
Ridgeway had no expertise concerning the system or its value and relied upon the promotional material and Russell's recommendation concerning1990 Tax Ct. Memo LEXIS 695">*726 the tax aspects and potential for profit. Ridgeway did not know whether the system allegedly leased had been installed with an end user or the name of his end user, if any, prior to the end of 1982.
Ridgeway spent little time and effort on the energy management equipment leasing transaction, and he made no independent investigation into the value of a system.
Petitioners/Ridgeway, presumably subsequent to 1982, filed for relief regarding involvement in the OEC transaction under the Witness and Victim Protection Act of 1982.
ULTIMATE FINDINGS OF FACT
The systems (EMS I units) involved in the transactions of each group of petitioners in these cases had a fair market value of $ 1,500 during 1982. The $ 65,000 value reported by each group of petitioners in connection with their claim for $ 13,000 in tax credits was overvalued 43.33 times, or an overvaluation of 4,333 percent of the fair market value. The motivation of each petitioner herein who became involved during 1982 in the OEC leasing transaction was to seek the tax benefits. Each petitioner who was involved in an OEC leasing transaction could not have made a profit and therefore did not have an "actual and honest objective1990 Tax Ct. Memo LEXIS 695">*727 of making a profit."
OPINION
Petitioners concede that they are not entitled to the claimed deductions and credits which related to the OEC transaction. The only issues remaining for our consideration involve the additions to tax and additional interest relating to petitioners' lease of energy management devices from OEC. The burden of proof is on petitioners to show they are not liable for these additions.
Petitioners' main argument on brief is that they "conducted themselves as reasonable and ordinary prudent persons under the circumstances * * * with the intent of earning a profit * * * [and that they] relied upon the professional opinion of Chandler Russell, their personal accountant." Petitioners also contend that they have proven that the energy minders were not installed during the 1982 taxable year, which would require us to hold that the addition to tax for overvaluation is inapplicable under the holding in
To the contrary, respondent essentially argues that the entire record supports1990 Tax Ct. Memo LEXIS 695">*728 the ultimate conclusion that petitioners did not have the objective to make a profit, but were motivated by their desire to obtain tax benefits and that the additions to tax and increased interest are applicable. We consider each addition to tax and increased interest separately.
We first address whether petitioners in cases with docket Numbers 27353-86, 44611-86, 4215-87, 4317-87, and 25670-87 are liable for the addition to tax under
Negligence, within the meaning of
In
It was petitioners' reliance upon the purported values of the energy minders and factual1990 Tax Ct. Memo LEXIS 695">*730 statements made by the promoters that generated the tax credits and deductions in these cases. The purported value of the energy minders is the very thing that the taxpayers and their advisors in these cases did not verify. See
In
Here a computer-like device purportedly worth at least $ 65,000 was being leased. Even though petitioners purported to be in an individual proprietorship leasing energy minding equipment, not one of the "investors"1990 Tax Ct. Memo LEXIS 695">*732 asked to see the device or be assured of its existence prior to "investing" and claiming relatively substantial deductions and credits in relation to his or her "investment."
Based upon a $ 5,000 investment, petitioners were not in a position to lease a $ 65,000 piece of equipment which was allegedly capable of generating as much as $ 20,000 of income and an immediate cash return of about three times the $ 5,000 "investment" in the form of reduced tax liability or refunds of tax paid in prior years. The purported $ 65,000 equipment value equaled an amount approaching petitioners' annual incomes, and yet they were satisfied with representations of value in the promotional materials. Moreover, even though petitioners had not seen the piece of equipment and were not aware of its existence or installation, they "invested" and claimed the tax benefits. These factors lead us to the conclusion that these OEC transactions were distorted, unrealistic, and structured merely to obtain tax benefits.
We consider here individuals who are personally setting out to engage in a complex leasing business involving a purportedly expensive and an obviously scientifically sophisticated piece of equipment. 1990 Tax Ct. Memo LEXIS 695">*733 They are not mere passive investors, but active business participants. They cannot avoid the negligence addition when they have wrongly claimed extraordinary tax benefits, merely because a tax advisor has read the prospectus and advised that it is feasible from a tax perspective, assuming the facts presented are true.
In
We believe that these consolidated cases are governed by
The responsibility in this case is analogous to the type of responsibility with which the executor in
We find it particularly relevant1990 Tax Ct. Memo LEXIS 695">*736 that petitioners did no outside investigation of the OEC program. We have rejected pleas of reliance when neither the taxpayer nor the "expert" relied upon (by the taxpayer) knew anything about the business.
Moreover, the inherent structure of the OEC transaction (where "investors" received an immediate return of about three times their "investment" from tax benefits irrespective of the success of the venture) is1990 Tax Ct. Memo LEXIS 695">*738 one where a profit objective is, at best, a secondary concern, if a concern at all. The actions of petitioners in these cases do not support their claims that they had an interest in profit. Petitioners did not read the offering materials in their entirety. While petitioners may not understand a complex tax opinion, they did not thoroughly review the other materials or seek technical assistance regarding the nontax aspects of this investment in which their advisor (Russell) was not versed. None of them investigated the facts which needed to be correct or true before the possibility of income could become a reality. Instead, petitioners seemed quite content to immediately receive refunds from the Government of tax paid and withheld and did not check into the details before claiming the various tax benefits. Although some petitioners made inquiries into the status of the energy system after investing in the OEC transaction and reporting the tax benefits, those inquiries were insignificant in relation to petitioners' reporting a $ 65,000 value for purposes of the $ 13,000 in tax credits without any inquiry into the basis for the value or the existence of the equipment. After all, 1990 Tax Ct. Memo LEXIS 695">*739 the negligence is in relation to what the taxpayers report to the Government regarding the income, deductions, and credits on their income tax returns.
Petitioners were aware of the tax benefits, including the investment tax credit, when they invested. They depended on the credits for the return of monies initially invested. The value of the equipment was essential to claim tax credits. Petitioners have not shown that they exhibited care in claiming this amount on their returns without some verification of the value. Petitioners claimed and received income tax refunds that were more than double the amount of the first year's prepaid rental. We cannot ignore the extraordinary substanceless inflation of the claimed value of the units (43.33 times fair market value).
In summary, reliance upon professional advice is "not an absolute defense to negligence * * * First it must be established that the reliance was reasonable."
At least one of the petitioners (all of whom signed the tax return) in each of these consolidated cases was college educated and involved in business and professional activity. One petitioner operated a proprietorship and included a business Schedule C with respect to his business in addition to the Schedule C reflecting the OEC*2015 leasing transaction. Other petitioners were executives in insurance companies, one was a computer expert, and another a commercial airline pilot. All petitioners were earning or being compensated at least $ 50,000, and some in excess of $ 100,000 per annum. In light of petitioners' level of business and professional sophistication, education, and financial success in other endeavors they have not convinced us here that it was prudent or reasonable for them to rely upon the accountant in this case for the factual information that each of them1990 Tax Ct. Memo LEXIS 695">*741 reported to respondent in order to claim entitlement to tax credits and deductions regarding their leasing business.
Next, we consider whether petitioners in cases bearing docket Numbers 27353-86, 43568-86, 44611-86, 4215-87, 4317-87, and 25670-87 are liable for the addition to tax determined under
1990 Tax Ct. Memo LEXIS 695">*742 Petitioners argue that the addition should not apply because the understatement was not "attributable to" a valuation overstatement, citing
Although the value claimed for each unit exceeds 250 percent of the correct amount and the disallowed tax credits1990 Tax Ct. Memo LEXIS 695">*743 for various years will result in underpayments of at least $ 1,000,
Although the parties argued about whether petitioners had shown that the EMS units had not been installed prior to the end of 1982, that question was addressed because of our holding in
Respondent determined a
1990 Tax Ct. Memo LEXIS 695">*745 Petitioners argue that there was substantial authority for the position taken regarding the OEC transaction. Although petitioners have not specifically indicated what that authority was or is, they pointed out that they all relied upon Russell. In this regard, petitioners' sole direction is to
To meet the requirements of1990 Tax Ct. Memo LEXIS 695">*746
The taxpayer in good faith relies on the opinion of a professional tax advisor, if the opinion is based on the tax advisor's analysis of the pertinent facts and authorities in the manner described in section 1.6661-3(b)(3) [which holds that the weight of the authorities for the tax treatment of an item is determined by the same analysis that a court would be expected to follow in evaluating the tax treatment of an item] and unambiguously states that the tax advisor concludes that there is a greater than 50-percent likelihood that the tax treatment of the item will be upheld in litigation if the claimed tax treatment is challenged by the Internal Revenue Service.
In this connection Russell (tax advisor/accountant to petitioners) testified that he did not make independent inquiry into any of the facts stated in the OEC materials. Additionally, petitioners were aware that Russell had no expertise in the energy minder business and that he did not verify the statements made by1990 Tax Ct. Memo LEXIS 695">*747 OEC in the promotional materials. Additionally, Russell did not testify concerning his analysis or the details of his opinion, if any, and there is no way to determine whether his analysis complied with the statute and regulations. Accordingly, we hold that petitioners are not entitled to any reduction of the understatement under
Petitioners also argue that
The standard for review with respect to the
The administrator's judgment and ability to provide uniform treatment to similarly situated taxpayers deserves our deference. We should not substitute our judgment for his. Nevertheless, we should not refrain from judging whether his discretion has been exercised arbitrarily, capriciously, or without sound basis in fact. * * *
In determining whether respondent has abused his discretion, we do not again consider whether petitioners' conduct satisfies the conditions for imposing the
The most important factor in determining reasonable cause and good faith is "the extent of the taxpayer's effort to assess [his] 1990 Tax Ct. Memo LEXIS 695">*749 proper tax liability under the law."
The rental deductions in each case exceeded the purchase price or value of the property being rented by more than three times the actual value (value - $ 1,500, rental - $ 5,000). The amount of rental claimed was prominently reflected on all tax returns of each petitioner and most, if not all of them, have testified and argued that the device was not installed and may not have been in existence at the time they claimed the $ 5,000 rental amount. Even to the untrained eye, a $ 5,000 rental for a device worth $ 1,500 would be unreasonable. The standard here requires that the factual basis upon which the tax advisor's opinion is rendered must be correct or to some extent reasonably verified. With these unverified factual premises, we cannot find that respondent abused his discretion in his refusal to waive a part or1990 Tax Ct. Memo LEXIS 695">*750 all of the understatements determined under
*2017 Our analysis of the facts of these cases, placing emphasis upon petitioners' lack of effort to assess the proper tax liability from a factual point of view is the correct focus in reviewing whether respondent abused his discretion. Having done so, we hold that reliance on a financial or tax advisor as to factual matters outside their knowledge is not a sufficient basis for finding that respondent abused his discretion in failing to waive the addition to tax. This is so here because of petitioners' failure to verify the factual aspects of their claimed business deductions and credits. That failure to verify, in the setting of these cases, is a significant factor which should be considered in deciding whether there was abuse of discretion.
The final issue is the interest imposed on tax-motivated transactions imposed by
Respondent has argued, 1990 Tax Ct. Memo LEXIS 695">*752 however, that the increased rate of interest applies to the disallowed credits, advanced rental, and other expenses under other categories under
All petitioners conceded that the credits and deductions were correctly disallowed by respondent. There were a number of grounds for disallowance. Petitioners have argued, in the same manner as they did for
To reflect the foregoing,
Footnotes
1. The cases of the following petitioners are consolidated with that of the Rogers' case for purposes of trial, briefing, and opinion: Leslie W. Moss and Barbara F. Moss, docket No. 43568-86; Richard B. Morgan and Betty B. Morgan, docket No. 44611-86; John M. Johnson and Dove P. Johnson, docket No. 4215-87; Robert E. McEvoy and Kathleen S. McEvoy, docket No. 4317-87; and, Royce B. Ridgeway and Melissa J. Ridgeway, docket No. 25670-87.↩
2. Respondent determined in all notices of deficiency that petitioners were liable for the increased rate of interest on tax-motivated transactions under
section 6621(c)↩ .3. All section references, unless otherwise indicated, are to the Internal Revenue Code of 1954, as amended and in effect for the years at issue. All rule references are to the Tax Court Rules of Practice and Procedure.↩
*. Pursuant to
section 6653(a)(1) , plus 50 percent of the interest on the deficiency pursuant tosection 6653(a)(2)↩ .*. Pursuant to
section 6653(a)(1) , plus 50 percent of the interest on the deficiency pursuant tosection 6653(a)(2)↩ .*. Pursuant to
section 6653(a)(1) , plus 50 percent of the interest on the deficiency pursuant tosection 6653(a)(2)↩ .*. Pursuant to
section 6653(a)(1) , plus 50 percent of the interest on the deficiency pursuant tosection 6653(a)(2)↩ .*. Pursuant to
section 6653(a)(1) , plus 50 percent of the interest on the deficiency pursuant tosection 6653(a)(2)↩ .4. These cases involve the same type leases of energy management devices as were at issue in
. However, in these actions petitioners seek to show only that respondent erred with respect to the additions to tax and the increased interest.Soriano v. Commissioner , 90 T.C. 44">90 T.C. 44↩ (1988)5. For reasons which remain unexplained in this record, respondent did not determine the same additions to tax in all of the notices of deficiency to the various petitioners here involved. The addition to tax for negligence under
sec. 6653(a) was determined with respect to all petitioners except petitioners/Moss. The addition undersec. 6659 was determined with respect to all petitioners. The addition undersec. 6661 was determined with respect to all petitioners except petitioners/Rogers and petitioners/Ridgeway. On the morning of the trial of these consolidated cases, respondent attempted (by motion) to raisesec. 6661 ↩ with respect to those petitioners for whom respondent had not determined that addition to tax in the notice of deficiency. Respondent's motion was denied due to untimeliness and its prejudicial effect on the affected petitioners.6. The term "petitioners" when used in this opinion refers to all petitioners collectively, to the extent that they participated in the OEC leasing transaction under consideration.↩
7. The reports of respondent's experts in this case,
(1988),Soriano v. Commissioner , 90 T.C. 44">90 T.C. 44 , andKaba v. Commissioner , T.C. Memo. 1989-148 , are similar, and in many respects are identical.Keenan v. Commissioner , T.C. Memo. 1989-300↩8. We will briefly explain the methodology used by respondent's expert in reaching his conclusions. Discounted cash flow equals lessee's discounted percentage of energy savings minus advanced rental and installation expenses. The starting point for total energy savings is the minimum annual bill. This is projected into the future using the anticipated energy inflation rate, i.e., $ 90,000 X 10.8 percent = $ 99,720 -- the energy bill for year 2; $ 99,720 X 10.8 percent = $ 110,490 -- the energy bill for year 3, and so on. The energy savings rate is then applied to each year's annual energy bill, resulting in total projected energy savings. The lessee is entitled to 10.62 percent of this figure. The lessee's portion of savings is then discounted to present value using a 20-percent rate of return. The projection is extended for 10 years into the future, the anticipated useful life of the machines. Because the rate of return is built into the discount rate, any discounted cash flow greater than or equal to zero produces an economic profit.↩
9. The record does not include the date each petitioner filed under the referenced Act or the reason such filing was made. Petitioners offered this testimony to show that they, at some point in time, realized and/or believed that they had been duped.↩
10. We note that each petitioner herein subscribed to the jurat on their Federal income tax returns containing the following language: "Under penalties of perjury, I declare that I have examined this return, including accompanying schedules and statements, and to the best of my knowledge and belief, it is true, correct, and complete. Declaration of preparer (other than taxpayer) is based on all information of which preparer has any knowledge."↩
11. Sec. 8002(b) of the Omnibus Budget Reconciliation Act of 1986, Pub. L. No. 99-509, 100 Stat. 1874, 1951, increased to 25 percent the addition for substantial understatement, effective for additions assessed after Oct. 21, 1986. Because the addition will be assessed after that date, the 25-percent rate applies.
.Pallottini v. Commissioner , 90 T.C. 498">90 T.C. 498↩ (1988)12. Prior to the Tax Reform Act of 1986, subsection (c) was designated subsection (d). Sec. 1511(a), Pub. L. 99-514, 100 Stat. 2085, 2744. The additional interest applies only after Dec. 31, 1984, notwithstanding that the transaction was entered into prior to that date.
(1985), affd. per curiam without published opinionSolowiejczyk v. Commissioner , 85 T.C. 552">85 T.C. 552795 F.2d 1005">795 F.2d 1005 (2d Cir. 1986).Sec. 6621(c)↩ was repealed as of Dec. 31, 1989, by sec. 7721(b) of Pub. L. 101-239, 103 Stat. 2106, 2395.