118 F.3d 184 (4th Cir. 1997), 96-2266, Zfass v. C.I.R.

Docket Nº:96-2266.
Citation:118 F.3d 184
Party Name:Hyman S. ZFASS, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
Case Date:June 23, 1997
Court:United States Courts of Appeals, Court of Appeals for the Fourth Circuit

Page 184

118 F.3d 184 (4th Cir. 1997)

Hyman S. ZFASS, Petitioner-Appellant,

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 96-2266.

United States Court of Appeals, Fourth Circuit

June 23, 1997

Argued May 9, 1997.

Page 185

ARGUED: Craig Dennis Bell, Taylor, Hazen & Kauffman, L.C., Richmond, VA, for appellant. Patricia McDonald Bowman, Tax Division, United States Department of Justice, Washington, DC, for appellee. ON BRIEF: Loretta C. Argrett, Assistant Attorney General, Richard Farber, Tax Division, United States Department of Justice, Washington, DC, for appellee.

Before MURNAGHAN and NIEMEYER, Circuit Judges, and FABER, United States District Judge for the Southern District of West Virginia, sitting by designation.

Affirmed by published opinion. Judge MURNAGHAN wrote the opinion, in which Judge NIEMEYER and Judge FABER joined.

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OPINION

MURNAGHAN, Circuit Judge:

The Internal Revenue Service ("IRS") determined that Hyman Zfass, Appellant, participated in a tax shelter which was solely tax motivated. The IRS, therefore, disallowed the deductions taken on his income tax returns and required him to pay interest and penalties. Zfass's wife was dismissed as an innocent party.

Zfass has argued that he exercised good faith in relying on his own expertise in the medical field and his accountant's advice in assessing the profitability of the tax shelter and that the negligence penalties were therefore improper. Moreover, he also has contested the overvaluation penalty assessed claiming that the deficiency was related to a reduction in deductions and not to a valuation overstatement. Zfass also objected to the increased rate of interest employed by the IRS in calculating what he owed.

The Tax Court upheld the IRS's determination regarding tax liability and penalties. The Tax Court declined to rule on the validity of the increased interest rate since the Tax Court concluded that it lacked jurisdiction to do so.

FACTS

Hyman Zfass is a medical doctor who specializes in sports medicine. In 1982 Zfass purchased one partnership share in Therapeutics CME Group, L.P., a limited partnership the stated purpose of which was to acquire by lease and to market continuing medical education ("CME") video programs.

The video disk master programs were produced by World Video Crop and the television center of Hahnemann Medical College and Hospital of Philadelphia ("Hahnemann"). The partnership was responsible for reproducing the programs and selling them to members of the medical profession to satisfy their continuing medical education requirements. Dr. Zfass was an expert in sports medicine and was familiar with Hahnemann and at least one of the physicians who was the moderator on one of the tapes.

The cost of one partnership share was $17,000, half of which was paid in 1982 and half in 1983. The partnership promised that in return for his investment Zfass would receive a tax deduction of $31,902 in 1982 and $27,745 in 1983. Assuming a taxpayer was in the 50% tax bracket, the taxpayer would receive almost $16,000 in 1982 and $14,000 in 1983.

Zfass learned about the partnership from B. Roland Freasier, Zfass's tax adviser and attorney. Freasier introduced Zfass to Virgil Williams who was the partnership's tax matters partner. Zfass was provided with a private placement memorandum which Zfass read "from cover to cover."

The private placement memorandum thoroughly discussed the tax implications of the partnership. The memorandum stated:

ESTIMATED TAX EFFECT PER $17,000 UNIT: Although Therapeutics CME Group, L.P. ("Partnership") may have income from its operations, for illustration purposes, the figures below do not take into account any income and assume a 50% tax bracket taxpayer. The Internal Revenue Service (the "IRS" or "Service") may disallow any of the various elements used in calculating Partnership expenses and credits thereby reducing federal income tax benefits on an investment. 1982 1983 Capital contribution $ 8,500 $ 8,500 Deductible Loss Equivalent 31,903 27,745 Tax Write-off to Cash Investment Ratio 3.8 to 1 3.3 to 1

The deductible loss equivalent represents the tax deduction to the taxpayer. 1 Therefore, in 1982 a taxpayer could expect to receive a $3.8 tax deduction for every one dollar invested. Assuming the taxpayer was in the 50% tax bracket this would represent a $1.90 return for every dollar invested. So assuming the

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partnership never made a penny, the taxpayer would still receive almost a 100% return on his investment by virtue of payment to the taxpayer from the United States Treasury.

The private placement memorandum, as well as a tax opinion letter that was attached to the memorandum, warned potential investors that the IRS was attempting to identify and examine "abusive" tax shelters and that the IRS's actions increased the likelihood that the investor's return would be audited.

The memorandum also warned investors that the depreciation deductions and investment tax credit that the partnership intended to claim and pass through to its partners would be based on a fair market value of each master video disk of $877,663, and that there was no assurance "that the Masters could be sold for the appraised value or that the lease fee program will provide the Partnership with a fair return on equity."

Although it is unclear to what extent, Zfass discussed the possibility of purchasing an interest in the partnership with Freasier. Zfass claims that due to his medical knowledge and his impression of Hahnemann and the physicians involved in the tapes he believed that the partnership would make a profit. However, the private placement memorandum made no projections regarding sales, income, or return on investment excluding tax benefits. In fact, the main return on investment representation assumed that the partnership was not profitable.

What Zfass knew was that, as the partnership was presented, he could not lose. He would receive almost a 100% return on his investment if the partnership failed to sell even one video tape. It was unnecessary for the partnership to convince Zfass that it could make a profit, because Zfass would profit, by way of payment by the United States Treasury, regardless of whether the partnership turned a profit.

After Zfass became a limited partner in the partnership, the partnership's tax return, as well as the tax returns of 26 similar partnerships, was audited by the IRS. The IRS sent notices to the parties that the tax deductions would be disallowed and the partnership's tax matters partner filed a petition in the Tax Court to contest the adjustments.

Since the 27 partnerships all involved the production of videotapes for use in CME programs, the partnerships and the IRS agreed to use three of the partnerships as a test case. See Charlton v. Commissioner, 60 T.C.M. (CCH) 324, 1990 WL 106668 (1990), aff'd 990 F.2d 1161 (9th Cir.1993). In Charlton, the Tax Court upheld the IRS's determination and held that: (1) the partnerships lacked any profit objective; (2) the sales forecast and the values of the license, leases, and tapes were grossly overstated; and (3) these were sham transactions entered into primarily for their tax benefits. Id. at 347-352, 355.

After the Charlton decision the partnership's tax matters partner agreed to the disallowance of all deductions and investment tax credits and the disallowance was passed through to each partner. Zfass was assessed $15,773 for 1982 and $10,805 for 1983 plus interest and penalties. The IRS argued that Zfass was negligent in claiming the deductions and penalized him under 26 U.S.C. § 6653. In addition, it claimed Zfass's underpayment of tax was due to a value overstatement and penalized him under 26 U.S.C. § 6659. The IRS further charged Zfass an increased rate of interest because his underpayment was due to a tax motivated transaction. Zfass does not contest that he owes $15,773 and $10,805 for the disallowed deductions, but he does contest the IRS's assessment of interest and penalties. The Tax Court upheld the penalties assessed by the IRS. The Tax Court declined to consider whether Zfass was liable for additional interest under § 6621(c) since the Tax Court determined that it lacked jurisdiction under White v. Commissioner, 95 T.C. 209, 1990 WL 125093 (1990).

Zfass appeals the Tax Court's determination that the negligence and overvaluation penalties apply. In addition, Zfass contends that White v. Commissioner is wrongly decided and that the Tax Court has jurisdiction over additional interest under § 6621(c).

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DISCUSSION

The Tax Court's findings of fact will be upheld unless they are clearly erroneous. Hendricks v. Commissioner, 32 F.3d 94, 97 (4th Cir.1994). The Tax Court's decision is clearly erroneous if "on the entire evidence the reviewing court is left with the definite and firm conviction that a mistake has been made." Faulconer v. Commissioner, 748 F.2d 890, 895 (4th Cir.1984). "[W]here there are two permissible views of the evidence, the factfinder's choice between them cannot be clearly erroneous." Hendricks, 32 F.3d at 97, citing Thomas v. Commissioner, 792 F.2d 1256, 1260 (4th Cir.1986).

I. Negligence Penalties

Under former § 6653, a taxpayer could be assessed a 5% penalty for underpayment of taxes if any part of the underpayment was due to negligence or intentional disregard of rules and regulations. 2 The taxpayer bears the burden of disproving IRS's determination of negligent underpayment. Korshin v. Commissioner, 91 F.3d 670, 671 (4th Cir.1996). Negligence denotes "lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances." Id. at 672, citing Schrum v. Commissioner, 33 F.3d 426, 437 (4th Cir.1994).

One factor which courts consider in determining if persons acted negligently is whether they relied on advice from a tax advisor. United...

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