Keller v. C.I.R., 06-75441.

• Decision Date: 26 February 2009
• Docket Number: No. 06-75441.,06-75441.
• Citation: 556 F.3d 1056
• Parties: Michael W. KELLER, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

556 F.3d 1056

Michael W. KELLER, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 06-75441.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted February 3, 2009.

Filed February 26, 2009.

Terri A. Merriam, Merriam & Associates, P.C., Seattle, WA, for the petitioner-appellant.

Anthony T. Sheehan, United States Department of Justice, Tax Division, Washington, D.C., for the respondent-appellee.

Appeal from a Decision of the United States Tax Court, Harry A. Haines, Presiding. Tax Ct. 9662-01.

Before: B. FLETCHER, PAMELA ANN RYMER and RAYMOND C. FISHER, Circuit Judges.

RYMER, Circuit Judge:

Michael W. Keller appeals the tax court's order upholding the Commissioner of Internal Revenue's imposition of accuracy-related penalties for his tax underpayment for years 1994 and 1995. Keller now concedes that a 20 percent penalty for negligence is appropriate under 26 U.S.C. § 6662(b)(1)¹ but contests the enhancement to a 40 percent penalty for gross valuation misstatements under § 6662(h). Because we agree with Keller that, under the law of this circuit, his tax underpayment is not "attributable to" a valuation overstatement, we affirm in part, reverse in part, and remand to the tax court for calculation of the 20 percent negligence penalty.

I

Keller is one of hundreds of individuals who obtained illegitimate tax benefits through the sheep and cattle investment shams directed by Walter J. Hoyt, III. This court is, by now, quite familiar with Hoyt inspired cases. See, e.g., River City Ranches # 1 Ltd. v. Comm'r, 401 F.3d 1136 (9th Cir.2005); Durham Farms, # 1 v. Comm'r, 59 Fed.Appx. 952 (9th Cir. 2003) (unpublished); River City Ranches # 4 v. Comm'r, 23 Fed.Appx. 744 (9th Cir.2001) (unpublished). Unlike many of his fellow investors, Keller was not a Hoyt partner—rather, his participation was limited to contributing money as a solo investor.

Keller is employed by the United States government's Military Sealift Command and has been since 1982. In the three years preceding his investment with Hoyt, Keller's income ranged from $70,094 to $107,841. Although Keller first learned of the Hoyt investment scheme as far back as 1985, his interest was piqued in December 1994 by colleagues while on a tour of duty at sea. The captain, and many other shipmates, were partners involved in the business of owning registered cattle.

Keller's colleagues informed him the investment scheme, which afforded significant tax savings, was found to be legitimate by the tax court in the Bales² case and gave him promotional materials to review. He found the promotional materials persuasive—Hoyt was described as one of the top cattlemen in the industry who had been in business for forty years. In Keller's opinion, if the investment scheme were not legitimate, it would already have been shut down by the Securities and Exchange Commission. Although Keller recognized he would receive significant tax savings through depreciation deductions at the beginning of the investment, he also claims to have expected a long-term profit.

In February 1995, Keller requested additional information from Hoyt and was contacted by Dave Barnes, a Hoyt representative. Barnes provided promotional materials and asked Keller to fill out a credit application and attach tax returns from the previous years. Eventually the two met at a Hoyt ranch in Elk Grove, California. The meeting lasted several hours and covered the investment opportunity generally and also included a description by Barnes of the outcome in Bales. Keller was additionally given independent media publications and cattle count reports.

Keller ultimately decided to invest in late February or early March 1995. He signed a 15-year promissory note to repay $956,980 in exchange for 146 heifers—half of which were only in the embryonic stage at purchase. Other sales documents included a bill of sale, a certificate of warranty, a sales order, and a security agreement. At no time in the purchasing process did Keller ever consult a tax expert or attorney regarding his investment.

Keller made no initial payments, other than a $50 application fee, to Hoyt to finance his investment. Instead, he agreed to allocate 75 percent of the tax savings he enjoyed from the investment back to Hoyt. He did, however, eventually begin making payments on the promissory note of a little over $1,000 each month. Upon finalization of the investment, Hoyt's accounting department immediately began preparing Keller's tax returns for 1994 and 1995.

As it turns out, Keller may not have acquired any cattle in the first instance. During Hoyt and his co-conspirators' criminal trial, the government described the cow shortage as "severe and pervasive." The shortage was growing, and yet nonexistent "phantom" cows continued to be sold to new investors. Additionally, the same cows—as identified by name and ear tag number—were often sold to more than one investor. Regardless, and although the purported cattle purchase did not occur until 1995, Keller's 1994 return contained a Schedule F—the schedule on which profits or losses associated with farming are reported—as did the 1995 return. The 1994 return reported a net loss of $302,818 and the 1995 return a loss of $107,951. Depreciation schedules showed the cost basis of the cattle to be $880,423 in 1994 and $625,100 in 1995.

Because Keller's losses for 1994 were so large and eliminated the totality of his 1994 income taxes with some loss leftover, he was able to carry back losses to eliminate any taxes that had been owed for 1991, 1992, and 1993. Keller was issued a refund of $11,773 for 1994 and a total of $40,740 for the carry back years. Hoyt collected $10,500 for 1994 and $30,500 for the carry back years for his services. Including the allocation of tax savings and the payments made on the promissory note, Keller ultimately paid Hoyt a total of $67,225.

Prior to the filing of the 1995 return, the Commissioner sent Keller notice that deductions stemming from the Hoyt tax shelter were unlikely to be allowable. Any return claiming a refund was to be reduced by the amount generated from the Hoyt investment scheme. It also warned of the accuracy-related penalties under § 6662 that would be applied in appropriate cases. The 1995 return was nonetheless filed, including Hoyt-related deductions, and requested a refund of $8,788. A refund was never issued.

On February 24, 1997, the Commissioner sent Keller a letter informing him that his 1994 and 1995 returns were under examination. A Notice of Deficiency, dated May 3, 2001, was later sent indicating a deficiency of $11,106 for 1994 and $17,410 for 1995. The Commissioner also assessed accuracy penalties under § 6662(h) of $4,442.40 for 1994 and $6,931.60 for 1995— that is, an additional amount equal to 40 percent of the underpayment. The deficiency was based on the Commissioner's conclusion that the cattle were not actually being used in a trade or business or to generate income. The 40 percent penalty was applied due to alleged gross valuation misstatements in the claimed value of the cattle.

Keller petitioned the tax court for a redetermination of the deficiency. However, prior to trial, Keller and the Commissioner stipulated that Keller should not have been entitled to any Hoyt-related deductions. The issue at trial was thus reduced to the imposition of accuracy-related penalties. The tax court determined that if Keller had in fact not acquired any cattle, his basis in the cattle would be zero for the relevant tax years, far below the claimed bases, and thus supported the 40 percent penalty for gross valuation misstatements. The court also found the 20 percent penalty for negligence applicable and rejected Keller's other defenses. Accordingly, it upheld the deficiency and penalty amounts in full. This appeal followed.

II

The factual findings underpinning whether an underpayment is attributable to a valuation overstatement are reviewed for clear error. Wolf v. Comm'r, 4 F.3d 709, 715 (9th Cir.1993). Application of the facts to the requirements of § 6662 is a question of law reviewed de novo. See Gainer v. Comm'r, 893 F.2d 225, 226 (9th Cir.1990) (reviewing now-repealed § 6659, a statute also imposing penalties for underpayment attributable to valuation overstatements).

III

In his briefing before this court, the Commissioner concedes that application of the gross valuation misstatement penalty to the 1994 tax year was inappropriate because Keller's purported purchase of cattle did not occur until 1995. Keller, on the other hand, concedes that a negligence penalty under § 6662(b)(1) is appropriate for both tax years 1994 and 1995. The question that remains for us is whether, for tax year 1995, the 40 percent penalty for gross valuation misstatements under § 6662(h) should be imposed instead—in other words, whether Keller owes around $7,000 plus interest (as the tax court held) or around $3,500 plus interest (as Keller claims).

Section 6662 of the Internal Revenue Code imposes a variety of accuracy-related penalties for tax underpayment. As a general rule, when § 6662 is applicable, the taxpayer is penalized "an amount equal to 20 percent of the portion of the underpayment." § 6662(a). Examples of when the 20 percent penalty applies include taxpayer negligence, § 6662(b)(1), and substantial valuation misstatements, § 6662(b)(3).³ The 20 percent penalty is enhanced to 40 percent, however, in the case of gross valuation misstatements. § 6662(h)(1). Keller makes no argument that if § 6662(h) applies to him, he did not make a gross valuation misstatement— that is, he does not contest that the claimed value of the cattle was more than 200 percent greater than their actual value.

Instead, he challenges whether § 6662(h) is applicable in the first instance. The statute applies to situations where the tax underpayment "is attributable to one or more gross valuation misstatements." § 6662(h)(1). Keller...