89 T.C. 986 (1987), 7034-84, Cherin v. C.I.R.

Docket Nº:7034-84
Citation:89 T.C. 986
Opinion Judge:WHITAKER, JUDGE:
Party Name:RALPH CHERIN, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Attorney:Judith A. Frankel, for the petitioner. Avery B. Cousins III, for the respondent.
Judge Panel:SWIFT, J., CONCURRING: JACOBS, J., agrees with this concurring opinion. CHABOT, J., concurring in part and dissenting in part: STERRETT, CHIEF JUDGE, dissenting:
Case Date:November 23, 1987
Court:United States Tax Court
 
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Page 986

89 T.C. 986 (1987)

RALPH CHERIN, Petitioner

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 7034-84

United States Tax Court

November 23, 1987

Petitioner invested in the Southern Star Land & Cattle Co ., Inc. tax shelter program. HELD, the purported sales of cattle were lacking in economic substance and the benefits and burden s of ownership were not transferred to petitioner. HELD FURTHER, applicability of sec. 6621(c) determined.

Judith A. Frankel, for the petitioner.

Avery B. Cousins III, for the respondent.

WHITAKER, JUDGE:

Respondent determined deficiencies in petitioner's Federal income tax for the years and in the amounts as follows:

Years Amount
1972 $27,425
1973 18,905
1974 13,191
1975 2,740
1976 1,586
1977 185
1978 1,416
By amendment to the answer, respondent asserts that the deficiencies constitute substantial underpayments attributable to tax-motivated transactions within the meaning of section 6621(c), [1] formerly section 6621(d). The issues for decision all arise out of petitioner's investment in a cattle program operated and offered by Southern Star Land & Cattle Co., Inc. (Southern Star). [2] Petitioner's investments were made in June 1971 and January 1972. This same cattle shelter has been the subject of three Memorandum Opinions of this Court, Hunter v. Commissioner, T.C. Memo. 1982-126; Siegel v. Commissioner, T.C. Memo. 1985-441; and Page 987 Jacobs v. Commissioner, T.C. Memo. 1985-609. Thus the essential question to be determined is whether this petitioner's case is factually distinguishable from Hunter, Siegel, and Jacobs. Petitioner contends that it is distinguishable. FINDINGS OF FACT Some of the facts have been stipulated and they are so found. Petitioner's residence at the time of the filing of this petition was in Hialeah, Florida. In and prior to 1971, petitioner's principal business was the management of beauty shop. In 1971, petitioner separated from his wife and allocated to her for her support many of the income- producing properties which comprised his beauty shop business. He also anticipated retirement upon reaching the age of 65 in 1975. Petitioner was looking for an investment which would produce significant income for his retirement years when his income from other sources was expected to be materially reduced. In due course, petitioner inquired of Nathan Newman, an accountant, financial advisor and attorney, who had been assisting petitioner for approximately 20 years, as to possible investments. Newman was then aware of the Southern Star program and apparently had an arrangement with Southern Star for payment of a finder's fee for investors in the program produced by him, a fact which petitioner did not discover until long after his investments had been made. Newman recommended that petitioner invest in the Southern Star program which was described by him to petitioner as one which would not require petitioner's personal attention and would produce a regular income after retirement. Newman showed to petitioner a projection showing receipt of regular income after 1975. The projection had been prepared by a Mr. Levine who was described as a friend. [3] Petitioner thereafter made some projections himself, but made no other investigation. Petitioner was relatively unsophisticated in making investments and had become accustomed to relying upon Newman whom petitioner regarded as capable and unbiased. Petitioner had no experience in either ownership or management of cattle and had no desire Page 988 to become a cattle operator. Petitioner's reliance upon Mr. Newman's advice under the facts of this case was reasonable. On June 1, 1971, petitioner and Southern Star entered into a sales agreement providing for the purchase [4] of a herd of 25 purebred Aberdeen Angus female cows and a one-third interest in a bull. Simultaneously with execution of the sales agreement, petitioner entered into a management agreement pursuant to which Southern Star undertook to manage the herd. Petitioner probably executed a number of related documents, as specified in these two agreements, including one or more promissory notes, a security agreement, and he may have received a separate bill of sale. On January 17, 1972, petitioner entered into a similar set of agreements for the purchase of a herd of five Aberdeen Angus cows and a two- thirds interest in an Aberdeen Angus bull. The principal reason for acquisition of the second herd was to obtain the contract right under the management agreement to have the herd include a bull calf out of Southern Star's prize bull. Petitioner never inspected the cattle allocated to his herds. The parties have primarily sought to focus on the distinctions from and similarities to the facts in Hunter, Siegel, and Jacobs. Therefore, a discussion of Southern Star and its cattle program is a necessary background. Southern Star was organized in 1970 by Neil Levine and Harry Epstein. [5] It operated three cattle ranches - at Citra, Florida; Cassoday, Kansas; and Marshfield, Missouri. In general the Southern Star program contemplated the purchase of one or more herds of cattle, varying in size, with herd management by Southern Star constituting an essential element of the program. The terms of the management agreements were indefinite, with termination to occur when the herds were liquidated. Liquidation was to occur upon notice under varying circumstances, the investor's opportunity to give notice being more restrictive than Southern Star's. While the management agreement remained in effect, the herds Page 989 were to be managed solely in the discretion of Southern Star. Each management agreement provided specifically that, so long as the agreement was in effect, Southern Star had ‘ full control of the location, maintenance, expansion, breeding, and culling‘ as well as the determination of the ‘ most opportune time for sales.‘ The size of each investor's herd was to be increased by about 50 percent through the retention of calves. Calves which were not so retained were to be sold by Southern Star and the proceeds divided between the parties, except that in all transactions except petitioner's 1971 purchase the proceeds were applied first on the unpaid purchase price. The herds of specific investors such as petitioner were at least in theory identified by tattoo and ear tag numbers but were mixed with other similar herds and other cattle of Southern Star and placed on one or more of the ranches in Southern Star's discretion. The purchase price of petitioner's first herd was $62,500. [6] $10,000 of that sum was allocated to the one-third interest in a bull, reflecting a purported value for the bull of $30,000. The balance of $52,500 was allocated to the 25 cows, reflecting a purchase price per cow of $2,100. The sale agreement required a downpayment of $900 and installment payments of $300 per month, plus interest, starting July 1, 1971, for 30 months. Starting January 1, 1974, the monthly payments increased to $500 for the succeeding 90 months. Thus, within 10 years $54,900 was specified in the contract to be paid on principal. The deferred payments were reflected by a nonrecourse promissory note. [7] Petitioner originally intended to make each of these payments as they came due. Petitioner's second herd of five cows and a two-thirds interest in a bull (which actually turned out to be 2 one-third interests in two bulls) had a purchase price of $32,500. The dow payment was $1,000, and the balance was to be paid from 30 percent of the proceeds from the sales of cattle. The cows cost $2,500 each and the bull was again valued at $30,000. Interest was required to be paid monthly Page 990 from January 1, 1973, through December 1, 1974. Thereafter, interest was also payable from salas of cattle from the second herd. Petitioner was obligated under each management agreement to make substantial cash payments for Southern Star's services in increasing amounts in each of the first 3 years. During 1971, petitioner paid in cash interest as well as principal and maintenance. Principal payments on the first herd were made through 1974 aggregating $15,900. No payments were made after 1975 and the payments in that year of interest and for management were less than $200. Petitioner continued to make the specified payments of principal through 1974 although he was aware of continuing deficiencies in Southern Star's management of the herds. He complained repeatedly about the inadequate calf crops, the failure to observe the 80-percent live birth guarantee, [8] and the failure to increase the size of his herd, but his complaints were unheeded. All of the animals in the two herds remained registered with the American Angus Association in the name of Southern Star. In 1979 petitioner filed suit against Southern Star in the Circuit Court of Dade County, Florida, but ultimately abandoned the suit. [9] The animals allocated to petitioner's herds were of inferior quality, many having been purchased by Southern Star from the Black Watch Farm, a somewhat similar program which went into bankruptcy. The cows in petitioner's herds were worth no more than the average auction sale prices of Aberdeen Angus cattle during this period, $468 in 1971 and $526 in 1972. The bulls allocated to the herds were worth approximately $647 in 1971 and $740 in 1972. [10] In 1981 Southern Star ceased business. It purported to recognize a dollar liability to petitioner but no payments were made to him. No collection efforts were made by petitioner since he believed that Southern Star was without Page 991 assets. Petitioner's herds were purportedly liquidated but petitioner never received any proceeds of sale. To the extent not sold to third parties, whatever was left of petitioner's herds was transferred to another cattle operation in Mississippi without petitioner's consent. When petitioner made each of these investments in 1971 and...

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