Durrett v. Commissioner
| Decision Date | 21 April 1994 |
| Docket Number | Docket No. 21771-84. |
| Parties | Joseph B. Durrett, Jr. and Carolyn C. Durrett v. Commissioner. |
| Court | U.S. Tax Court |
Thomas E. Redding, Paul J. Coselli, Alan L. Tinsley, and Charles Benjamin Koerth, 4544 Post Oak Pl. Dr., Houston, Tex., and David C. Holland, 2727 Allen Parkway, Houston, Tex., for the petitioners. Paul J. Krug, for the respondent.
Memorandum Findings of Fact and Opinion
This case was assigned to Special Trial Judge Carleton ID. Powell pursuant to 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.
POWELL, Special Trial Judge:
By notice of deficiency dated April 3, 1984, respondent determined deficiencies in petitioners' Federal income taxes and additions to tax as follows:
Additions to Tax
---------------------------------
Years Deficiency Sec. 6653(a)(1) Sec. 6653(a)(2)
1979 $ 68,279 $ 3,414.00 --
1980 858,193 42,909.65 --
1981 196,220 9,811.00 1
1 50 percent of the interest due on the underpayment
In an amended answer, respondent asserted that the deficiencies for all the years in issue were substantial underpayments due to tax-motivated transactions, and that the increased rate of interest under section 6621(c) was applicable.
At the time the petition was timely filed petitioners resided in Houston, Texas.
The issues are: (1) Whether petitioners may amend their petition to claim an investment tax credit carryback from 1983 to the 1980 taxable year; (2) whether the increased interest provisions of section 6621(c) apply; and (3) whether petitioners are liable for additions to tax under section 6653(a).
Petitioners were represented by counsel at all relevant times. The notice of deficiency in this case was issued on April 3, 1984, and the petition was timely filed on June 29, 1984. Petitioners' 1983 Federal income tax return was filed on or about October 15, 1984. On that return petitioners showed a "tentative regular investment credit" in the amount of $95,766; they did not claim, however, any credit because of other limitations on credit arising from the alternative minimum tax.
This case was calendared for trial on the negligence and section 6621(c) issues commencing on April 29, 1993. On April 21, 1993, petitioners filed a Motion for Leave to Amend Petition, and lodged with the Court a proposed First Amendment to Petition. The proposed amendment states, inter alia:
Petitioners are entitled in 1980 to a[n] * * * investment tax credit carryback from 1983 based on their 1983 Form 1040 as originally filed.
The 1983 investment tax credit arises from the activities of a partnership subject to sections 6221 through 6233 (). In addition to the potential credit, petitioners' 1983 return also claims substantial losses from other partnership and farming activities. Respondent did not commence an administrative proceeding with respect to the partnership and did not examine petitioners' 1983 return. Respondent opposes the motion for leave to amend. In so doing, respondent alleges that she would suffer prejudice because the files concerning the 1983 return are now unavailable.
The deficiencies in this case result, in part,2 from the disallowance of partnership losses in the following amounts:
Ordinary Short Term Capital
------------------- ---------------------
Partnership Year Income Loss Gain Loss
10179 1979 -0- ($143,235) -0- -0-
10179 1980 -0- (524) -0- -0-
5180 19801 -0- (391,422) $962,962 ($964,061)
5180 1981 -0- (398,043) -0- -0-
1 For 1980, respondent disallowed all losses but did not take the short term capital gain
out of the computation of the deficiency for that year. The parties have stipulated that
neither the gains nor losses will be recognized
The partnership gains and losses arise from alleged straddle transactions of forward contracts for government-backed financial securities with First Western Government Securities, Inc. (First Western).
The First Western losses were the subject of this Court's opinion in Freytag v. Commissioner [Dec. 44,287], 89 T.C. 849 (1987), affd. [90-2 USTC ¶ 50,381] 904 F.2d 1011 (5th Cir. 1990), affd. on other grounds [91-2 USTC ¶ 50,321] 501 U.S. ___, 111 S. Ct. 2631 (1991). After a lengthy trial, this Court found, based on that record, inter alia, that "The transactions between First Western and its customers were illusory and fictitious and not bona fide transactions." Freytag v. Commissioner [Dec. 44,287], 89 T.C. at 875. This Court alternatively held that, even if the transactions had substance, they "were entered into primarily, if not solely, for tax-avoidance purposes." Id. at 876. Based on the finding that the transactions were not bona fide, this Court concluded that additional interest under section 6621(c) was due on the underpayments. Id. at 886-887.
In concluding that the transactions were not bona fide, this Court examined various aspects of the First Western program, including the risk of profit and loss, the hedging operation, the margins required and fees charged, the pricing of the forward contracts that were involved, and the manner in which the transactions were closed. In all of these areas we found that the First Western operations were deficient and not conducted as they should have been if bona fide financial transactions were being conducted. With respect to the losses, this Court noted:
Petitioners' portfolios were constructed so as to achieve their desired tax losses. In this regard, the most important required data supplied by petitioners were their requested tax losses. Indeed, the program could not be implemented without the tax information. Thus, in analyzing the program for a profit standpoint, from the first, the tax tail wagged an economic dog. * * * [Id. at 878.]
We also pointed out that there were other "gremlins" in First Western's world that dispelled the notion that these transactions were bottomed in financial reality—reversing transactions months later, confirmations being months late, transactions being made with no documentation, etc. Id. at 882.
In the case currently before the Court, petitioner3 concedes that the transactions with First Western were conducted in the same way as the transactions discussed in Freytag, i.e., the same pricing algorithms were used, the transactions were closed in the same way, etc. He does not contest the disallowance of the losses claimed. He does, however, contest the increased interest under section 6621(c) and the additions to tax for negligence under section 6653(a).
Petitioner has a degree in chemical engineering. In 1976 he started his own business, Chemical Exchange (Chemical). Chemical's (and petitioner's) primary business was buying and selling fuel oil. Petitioner was president of Chemical and information concerning the profitability of the corporation was available to him at all times. By 1979, the business had become very successful. Petitioner's compensations from Chemical were $333,562.50, $516,987, and $605,658, respectively for the taxable years 1979, 1980, and 1981. Petitioner's withheld taxes for each year were $16,168, $16,546, and $26,953, respectively.
Petitioner was introduced into First Western's world by Allen Daniels (Daniels). Daniels is an attorney with apparently a general business practice. He is not an expert in financial markets or in tax advantaged investments; he had, however, advised petitioner with respect to a truck leasing venture that was successful. Through Daniels, petitioner was introduced to Kenneth McCoin (McCoin) who was with Mosher, McCoin & Sims, Inc., a firm that provides investment advice. McCoin told petitioner and Daniels that he had reviewed the First Western operations and that they appeared to be a bona fide business. Although McCoin explained the First Western program to petitioner and Daniels, neither understood how the program worked. Petitioner testified that
I don't think I had ever been acquainted with a straddle before, but he [McCoin] said that [is] what we would do—what I understood to do—and contrary to what everybody has been talking about, I had never heard of a formula.
I thought we were buying some sort of a bond, and then we were buying bonds on the other side; buying Freddie Macs and selling Fannie Maes or vice versa. There was some difference in the interest [rates] between those two, and we could make some money on that. Frankly, I didn't understand.
In short, both petitioner and Daniels relied on McCoin.
McCoin was a so-called "finder" for First Western; he was paid by First Western for putting clients into the First Western program. He had approximately 100 clients in the First Western program and the firm was paid over $600,000 by First Western. Petitioner and Daniels were aware that McCoin was paid by First Western. McCoin also was an investor in the programs and claimed deductions from purported losses. Freytag v. Commissioner [Dec. 44,287], 89 T.C. at 873-875. With regard to the firm of Mosher, McCoin & Sims, Inc., we noted:
The corporation [Mosher, McCoin & Sims, Inc.] prepared various presentations of the First Western program for its customers in which it was pointed out that, even if the customer lost his entire margin, he would make a profit from tax savings. The following statement was made by the corporation: "Cash deposit 17% of writeoff should expect to lose all...
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