Glassley v. Commissioner

• Citation: 71 T.C.M. 2898
• Decision Date: 30 April 1996
• Docket Number: Docket No. 24177-89.,Docket No. 19140-89.,Docket No. 13431-89.
• Parties: Stephen H. Glassley and Judith Glassley, et al.<SMALL><SUP>1</SUP></SMALL> v. Commissioner.
• Court: United States Tax Court

71 T.C.M. 2898

T.C. Memo. 1996-206

Stephen H. Glassley and Judith Glassley, et al.¹ v. Commissioner.

Docket No. 13431-89.

Docket No. 19140-89.

Docket No. 24177-89.

United States Tax Court.

Filed April 30, 1996.

John E. Williams and Eric W. Bloom, Washington, D.C., for the petitioners. Rodney J. Bartlett and Brian M. Harrington, for the respondent.

                CONTENTS
                [CCH Pages]
                MEMORANDUM FINDINGS OF FACT AND OPINION .................................................      2899
                OPINION OF THE SPECIAL TRIAL JUDGE ......................................................      2899
                FINDINGS OF FACT ........................................................................      2900
                  A. Background
                     1. The Jojoba Industry in General ..................................................      2900
                     2. Carol A. Whittaker ..............................................................      2900
                     3. Joseph E. Berberich .............................................................      2900
                     4. Jojoba Development Partners, Ltd.  ..............................................      2901
                        a. The Private Offering Memorandum ..............................................      2901
                

                        b. The Research and Development Agreement .......................................      2903
                        c. The Option and Joint Venture Agreement .......................................      2904
                        d. The Farm Lease ...............................................................      2905
                        e. The option and Farm Lease Agreement ..........................................      2906
                     5. Petitioners .....................................................................      2906
                        a. Petitioners Stephen H. Glassley and Judith S. Glassley .......................      2906
                        b. Petitioner Paul S. Mahoney  ..................................................      2907
                        c. Petitioners Edward F. Houser, Jr. and Kathryn G. Houser ......................      2907
                  B. The Jojoba Plantation ..............................................................      2908
                  C. The Consequences of Petitioner's Initial Investment ................................      2911
                  D. The Experts ........................................................................      2911
                     1. Paul H. Gross ...................................................................      2911
                     2. Dr. Eberhardt ...................................................................      2912
                     3. Marvin T. Parr ..................................................................      2913
                OPINION
                  A. The Criteria That Must Be Satisfied For Expense Treatment Under Section 174 ........      2913
                     1. The Expenditures Must Be For Research or Experimentation ........................      2914
                     2. The Expenditures Must Be Paid or Incurred on Behalf of the Taxpayer .............      2917
                     3. The Expenditures Must Be Paid Or Incurred in Connection with the Taxpayer's Trade
                         or Business ....................................................................      2918
                  B. Negligence .........................................................................      2921
                     1. Petitioners Glassley and Houser .................................................      2921
                     2. Dr. Mahoney .....................................................................      2922
                  C. Increased Interest .................................................................      2922
                

MEMORANDUM FINDINGS OF FACT AND OPINION

DAWSON, Judge:

These cases were assigned to Special Trial Judge Norman H. Wolfe pursuant to the provisions of section 7443A(b)(4) and Rules 180, 181, and 183.² The Court agrees with and adopts the opinion of the Special Trial Judge, which is set forth below.

OPINION OF THE SPECIAL TRIAL JUDGE

WOLFE, Special Trial Judge:

Respondent determined deficiencies in and additions to petitioners' Federal income taxes as follows:

                Additions to Tax
                                                                      ---------------------------------------------
                Petitioners                       Year   Deficiency   Sec. 6653(a)(1)   Sec. 6653(a)(1)   Sec. 6659
                Glassley ......................   1981   $20,222.00     $1,011.00              1             --
                Mahoney .......................   1981    23,283.00      1,164.15              2          $6,984.90
                Houser ........................   1981    19,476.06      1,337.12              3             --
                                                  1982       160.00        277.35              4             --
                1 50 percent of the interest due on $20,222
                2 50 percent of the interest due on 23,283
                3 50 percent of the interest due on $19,476.06
                4 50 percent of the interest due on $160
                

In the statutory notices of deficiency for petitioners Stephen H. Glassley and Judith S. Glassley (petitioners Glassley) and petitioner Paul S. Mahoney (Dr. Mahoney), respondent also determined that the provision for increased interest under section 6621(c)³ applied. Subsequently, respondent asserted by first amendment to answer that petitioners Edward F. Houser, Jr., and Kathryn G. Houser (petitioners Houser) were liable for increased interest under section 6621(c).⁴ Respondent concedes that there is no addition to tax due from Dr. Mahoney under section 6659.

The issues remaining for decision are: (1) Whether petitioners are entitled to deduct losses relating to their investments in a limited partnership, Jojoba Development Partners, Ltd., which arose principally from that partnership's deduction of purported research and development expenditures paid or incurred during 1981; (2) whether petitioners are liable for additions to tax for negligence; and (3) whether petitioners' underpayments of tax are attributable to a tax-motivated transaction for purposes of computing increased interest pursuant to section 6621(c).

FINDINGS OF FACT

Some of the facts have been stipulated, and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.

A. Background

1. The Jojoba Industry in General

The jojoba plant is a shrub that is native to the Sonoran Desert region in Arizona, California, and Mexico. A jojoba plant may live well over 100 years. The female jojoba plant produces a seed, sometimes referred to as a bean, that contains approximately 50 percent by weight of an unusual oil. Jojoba oil is actually a liquid wax ester, unlike the triglyceride oils typically produced by plants, and is similar to sperm whale oil.

It takes 5 years or more for a jojoba plant to produce seeds in a harvestable quantity. Approximately 20 pounds of jojoba seeds are needed to produce 1 gallon of jojoba oil. Jojoba oil is useful for a variety of purposes, ranging from cosmetics and shampoos to industrial lubricants.

The ban in 1971 on the importation of sperm whale oil and products using that oil stimulated an interest in the commercial production of jojoba oil. During the nineteen seventies and into the early nineteen eighties, jojoba oil was available only from native jojoba plants. At that time in the United States, there were only a few commercial-sized jojoba plantations, all of which were in developmental stages. Domestication studies were being conducted in the United States during that time at the University of California at Riverside and the University of Arizona, among other places.

2. Carole A. Whittaker

Prior to 1978, Carole A. Whittaker (Whittaker) taught mathematics and science, primarily chemistry, at the high school through college levels. Whittaker became generally interested in the jojoba plant and its seed during 1976 or 1977. She left her teaching position in 1978 to consider entering private business and then took a sabbatical year, during which she investigated jojoba more intensively. By the end of 1978, she had decided to plant and farm jojoba as a business. From 1978 through 1980, Whittaker read extensively on the subject, attended international conferences on jojoba, and consulted various authorities in the field, including Dr. Demetrios Yermanos (Yermanos)⁵ of the University of California at Riverside and Dr. Lemoyne Hogan of the University of Arizona.

From September 1978 through the spring of 1979, Whittaker searched for a location on which to develop a commercial jojoba plantation. Whittaker had experience in science and project management but she had no experience in economics or business. She therefore also sought advice during that time from friends and colleagues about how to develop a commercial jojoba enterprise.

By June 1979, Whittaker identified a section of land in Hyder, Arizona, on which to develop a commercial jojoba plantation. At that time, with some associates, she formed Hyder Jojoba, Inc. (HJI), a subchapter S corporation organized under the laws of Arizona. Whittaker became HJI's president and chairman and was its principal shareholder.

During August 1979, HJI acquired a 640-acre parcel of partially developed land in Hyder, Arizona, and began farm development. A small planting of jojoba undertaken in the fall of 1979 failed. Extensive planting of jojoba plants began in the spring of 1980. HJI had planted 400 acres of jojoba by the fall of 1980. Planting of the remaining 240 acres was completed in 1981 with the help of financing provided by Hyder Jojoba Partners (HJP), a farming partnership. HJI was the general partner of HJP, provided farm management services to HJP, and leased land to HJP.

3. Joseph E. Berberich

Joseph E. Berberich (Berberich) is a partner in the law firm of Manning, Leaver, Bruder, and Berberich, located in Los Angeles, California. He is involved primarily in a commercial and business practice of law. His law firm was not directly involved in the transactions in issue in the instant cases.

Berberich became interested in jojoba in 1979 after reading in World Market Perspective, an industrial newsletter, an article entitled "Jojoba, Super Bean of the Future"....