Kellen v. Commissioner
| Decision Date | 22 January 2002 |
| Docket Number | Docket No. 5429-00. |
| Parties | William G. and Debra C. Kellen v. Commissioner. |
| Court | U.S. Tax Court |
In a so-called affected items notice of deficiency, respondent determined additions to tax to petitioners' Federal income tax for the year and in the amounts as shown below:
Additions to tax
________________________________________
Sec.1 Sec. Sec
Year 6653(a)(1) 6653(a)(2) 66613
1983 ................................ $685.50 $29,095.942 $3,427.50
1 Throughout this opinion and unless otherwise indicated, all section references are to the Internal Revenue Code in effect for
the taxable year in issue
2 The first page of the notice of deficiency mistakenly shows this amount as the sum of the additions to tax under sec
6653(a)(1) and (2), i.e., $29,781
3 The first page of the notice of deficiency mistakenly references sec. 6662(d), which section is the successor to sec. 6661 and
is applicable for returns the due date for which (determined without regard to extensions) is after December 31, 1989. See
Omnibus Budget Reconciliation Act of 1989, Pub. L. 101-239, sec. 7721(a), (c)(2), (d), 103 Stat. 2395-2400
After concessions by the parties,1 the issues for decision are as follows:
(1) Whether petitioner William G. Kellen (petitioner) is liable for additions to tax under section 6653(a)(1) and (2) for negligence or intentional disregard of rules or regulations. We hold that petitioner is liable for such additions.
(2) Whether petitioner is liable for the addition to tax under section 6661 for substantial understatement of tax liability. We hold that petitioner is liable for such addition.
The foregoing two issues relate to the participation of petitioner as a limited partner in a jojoba partnership known as San Nicholas Research, Ltd.
Some of the facts have been stipulated, and they are so found. The stipulated facts and attached exhibits are incorporated herein by this reference.
Petitioner resided in Cora, Wyoming, at the time that his petition was filed with the Court.
Petitioner is a highly educated individual. In 1964, he graduated from Loyola University of Los Angeles with a bachelor of science degree in civil engineering, specializing in water systems. Ten years later, in 1974, he received a law degree from Western State College of Law in Fullerton, California.
Since 1964, petitioner has practiced engineering in both the public and private sectors. Since 1974, he has practiced law in the private sector.
Petitioner also has experience related to farming. In 1974, he formed a company known as the Great American Hay Company that grew hay in Desert Center, California. In 1975, he and certain friends and investors purchased property known as Brown's Farm that grew citrus, alfalfa, and row crops.
In 1983, the taxable year in issue, petitioner was actively engaged in the practice of law, although he also served as a consulting engineer and was involved in farming.2 Petitioner maintained a law office in Riverside, California, and he specialized in the formation of financial institutions, such as banks, savings and loan associations, and thrift and loan associations. Petitioner formed more than 23 financial institutions in southern California.
Neither in 1983 nor at any other time relevant to this case did petitioner have any expertise in accounting or tax matters, nor did he ever attempt to render advice on those subjects.
In 1983, petitioner was financially well-off and sophisticated. For that year, he earned a net profit of $122,464 from his law practice, and he derived capital gains from stock transactions in the net amount of $115,5083 and interest in the amount of $21,747. In addition, petitioner had equity interests in: (1) An equipment rental proprietorship, (2) a partnership known as Fontana Bancorp Development, (3) five jojoba partnerships, see pp. 5-6, and (4) an S corporation known as Vancouver Coors, Inc.4
In late 1982, petitioner became the general partner and tax matters partner of four limited partnerships: Utah Jojoba Research, Ltd. (Utah Jojoba); Blythe Jojoba I Research, Ltd. (Blythe Jojoba I); Blythe Jojoba II Research, Ltd. (Blythe Jojoba II); and Desert Center Jojoba Research, Ltd. (Desert Center Jojoba).5 Each of these partnerships was similar, if not identical, to San Nicholas Research, Ltd., described infra pp. 5-11.
Prior to 1982, petitioner did not have any experience in growing jojoba, nor did he have any experience in either the research or development of jojoba. Prior to that time, petitioner's knowledge concerning jojoba was limited to articles that he had read in various magazines and a general familiarity with the existence of an experimental jojoba plantation located at the University of California at Riverside.
In late 1983, petitioner signed a subscription agreement and purchased 15 limited partnership units (an 11.719-percentage interest) in San Nicholas Research, Ltd. (San Nicholas or the partnership).6 Petitioner purchased the partnership units pursuant to a private placement memorandum dated October 10, 1983. See infra pp. 6-8, 8-11.
Petitioner paid $2,790 per limited partnership unit, or a total of $41,850, for his 15 units in San Nicholas. Of this amount, $1,140 per unit, or $17,100 for 15 units, was paid in cash. The balance, $1,650 per unit or $24,750 for 15 units, was payable pursuant to a 10-year promissory note.7
At the time that he signed the subscription agreement, petitioner believed that his investment in San Nicholas offered tax benefits, and his decision to invest was influenced by that belief.
According to the private placement memorandum dated October 10, 1983 (the offering memorandum), San Nicholas was formed in order "to undertake a comprehensive research and development program on the plant Simmondsia Chinesis (Jojoba)." The offering memorandum described how this program was to be carried out:
The Partnership will enter into a research and development contract * * * with U.S. Agri Research and Development Corp. (the "R & D Contractor"), who will conduct the experiments in various test sites * * * as well as its laboratory or greenhouse facilities that it in its sole discretion deems advisable. In addition, the R & D Contract sets forth that a site in the vicinity of Desert Center and Blythe, California of from 30-50 acres will be delineated as the applied research site upon which all technology and improved cultivars developed on behalf of the Partnership during the term of the contract will be placed "in field." The Partnership will also have the right but not be obligated to enter into a License Agreement * * * to license to U.S. Agri Research and Development Corp. all technology developed on behalf of the Partnership for a period of forty (40) years and receive therefrom an amount equal to 85% of the products produced from the developed technology.8
Copies of the research and development (R&D) contract and the license agreement referred to in the preceding paragraph were attached as exhibits to the offering memorandum. The R&D contract identified U.S. Agri Research and Development Corp. (U.S. Agri) as a party to the contract and the R&D contractor thereunder. The license agreement identified U.S. Agri as a party to the contract and the licensee thereunder.
As previously indicated, the offering memorandum identified U.S. Agri as the R&D contractor under the R&D contract and as the licensee under the license agreement. U.S. Agri was also the R&D contractor and the licensee for Utah Jojoba, Blythe Jojoba I, Blythe Jojoba II, and Desert Center Jojoba.
The president of U.S. Agri was Eugene Pace (Mr. Pace), who was also a member of its board of directors. Petitioner also served as a member of U.S. Agri's board until he became general partner of Utah Jojoba, Blythe Jojoba I, Blythe Jojoba II, and Desert Center Jojoba in late 1982.
At the time that petitioner invested in San Nicholas, he and Mr. Pace had been personal friends and business associates for a number of years.
The face of the offering memorandum warned, in block letters, that "THIS OFFERING INVOLVES A HIGH DEGREE OF RISK". The offering memorandum also included the following cautionary language in block letters:
PROSPECTIVE INVESTORS ARE CAUTIONED NOT TO CONSTRUE THIS MEMORANDUM OR ANY PRIOR OR SUBSEQUENT COMMUNICATIONS AS CONSTITUTING LEGAL OR TAX ADVICE. * * * INVESTORS ARE URGED TO CONSULT THEIR OWN COUNSEL AS TO ALL MATTERS CONCERNING THIS INVESTMENT.
* * * * * * *
THERE IS NO PUBLIC OR OTHER MARKET FOR THE UNITS, NOR WILL SUCH MARKET DEVELOP.
* * * * * * *
THE PURCHASE OF SUCH UNITS DESCRIBED IN THIS MEMORANDUM INVOLVES A HIGH DEGREE OF RISK (SEE "RISK FACTORS") AND SHOULD BE CONSIDERED ONLY BY PERSONS WHO CAN AFFORD THE TOTAL LOSS OF THEIR INVESTMENT.
* * * * * * *
EACH PURCHASER OF THE UNITS HEREIN SHOULD AND IS EXPECTED TO CONSULT WITH HIS OWN TAX ADVISOR AS TO THE TAX ASPECTS.
In addition, the offering memorandum limited the sale of partnership units to investors with a net worth (exclusive of home, furnishings, and automobiles) of at least $150,000, or investors whose net worth was at least $50,000 (exclusive of home, furnishings, and automobiles) and who anticipated that, for the taxable year of the investment, they would have gross income of at least $65,000 or taxable income, a...
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