                       T.C. Memo. 2007-101



                     UNITED STATES TAX COURT



                GARY W. McDONOUGH, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 15239-04.             Filed April 25, 2007.



     Wendy S. Pearson, Terri A. Merriam, Jennifer A. Gellner,

Jaret R. Coles, Asher B. Bearman, and Brian G. Isaacson, for

petitioner.1

     Nhi T. Luu and Catherine Caballero, for respondent.



     1
       Wendy S. Pearson (Pearson), Terri A. Merriam (Merriam),
Jennifer A. Gellner (Gellner), and Jaret R. Coles entered their
appearances by subscribing the petition commencing this case.
See Rule 24(a). (Unless otherwise indicated, Rule references are
to the Tax Court Rules of Practice and Procedure, and section
references are to the applicable versions of the Internal Revenue
Code (Code).) Asher B. Bearman (Bearman) and Brian G. Isaacson
entered their appearances on July 18, 2005, and Aug. 15, 2006,
respectively. Pearson, Gellner, and Bearman withdrew from the
case on Oct. 16, Nov. 14, and Nov. 15, 2006, respectively.
                                 - 2 -

               MEMORANDUM FINDINGS OF FACT AND OPINION


     LARO, Judge:     This is an affected items proceeding arising

from disallowed partnership losses claimed for 1989 and 1991 by

Timeshare Breeding Service 1989-1, J.V. (TBS 89-1), a cattle

partnership organized, promoted, and operated by Walter J. Hoyt

III (Hoyt).2   Petitioner was a partner in TBS 89-1, and he

reported his distributive shares of its reported losses on his

1989 and 1991 Federal income tax returns.      Respondent determined

that petitioner is liable for the following accuracy-related

penalties with respect to his reporting of those disallowed

losses:3

                          Accuracy-related penalties
               Year       Sec. 6662(a) Sec. 6662(h)

               1989           -0-        $3,577.20
               1991        $5,669.40        -0-




     2
       Respondent’s disallowance of these losses was upheld in
Durham Farms #1, J.V. v. Commissioner, T.C. Memo. 2000-159, affd.
59 Fed. Appx. 952 (9th Cir. 2003).
     3
       For 1989, respondent determined that the accuracy-related
penalty under sec. 6662(h) applied to the portion of petitioner’s
underpayment resulting from a disallowed depreciation deduction
claimed by TBS 89-1. For 1991, respondent determined that
petitioner had an underpayment attributable to one or more of the
following under sec. 6662(a) and (b): (1) Negligence or
disregard of rules or regulations; (2) substantial understatement
of income tax; (3) substantial valuation misstatement. Because
respondent in his posttrial opening brief addresses only the
first two elements, we consider respondent to have waived any
argument that petitioner’s underpayment for 1991 was attributable
to a substantial valuation misstatement.
                                - 3 -

Petitioner petitioned the Court on August 23, 2004, to

redetermine that determination.

     On November 5, 2004, respondent filed with the Court an

answer to petitioner’s petition.   The answer alleges that in lieu

of the determined amounts, petitioner is liable for a $3,029.60

accuracy-related penalty under section 6662(h) for 1989 and a

$5,664.80 accuracy-related penalty under section 6662(a) for

1991.    On April 18, 2006, respondent amended his answer to allege

as an alternative to the accuracy-related penalty under section

6662(h) for 1989 that petitioner is liable for a $1,514.80

accuracy-related penalty under section 6662(a) for negligence or

disregard of rules or regulations, see sec. 6662(b)(1), and/or

for substantial understatement of income tax, see sec.

6662(b)(2).

     We decide whether petitioner is liable for the disputed

accuracy-related penalties.   We hold that petitioner is liable

for a section 6662(h) accuracy-related penalty for 1989 and a

section 6662(a) accuracy-related penalty for 1991, both in the

amounts alleged by respondent in his answer.4



     4
       At the outset, we note that three Courts of Appeals have
affirmed prior decisions of this Court holding that other
investors in Hoyt partnerships were liable for accuracy-related
penalties for negligence under sec. 6662(a) and (b)(1). See
Hansen v. Commissioner, 471 F.3d 1021 (9th Cir. 2006), affg. T.C.
Memo. 2004-269; Mortensen v. Commissioner, 440 F.3d 375 (6th Cir.
2006), affg. T.C. Memo. 2004-279; Van Scoten v. Commissioner,
439 F.3d 1243 (10th Cir. 2006), affg. T.C. Memo. 2004-275.
                                  - 4 -

                            FINDINGS OF FACT

      The parties filed with the Court stipulations of fact and

accompanying exhibits.     The stipulated facts are found

accordingly.      When the petition was filed, petitioner resided in

Westminister, California.

1.   Petitioner

      Petitioner was born in or about 1949.     He graduated from

high school and completed approximately 2-1/2 years of further

education mostly in business administration and fire science.       He

has never taken an accounting or tax course.

      In 1972, petitioner began working as a firefighter for the

Los Angeles Fire Department (LAFD).       He was promoted to captain

in 1986, and he held that position for 6 years.      In 1992, he

began working for the LAFD in its Internal Affairs Department.

In that capacity, he investigated suspect individuals who worked

for the fire department.

      Throughout the relevant years, petitioner has had limited

experience with cattle ranching.     He has worked sporadically on

some ranches branding and castrating cattle and bulls, and he has

occasionally helped a professional rodeo association set up and

run its rodeos.     He has never worked in a business office of a

cattle ranch, and he has no experience with cattle valuation.
                                 - 5 -

2.   Hoyt and His Organization

      From about 1971 through 1998, Hoyt organized, promoted, and

operated as a general partner various cattle breeding

partnerships.    Three of the partnerships were Durham Shorthorn

Breed Syndicate 1987-C J.V. (DSBS 87-C), Timeshare Breeding

Service J.V. (TBS), and TBS 89-1.    Hoyt organized, marketed,

promoted, and operated all of his partnerships in essentially the

same fashion.    Among other things, Hoyt was responsible for and

directed the preparation of each partnership’s tax returns, and

he typically signed and filed each of those returns.

3.   Petitioner’s Involvement With the Hoyt Partnerships

      In or about 1986, petitioner heard about the Hoyt

partnerships from his fellow firefighters at the LAFD.

Petitioner knew that 12 of his close coworkers either were

considering participating in a Hoyt partnership or had

participated in a Hoyt partnership.      Petitioner knew that two of

those coworkers had participated in one or more of the Hoyt

partnerships for as long as 10 years.

      In 1988, petitioner decided to participate in some of the

Hoyt partnerships with an intent to acquire a tax shelter and to

generate funds for his retirement.       Previously, in 1987 or 1988,

petitioner had visited Hoyt’s main office in Elk Grove,

California, and he had toured Hoyt’s facilities and ranches in

Burns, Oregon.    During his visit and tour, petitioner saw land
                               - 6 -

and equipment typically associated with ranches.    Petitioner did

not see (or ask to see) any record pertaining to a Hoyt

partnership.

     On July 15, 1988, petitioner signed a four-page document

memorializing his intent to buy two units in TBS at a total cost

of $7,000.   The document (TBS document) included sections

entitled “SUBSCRIPTION AGREEMENT AND SIGNATURE PAGE”,

“CERTIFICATION”, “POWER OF ATTORNEY”, “FILING ACKNOWLEDGEMENT”,

and “PARTNERSHIP AGREEMENT”, and it referenced a section in the

partnership agreement entitled “Risk Factors”.    The document

stated that petitioner, as a signer of the document, “recognizes

that even though the Partnership has a four year history of

operations and earnings, their [his] investment therein is a

speculative venture, and if they elect [he elects] to

participate, they [he] may lose the total amount of their [his]

investment.”   Petitioner did not seek independent professional

advice as to the TBS document before signing it, opting instead

to rely upon the words and actions of his coworkers as to their

participation in one or more Hoyt partnerships.    Later,

petitioner purchased interests in DSBS 87-C and TBS 89-1, without

signing any partnership document as to those purchases.

Petitioner knew at the time of his purchases that the Hoyt

partnerships advertised that his participation in a Hoyt

partnership allowed him to claim refunds of Federal income tax,
                                - 7 -

75 percent of which he had to give to the Hoyt organization and

25 percent of which he could keep.

     Petitioner received promotional materials from the Hoyt

organization, which he showed to other firemen who were Hoyt

participants but did not take to an attorney independent of the

Hoyt organization.   One of those documents was similar to a

brochure entitled “The 1,000 lb. Tax Shelter”.   That brochure

explained that the Hoyt partnerships were designed to provide

profits over time and emphasized that the primary return on

investment was realized through tax savings.   The brochure

indicated that the benefit of participating in a Hoyt partnership

was that participants could obtain refunds of Federal income tax

paid in the previous 3 years by amending their returns for those

years so as to claim a carryback of investment tax credits

generated by the partnership.   The brochure stated that each

partner had to pay 75 percent of the tax refunds to the Hoyt

organization as an investment in the cattle but could keep the

remaining 25 percent as a 30-percent return on investment.     The

brochure stated that the Hoyt organization would prepare each

partner’s tax returns, and

     would assist the Partners in claiming all the tax
     savings available to them first, before entering the
     Partnership numbers. If a Partner needs more or less
     Partnership loss any year, it is arranged quickly
     within the office, without the Partner having to pay a
     higher fee while an outside preparer spends more time
     to make the arrangements.
                                  - 8 -

The brochure discussed the potential of audits by the Internal

Revenue Service and stated that the Commissioner would brand the

Hoyt partnerships “an abuse” and would subject the partnerships

to “automatic” and “constant” audit.      The brochure stated the

Hoyt organization alone should be trusted to prepare each

partner’s tax returns.

      From July 1, 1988, through September 30, 1992, petitioner

paid the Hoyt organization the following amounts on the

accompanying dates:

                Date of Payment             Amount

                 July 1, 1988               $7,000
                 Jan. 4, 1991                6,000
                 Dec. 17, 1991               4,000
                 Dec. 17, 1991               5,000
                 Sept. 2, 1992               4,785
                                            26,785

4.   Petitioner’s Federal Income Tax Returns

      Petitioner’s 1988, 1989, 1990, and 1991 Federal income tax

returns were prepared by tax preparation entities operated by

Hoyt.   Petitioner provided those entities with his personal

information, such as wages, interest, dividends, mortgage

interest, and real estate taxes, and the Hoyt organization

provided the tax preparers with the amounts of losses and other

tax attributes to be reported as distributed from the Hoyt

partnerships.   Petitioner signed and filed his 1988, 1989, 1990,

and 1991 tax returns on the following dates:
                                - 9 -

    Year of Tax Return       Date Signed            Date Filed

          1988              Apr. 27, 1989          May 1, 1989
          1989              June 1, 1990           June 4, 1990
          1990              June 20, 1991          June 24, 1991
          1991              Sept. 30, 1992         Oct. 2, 1992

Petitioner did not make any meaningful inquiry to find a tax

professional independent of the Hoyt organization to prepare or

review the Hoyt organization’s preparation of those returns.

     Petitioner’s 1988 through 1991 tax returns reported the

following relevant items:

                              1988         1989       1990        1991

   Wages                  $69,612       $71,538    $94,995   $99,979
   Taxable interest           449           958      1,129     2,030
   Refund of State and
     local income taxes       843         3,694      1,789     3,173
   Capital gains (losses)   5,311        (3,000)       308       -0-
   Farm income                -0-           -0-        -0-    25,094
   Losses from Hoyt
     partnerships          40,414        31,069     55,941    92,961
   Losses from other
     partnerships             -0-           524      2,413     2,857
   Total income            35,801        41,597     39,867    34,458
   Tax liability              664         1,601      1,189        17
   Withholdings            11,378         3,024      5,039     4,070
   Refund                  10,714         1,423      3,850     4,053

The losses reported as flowing from the Hoyt partnerships were

broken down as follows:

   Partnership               1988        1989       1990         1991

     TBS                    $1,424       $3,560    $3,560        -0-
     DSBS 87-C              38,990         -0-     18,810        -0-
                                        1                    2
     TBS 89-1                -0-          27,509   33,571      $92,961
       Total                40,414       31,069    55,941       92,961
     1
       This partnership loss was attributable to a depreciation
    adjustment on property placed in service after 1986.
                               - 10 -
      2
        This partnership loss was further broken down as
     follows: Ordinary loss of $59,179 and a special
     allocation deduction of $33,782 for legal fees.

Petitioner never asked the Hoyt organization to let him see any

record relating to a partnership for which petitioner claimed

losses for 1988 and 1991, and petitioner never contacted the Hoyt

organization to ask questions or request records substantiating

the amounts of partnership losses reported on his 1989 and 1991

tax returns.

     Petitioner’s 1988, 1989, 1990, and 1991 tax returns included

Forms 8271, Investor Reporting of Tax Shelter Registration

Number, listing a number of tax shelters including TBS (for 1988,

1989, and 1990), DSBS 87-C (for 1988 and 1990), and TBS 89-1 (for

1989, 1990, and 1991).   Petitioner’s 1991 return also included a

one-page document that he entitled “Material Participation

Statement”.    Petitioner signed that statement on September 30,

1992, asserting therein that he had spent 145 hours in 1991

materially participating in a business activity of his named

“Gary McDonough Co.”    Petitioner’s 1991 return also included two

Schedules F, Profit or Loss from Farming, reporting farm income

of $1,800 and $23,294 from a “SALE OF COW” and “BREEDING VALUE

PRODUCTION AND SALES”, respectively, and reporting no related

farm expense.   The $23,294 stemmed from petitioner’s

participation in TBS 89-1 and appeared on his 1991 Schedule K-1,

Partner’s Share of Income, Credits, Deductions, Etc., from TBS
                                - 11 -

89-1.     The $1,800 may or may not have been related to

petitioner’s participation in TBS 89-1.

     For 1988, 1989, 1990, and 1991, petitioner received Federal

income tax refunds as follows:

             Year      Refund Amount     Date Refund Issued

             1988         $10,714           May 29, 1989
             1989           1,423           July 9, 1990
             1990           3,850           July 29, 1991
             1991           4,053           Nov. 2, 1992

5.   Documents From the Internal Revenue Service

        Before signing his 1991 tax return, petitioner received

notices of beginning of administrative proceeding (NBAP)

informing him that the Commissioner was examining the 1988, 1989,

and 1990 taxable years of DSBS 87-C.     Petitioner never took any

of the NBAPs to a tax professional independent of the Hoyt

organization, e.g., to inquire about its significance.      Before

signing his 1991 tax return, petitioner also received two letters

from the Internal Revenue Service, containing information

regarding material participation and section 469.

6.   The Bales Memorandum Opinion

        The case of Bales v. Commissioner, T.C. Memo. 1989-568,

pertained to Hoyt cattle partnerships (not including TBS 89-1)

and their 1974 through 1981 taxable years.     The Court in Bales

decided that those partnerships were not shams.     After Bales was

decided, Hoyt promoted the Hoyt partnerships to prospective

participants by referring to the case.
                                 - 12 -

     Petitioner obtained a copy of the Bales Memorandum Opinion

from another fireman.     Petitioner read that Memorandum Opinion,

and he read other related materials provided by Hoyt.     Petitioner

never took the Bales Memorandum Opinion to a tax professional

independent of the Hoyt organization for advice.

7.   Durham Farms #1

      On April 18 and August 15, 1994, respectively, respondent

mailed to petitioner an NBAP and notice of final partnership

administrative adjustment (FPAA) relating to the 1989 taxable

year of TBS 89-1.      On May 8, 1995, respondent issued to Hoyt, as

the tax matters partner (TMP) of TBS 89-1, an FPAA for the 1991

taxable year of TBS 89-1.     In response to these FPAAs, Hoyt, as

TMP of TBS 89-1, petitioned the Court on October 14, 1994, and

August 4, 1995.    The Court docketed the respective cases at our

docket Nos. 18707-94 and 14712-95.

      The Court decided the disputed issues underlying those

petitions in a partnership proceeding.     See Durham Farms #1, J.V.

v. Commissioner, T.C. Memo. 2000-159, affd. 59 Fed. Appx. 952

(9th Cir. 2003).    The Court held that various partnerships,

including TBS 89-1, did not receive the benefits and burdens of

ownership of the cattle in dispute there and were not entitled to

the claimed partnership deductions and losses.     On April 24,

2001, the Court entered decisions in Timeshare Breeding Serv.

1989-1, J.V. v. Commissioner, docket No. 18707-94, and Timeshare
                               - 13 -

Breeding Serv. 1989-1, J.V. v. Commissioner, docket No. 14712-95.

The decision for 1989 ordered and decided the following:

       Partnership Item           As Reported     As Determined

     Depreciation expense       $1,056,720            -0-
     Depreciation after 1986     1,056,720            -0-

The decision for 1991 ordered and decided the following:

       Partnership Item             As Reported     As Determined

     Farm income                        -0-             -0-
     Depreciation expense            $555,199           -0-
     Board expenses                 1,983,470           -0-
     Loss to drought                  237,325           -0-
     Interest expense                     -0-           -0-
     Net self-employment income    (2,750,837)          -0-
     Other deductions                  14,578           -0-
     Gain under section 1231           11,686           -0-
     Guaranteed payments                  -0-           -0-

     Respondent determined initially that these decisions

increased petitioner’s 1989 and 1991 income by $32,225 and

$100,241, respectively.   On May 13, 2002, respondent reflected

those increases by assessing against petitioner $8,943 and

$28,347 of deficiencies for 1989 and 1991, respectively, as

computational adjustments under section 6231(a)(6).      On May 26,

2004, respondent issued to petitioner the relevant affected items

notices of deficiency; those notices stated that petitioner was

liable for the disputed accuracy-related penalties as determined

on the basis of the deficiencies assessed as computational

adjustments.   On September 1, 2004, respondent notified

petitioner that respondent had revised his computations of the

increases to petitioner’s 1989 and 1991 income, and thus the
                                   - 14 -

amounts that should have been assessed as deficiencies related

thereto, to reflect his recent finding that the aforementioned

decisions increased petitioner’s income in the respective years

only by $28,059 and $100,226.5       On October 25, 2004, respondent

abated $1,369 and $23 of the assessed computational adjustments

for 1989 and 1991, respectively, thus reducing the assessed

amounts to $7,574 and $28,324, respectively.       Those reductions

led to respondent’s allegation in the answer that the accuracy-

related penalties for 1989 and 1991 equal $3,029.60 and

$5,664.80, respectively ($7,574 x .40 = $3,029.60; $28,324 x .20

= $5,664.80).

                                   OPINION

1.   Burden of Production

      Petitioner argues that section 7491(c) applies to place upon

respondent the burden of production as to the accuracy-related

penalties.6     Section 7491(c) was added to the Code by the


      5
       The letters also explained that respondent was reducing
petitioner’s self-employment tax for 1991 to reflect a correction
made in the calculation of self-employment income.
      6
          Sec. 7491(c) provides:

           SEC. 7491(c). Penalties.--Notwithstanding any
      other provision of this title, the Secretary shall have
      the burden of production in any court proceeding with
      respect to the liability of any individual for any
      penalty, addition to tax, or additional amount imposed
      by this title.

In order for the Commissioner to satisfy that burden of
                                                   (continued...)
                              - 15 -

Internal Revenue Service Restructuring and Reform Act of 1998,

Pub. L. 105-206, sec. 3001(a), 112 Stat. 726.    The amendment is

effective for “court proceedings arising in connection with

examinations commencing after” July 22, 1998.    Id. sec.

3001(c)(1), 112 Stat. 727.   While the parties agree that

respondent started examining TBS 89-1 before the effective date

of section 7491(c), the parties dispute whether respondent’s

examination of TBS 89-1 is the relevant examination for purposes

of establishing the date on which respondent started his

examination as to the affected items at issue.   According to

respondent, the affected items were determined “in connection

with” the examination of TBS 89-1 and, hence, the date on which

that examination began is the date that is used to test whether

section 7491(c) applies to this case.   According to petitioner,

respondent’s determination of the affected items resulted from a

separate, non-partnership-level examination of petitioner

personally and, hence, the starting date of the later examination

is the date to be used to determine the applicability of section

7491(c).   Notwithstanding which party bears the burden of


     6
      (...continued)
production, the record must establish that it is appropriate to
impose the relevant penalty, addition to tax, or additional
amount. See Higbee v. Commissioner, 116 T.C. 438, 446 (2001).
The burden of production and proof remain on the taxpayer to
establish that the penalty, addition to tax, or additional amount
does not apply because of reasonable cause, substantial
authority, or the like. Id.; see also H. Conf. Rept. 105-599, at
241 (1998), 1998-3 C.B. 747, 995.
                                - 16 -

production in this case, however, our review of the record leads

us to the same conclusion; i.e., that petitioner is liable for

the section 6662(h) accuracy-related penalty for 1989 and the

section 6662(a) accuracy-related penalty for 1991, both in the

amounts respondent alleged in his answer.     Thus, we need not and

do not discuss any further the parties’ dispute as to which of

them bears the burden of production in this case.

2.   Sections 6662 and 6664

       a.   Overview

       Section 6662 provides that a taxpayer may be liable for a

20-percent accuracy-related penalty on the portion of an

understatement of income tax attributable to (among other things)

negligence or disregard of rules or regulations or a substantial

understatement of income tax.     See sec. 6662(a) and (b)(1) and

(2).    Section 6662(h)(1) increases the amount of the section

6662(a) accuracy-related penalty to 40 percent in the case of

gross valuation misstatements.     Section 6664(c)(1) provides that

no accuracy-related penalty under section 6662 applies to the

extent that the taxpayer has reasonable cause for an underpayment

of tax and acted in good faith with respect to that underpayment.

       b.   Negligence/Disregard of Rules or Regulations

       For purposes of section 6662(a), negligence includes any

failure to make a reasonable attempt to comply with the

provisions of the Code or to exercise ordinary and reasonable
                              - 17 -

care in the preparation of a tax return; disregard includes any

careless, reckless, or intentional disregard of rules or

regulations.   Sec. 6662(c); see also Hansen v. Commissioner,

471 F.3d 1021, 1028 (9th Cir. 2006), affg. T.C. Memo. 2004-269.

Negligence has also been defined as the lack of due care or

failure to do what a reasonable and ordinarily prudent person

would do under similar circumstances.   Allen v. Commissioner,

925 F.2d 348, 353 (9th Cir. 1991), affg. 92 T.C. 1 (1989).

Negligence includes any failure by the taxpayer to keep adequate

books and records or to substantiate items properly, sec.

1.6662-3(b)(1), Income Tax Regs., and negligence is strongly

indicated where the taxpayer fails to make a reasonable attempt

to ascertain the correctness of a deduction, credit, or exclusion

on a return which would seem to a reasonable and prudent person

to be too good to be true under the circumstances, sec.

1.6662-3(b)(1)(ii), Income Tax Regs.

     Negligence is determined by testing a taxpayer’s conduct

against that of a reasonable, prudent person, Zmuda v.

Commissioner, 731 F.2d 1417, 1422 (9th Cir. 1984), affg. 79 T.C.

714 (1982), and courts generally look both to the reasonableness

of the underlying investment and to the taxpayer’s position taken

on the return in evaluating whether the taxpayer was negligent,

Sacks v. Commissioner, 82 F.3d 918, 920 (9th Cir. 1996), affg.

T.C. Memo. 1994-217.   When an investment has such obviously
                               - 18 -

suspect tax claims as to put a reasonable taxpayer under a duty

of inquiry, a good faith investigation of the underlying

viability, financial structure, and economics of the investment

is required.   Roberson v. Commissioner, T.C. Memo. 1996-335

(citing LaVerne v. Commissioner, 94 T.C. 637, 652-653 (1990),

affd. without published opinion 956 F.2d 274 (9th Cir. 1992),

affd. without published opinion sub nom. Cowles v. Commissioner,

949 F.2d 401 (10th Cir. 1991), and Horn v. Commissioner, 90 T.C.

908, 942 (1988)), affd. without published opinion 142 F.3d 435

(6th Cir. 1998).

     c.   Substantial Understatement of Income Tax

     An understatement of income tax is substantial if the amount

of the understatement exceeds the greater of 10 percent of the

tax required to be shown on the return or $5,000.     Sec.

6662(d)(1).    An understatement is the excess of the amount of tax

required to be shown on the return over the amount of tax

actually reported on the return.   Sec. 6662(d)(2).

     d.   Gross Valuation Misstatements

     Section 6662(h) provides that a taxpayer may be liable for a

40-percent penalty on any portion of an underpayment of tax

attributable to gross valuation misstatements.   No penalty is

imposed under that section, however, unless the portion exceeds

$5,000.   Sec. 6662(e)(2).   A gross valuation misstatement denotes

any substantial valuation misstatement, as determined under
                              - 19 -

section 6662(e), by substituting “400 percent” for “200 percent”.

Sec. 6662(h)(2)(A).   Pursuant to section 6662(e)(1)(A), as read

without the referenced substitution of text, a substantial

valuation misstatement occurs if “the value of any property (or

the adjusted basis of any property) claimed on any return * * *

is 200 percent or more of the amount determined to be the correct

amount of such valuation or adjusted basis”.   After the

referenced substitution of text, a gross valuation misstatement

occurs when the value or basis claimed on a return is 400 percent

or more of the correct value or basis.

     e.   Reasonable Cause and Good Faith

     No penalty is imposed under section 6662 to the extent that

the taxpayer had reasonable cause for the underpayment of tax and

acted in good faith with respect to the underpayment.   Sec.

6664(c)(1); see also Hansen v. Commissioner, supra at 1029.    The

determination of whether a taxpayer acted with reasonable cause

and in good faith is made on a case-by-case basis, taking into

account all pertinent facts and circumstances.   Sec.

1.6664-4(b)(1), Income Tax Regs.; see also Hansen v.

Commissioner, supra at 1028-1029.   The extent of the taxpayer’s

efforts to ascertain his proper tax liability is generally the

most important factor.   Sec. 1.6664-4(b)(1), Income Tax Regs.;

see also Hansen v. Commissioner, supra at 1028-1029.
                                - 20 -

     Reasonable cause and good faith under section 6664(c) may be

established where there is an honest misunderstanding of fact or

law that is reasonable in the light of all facts and

circumstances, including the experience, knowledge, and education

of the taxpayer.    Sec. 1.6664-4(b)(1), Income Tax Regs.

Reasonable cause and good faith are not necessarily established

by reliance on facts that, unknown to the taxpayer, are

incorrect.    Id.

3.   Applicability of the Accuracy-Related Penalties

      a.   Gross Valuation Misstatement

      In Durham Farms #1, J.V. v. Commissioner, T.C. Memo.

2000-159, the Court held that TBS 89-1 did not receive the

benefits and burdens of ownership of the cattle in dispute there

and was not entitled to the partnership deductions and losses

claimed with respect thereto.    The Court’s decision stated that

the partnership’s “Depreciation Expense” and “Depreciation after

1986”, each of which was reported as $1,056,720, were both zero.

The disallowance of those items resulted in a computational

adjustment (and tax understatement) for 1989 of $7,574.     Because

petitioner’s adjusted basis for the depreciation expense

deduction also was zero, the underpayment for 1989 resulting from

the disallowance of petitioner’s partnership loss from TBS 89-1,

all of which was attributable to a disallowed depreciation

expense, is attributable to an overstatement of bases of more
                              - 21 -

than 400 percent of the amounts determined to be the correct

adjusted bases.   See Keller v. Commissioner, T.C. Memo. 2006-131;

Jaroff v. Commissioner, T.C. Memo. 2004-276; see also Zirker v.

Commissioner, 87 T.C. 970 (1986).     In that petitioner’s resulting

underpayment of tax for 1989 exceeded $5,000, we conclude that

petitioner’s underpayment of 1989 tax resulting from the

disallowance of his reported cost bases and depreciation

deduction was attributable to a gross valuation misstatement of

over $5,000.   See Massengill v. Commissioner, 876 F.2d 616 (8th

Cir. 1989), affg. T.C. Memo. 1988-427; Zirker v. Commissioner,

supra; Jaroff v. Commissioner, supra.     We thus also conclude that

petitioner is liable for the 40-percent accuracy-related penalty

under section 6662(h) for 1989, rather than the 20-percent

accuracy-related penalty set forth in section 6662(a), unless he

meets the section 6664(c) exception for reasonable cause and good

faith, in which case no penalty will apply.

     Petitioner’s posttrial briefs contain no discussion of

Massengill, Zirker, or Jaroff, arguing instead that Gainer v.

Commissioner, 893 F.2d 225 (9th Cir. 1990), affg. T.C. Memo.

1988-416, and Todd v. Commissioner, 862 F.2d 540 (5th Cir. 1988),

affg. 89 T.C. 912 (1987), establish that the accuracy-related

penalty under section 6662(h) cannot apply if an asset such as

the cattle at issue does not exist.    We disagree with

petitioner’s argument.   The deductions in the two cases
                                - 22 -

petitioner relies on were disallowed because the relevant assets

were not placed in service during the years that were the subject

of those cases; the disallowance did not result from an asset’s

valuation or basis.   Here, valuation or basis was a deciding

factor in determining whether the benefits and burdens of

ownership passed to TBS 89-1.    Moreover, as we stated in Keller

v. Commissioner, supra, in rejecting an argument similar to that

of petitioner:

          If we accept petitioner’s assertion that he never
     received the benefits and burdens of ownership of the
     cattle, or that the cattle never existed, then his
     bases in the cattle would be zero. See Zirker v.
     Commissioner, 87 T.C. 970, 978-979 (1986) (finding that
     no actual sale of cattle took place and the correct
     adjusted basis of cattle was zero); Massengill v.
     Commissioner, T.C. Memo. 1988-427 (same as Zirker),
     affd. 876 F.2d 616 (8th Cir. 1989). This conclusion is
     supported by petitioner’s concession that he was not
     entitled to cost basis or depreciation deductions. If
     petitioner’s correct bases are zero, then the bases
     claimed on his returns are considered to be 400 percent
     or more of the correct amount, and are thus gross
     valuation misstatements. See sec. 1.6662-5(g), Income
     Tax Regs.; see also Zirker v. Commissioner, supra at
     978-979.

     b.   Negligence/Disregard of Rules or Regulations

     Respondent alleged in his answer that petitioner was liable

for 1991 for an accuracy-related penalty under section 6662(a)

because his underpayment of tax for that year was attributable to

negligence or disregard of rules or regulations.   Petitioner

argues that he is not liable for such an accuracy-related penalty

because he acted reasonably in joining TBS 89-1 and in monitoring
                               - 23 -

his participation in that venture.      We hold that petitioner was

negligent both in participating in TBS 89-1 and in claiming on

his 1991 return that he had a loss attributable to that

participation.

     Before joining TBS 89-1, petitioner had limited education

and practical experience with regard to cattle ranching, and he

had no experience with cattle valuation.     Nonetheless, before

joining TBS 89-1, petitioner sought no independent professional

advice on the legitimacy of TBS 89-1, opting instead to join that

venture on the basis of his conversations with his colleagues at

work.   Generally, a taxpayer is required to have made a

reasonable inquiry into the validity of a questionable tax

shelter benefit in order not to be liable for an accuracy-related

penalty for negligence.    See Collins v. Commissioner, 857 F.2d

1383, 1386 (9th Cir. 1988), affg. Dister v. Commissioner, T.C.

Memo. 1987-217; Zmuda v. Commissioner, 731 F.2d at 1422; cf.

Freytag v. Commissioner, 89 T.C. 849, 888 (1987), affd. 904 F.2d

1011 (5th Cir. 1990), affd. 501 U.S. 868 (1991).     Petitioner has

failed that requirement.    Accord Hansen v. Commissioner, 471 F.3d

at 1029-1030 (in the setting of a “highly suspicious” investment

in a Hoyt venture, the taxpayers were negligent in that they did

not seek to verify the legitimacy of the tax benefits with a

source independent of Hoyt); Van Scoten v. Commissioner, T.C.

Memo. 2004-275 (participants in Hoyt ventures were negligent in
                             - 24 -

joining those ventures because they failed to investigate the

legitimacy of the ventures with someone independent of those

ventures), affd. 439 F.3d 1243 (10th Cir. 2006).

     Petitioner knew that the Hoyt organization had labeled any

investment in a Hoyt partnership a “speculative investment” and

that the Commissioner considered the Hoyt partnerships to be tax

shelters that had to be registered and reported as such.

Petitioner also knew when he joined TBS 89-1 that the Hoyt

organization would be acting with and for him to claim refunds of

his Federal income taxes and that he had to pay 75 percent of any

tax refund to the Hoyt organization.   Petitioner also knew when

he joined TBS 89-1 that he could receive preferential tax

allocations for any given year simply by asking the Hoyt

organization for such allocations.    In the light of petitioner’s

background and his lack of experience and knowledge of the cattle

ranching business, and the questionable content of the

promotional materials, petitioner was required to perform a

meaningful investigation of TBS 89-1 before claiming any tax

benefits purportedly flowing therefrom.   We find that he did not.

While petitioner stresses that he investigated the Hoyt

partnerships by visiting the Hoyt operation before and during his

participation in TBS 89-1, the fact of the matter is that such

visits do not replace the requirement in this case that

petitioner have consulted an independent professional adviser
                              - 25 -

concerning the legitimacy and tax status of the advertised

“investment”.   A reasonable and prudent individual standing in

petitioner’s shoes would have had ample grounds for suspicion.

Moreover, as to petitioner’s visits to Hoyt’s establishments, we

decline to find that petitioner during that time adequately

investigated the legitimacy of TBS 89-1.   Petitioner never even

asked to see, nor did he actually see, any of Hoyt’s records

concerning TBS 89-1.   We conclude that petitioner’s failure to

investigate properly was inconsistent with what a reasonable and

ordinarily prudent person would have done under the

circumstances; i.e., it was negligence.

     Petitioner did not demonstrate due care in claiming a loss

from TBS 89-1 for 1991.   In order to prepare his tax return for

that year, petitioner supplied the Hoyt organization with all of

his tax information (except his reported loss from TBS 89-1), and

he allowed the organization to prepare his return by adding to

his information a $92,961 loss that purportedly flowed from his

participation in TBS 89-1.   Notwithstanding the substantial

amount of that reported loss, and the fact that it was

significantly greater than petitioner’s payments to the Hoyt

organization,7 petitioner never took his return to a professional


     7
       As of the time that petitioner filed his 1991 return, he
had paid the Hoyt organization $26,785 and had received $15,987
in tax refunds for 1988, 1989, and 1990 (and was awaiting a
refund of $4,053 for 1991). We also note that petitioner’s 1988
                                                   (continued...)
                               - 26 -

independent of the Hoyt organization for review.    Accord Hansen

v. Commissioner, supra at 1031.    While petitioner attempted to

excuse his lack of due care by alleging that he tried but was

unable to find such an independent professional, we decline to

find this testimony as a fact.    Petitioner’s lack of due care for

1991 is further seen by noting that his return claimed a tax

refund for that year even though he knew that respondent was

investigating at least one of the Hoyt partnerships.

      We conclude that petitioner’s underpayment of tax for 1991

was the result of negligence.8    Thus, petitioner is liable for

the 20-percent accuracy-related penalty under section 6662(b)(1)

for 1991 unless he meets the section 6664(c) exception for

reasonable cause and good faith.

4.   Claimed Defenses to the Accuracy-Related Penalties

      a.   Honest Misunderstanding of Fact

      Petitioner argues that his underpayments of tax for 1989 and

1991 resulted from an honest mistake of fact because he was

defrauded by Hoyt, he had insufficient information concerning his

participation in TBS 89-1, and all available evidence supported



      7
      (...continued)
through 1991 returns claimed partnership losses from the Hoyt
organization totaling $220,385.
      8
       Because we have concluded that petitioner’s underpayment
of tax for 1991 was attributable to negligence, we do not
consider whether the underpayment also was attributable to a
substantial understatement of income tax.
                               - 27 -

Hoyt’s assertions.   We disagree with petitioner that he had any

such misunderstanding of fact as would absolve him from liability

for the accuracy-related penalties.

     In joining TBS 89-1 and claiming the accompanying losses for

1989 and 1991, petitioner relied exclusively on the assertions

made by Hoyt, members of the Hoyt organization, and other

participants in the Hoyt partnerships.   Petitioner neither

verified, nor attempted to verify, any of that information by

speaking to someone independent of the Hoyt organization.     While

Hoyt may have misled petitioner concerning his participation in

TBS 89-1, petitioner nevertheless was negligent in not properly

investigating Hoyt’s claims or otherwise inquiring into the

nature of the tax benefits that petitioner claimed on his return

with respect to his participation in TBS 89-1.   See Keller v.

Commissioner, T.C. Memo. 2006-131; Barnes v. Commissioner, T.C.

Memo. 2004-266.   We conclude that any misunderstanding that

petitioner may have had with respect to the facts surrounding his

participation in TBS 89-1, and any difficulty that he may have

had in obtaining all information necessary to evaluate TBS 89-1

and his participation therein, was not due to an honest

misunderstanding of fact such as would constitute a defense to

the imposition of the accuracy-related penalties; it was due to a

negligent disregard of fact.
                               - 28 -

     b.   Reliance on the Bales Memorandum Opinion

     Petitioner argues he had reasonable cause for his

underpayments of tax for 1989 and 1991 because he relied on Bales

v. Commissioner, T.C. Memo. 1989-568.   We disagree.   In addition

to the fact that petitioner by his own admission did not consult

an independent professional for advice on Bales, Bales involved

different participants, different partnerships, and different

years.    Moreover, although petitioner may have read the Bales

Memorandum Opinion, we decline to find that he had any

understanding of or reliance on that case independent of what was

explained to him by the Hoyt organization.   We conclude that any

reliance that petitioner placed on Bales was not reasonable.9

See Hansen v. Commissioner, 471 F.3d at 1032-1033; Mortensen v.

Commissioner, 440 F.3d 375, 391-392 (6th Cir. 2006), affg. T.C.

Memo. 2004-279; Sanders v. Commissioner, T.C. Memo. 2005-163.




     9
       Petitioner argues that he acted reasonably in that this
Court was unable to uncover Hoyt’s fraud and petitioner was in no
better position to evaluate the legitimacy of his participation
in TBS 89-1 or the tax benefits claimed therefrom. Petitioner is
misfocused in making this argument. The argument relates
improperly to the question (irrelevant herein) of whether
petitioner could or should have uncovered the fraud, rather than
to the relevant and decisive issue of whether he was negligent in
not adequately investigating the partnership and/or seeking
qualified independent advice concerning it. See Hansen v.
Commissioner, 471 F.3d at 1032-1033; Mortensen v. Commissioner,
440 F.3d at 389-390.
                             - 29 -

     c.   Conclusion

     We conclude that petitioner did not have reasonable cause

for his underpayments of tax for 1989 and 1991.   Accordingly, we

hold that petitioner is liable for a section 6662(h) accuracy-

related penalty for 1989 and a section 6662(a) accuracy-related

penalty for 1991, both in the amounts alleged by respondent in

his answer.10



     We have considered all arguments made by petitioner for

holdings contrary to those expressed herein, and we conclude that

those arguments not discussed herein are either irrelevant or

without merit.


                                        Decision will be entered

                                   for respondent.




     10
       As to the amounts of these accuracy-related penalties, we
have reviewed respondent’s computations of the amounts set forth
in his answer and find them to be correct.
