                        T.C. Memo. 1996-525



                      UNITED STATES TAX COURT



     ROBERT R. GRAY, JR. AND VICKEY L. GRAY, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 14349-88.                 Filed November 27, 1996.



     Robert R. Gray, Jr. and Vickey L. Gray, pro se.

     Lavonne D. Lawson, for respondent.



                        MEMORANDUM OPINION

     WRIGHT, Judge:   This matter is before the Court on

respondent's motion for order to show cause why judgment should

not be entered against petitioners on the basis of a previously

decided case.   Respondent filed her above-referenced motion in

the instant case with respect to the disallowance of deductions,

investment tax credits, and related additions to tax in
                               - 2 -

connection with petitioners' participation in a tax shelter

entitled the Encore Leasing Program (Encore).    By order dated

August 24, 1994, the Court granted respondent's motion and

directed petitioners to show cause why judgment should not be

entered against them on the basis of the Court's decisions in

Wolf v. Commissioner, T.C. Memo. 1991-212, affd. 4 F.3d 709 (9th

Cir. 1993), Feldmann v. Commissioner, T.C. Memo. 1991-353, affd.

without published opinion 5 F.3d 536 (9th Cir. 1993), and Garcia

v. Commissioner, T.C. Memo. 1991-451, affd. without published

opinion 5 F.3d 536 (9th Cir. 1993).    In their response,

petitioners failed to provide the Court with an adequate basis

upon which to distinguish the instant case from the previously

decided cases.   The Court subsequently ordered petitioners either

to sign a stipulated decision in the instant case or appear

before the Court for a hearing on the matter.    Petitioners chose

the latter of these alternatives, and this case was heard at a

motions session held at Houston, Texas.

     Petitioners resided in Beaumont, Texas, at the time they

filed their petition.   This case arises out of petitioners'

participation in Encore, a tax shelter in the business of leasing

master recordings of previously released "pop" and Gospel

albums.1   Trials were conducted in the three above-mentioned

     1
      For a detailed discussion of the facts and the applicable
law with respect to participation in the Encore Leasing Program,
see Booker v. Commissioner, T.C. Memo. 1996-261; Wolf v.
                                                   (continued...)
                                - 3 -

cases with respect to deficiencies in and additions to tax

resulting from participation in Encore.   In each case, and on all

issues, the Court held in favor of the Government.   Each case was

subsequently affirmed by the Court of Appeals for the Ninth

Circuit.

     Petitioners were among a large number of persons who

invested in Encore and who claimed credits, deductions, and

losses with respect thereto that were disallowed by respondent.

For purposes of judicial economy and efficiency, and to resolve

common issues, Wolf v. Commissioner, supra, was selected as a

test case.    We rendered an opinion in Wolf and held that Encore's

underlying lease transaction was a sham entered into without the

intent to make a profit, in which tax considerations were

paramount.

     More specifically, in Wolf v. Commissioner, supra, this

Court held:   (1) The taxpayers were not entitled to claimed

deductions and investment tax credits related to their

participation in Encore; (2) the taxpayers’ underpayments for the

years at issue were due to negligence or intentional disregard of

rules and regulations, and as a result, they were liable for the



     1
      (...continued)
Commissioner, T.C. Memo. 1991-212, affd. 4 F.3d 709 (9th Cir.
1993); Feldmann v. Commissioner, T.C. Memo. 1991-353, affd.
without published opinion 5 F.3d 536 (9th Cir. 1993); Garcia v.
Commissioner, T.C. Memo. 1991-451, affd. without published
opinion 5 F.3d 536 (9th Cir. 1993).
                              - 4 -

additions to tax under section 6653;2 (3) the taxpayers grossly

overvalued the subject master recording and were liable for the

addition to tax under section 6659 due to a valuation

overstatement; (4) the taxpayers were liable for the increased

rate of interest under section 6621(c) due to an underpayment of

tax in excess of $1,000 attributable to one or more enumerated

“tax motivated transactions”; and (5) the taxpayers were liable

for a penalty under section 6673 as a result of advancing

frivolous and groundless arguments.

     In Feldmann v. Commissioner, supra, and Garcia v.

Commissioner, supra, the Court held:   (1) The taxpayers'

underpayments for the years at issue were due to negligence or

intentional disregard of rules and regulations, and, as a result,

the taxpayers were liable for the additions to tax under section

6653; (2) the taxpayers grossly overvalued the subject master

recording and were liable for the addition to tax under section

6659 due to a valuation overstatement; and (3) the taxpayers were

liable for a penalty under section 6673 as a result of advancing

frivolous and groundless arguments.

     Petitioners claimed $3,078 in deductions and $5,952 in

investment tax credits with respect to their participation in

Encore during taxable year 1984.   Both were disallowed by

     2
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year at issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
                                 - 5 -

respondent.    Although the underlying transaction in the instant

case is essentially identical to the transaction considered in

the test case, petitioners maintain that their case is factually

different from the test case.    After concessions, however, the

sole issue for our determination is whether petitioners are

liable for the additions to tax for negligence under section

6653(a)(1) and (2) for taxable year 1984.

     Section 6653(a)(1) provides for an addition to tax equal to

5 percent of any underpayment if any part of the underpayment is

due to negligence or intentional disregard of rules or

regulations.    Section 6653(a)(2) provides for an addition to tax

of 50 percent of the interest on that portion of the underpayment

attributable to negligence.    Negligence is defined as a lack of

due care or the failure to act as a reasonable person would act

under similar circumstances.     Chamberlain v. Commissioner, 66

F.3d 729, 732 (5th Cir. 1995), affg. in part and revg. in part

T.C. Memo. 1994-228; Heasley v. Commissioner, 902 F.2d 380, 383

(5th Cir. 1990), revg. T.C. Memo. 1988-408; Neely v.

Commissioner, 85 T.C. 934, 947 (1985).    Petitioners bear the

burden of proving that no part of the underpayment for the year

at issue is due to negligence or intentional disregard of rules

or regulations.    Rule 142(a); Bixby v. Commissioner, 58 T.C. 757

(1972).   The negligence addition under section 6653 is correctly

assessed in cases where claimed deductions are not supported by

the facts.     Sandvall v. Commissioner, 898 F.2d 455 (5th Cir.
                               - 6 -

1990), affg. T.C. Memo. 1989-56 and T.C. Memo. 1989-189; Marcello

v. Commissioner, 380 F.2d 499 (5th Cir. 1967), affg. in part and

remanding in part 43 T.C. 168 (1964).

     Citing Heasley v. Commissioner, supra, petitioners contend

that they acted in a reasonable manner and exercised ordinary

business care and prudence in claiming the deductions and credits

attributable to their participation in Encore.   In support of

that contention, petitioners allege that they relied upon the

financial advice of their friend and investment adviser, Derwyn

Booker (Booker).   Booker was a paid promoter for Encore.3

     Under some circumstances, a taxpayer may avoid liability for

the additions to tax under section 6653(a)(1) if reasonable

reliance on a competent professional adviser is shown.   United

States v. Boyle, 469 U.S. 241 (1985); Freytag v. Commissioner, 89

T.C. 849, 888 (1987), affd. 904 F.2d 1011 (5th Cir. 1990), affd.

501 U.S. 868 (1991).   Reliance on professional advice, standing

alone, is not an absolute defense to negligence, but rather a

factor to be considered.   Freytag v. Commissioner, supra at 888.

In order for reliance on professional advice to excuse a taxpayer

from the negligence additions to tax, the reliance must be

reasonable, in good faith, and based upon full disclosure.     Id.

Reliance on representations by insiders, promoters, or offering

materials has been held an inadequate defense to negligence.


     3
      See Booker v. Commissioner, T.C. Memo. 1996-261.
                                 - 7 -

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); Marine v. Commissioner, 92 T.C. 958,

992-993 (1989), affd. without published opinion 921 F.2d 280 (9th

Cir. 1991).

       Based upon our review of the instant record, we find that

petitioners' reliance on Booker was not reasonable.      During 1984,

Booker worked as an agent for Encore, selling its tax shelters at

a commission rate of 20 percent of receipts.       Booker v.

Commissioner, T.C. Memo. 1996-261.       He received $13,986 in

commissions from Encore with respect to his 1984 sales.        Id.   As

previously stated, reliance on representations by insiders or

promoters is an inadequate defense to negligence.      Further,

reliance on professional advice must be objectively reasonable.

Chamberlain v. Commissioner, supra at 732; Goldman v.

Commissioner, 39 F.3d 402 (2d Cir. 1994), affg. T.C. Memo. 1993-

480.    Moreover, taxpayers may not rely on someone with an

inherent conflict of interest.     Chamberlain v. Commissioner,

supra at 732; Goldman v. Commissioner, supra at 408.

Additionally, taxpayers must be able to show that the adviser

reached his or her decisions independently.      See Leonhart v.

Commissioner, 414 F.2d 749 (4th Cir. 1969), affg. T.C. Memo.

1968-98.    As an agent for Encore, Booker had an inherent conflict

of interest, and, as a result, petitioners cannot show that
                                 - 8 -

Booker reached his decisions independently when advising them.

We find that any reliance upon Booker's advice with respect to

Encore was not objectively reasonable.4

     Contrary to petitioner's argument, this case is factually

distinguishable from Heasley v. Commissioner, supra, and we find

their efforts to analogize it to the Heasley case unpersuasive.

Like the instant case, the Heasley case involved, inter alia,

whether the taxpayers could be held liable for the negligence

penalty, as set forth in section 6653, after claiming various

deductions and an investment tax credit attributable to a failed

investment shelter.     After we found for the Government, the Court

of Appeals for the Fifth Circuit reversed our opinion in Heasley,

explaining that our standard of review was too stringent in light

of the facts.     Heasley v. Commissioner, 902 F.2d at 383.    The

Court of Appeals in Heasley explained that the taxpayers in that

case did not act negligently because they honestly misunderstood

the law and the facts, relied on a financial adviser and an

accountant, and expended efforts to monitor their investment.

Id. at 384.     In so explaining, the Court of Appeals stated that

moderate-income investors need not independently investigate

their investments and that such investors may rely on the

expertise of their financial advisers and accountants.        Id.    The

court further explained that unsophisticated investors need not


     4
      See Brooke v. Commissioner, T.C. Memo. 1996-262.
                                - 9 -

scrutinize a prospectus or other offering materials prior to

undertaking an investment, but need only read pertinent portions

of such documents and have the remaining portions explained to

them by their advisers.   Id.

     As it pertains to the instant issue, we find Heasley v.

Commissioner, supra, to be distinguishable on its facts.     We do

not believe, as petitioners contend, that the court was declaring

that a claim of negligence can be defeated merely by a taxpayer's

showing that he or she, being unsophisticated, relied on the

advice of a financial adviser, irrespective of whether such

adviser was an insider or whether such advice was reasonable.

See Chamberlain v. Commissioner, supra at 732.   Two noteworthy

factors distinguish the facts of the instant case from those in

Heasley.   First, unlike the taxpayers in Heasley, who not only

relied on the advice of their investment adviser, but who also

received advice regarding their investment from a certified

public accountant, petitioners relied solely on the advice of

Booker, Encore's promoter.

     Another factor that distinguishes this case from Heasley v.

Commissioner, supra, involves petitioners' review of the Encore

prospectus.   Although the court in Heasley explained that

unsophisticated taxpayers need read only the pertinent portions

of a prospectus or other offering material in order to exercise

reasonable care, even the most cursory consideration of the

Encore prospectus and its accompanying tax opinion, in light of
                              - 10 -

their discussions of tax advantages, risk of audit, and risk of

litigation in the Tax Court, would have alerted a prudent and

reasonable investor to the questionable nature of the promised

deductions and investment tax credits.    To be sure, although the

first page of the prospectus refers to an "exciting business

opportunity while taking advantage of current tax laws," it

mentions very little about that opportunity.    Instead, it heavily

emphasized the benefits derived from the investment tax credit.

     Encore's prospectus in substance contains only one page that

discusses the Gospel record market.    That discussion lacks the

slightest degree of specificity and is otherwise presented in

very general terms.   Further, the prospectus does not

specifically address the master recordings leased by Encore, the

quality of such recordings, nor any other facets of the Encore

program.

     Although the prospectus contains a section entitled    “How

Our Program Works,” that section is a single page in length and

contains a mere four paragraphs.   Three paragraphs are devoted to

the tax aspects of the program, while one paragraph refers to the

lease agreement.   The remainder of the page outlines in tabular

form the amount of advance payment required from the lessee and

the amount of investment tax credit passed through to the lessee.

     The "Financial Section" of the prospectus contains two

paragraphs and discusses the investment tax credit available with

respect to the sound recordings and computer software.     There is
                              - 11 -

no analysis in the prospectus of the potential nontax, economic

profitability of the leasing program.   Furthermore, there is no

information in the prospectus regarding the marketability of the

master recordings that Encore intends to lease nor any

information concerning how master recordings can be marketed.

     Finally, the prospectus contains a letter from Henry D.

Nunez, a tax attorney, stating the following:

     upon request by Encore, we will assist a lessee and
     their counsel and accountants if the Internal Revenue
     Service challenges the tax structure of the transaction
     as set forth in the Opinion and the lessee is unable to
     reach a satisfactory resolution at the initial audit
     level. Such assistance would include advice in
     connection with their appearances before the appellate
     division of the Internal Revenue Service. We would
     also be available to assist the lessee’s counsel in
     defense before the U.S. District Court, U.S. Tax Court
     or the U.S. Court of Claims.

     In light of the content of the Encore prospectus, we doubt

the sincerity of petitioners' contention that they examined its

pertinent parts.   Even a simple review of the information

contained in the prospectus should have raised serious questions

in the minds of ordinarily prudent investors.

     Based upon careful consideration of the record, we find that

petitioners have failed to show that the instant case differs in

any meaningful respect from the previously decided cases in which

we held the taxpayers liable for the additions to tax for

negligence in connection with their participation in Encore.

Accordingly, petitioners are liable for the additions to tax
                             - 12 -

under section 6653(a)(1) and (2) due to negligence for the

taxable year 1984.

     We decline to grant respondent's request for damages

pursuant to section 6673.

     To reflect the foregoing,

                                      An appropriate order and

                                 decision will be entered for

                                 respondent.
