                          T.C. Memo. 2006-131



                      UNITED STATES TAX COURT



                MICHAEL W. KELLER, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 9662-01.                 Filed June 22, 2006.



     Asher B. Bearman, Jaret R. Coles, Jennifer A. Gellner, Terri

A. Merriam, and Wendy S. Pearson, for petitioner.

     Catherine J. Caballero, Gregory M. Hahn, Nhi T. Luu-Sanders,

and Thomas N. Tomashek, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     HAINES, Judge:   Respondent determined deficiencies in

petitioner’s Federal income taxes of $11,106 and $17,410 for 1994

and 1995, respectively.    Respondent further determined that

petitioner was liable for accuracy-related penalties under
                                - 2 -

section 6662(h) of $4,442 and $6,932, respectively.1   After

concessions,2 the only issues for decision are:   (1) Whether

petitioner is liable for 40-percent accuracy-related penalties

under section 6662(h); and (2) in the alternative, whether

petitioner is liable for 20-percent accuracy-related penalties

under section 6662(b)(1) or (2).

                          FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

The first, second, and third stipulations of fact and the

attached exhibits are incorporated herein by this reference.

Petitioner resided in Escondido, California, when he filed his

petition.

A.   Hoyt and the Hoyt Partnerships

     The issues in this case revolve around petitioner’s

investment in a partnership organized and promoted by Walter J.

Hoyt III (Hoyt).    Hoyt’s father was a prominent cattle breeder.

To expand his business and attract investors, Hoyt’s father

started organizing and promoting cattle breeding partnerships in

the late 1960s.    Before his father’s death in early 1972, Hoyt


     1
        All section references are to the Internal Revenue Code,
as amended, and all Rule references are to the Tax Court Rules of
Practice and Procedure. Amounts are rounded to the nearest
dollar.
     2
        Petitioner concedes that: (1) He did not realize any
farm income in 1994 and 1995; and (2) he is not entitled to the
deductions claimed on Schedules F, Profit or Loss From Farming,
attached to his 1994 and 1995 Federal income tax returns.
                                - 3 -

and other members of the Hoyt family were extensively involved in

organizing and operating numerous cattle breeding partnerships.

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

operated more than 100 cattle breeding partnerships (Hoyt

partnerships).   Hoyt also organized, promoted, and operated sheep

breeding partnerships.

     From 1983 until his removal by the Tax Court in 2000 through

2003, Hoyt was the tax matters partner of each Hoyt partnership.

From approximately 1980 through 1997, Hoyt was a licensed

enrolled agent, and as such, he represented many of the Hoyt

partners before the IRS.   In 1998, Hoyt’s enrolled agent status

was revoked.

     Hoyt also operated tax return preparation companies,

including “Tax Office of W.J. Hoyt Sons”, “Agri-Tax”, and “Laguna

Tax Service” (Laguna).    These companies prepared most of the Hoyt

investors’ tax returns.

B.   Petitioner’s Background and Involvement With Hoyt

     Petitioner is married and has two stepchildren.   Petitioner

has a bachelor of science degree in marine transportation and

management and has been employed by Military Sealift Command

since June 1982.

     Before his involvement with Hoyt, petitioner’s only

experience in investing included an investment of $20,000 in the

stock market in 1982 and the purchase of two homes in 1990 and
                                 - 4 -

1994, respectively.   He had never been a partner in a

partnership.

     Petitioner’s only experience in farming came in the late

1970s, when he spent a couple of weeks milking cows.     Petitioner

has never purchased livestock.    Petitioner is not an expert in

cattle or embryo valuation and has no knowledge of the success

rate of embryo transplants in cattle.

     Petitioner first heard about the Hoyt organization in 1985

from several coworkers.   At that time, petitioner understood that

Hoyt was in the business of breeding cattle, that the business

was profit motivated, and that investment in a Hoyt partnership

would minimize a partner’s tax liability.    Petitioner did not

invest in 1985, taking a “wait-and-see attitude” because the

investment “just [sounded] too good to be true.”

     In 1994, petitioner talked to current and former coworkers,

including Joe Trodglen (Trodglen), about Hoyt and the tax

benefits of investing in a Hoyt partnership.    In December 1994,

petitioner told Trodglen that he wanted to invest in the Hoyt

organization.   Trodglen provided petitioner with Hoyt promotional

materials, including a pamphlet entitled “Registered Livestock

Purchase Guide” (the purchase guide).    The purchase guide

provides an outline of Hoyt’s partnerships and “investment

opportunities.”   Many sections are devoted to tax considerations,

including tax benefits and tax risks.    The purchase guide states:
                                   - 5 -

          Cattle ranchers use the tax benefits Congress has
     given us. Some of us bring the tax benefits to town,
     sell them for cash to help pay to produce the beef.
     The cows produce beef, and tax benefits for their
     owners. Ranchers sell the beef at the store, and the
     tax benefits to provide additional capital. The cash
     raised from the selling of both items is enough to pay
     for the cattle purchase and the operating expenses.
     Those that buy the beef get a steak. Those that buy
     the tax benefits have the opportunity for ownership in
     the cattle herd.

          Again, you only considered making an investment in
     the cattle business AFTER you heard about the tax
     benefits. Tax benefits were your incentive. They
     encouraged you to make a high risk business investment.

                *     *     *      *       *   *   *

          In the country, tax accountants don’t read brands,
     and cowboys don’t read tax law. If you must have a tax
     man give you specific personal advice as to whether or
     not you belong in the cattle business, stay out.

                      *     *      *       *   *   *   *

          A change in the tax laws or an audit and
     disallowance by the IRS could take away all or part of
     the tax benefits, plus the possibility of having to pay
     the tax along with penalties and interest.

Petitioner also received a pamphlet entitled “Registured [sic]

Livestock:   The Real ‘Bull Market’ Business Opportunities” (the

business opportunities pamphlet).      On its cover, the business

opportunities pamphlet states “HARVESTING TAX SAVINGS BY FARMING

THE TAX CODE”, and it contains much of the same information as

the purchase guide.

     On February 14, 1995, petitioner sent to the Hoyt

organization a “Confidential Buyers Information” form, requesting

an “information package”.       Dave Barnes (Barnes), a Hoyt employee,
                               - 6 -

responded on February 17, 1995, thanked petitioner for his

interest, provided him with promotional materials, and requested

that he “fill out the enclosed credit application and return it

with copies of your tax returns for the years 1991, 1992, and

1993, so I can review your qualifications for your livestock

purchase.”   The promotional materials included copies of the

purchase guide and the business opportunities pamphlet provided

to petitioner by Trodglen.   Petitioner sent the requested

information to Barnes in March 1995.

     Sometime in early 1995, petitioner met with Barnes at Elk

Grove, a Hoyt ranch, to further discuss “investment

opportunities”.3   Their meeting lasted approximately 3 hours,

during which Barnes explained Bales v. Commissioner, T.C. Memo.

1989-568 (the Bales case, or Bales) and spent at least 15 minutes

discussing tax benefits.

     After talking to Barnes, petitioner decided to invest.

Petitioner did not consult a tax attorney, an accountant, or an

expert in the cattle industry before he invested.

     On April 15, 1995, David Cross (Cross), a Hoyt employee,

sent petitioner a letter stating:

          After reviewing your information we are
     comfortable with your income, you can afford the
     payments on 73 head [of cattle].



     3
        It is not clear whether this meeting took place before or
after petitioner requested information from Hoyt.
                                - 7 -

          You are now ready for the next step. As soon as
     possible, please get your 1994 taxes to Laguna Tax
     Service. Dave Barnes will take them, the copies of
     your 1991, 1992 and 1993 returns. Laguna will
     calculate your tax savings to verify what we have
     figured.

     On July 28, 1995, petitioner purportedly purchased 73

“Registured [sic] Durham Shorthorn Bred Heifers” and 73

“confirmed embryos” from W.J. Hoyt Sons Ranches MLP (Hoyt

Ranches) for $956,980.    Hoyt determined the number of cattle

petitioner could purchase and set the purchase price without

petitioner’s input.   Petitioner did not see any of the cattle

that he was purchasing.    Petitioner initially thought he was

purchasing only cattle and did not realize he was also purchasing

embryos until he received the “Sales Order”, described infra.

     In connection with the purchase, petitioner signed and/or

received a “Livestock Bill of Sale”, a “Certificate of Warranty”,

a “Sales Order”, a “Fifteen Year Promissory Note”, and a

“Security Agreement” on July 28, 1995.

     The “Livestock Bill of Sale” (bill of sale) indicated that

petitioner, “D.B.A. Durham Genetic Engineering 1990-2”,4

purchased the Durham shorthorn cattle described on the attached

schedule for a “total purchase price” of $956,980.    The schedule

included the names and other information for 73 Durham Shorthorn

heifers.   The bill of sale did not mention confirmed embryos or


     4
        Petitioner was a partner in Durham Genetic Engineering
1990-2 J.V. (DGE). For more information, see infra note 5.
                                - 8 -

indicate that any part of the total purchase price was paid for

those embryos.

     The “Certificate of Warranty” guaranteed that all heifers

listed on the bill of sale would be able to reproduce for 10

consecutive years.

     The “Sales Order” indicated that petitioner purchased 73

Durham Shorthorn heifers for $478,490 and 73 confirmed embryos

for $478,490.

      To fund his purchase of cattle, petitioner signed a

“Fifteen Year Promissory Note” (promissory note), agreeing to pay

Hoyt Ranches $956,980.   The promissory note provided that

petitioner was required to pay interest in 50 monthly

installments of $1,075, beginning on September 1, 1995.

Beginning in August 2000, petitioner was required to pay 10

percent of the unpaid principal each year until the entire debt

was satisfied.   Petitioner did not keep a copy of the promissory

note for his records.

     To secure repayment of the promissory note, petitioner

signed a “Security Agreement”, granting Hoyt Ranches a security

interest in all cattle purchased or bred by petitioner.

Petitioner did not keep a copy of the security agreement for his

records.

     On July 31, 1995, petitioner signed a “Share-Crop Board

Agreement” (board agreement).   The board agreement provided that
                                - 9 -

W.J. Hoyt Sons Management Co. would breed and board all of

petitioner’s cattle.    Petitioner did not keep a copy of the board

agreement for his records.

     Petitioner did not have any records of what happened to the

cattle or the embryos after he purchased them.      Petitioner did

not request from Hoyt, nor did Hoyt provide, any written account

of his cattle.

     Other than a $50 application fee, petitioner did not incur

any upfront costs related to his investment.    However, petitioner

agreed to remit to the Hoyt organization 75 percent of any tax

refunds received.    In connection with his 1991, 1992, and 1993

refunds totaling $40,740, see infra, petitioner paid to Hoyt

$30,500.   In connection with his 1994 refund of $11,773, see

infra, petitioner paid to Hoyt $10,500.    Petitioner also made 10

interest payments to Hoyt of $1,075 between September 8, 1995,

and May 28, 1996.

C.   Petitioner’s Tax Claims

     Before investment in the Hoyt organization, petitioner

usually prepared his own tax returns.    On his tax returns for

1991, 1992, and 1993, petitioner reported the following:

              Year       Total income   Total tax

              1991         $81,574        $10,662
              1992          70,094          9,035
              1993         107,841         21,043
                               - 10 -

     Petitioner’s 1994 and 1995 tax returns were prepared and

signed by Hoyt and listed Laguna as the preparer’s firm.

Petitioner provided Laguna with his Forms W-2, Wage and Tax

Statement, and with information regarding his Schedule A itemized

deductions.    However, petitioner did not provide Laguna with any

of the information used to prepare the Schedules F.    Laguna also

prepared for petitioner a Form 1045, Application for Tentative

Refund.

     After the returns and the application for refund were

prepared, Laguna forwarded them to petitioner for his review and

signature.    Petitioner signed and filed the returns and the

application without having them reviewed by an accountant or

attorney outside of the Hoyt organization.

     Petitioner filed his 1994 Federal income tax return on

December 25, 1995.    On an attached Schedule F,5 petitioner



     5
        This Court has heard numerous Hoyt-related cases. In the
majority of those cases, the issues for decision revolved around
partnership losses taken by taxpayers as partners in various
Hoyt-operated partnerships. See, e.g., Mortensen v.
Commissioner, 440 F.3d 375, 387 (6th Cir. 2006), affg. T.C. Memo.
2004-279; Van Scoten v. Commissioner, 439 F.3d 1243, 1253 (10th
Cir. 2006), affg. T.C. Memo. 2004-275; Hansen v. Commissioner,
T.C. Memo. 2004-269; cf. Jaroff v. Commissioner, T.C. Memo. 2004-
276.

     Petitioner was a partner in DGE and was issued Schedules K-
1, Partner’s Share of Income, Credits, Deductions, Etc., for 1994
and 1995. However, unlike the majority of taxpayers in Hoyt
cases, petitioner did not report any partnership items on his
returns. Instead, petitioner reported income and losses on
                                                   (continued...)
                              - 11 -

reported the following:

     Farm income, sales of livestock     $152,059
     Depreciation                        (247,842)
     Interest expense                      (8,830)
     “1994 Sharecropboard Exp”           (121,647)
     “Expense for the cost basis of
       purchased cattle that died”        (76,558)
     Net farm profit or (loss)           (302,818)

With respect to the depreciation deduction, petitioner attached a

depreciation schedule reporting a cost basis in his “registured

[sic] cattle” of $880,423.   Petitioner subtracted his net farm

loss of $302,818 from wage and interest income totaling $72,942

for total negative income of $229,876.   Petitioner reported zero

taxable income and zero tax due.   Petitioner reported taxes

withheld of $11,773 and requested a refund of that amount, which

respondent issued.

     In December 1995, petitioner also filed a Form 1045 seeking

to carry back to 1991, 1992, and 1993 net operating losses of

$231,952 realized in 1994.   As a result of the carryback,

petitioner reported decreases in tax of $10,662, $9,035, and


     5
      (...continued)
Schedules F as if he were directly involved in the farming
activity.

     Respondent issued to petitioner a notice of final
partnership administrative adjustment (FPAA) with respect to his
partnership interest in DGE. In a motion to dismiss for lack of
jurisdiction, petitioner argued that this Court lacked
jurisdiction over the Schedule F items because they were
partnership items or affected items, referring to the FPAA.
Petitioner’s motion was denied because the Court concluded that
the Schedule F items were not partnership items or affected
items.
                               - 12 -

$21,043 for 1991, 1992, and 1993, respectively.      Respondent

issued refunds in those amounts on February 5, 1996.

     Petitioner filed his 1995 Federal income tax return on

August 5, 1996.    On an attached Schedule F, petitioner reported

the following:

     Farm income, sales of livestock             $80,928
     Depreciation                                (83,351)
     Interest expense                            (24,600)
     “1994 Sharecropboard exp”                   (80,928)
     Net farm profit or (loss)                  (107,951)

With respect to the depreciation deduction, petitioner attached a

depreciation schedule reporting a cost basis in his “registured

[sic] cattle” of $625,100.    Petitioner subtracted his net farm

loss of $107,951 from wage, interest, and capital gains income

totaling $132,527 for total income of $24,576.      After subtracting

other deductions, petitioner reported zero taxable income and

zero taxes due.    Petitioner reported taxes withheld of $8,788 and

requested a refund of that amount.      Respondent did not issue a

refund for 1995.

D.   Respondent’s Review of Petitioner’s Tax Claims

     On January 10, 1996, nearly 7 months before petitioner filed

his 1995 return, respondent sent petitioner a prefiling notice.

The prefiling notice informed petitioner that he had been

identified as an investor in a tax shelter promoted by Hoyt.      It

further informed petitioner that deductions relating to the tax

shelter would not be allowed and that claiming such deductions
                               - 13 -

could result in the imposition of an accuracy-related penalty

under section 6662.

     After receiving the prefiling notice, petitioner visited

Barnes at Elk Grove Ranch.   Barnes told petitioner that the

letter was a part of an “ongoing bitter battle” and that Hoyt was

still an enrolled agent.    Barnes took petitioner on a tour of Elk

Grove and the Laguna office and showed him a copy of the Bales

case and other documents.

     On February 24, 1997, respondent sent petitioner a letter

indicating that petitioner’s 1994 and 1995 tax years were under

examination.

     On May 3, 2001, respondent sent petitioner a notice of

deficiency.    Respondent disallowed all of petitioner’s Schedule F

deductions for 1994 and 1995 and determined that the “Farm

income, sales of livestock” listed on the Schedules F were not

includable in income.6   As a result, respondent determined

deficiencies in petitioner’s Federal income taxes of $11,106 and

$17,410 for 1994 and 1995, respectively.   Respondent further

determined that the underpayments of tax were attributable to

gross valuation misstatements, and therefore petitioner was

liable for 40-percent accuracy-related penalties under section

6662(h) of $4,442 and $6,932, respectively.


     6
        Petitioner has conceded that he did not receive farm
income and is not entitled to any Schedule F deductions for 1994
and 1995. See supra note 2.
                               - 14 -

       In response to the notice of deficiency, petitioner filed

his petition with this Court on August 2, 2001.

       In an amendment to answer filed May 18, 2005, respondent

asserted that, in the alternative to the 40-percent penalties

under section 6662(h), petitioner is liable for 20-percent

accuracy-related penalties under either section 6662(b)(1) or

(2).

                               OPINION

A.     Accuracy-Related Penalties in General

       Under section 6662(a), a taxpayer may be liable for a 20-

percent penalty on the portion of an underpayment of tax

attributable to negligence or disregard of rules or regulations

or to a substantial underpayment of tax.       Sec. 6662(a) and (b)(1)

and (2).    The section 6662(a) penalty is increased to 40-percent

when the underpayment of tax is the result of “gross valuation

misstatements”.    Sec. 6662(h)(1).   However, no penalty is imposed

under section 6662 if there is reasonable cause for the

underpayment of tax and the taxpayer has acted in good faith.

Sec. 6664(c)(1).

B.     Burden of Proof

       Generally, a taxpayer bears the burden of proving the

Commissioner’s determinations incorrect.       Rule 142(a)(1); Welch
                                - 15 -

v. Helvering, 290 U.S. 111, 115 (1933).7    However, the

Commissioner bears the burden of proof with respect to any new

matter raised in the answer.     Rule 142(a).   The parties agree

that petitioner bears the burden of proof with respect to the

penalties under section 6662(h).     The parties also agree that

respondent bears the burden of proof with respect to the

penalties under section 6662(b)(1) and (2) because respondent

asserted these penalties in his amendment to answer.

C.   Section 6662(h):    Gross Valuation Misstatements

     Under section 6662(h), a taxpayer may be liable for a 40-

percent penalty on any portion of an underpayment of tax

attributable to gross valuation misstatements.      However, no

penalty is imposed unless the portion of such underpayment

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

means any substantial valuation misstatement, as determined under

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

Sec. 6662(h)(2)(A).     There is a substantial valuation

misstatement 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


     7
        While sec. 7491 shifts the burden of proof and/or the
burden of production to the Commissioner in certain
circumstances, this section is not applicable in this case
because respondent’s examination of petitioner’s returns did not
commence after July 22, 1998. See Internal Revenue Service
Restructuring and Reform Act of 1998, Pub. L. 105-206, sec.
3001(c), 112 Stat. 727.
                                - 16 -

valuation or adjusted basis”.    Sec. 6662(e)(1)(A).    In other

words, there is a gross valuation misstatement when the value or

basis claimed on a return is 400 percent or more of the correct

value or basis.

     Respondent determined that the full amounts of petitioner’s

underpayments of tax were attributable to gross valuation

misstatements.    For 1994, petitioner’s underpayment was

attributable to the disallowance of the Schedule F deductions for

depreciation, “the cost basis of purchased cattle that died”

(cost basis deduction), interest, and “sharecropboard” expenses.

For 1995, petitioner’s underpayment was attributable to the

disallowance of the Schedule F deductions for depreciation,

interest, and “sharecropboard” expenses.    Because the interest

and sharecropboard expenses did not depend on valuation or basis

statements, any underpayments of tax resulting from their

disallowance cannot be based on gross valuation misstatements.

See Jaroff v. Commissioner, T.C. Memo. 2004-276.       However, the

depreciation and cost basis deductions depended on petitioner’s

reported bases in cattle.    Therefore, 40-percent penalties may

apply to petitioner’s underpayments resulting from the

disallowance of the depreciation and cost basis deductions if the

bases petitioner reported were gross valuation misstatements.

See id.
                              - 17 -

     On his 1994 return, petitioner reported a “cost basis of

purchased cattle that died” of $76,558 and a cost basis in his

“registured [sic] cattle” of $880,423.    On his 1995 return,

petitioner reported a cost basis in his “registured [sic] cattle”

of $625,100.   As stated above, petitioner bears the burden of

proof with respect to the section 6662(h) penalties.    Therefore,

petitioner bears the burden of proving that the reported bases

were not gross valuation misstatements.

     Petitioner does not argue that the reported bases were

correct or were less than 400 percent of the correct bases (and

thus not gross valuation misstatements).    Instead, “It is

Petitioner’s position that he never received the benefits and

burdens of ownership of the purported cattle--if such cattle even

existed, thus the overvaluation penalty cannot apply.”

Petitioner’s position is without support.

     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
                              - 18 -

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.

     Petitioner failed to meet his burden of proving that his

reported bases were not gross valuation misstatements.   We hold

that petitioner’s underpayments of tax resulting from the

disallowance of the cost basis and depreciation deductions were

attributable to gross valuation misstatements.   Unless the total

of the underpayments attributable to gross valuation misstatments

is less than $5,000, or petitioner had reasonable cause for the

underpayments, petitioner will be liable for 40-percent penalties

under section 6662(h) on the underpayments of tax attributable to

the items described in this paragraph.8

D.   Section 6662(b)(1):   Negligence or Disregard of Rules or
     Regulations

     Under section 6662(a) and (b)(1), a taxpayer may be liable

for a 20-percent penalty on an underpayment of tax which is

attributable to negligence or disregard of rules or regulations.

“Negligence” includes any failure to make a reasonable attempt to


     8
        As part of the Rule 155 computations, the parties shall
determine whether the total of petitioner’s underpayments
discussed in this paragraph exceeds $5,000. If the parties
determine that the total does not exceed $5,000, then those
underpayments will instead be subject to the 20-percent penalty
under sec. 6662(b)(1), as discussed infra.
                               - 19 -

comply with the provisions of the Internal Revenue Code.     Sec.

6662(c).   The regulations under section 6662 provide that

negligence is strongly indicated where a 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 defined as the “‘lack of due care or failure

to do what a reasonable or ordinarily prudent person would do

under the circumstances.’”    Neely v. Commissioner, 85 T.C. 934,

947 (1985) (quoting Marcello v. Commissioner, 380 F.2d 499, 506

(5th Cir. 1967), affg. in part and remanding in part on another

ground 43 T.C. 168 (1964)); see Allen v. Commissioner, 925 F.2d

348, 353 (9th Cir. 1991), affg. 92 T.C. 1 (1989).   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).   Courts

generally look both to 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 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
                               - 20 -

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 sub nom. Cowles v.

Commissioner, 949 F.2d 401 (10th Cir. 1991), affd. without

published opinion 956 F.2d 274 (9th Cir. 1992), and Horn v.

Commissioner, 90 T.C. 908, 942 (1988)), affd. without published

opinion 142 F.3d 435 (6th Cir. 1998).

     Petitioner testified that he invested in Hoyt’s program as a

means to provide for retirement.    However, other than a couple of

weeks spent milking cows, petitioner had no background in farming

or cattle ranching.    Before his investment, he had not been a

partner in a partnership.    Petitioner was not an expert in cattle

or embryo valuation, nor had he purchased any livestock.

     Petitioner relied on Hoyt to determine the number of cattle

he could purchase.    He further relied on Hoyt to establish a

purchase price of $478,490 for 73 heifers and $478,490 for 73

embryos.   To facilitate this purchase, petitioner signed a

promissory note for $956,980 and testified that he believed he

would be held personally liable for the entire amount.    Before

signing the note and completing the transaction, petitioner did

not see the cattle he was purchasing, nor is there any indication

that he attempted to do so.

     Despite his lack of experience or expertise with ranching,

partnerships, cattle and embryo valuation, and livestock
                               - 21 -

purchases, petitioner put himself at risk for nearly $1 million

without consulting any independent investment advisers or cattle

valuation experts.   Petitioner did not even have a clear

understanding of what he was purchasing.     He initially thought he

was purchasing 73 head of cattle for $956,980, which was also

indicated in the letter from Cross and the bill of sale.      Yet the

sales order indicates that he was purchasing 73 heifers for

$478,490 and 73 embryos for $478,490.     There is no indication

that petitioner questioned this discrepancy.     He did not examine

the cattle and the embryos he was purchasing.     He did not even

keep copies of the promissory note, the security agreement, or

the board agreement.    For these reasons, we conclude that

petitioner was negligent in entering into the investment.

     The record is replete with facts that should have put

petitioner on notice of the suspect tax claims made on his tax

returns.   First, and most obvious, is the timing of petitioner’s

deductions.   Petitioner’s first contact with the Hoyt

organization was in February 1995.      Petitioner did not begin his

investment until July 28, 1995.    Despite this, petitioner claimed

Schedule F deductions on his 1994 return and then used the net

operating loss generated by those deductions to claim refunds for

1991, 1992, and 1993.   Petitioner could not provide a rational

explanation of why he began taking Schedule F deductions in 1994

for an investment he entered into in 1995.
                              - 22 -

     On his self-prepared returns for 1991, 1992, and 1993,

petitioner reported total taxes of $10,662, $9,035, and $21,043,

respectively.   On his returns for 1994 and 1995, prepared by

Laguna, petitioner reported zero total tax despite having roughly

the same total income (not including Schedule F items) as in 1991

through 1993.   The relative change in petitioner’s total tax was

attributable solely to the Schedule F deductions.   Petitioner

realized these significant tax benefits and received refunds from

the net operating loss carrybacks while incurring no upfront

costs.

     Before petitioner filed his 1995 return, respondent informed

petitioner that he had been identified as an investor in a tax

shelter and his Hoyt-related deductions would not be allowed.

Despite this warning, petitioner did not seek independent advice

but continued to rely on the assurances of Barnes, a Hoyt

employee.   After he received the warning, petitioner still

claimed Schedule F deductions related to his Hoyt investment on

his 1995 return.

     Other facts that should have put petitioner on notice of the

suspect tax claims include:   (1) The promotional materials

petitioner received from Hoyt included warnings about significant

tax risks; and (2) petitioner testified that he was investing in

a partnership, yet he claimed purported losses as Schedule F

losses instead of partnership losses.
                               - 23 -

     Despite these red flags, petitioner did not consult a tax

attorney or an accountant outside of the Hoyt organization, nor

did he have his returns reviewed by an independent tax return

preparer.   Petitioner claimed the tax benefits from the Schedule

F losses solely on the advice he received from the promoters of

the investment.   He relied exclusively on Laguna, a Hoyt entity,

to prepare his returns.    In other words, he relied on the same

people who were to receive 75 percent of his tax refunds.    Given

the suspect tax claims, petitioner did not meet his duty of

inquiry or make a good faith investigation.    Petitioner did not

exercise due care and failed to do what a reasonable or

ordinarily prudent person would do given the facts surrounding

petitioner’s investment.    Therefore, we find that respondent has

met his burden of proof and hold that petitioner’s underpayments

of tax for 1994 and 1995 were the result of negligence.   Unless

petitioner had reasonable cause, petitioner will be liable for

20-percent penalties under section 6662(b)(1) on his

underpayments of tax to the extent that those underpayments are

not already subject to the 40-percent penalties under section

6662(h).

E.   Section 6662(b)(2):   Substantial Understatement of Income
     Tax

     The accuracy-related penalty under section 6662 cannot

exceed 20-percent of the underpayment of tax (or 40 percent if

attributable to gross valuation misstatements).   Sec. 1.6662-
                                   - 24 -

2(c), Income Tax Regs.    The penalties cannot be stacked, even

when the taxpayer’s understatement of income is attributable to

more than one of the types of misconduct listed in section

6662(b).    Id.   Because petitioner’s underpayments of tax were the

result of either gross valuation misstatements or negligence, we

need not consider whether those underpayments were also the

result of substantial understatements of income tax.

F.   Alleged Defenses to the Accuracy-Related Penalties

     1.      Section 6664(c)(1):    Reasonable Cause

     No penalty is imposed under section 6662 if the taxpayer had

reasonable cause for the underpayment of tax and acted in good

faith.     Sec. 6664(c)(1).   “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.      The

extent of the taxpayer’s efforts to ascertain his proper tax

liability is generally the most important factor.        Id.

             a.   Reliance on the Hoyt Organization

     Good faith reliance on professional advice concerning tax

laws may be a defense to negligence penalties.         United States v.

Boyle, 469 U.S. 241, 250-251 (1985); see also sec. 1.6664-

4(b)(1), Income Tax Regs.      However, “Reliance on professional

advice, standing alone, is not an absolute defense to negligence,

but rather a factor to be considered.”       Freytag v. Commissioner,
                              - 25 -

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

affd. 501 U.S. 868 (1991).   To be considered a defense to

negligence, the taxpayer’s reliance must be reasonable.      Id.   To

be objectively reasonable, the advice generally must be from

competent and independent parties unburdened with an inherent

conflict of interest, not from the promoters of the investment.

Mortensen v. Commissioner, 440 F.3d 375, 387 (6th Cir. 2006),

affg. T.C. Memo. 2004-279; Van Scoten v. Commissioner, 439 F.3d

1243, 1253 (10th Cir. 2006), affg. T.C. Memo. 2004-275; Goldman

v. Commissioner, 39 F.3d 402, 408 (2d Cir. 1994), affg. T.C.

Memo. 1993-480; LaVerne v. Commissioner, 94 T.C. at 652; Rybak v.

Commissioner, 91 T.C. 524, 565 (1988); Hansen v. Commissioner,

T.C. Memo. 2004-269.

     Petitioner argues that he reasonably and in good faith

relied on Hoyt as an enrolled agent, on Laguna to prepare his

returns, and on “Hoyt’s outside advisors.”   Petitioner places

strong emphasis on Hoyt’s status as an enrolled agent.    However,

any significance that such status may have is clearly outweighed

by the fact that Hoyt was the creator and promoter of the

investment scheme.   Petitioner’s reliance on Hoyt and his

organization, including Laguna, was not objectively reasonable

because Hoyt and his organization created and promoted the

investment, they completed petitioner’s tax returns, and they

received 75 percent of the refunds petitioner received.
                              - 26 -

     Petitioner argues:

     Hoyt made certain that Petitioner was aware of outside
     counsel by referencing outside counsel in newsletters
     and other documents * * *. Hoyt made certain that
     Petitioner (and other Hoyt investors) were aware that
     Mr. MacDonald and Mr. Dismukes were the attorneys who
     had won Bales * * *. In light of Petitioner’s lack of
     sophistication, his reliance on the tax professionals
     that won the Bales case is even more understandable.
     Therefore, the negligence penalty is also inappropriate
     due to Petitioner[’s] reasonable reliance on the Hoyt
     outside advisors.

Whether or not petitioner was aware that Hoyt had “outside

advisors”, there is no evidence that petitioner sought or

received advice directly from these “outside advisors”.     The

advisors were hired by Hoyt, and any advice that petitioner may

have received from them was filtered through Hoyt.

     Petitioner testified that he did not seek advice from tax

attorneys or accountants outside of the Hoyt organization.

Petitioner’s reliance on Hoyt, Laguna, and persons hired by Hoyt,

coupled with his failure to seek independent advice, was

unreasonable.

          b.    Honest Misunderstanding of Fact

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

indicated where there is “an honest misunderstanding of fact or

law that is reasonable in light of all the facts and

circumstances, including the experience, knowledge and education

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

However, “reasonable cause and good faith is not necessarily
                                - 27 -

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

incorrect.”     Id.

     Petitioner argues that he had reasonable cause for his

underpayments of tax because he was defrauded by Hoyt and

therefore made an “honest mistake of fact”.       He asserts that he

had insufficient information concerning his investment, and that

all “available independent evidence * * * supported Hoyt’s

assertions.”    However, petitioner testified that he relied

exclusively on the assertions made by Hoyt, members of the Hoyt

organization, and other Hoyt investors.     There is no indication

that petitioner attempted to verify any of the information he was

given.   He did not seek an outside opinion from an investment

advisor, tax attorney, or accountant.     Petitioner’s argument that

he had insufficient information, while at the same time admitting

he made no attempt to get additional information, is not

persuasive.     If petitioner misunderstood the facts surrounding

his investment, it was not an honest misunderstanding but a

negligent one.

           c.     Reliance on the Bales Opinion

     Petitioner argues he had reasonable cause for his

underpayments of tax because he relied on this Court’s opinion in

Bales v. Commissioner, T.C. Memo. 1989-568.9      Bales involved


     9
        Petitioner also argues that the opinion in Bales v.
Commissioner, T.C. Memo. 1989-568, provided substantial authority
                                                   (continued...)
                               - 28 -

deficiencies determined against various investors in several Hoyt

partnerships.    This Court found in favor of the investors on

several issues, stating that “the transaction in issue should be

respected for Federal income tax purposes.”    Bales involved

different investors and different taxable years from the present

case.    It also involved different underlying deductions; namely,

partnership deductions as opposed to Schedule F deductions.

     Despite the differences between Bales and the present case,

petitioner argues that he relied on the Bales opinion in claiming

his Schedule F deductions.   However, petitioner’s testimony on

direct examination is illuminating:

     [Bales] was a court case. There was a--and I’m not
     familiar with these type of documents, but in the left-
     hand margin it had all these numbers in it, and it was
     from the Supreme Court in California, Judge Divens, I
     believe, was the name. I actually didn’t go through
     the entire transcript. It was hard for me to follow
     there, since I’m not a lawyer. But I read the abstract
     that Hoyt provided with that that they sent out in a
     newsletter where they--and they had highlighted that
     the judge said that it was a legitimate business.

First, Bales was not decided by a Judge Divens of the Supreme

Court of California, but was decided by Judge Scott of the United



     9
      (...continued)
for the positions taken on his return, thus relieving him from
liability from any penalty under sec. 6662(b)(2) and (d). See
sec. 6662(d)(2)(B)(i). Because we find that petitioner’s
underpayments were the result of negligence and therefore do not
address whether the underpayments were also attributable to
substantial understatements of tax, we need not consider whether
Bales is substantial authority for purposes of sec.
6662(d)(2)(B)(i).
                              - 29 -

States Tax Court, adopting the opinion of Special Trial Judge

Dinan.   Second, and more importantly, petitioner admits that he

did not read the entire case, nor did he understand it.    Instead,

he relied on the interpretation provided by Hoyt.   We have

already found that petitioner’s reliance on Hoyt and his

organization was unreasonable.   Likewise, accepting Hoyt’s

assurances that Bales was a wholesale affirmation of the

legitimacy of his organization was also unreasonable.

     Petitioner also argues that, because this Court was unable

to uncover the fraud or deception by Hoyt in Bales, petitioner,

as an individual taxpayer, an “unsophisticated investor”, and a

person of “modest income”, was in no position to evaluate the

legitimacy of his investment or the tax benefits claimed with

respect thereto.   As previously noted by this Court:

     This argument employs the Bales case as a red herring:
     The Bales case involved different investors, different
     partnerships, different taxable years, and different
     issues. Furthermore, adopting petitioners’ position
     would imply that taxpayers should have been given carte
     blanche to invest in partnerships promoted by Mr. Hoyt,
     merely because Mr. Hoyt had previously engaged in
     activities which withstood one type of challenge by the
     Commissioner, no matter how illegitimate the
     partnerships had become or how unreasonable the
     taxpayers were in making investments therein and
     claiming the tax benefits that Mr. Hoyt promised would
     ensue.

Hansen v. Commissioner, T.C. Memo. 2004-269; see also Mortensen

v. Commissioner, 440 F.3d at 390-391; Van Scoten v. Commissioner,
                                  - 30 -

439 F.3d at 1254-1256; Sanders v. Commissioner, T.C. Memo. 2005-

163.    Petitioner’s reliance on Bales was unreasonable.

       On the basis of the above, we conclude that petitioner did

not have reasonable cause for his underpayments of tax.

       2.     Judicial Estoppel

       In general terms, petitioner asks the Court to “apply the

doctrine of judicial estoppel to facts Respondent has asserted in

previous litigation.”       Petitioner does not elaborate.

Presumably, petitioner is arguing that because the U.S.

Government successfully prosecuted Hoyt for fraud, respondent is

somehow judicially estopped from asserting an accuracy-related

penalty against petitioner.

       The doctrine of judicial estoppel prevents a party from

asserting a claim in a legal proceeding that is inconsistent with

a position successfully taken by that party in a previous

proceeding.       New Hampshire v. Maine, 532 U.S. 742, 749 (2001).

Among the requirements for judicial estoppel to be invoked, a

party’s current litigating position must be “clearly

inconsistent” with a prior litigating position.       Id. at 750-751.

       Respondent’s position in asserting an accuracy-related

penalty against petitioner is in no manner inconsistent with the

position taken by the United States in the criminal conviction of

Hoyt.       See, e.g., Goldman v. Commissioner, 39 F.3d at 408

(taxpayer-appellants’ argument that an investment partnership
                              - 31 -

“constituted a fraud on the IRS, as found by a civil jury * * *

and by the tax court * * * cannot justify appellants’ own failure

to exercise reasonable care in claiming the losses derived from

their investment”); see also Mortensen v. Commissioner, 440 F.3d

375 (6th Cir. 2006); Van Scoten v. Commissioner, 439 F.3d 1243

(10th Cir. 2006); Hansen v. Commissioner, supra.   Other than his

vague assertions, petitioner has failed to identify any clear

inconsistencies between respondent’s current position and his

position in any previous litigation.   We conclude that there are

no grounds for judicial estoppel in the present case.

     3.   Fairness Considerations

     Petitioner argues that the application of accuracy-related

penalties would be unfair or unjust because such an application

does not comport with the underlying purpose of the penalties.

Petitioner states:

     Here, the problem was not Petitioner’s disregard of the
     tax laws, but was Jay Hoyt’s fraud and deception.
     Petitioner did not engage in noncompliant behavior,
     instead, he was the victim of a complex fraud that it
     took Respondent years to unravel completely.

          Petitioner made a good faith effort to comply with
     the tax laws and punishing him by imposing penalties
     does not encourage voluntary compliance, but instead
     has the opposite effect of the appearance of unfairness
     by punishing the victim. Indeed, penalties are
     improper for any investor in the Hoyt partnerships on a
     policy basis alone. [Fn. ref. omitted.]

We are mindful of the fact that Hoyt was convicted for his

fraudulent actions.   We also recognize that petitioner remitted
                              - 32 -

the bulk of his refunds to the Hoyt organization.   However, this

does not alter our conclusion that petitioner was negligent with

respect to entering into the investment, and he was negligent

with respect to the positions taken on his returns.    Despite

Hoyt’s actions, the positions taken on the 1994 and 1995 returns,

signed by petitioner, were ultimately the positions of

petitioner.

G.   Conclusion

      Petitioner’s underpayments of tax for 1994 and 1995 were

the result of petitioner’s negligence, and portions of those

underpayments were attributable to gross valuation misstatements.

Petitioner did not have reasonable cause for the underpayments.

Likewise, petitioner’s arguments regarding judicial estoppel and

fairness do not absolve him from liability for the accuracy-

related penalties.   Therefore, we hold that petitioner is liable

for 40-percent accuracy-related penalties under section 6662(h)

on his underpayments attributable to gross valuation

misstatments, so long as the total of those underpayments exceeds

$5,000.   On his underpayments not subject to penalties under

section 6662(h), we hold that petitioner is liable for 20-percent

accuracy-related penalties under section 6662(a) and (b)(1).
                        - 33 -

To reflect the foregoing and the concessions of the parties,


                                   Decision will be entered

                              under Rule 155.
