                        T.C. Memo. 1995-533



                      UNITED STATES TAX COURT



        ALBERT R. AND PHYLLIS F. DWORKIN, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 34384-87.               Filed November 9, 1995.



     Albert R. Dworkin, pro se.

     Mae J. Lew, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     DAWSON, Judge:   This case was assigned to Special Trial

Judge Norman H. Wolfe pursuant to the provisions of section

7443A(b)(4) and Rules 180, 181, and 183.1     The Court agrees with



1
     All section references are to the Internal Revenue Code, in
effect for the year in issue, unless otherwise stated. All Rule
references are to the Tax Court Rules of Practice and Procedure.
                              - 2 -

and adopts the opinion of the Special Trial Judge, which is set

forth below.

               OPINION OF THE SPECIAL TRIAL JUDGE

     WOLFE, Special Trial Judge:     This case is part of the

Plastics Recycling group of cases.    For a detailed discussion of

the transactions involved in the Plastics Recycling cases, see

Provizer v. Commissioner, T.C. Memo. 1992-177, affd. without

published opinion 996 F.2d 1216 (6th Cir. 1993).    The underlying

transaction in this case is substantially identical to the

transaction considered in the Provizer case.

     In a notice of deficiency, respondent determined a

deficiency in petitioners' joint 1981 Federal income taxes in the

amount of $83,294, and additions to tax for that year in the

amount of $21,296 under section 6659 for valuation overstatement,

in the amount of $4,165 under section 6653(a)(1) for negligence,

and under section 6653(a)(2) in an amount equal to 50 percent of

the interest due on the underpayment attributable to negligence.

Respondent also determined that interest on deficiencies accruing

after December 31, 1984, would be calculated at 120 percent of

the statutory rate under section 6621(c).2

2
     The notice of deficiency refers to sec. 6621(d). This
section was redesignated as sec. 6621(c) by sec. 1511(c)(1)(A) of
the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085, 2744
and repealed by sec. 7721(b) of the Omnibus Budget Reconciliation
Act of 1989 (OBRA 89), Pub. L. 101-239, 103 Stat. 2106, 2399,
effective for tax returns due after Dec. 31, 1989, OBRA 89 sec.
7721(d), 103 stat. 2400. The repeal does not affect the instant
                                                   (continued...)
                                - 3 -

     On February 22, 1994, the parties filed a Stipulation of

Settled Issues with respect to petitioners' 1981 Federal income

tax return.   The parties stipulated that petitioners are not

entitled to any deductions, losses, investment tax credits,

business energy credits, or any other tax benefits claimed on

their tax returns as a result of their participation in the

"Plastics Recycling Program".   The parties further stipulated

that the underpayments in income tax attributable to petitioners'

participation in the "Plastics Recycling Program" are substantial

underpayments attributable to tax motivated transactions, subject

to the increased rate of interest established under section

6621(c).

     On March 21, 1994, the parties filed a Partial Stipulation

of Settlement regarding interest income.   The parties stipulated

that interest income from accounts with the Irving Trust Co. in

the amount of $1,271, and interest income from Emigrant Savings

Bank account number 2-5054650-4, in the amount of $2,000 is

includable in petitioners' taxable income for tax year 1981.     The

parties also stipulated that interest income from Emigrant

Savings Bank account number 2-5054650-4, in the amount of $2,000


2
 (...continued)
case. For simplicity, we will refer to this section as sec.
6621(c). The annual rate of interest under sec. 6621(c) for
interest accruing after Dec. 31, 1984, equals 120 percent of the
interest payable under sec. 6601 with respect to any substantial
underpayment attributable to tax-motivated transactions.
                                 - 4 -

is not includable in petitioners' taxable income for tax year

1981.   Lastly, the parties stipulated that sections 6653, 6661,

and 6621(c) were not applicable to any of the adjustments set

forth in the Partial Stipulation of Settlement.

     After trial, respondent conceded a reduction in the section

6659 addition to tax for 1981.    In the notice of deficiency,

respondent determined a section 6659 addition to tax in the

amount of $21,295.    In her reply brief, respondent asserted that

the section 6659 addition to petitioners' tax for 1981 should be

reduced to $19,083.   We consider that respondent has conceded the

addition to tax under section 6659 for 1981 in excess of the

amount of such addition to tax in dispute as set forth in

respondent's reply brief.

     The issues for decision with respect to petitioners' Federal

income tax for 1981 are:    (1) Whether petitioners are liable for

additions to tax for negligence or intentional disregard of rules

or regulations under section 6653(a)(1) and (2); and (2) whether

petitioners are liable for the addition to tax under section 6659

for an underpayment of tax attributable to valuation

overstatement.

                           FINDINGS OF FACT

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

The stipulated facts and attached exhibits are incorporated by

this reference.   Petitioners resided in Longboat Key, Florida,

when their petition was filed.
                               - 5 -

     During 1981, Albert R. Dworkin (petitioner) was a semi-

retired certified public accountant (C.P.A.) and an investor in

real estate and other entities.   His spouse, petitioner Phyllis

F. Dworkin, was not employed outside the home during 1981.    On

their 1981 Federal income tax return, petitioners reported gross

income from interest, dividends, business, capital gains, and

other sources in excess of $196,500.   Consequently, in the

absence of significant deductions or credits, they were subject

to payment of Federal income taxes in substantial amounts.

     The facts of the underlying transaction in this case are

substantially identical to those in Provizer v. Commissioner,

supra, and may be summarized as follows.   In 1981, Packaging

Industries, Inc. (PI), manufactured and sold seven Sentinel

expanded polyethylene (EPE) recyclers to ECI Corp. for $6,867,000

($981,000 each), of which $530,000 was paid in cash.   ECI Corp.,

in turn, resold the recyclers to F & G Corp. for $8,138,667

($1,162,666 each), of which $615,000 was paid in cash.   F & G

Corp. then leased the recyclers to Northeast Resource Recovery

Associates (Northeast), a limited partnership, which licensed the

recyclers to FMEC Corp., which sublicensed them back to PI.     All

of the monthly payments required among the entities in the above

transactions offset each other.   These transactions were done

simultaneously.   We refer to these transactions collectively as

the Northeast transaction.
                               - 6 -

     In Provizer v. Commissioner, supra, we examined the

Clearwater transaction.   In the Clearwater transaction, PI sold

six EPE recyclers to ECI Corp. for $981,000 each, which in turn

resold the recyclers to F & G Corp. for $1,162,666 each.     F & G

leased the recyclers to a limited partnership, Clearwater, which

licensed them to FMEC, which sublicensed them to PI.   The

transaction involved herein differs in two respects:   (1) Seven

Sentinel EPE recyclers were sold and leased rather than six; and

(2) Northeast, rather than Clearwater, leased the recyclers from

F & G and then licensed them to FMEC.   Northeast is thus like

Clearwater, occupying the same link in the transactional chain.

In addition, the Sentinel EPE recyclers considered in this case

are the same type of machines considered in the Provizer case.

The fair market value of a Sentinel EPE recycler in 1981 was not

in excess of $50,000.

     PI allegedly sublicensed the recyclers to entities that

would use them to recycle plastic scrap.   The sublicense

agreements provided that the end-users would transfer to PI 100

percent of the recycled scrap in exchange for a payment from FMEC

Corp. based on the quality and amount of recycled scrap.

     In 1981, petitioner acquired a 3.908-percent limited

partnership interest in Northeast in exchange for his investment

of $37,500.   As a result of the passthrough from Northeast,

petitioners deducted on their 1981 Federal income tax return an

operating loss in the amount of $30,510 and claimed investment
                               - 7 -

tax and business energy credits totaling $63,612.    Respondent

disallowed petitioners' claimed operating loss and credits

related to Northeast for taxable year 1981.

     Petitioner Albert Dworkin is a well-educated and

sophisticated businessman, investor, and tax professional.

Petitioner received a B.S. degree from New York University and an

LL.B. degree from Fordham Law School.    He is a certified public

accountant (C.P.A.) and has been admitted to the New York bar.

Petitioner was employed as an internal revenue agent from 1941 to

1945.   In 1945 he joined the accounting firm of David Berdon &

Co.; he became a partner in that firm in 1952.    While at David

Berdon & Co., petitioner represented clients by assisting Federal

examiners in income and estate tax return examinations; resolved

disputes at the District Conference and Appeals Office levels of

the Internal Revenue Service (IRS); supervised and assisted in

the preparation of tax returns; and researched and drafted

memoranda addressing tax issues.   For a number of years,

petitioner was also a member of the Federal Taxation Committee of

the American Institute of Certified Public Accountants.

     Petitioner left David Berdon & Co. in 1970.    He has since

acted as a consultant, engaged in various business matters, and

made numerous business investments.    Between 1952 and 1980

petitioner held minority interests in 16 different unincorporated

entities.   Two of these were oil drilling operations and 14 were

real estate interests.   From 1977 to 1988 petitioner held
                                - 8 -

fractional interests in four oil wells in Alberta, Canada.

Petitioner also invested as a limited partner in five other

unincorporated entities from 1983 to 1988.    Three of these were

real estate ventures, one involved oil wells and the last

involved equipment leasing.    Over the course of his career

petitioner has examined a large number of private placement

offering memoranda and has participated in the preparation of

such memoranda.

       In 1981, petitioner learned of the Northeast transaction

from Raymond Grant (Grant).    Petitioner first became acquainted

with Grant about 1946 when they both worked for David Berdon &

Co. in New York City.    After about 2 years, Grant left David

Berdon & Co. to enter the mutual fund business.    Grant became

general counsel and senior vice president at Waddell & Reed, a

large mutual fund organization in Kansas City.    He returned to

New York in the mid-1970's.    At that time Grant became a member

of the same tennis and social club as petitioner.    During 1981

Grant was an investment banker, an attorney, and an accountant.

He was also the president and 100 percent owner of the stock of

ECI.

       After learning of the Northeast transaction from Grant,

petitioner spoke with Richard Roberts (Roberts), a businessman

and the general partner in Northeast.    Roberts was a 9-percent

shareholder in F & G and the general partner in a number of

limited partnerships which leased Sentinel EPE recyclers.      Grant
                                - 9 -

and Roberts were general partners together in other investments

and maintained an office together in New York City.    During 1981

Roberts served as second vice chairman of the Mountain Ridge

State Bank (Mountain Ridge) in West Orange, New Jersey.

     As general partner, Roberts was personally responsible for

the full amount due on the Northeast partnership lease.

Petitioner contacted Roberts to discuss the Northeast

transaction.   Petitioner was provided a copy of Roberts'

individual financial statement dated August 20, 1981.    The

financial statement showed a net worth for Roberts in the amount

of $3,830,000.   Petitioner asked his banker, Joseph Dowding

(Dowding), to run a background check on Roberts and Mountain

Ridge.   Dowding reported that Mountain Ridge was a small bank and

that its president had told him that Roberts had a fine business

reputation.    Also, a financial statement for Mountain Ridge was

forwarded to petitioner.

     Petitioner was provided a copy of the offering memorandum

for Northeast.   The offering memorandum summarized the Northeast

transaction and detailed the tax risk factors, business risk

factors, and the business of the partnership, inter alia.      The

offering memorandum unambiguously disclosed that both Grant and

Roberts were promoters of Northeast.    Appendices to the

memorandum include reports of F & G's evaluators, Stanley M.

Ulanoff and Samuel Z. Burstein, and a draft letter of counsel

regarding the tax risks associated with Northeast.    Petitioner
                               - 10 -

asked some New York City attorneys about the New York law firm

that prepared the draft opinion letter and was satisfied with its

reputation.   The preface to the offering memorandum contained the

following emphasized admonition:   THIS MEMORANDUM AND ATTACHED

APPENDICES IS AN INTEGRAL DOCUMENT AND MUST BE READ IN ITS

ENTIRETY.

     Petitioner had no education or work experience in plastics

recycling or plastics materials.   Petitioner did not conduct any

independent research as to the value of the Sentinel EPE

recyclers.    Petitioner did not contact either Mr. Ulanoff or Mr.

Burstein regarding their evaluation of the recyclers, and did not

contact any other expert on plastics or engineering.

                               OPINION

     In Provizer v. Commissioner, T.C. Memo. 1992-177, a test

case involving the Clearwater transaction, this Court (1) found

that each Sentinel EPE recycler had a fair market value not in

excess of $50,000, (2) held that the Clearwater transaction was a

sham because it lacked economic substance and a business purpose,

(3) upheld the section 6659 addition to tax for valuation

overstatement since the underpayment of taxes was directly

related to the overstatement of the value of the Sentinel EPE

recyclers, and (4) held that losses and credits claimed with

respect to Clearwater were attributable to tax-motivated

transactions within the meaning of section 6621(c).    In reaching

the conclusion that the Clearwater transaction lacked economic
                              - 11 -

substance and a business purpose, this Court relied heavily upon

the overvaluation of the Sentinel EPE recyclers.

     Although petitioners have not agreed to be bound by the

Provizer opinion, they have stipulated that petitioner's

investment in the Sentinel EPE recyclers was similar to the

investment described in Provizer v. Commissioner, supra. The

underlying transaction in this case (the Northeast transaction)

is in all material respects identical to the transaction

considered in the Provizer case.     The Sentinel EPE recyclers

considered in this case are the same type of machines considered

in the Provizer case.

     Based on the entire record in this case, including the

extensive stipulations, testimony of respondent's experts, and

cross-examination of them, and petitioner's testimony, we hold

that the Northeast transaction was a sham and lacked economic

substance.   In reaching this conclusion, we rely heavily upon the

overvaluation of the Sentinel EPE recyclers.    Respondent is

sustained on the question of the underlying deficiency.    We note

that petitioner has explicitly conceded this issue in a

Stipulation of Settled Issues filed shortly before trial.    The

record plainly supports respondent's determination regardless of

such concession.   For a detailed discussion of the facts and the

applicable law in a substantially identical case, see Provizer v.

Commissioner, supra.

Issue 1:   Sec. 6653(a) Negligence
                              - 12 -

     Respondent determined that petitioners were liable for the

additions to tax under section 6653(a).   Petitioners have the

burden of proving that respondent's determination of an addition

to tax is erroneous.   Rule 142(a); Luman v. Commissioner, 79 T.C.

846, 860-861 (1982).

     Section 6653(a)(1) imposes an addition to tax equal to 5

percent of the underpayment if any part of an underpayment of tax

is due to negligence or intentional disregard of rules or

regulations.   In cases involving negligence, an additional amount

is added to the tax under section 6653(a)(2); such amount is

equal to 50 percent of the interest payable with respect to the

portion of the underpayment attributable to negligence.

Negligence is defined as the failure to exercise the due care

that a reasonable and ordinarily prudent person would employ

under the circumstances.   Neely v. Commissioner, 85 T.C. 934, 947

(1985).   The question is whether a particular taxpayer's actions

in connection with the transactions were reasonable in light of

his experience and the nature of the investment or business.     See

Henry Schwartz Corp. v. Commissioner, 60 T.C. 728, 740 (1973).

     Petitioner contends that he was reasonable in claiming

deductions and credits with respect to his investment in

Northeast and asserts that the instant case is distinguishable

from Provizer v. Commissioner, supra, in that:   (1) Petitioner

acted reasonably and exercised due diligence in relying on Grant,

Roberts, and the draft opinion letter in the offering memorandum;
                              - 13 -

and (2) petitioners' intent in making the investment was to

obtain a stream of rental income generated from the resale and

reuse of recycled plastic.

     When petitioners claimed the disallowed deductions and tax

credits, they had no knowledge of the plastics or recycling

industries and no engineering or technical background.

Petitioner did not independently investigate the economic

potential of the Sentinel EPE recyclers.

     Under some circumstances a taxpayer may avoid liability for

the additions to tax under section 6653(a)(1) and (2) if

reasonable reliance on a competent professional adviser is shown.

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.     Id.   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.;

see Weis v. Commissioner, 94 T.C. 473, 487 (1990); Ewing v.

Commissioner, 91 T.C. 396, 423-424 (1988), affd. without

published opinion 940 F.2d 1534 (9th Cir. 1991); Pritchett v.

Commissioner, 63 T.C. 149, 174-175 (1974).

     Reliance on representations by insiders, promoters, or

offering materials has been held an inadequate defense to

negligence.   LaVerne v. Commissioner, 94 T.C. 637, 652-653
                               - 14 -

(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); McCrary v.

Commissioner, 92 T.C. 827, 850 (1989); Rybak v. Commissioner, 91

T.C. 524, 565 (1988).   We have rejected pleas of reliance when

neither the taxpayer nor the advisers purportedly relied upon by

the taxpayer knew anything about the nontax business aspects of

the contemplated venture.   Beck v. Commissioner, 85 T.C. 557

(1985); Flowers v. Commissioner, 80 T.C. 914 (1983); Steerman v.

Commissioner, T.C. Memo. 1993-447.

     Petitioner first learned of the Northeast transaction from

Grant.   Grant and petitioner worked in the same accounting firm

for 2 years in the late 1940's, and they were members of the same

tennis and social club during the late 1970's.   Petitioner

explained that "The Shelter Rock Tennis Club was a country club

based on tennis.   It had a restaurant and a bar, and it was a

social center for its members."   Petitioner stated that he and

Grant played tennis together and shared social acquaintances, and

that Grant "lived quite well, somewhat expensively."   Petitioner

also noted that he and Grant's brother-in-law had been partners

in the same accounting firm.   Petitioner was aware that Grant had

no background knowledge or expertise in the plastics recycling

area.
                               - 15 -

     Petitioner testified that before petitioner invested in

Northeast, Grant told him that he had investigated the Sentinel

EPE recyclers and that the recycling machine "was to the best of

his knowledge truly unique."   Petitioner testified that, given

Grant's statement, he thought the question of the price of a

comparable machine was academic.   Petitioner argues that there

should have been no comparable machine.     In fact, there were at

least four other plastics recycling machines available during

1981, ranging in price from $20,000 to $200,000:     Foremost

Densilator, Nelmor/Weiss Densification System (Regenolux), Buss-

Condux Plastcompactor, and Cumberland Granulator.     See Provizer

v. Commissioner, supra.

     Petitioner also contacted Roberts.     Petitioner testified

that because Grant and Roberts shared office space and engaged in

business transactions together, petitioner presumed that Grant

considered Roberts to be a person of suitable moral character and

business competence.   Petitioner also stated that he asked

Roberts whether he expected the IRS to question the price of the

recyclers for the tax credits.   According to petitioner, Roberts

told him he would not be surprised if the IRS questioned the

purported price of the Sentinel EPE recyclers, but that he

believed there would be a compromise reducing the amount of

valuation by less than 20 percent.      Petitioner accepted Roberts'

statement without further question.
                               - 16 -

     Petitioner also claims that he reasonably relied upon the

conclusions of the draft opinion letter.    Petitioner contends

that the nonrecourse nature of F & G's note was not readily

apparent in the draft opinion letter and that he would not have

made the investment had he been aware that the note was

nonrecourse.    However, the nonrecourse nature of the note was

clearly stated in two different sections of the main body of the

offering memorandum.3   One section was headlined "Price of the

Sentinel Recyclers To F & G and Payment Terms" and the other was

headlined "F & G's Purchase of the Sentinel Recyclers".

     Petitioner's reliance on Grant and Roberts, two promoters of

Northeast, was not reasonable, in good faith, nor based upon full

disclosure.    The record does not show that either Grant or

Roberts possessed any special qualifications or professional

skills in the recycling or plastics industries.    Petitioner's

stated reliance on Grant in making a substantial investment in a

complex transaction stemmed from nothing more than a 2-year

shared work environment in the late 1940's and membership in the

same country club and social group for a few years during the

late 1970's.    Petitioner's reliance on Roberts derived almost


3
     According to the purchase agreement as described in the
Northeast offering memorandum, of the $8,138,667 purchase price,
F & G would pay $615,000 in cash at closing, with the balance to
be paid with a "partial recourse note." Ten percent of the note
would be full recourse, but such recourse portion would only be
due and payable after the nonrecourse portion of the note had
been satisfied.
                               - 17 -

entirely from petitioner's acquaintance with Grant.    As to

petitioner's reliance on the offering memorandum, the record

indicates that petitioner either did not read the offering

memorandum in its entirety or was careless when doing so.

     Petitioners' reliance on Epsten v. Commissioner, T.C. Memo.

1991-252, is misplaced.   The taxpayers in Epsten invested in a

grantor trust that sold and leased IBM computers.    The activities

of the trust were not an economic sham; they had economic

substance.   There was a reasonable possibility of an economic

profit to both the trust and the taxpayers apart from the

attendant tax benefits.   Both the trust and the taxpayers had an

actual and honest profit objective with respect to the

transactions at issue.    While the taxpayers in the Epsten case

conceded disallowance of the tax benefits because they were not

at risk pursuant to section 465, the Court did not find them

negligent under section 6653(a).   However, it was not the

taxpayers' reliance on the offering memorandum and other

documents that absolved them of negligence.    Rather, at the time

of their investment there was little case law interpreting the

recently enacted section 465(b)(4).     Consequently, there were no

indications that the professional advice given the taxpayers was

not reasonable.

     In the instant case, petitioners invested in a transaction

that had no economic substance, and neither they nor Northeast

could have reasonably expected to realize an economic profit.
                               - 18 -

There was ample case law and commentary at the time of

petitioners' investment addressing the disallowance of tax

benefits flowing from transactions lacking economic substance.

Indeed, petitioner testified that had he been aware of the

nonrecourse nature of the debt issued by F & G he would not have

invested in Northeast.   Yet the nonrecourse nature of the debt

issued by F & G was unambiguously disclosed in multiple sections

of the offering memorandum.    More significantly, the transaction

here was a sham, and that was not the case in Epsten.    Here

petitioner accepted an inflated value of $1,162,666 each for

machines with an actual value not in excess of $50,000, and

petitioner made no investigation of the valuation.    The Epsten

case, involving the interpretation of recently enacted law, does

not support petitioners' investment in a sham transaction

involving inflated valuations without investigation.

     Finally, petitioners argue that they had a business motive

for their investment in Northeast, independent of any tax

benefits.   Their alleged intent in making the investment was to

obtain a stream of rental income generated from the resale and

reuse of recycled plastic.    Petitioner was aware that plastics

were oil derivatives.    Petitioner argues, in general terms, that

because of the media coverage of a supposed oil crisis in the

United States during 1981, he believed that an investment in

plastics recycling had good economic potential.    In addition,
                              - 19 -

petitioner argues that the Federal Government, by virtue of the

energy tax credit, was encouraging this type of investment.

     Petitioner failed to explain how the so-called oil crisis,

or the media coverage thereof, provided a reasonable basis for

him to invest in Northeast and claim the associated tax

deductions and credits.   Instead, he testified that he made the

decision with respect to Northeast "primarily as a speculation".

The offering memorandum noted several business risks associated

with Northeast, including the circumstances that there was no

established market for the recyclers, that there could be no

assurances that the recycled resin pellets would be marketable as

new resin pellets, and that there could be no assurances that

prices for new resin pellets would remain at their then current

level.   Moreover, during 1980 and 1981, in addition to the media

coverage of the so-called oil crisis, there was "extensive

continuing press coverage of questionable tax shelter plans."

Zmuda v. Commissioner, 731 F.2d 1417, 1422 (9th Cir. 1984), affg.

79 T.C. 714 (1982).   Furthermore, as respondent's expert Grossman

noted in his written report, "a 300% increase in crude oil prices

results in only a 30 to 40% increase in the cost of plastic

products."

     The anticipated tax benefits, on the other hand, were stated

in the offering materials.   According to the Northeast offering

memorandum, the projected benefits for each $50,000 investor were

investment tax credits in 1981 of $84,813 plus deductions in 1981
                                - 20 -

of $40,174.   In the first year of the investment alone,

petitioners claimed an operating loss in the amount of $30,510

and investment tax and business energy credits related to

Northeast totaling $63,612, while petitioners' investment in

Northeast was only $37,500.    The direct reductions in their

Federal income tax, via the tax credits, equaled 170 percent of

their cash investment.    Therefore, like the taxpayers in Provizer

v. Commissioner, T.C. Memo. 1992-177, "except for a few weeks at

the beginning, petitioners never had any money in the [Northeast]

deal."    A reasonably prudent person would not conclude without

substantial investigation that the Government was providing tax

benefits so disproportionate to the taxpayers' investment of

their own capital.    A reasonably prudent person would have asked

a qualified independent tax adviser if this windfall were not too

good to be true.     McCrary v. Commissioner, 92 T.C. 827, 850

(1989).

     Petitioners have not distinguished their situation from that

of the taxpayers in Provizer v. Commissioner, supra, where the

negligence additions to tax were upheld.    We hold, upon

consideration of the entire record, that petitioners are liable

for the negligence additions to tax under the provisions of

section 6653(a)(1) and (2).    Respondent is sustained on this

issue.
                                - 21 -

Issue 2:   Sec. 6659 Valuation Overstatement

     Respondent determined that petitioners are liable for the

section 6659 addition to tax on the portion of their 1981

underpayment attributable to valuation overstatement.   In

respondent's notice of deficiency, the addition to tax under

section 6659 was applied to the entire amount of the disallowed

loss and credits, resulting in a section 6659 addition to tax in

the amount of $21,296.   Respondent subsequently reduced the

section 6659 addition to tax to apply only to the underpayment

attributable to the disallowed credits.   Respondent asserted in

her reply brief a reduced section 6659 addition to petitioners'

tax for 1981 in the amount of $19,083.    We consider the addition

to tax under section 6659 for 1981 reduced to correspond to the

amount in dispute as set forth in respondent's reply brief.

     A graduated addition to tax is imposed when an individual

has an underpayment of tax that equals or exceeds $1,000 and "is

attributable to" a valuation overstatement.    Sec. 6659(a), (d).

A valuation overstatement exists if the fair market value (or

adjusted basis) of property claimed on a return equals or exceeds

150 percent of the amount determined to be the correct amount.

Sec. 6659(c).   If the claimed valuation exceeds 250 percent of

the correct value, the addition is equal to 30 percent of the

underpayment.   Sec. 6659(b).

     Petitioners claimed an investment tax credit and a business

energy credit based on purported values of $1,162,666 for each
                                - 22 -

Sentinel EPE recycler.    Petitioners concede that the fair market

value of each recycler was not in excess of $50,000.      Therefore,

if disallowance of petitioners' claimed credits is attributable

to the valuation overstatement, petitioners are liable for the

section 6659 addition to tax at the rate of 30 percent of the

underpayment of tax attributable to the credits claimed with

respect to Northeast.

     Section 6659 does not apply to underpayments of tax that are

not "attributable to" valuation overstatements.    See McCrary v.

Commissioner, 92 T.C. 827 (1989); Todd v. Commissioner, 89 T.C.

912 (1987), affd. 862 F.2d 540 (5th Cir. 1988).    To the extent

taxpayers claim tax benefits that are disallowed on grounds

separate and independent from alleged valuation overstatements,

the resulting underpayments of tax are not regarded as

attributable to valuation overstatements.     Krause v.

Commissioner, 99 T.C. 132, 178 (1992), affd. sub nom. Hildebrand

v. Commissioner, 28 F.3d 1024 (10th Cir. 1994), citing Todd v.

Commissioner, supra.     However, when valuation is an integral

factor in disallowing deductions and credits, section 6659 is

applicable.   See Illes v. Commissioner, 982 F.2d 163, 167 (6th

Cir. 1992), affg. T.C. Memo. 1991-449; Masters v. Commissioner,

T.C. Memo. 1994-197; Harness v. Commissioner, T.C. Memo. 1991-

321; see Gilman v. Commissioner, 933 F.2d 143, 151 (2d Cir.

1991), affg. T.C. Memo. 1989-684.
                              - 23 -

      In the Stipulation of Settled Issues, petitioners conceded

that they "are not entitled to any deductions, losses, investment

credits, business energy investment credits, or any other tax

benefits claimed on their tax returns as a result of their

participation in the Plastics Recycling Program."   In Todd v.

Commissioner, supra, and McCrary v. Commissioner, supra, we

denied application of section 6659, even though the subject

property was overvalued, because the related deductions and

credits had been conceded or denied in their entirety on other

grounds.   In Todd we found that an underpayment was not

attributable to a valuation overstatement because property was

not placed in service during the years in issue.    In McCrary we

found the taxpayers were not liable for the section 6659 addition

to tax when, prior to the trial of the case, the taxpayers

conceded that they were not entitled to the investment tax credit

because the agreement in question was a license and not a lease.

In both cases the underpayment was attributable to something

other than a valuation overstatement.

      This Court has held that concession of the investment tax

credit in and of itself does not relieve taxpayers of liability

for the section 6659 addition to tax.   Dybsand v. Commissioner,

T.C. Memo. 1994-56.   Instead, what is significant is the ground

upon which the investment tax credit is disallowed or conceded.

Id.
                              - 24 -

     In petitioners' case, there was no argument made and no

evidence presented to the Court to prove that disallowance and

concession of the investment tax credits related to anything

other than a valuation overstatement.    To the contrary,

petitioners stipulated substantially the same facts concerning

the underlying transactions as we found in Provizer v.

Commissioner, T.C. Memo. 1992-177.     In the Provizer case, we held

that the taxpayers were liable for the section 6659 addition to

tax because the underpayment of taxes was directly related to the

overvaluation of the Sentinel EPE recyclers.    The overvaluation

of the recyclers, exceeding 2325 percent, was an integral part of

our findings in Provizer that the transaction was a sham and

lacked economic substance.   Similarly, the record in this case

plainly shows that the overvaluation of the recyclers is integral

to and is the core of our holding that the underlying transaction

here was a sham and lacked economic substance.

     Consistent with our findings in Provizer, petitioners

stipulated that the Northeast partnership had no net equity

value, that Northeast's sole activity lacked any potential for

profit, and that the Northeast transaction therefore lacked

economic substance.   When a transaction lacks economic substance,

section 6659 will apply because the correct basis is zero and any

basis claimed in excess of that is a valuation overstatement.

Gilman v. Commissioner, supra; Rybak v. Commissioner, 91 T.C.

524, 566-567 (1988); Zirker v. Commissioner, 87 T.C. 970, 978-979
                              - 25 -

(1986); Donahue v. Commissioner, T.C. Memo. 1991-181, affd.

without published opinion 959 F.2d 234 (6th Cir. 1992), affd. sub

nom. Pasternak v. Commissioner, 990 F.2d 893 (6th Cir. 1993).

     We held in Provizer v. Commissioner, supra, that each

Sentinel EPE recycler had a fair market value not in excess of

$50,000.   Our finding in the Provizer case that the Sentinel EPE

recyclers had been overvalued was integral to and inseparable

from our finding of a lack of economic substance.   Petitioners

conceded that the Northeast transaction was similar to the

Clearwater transaction described in Provizer v. Commissioner,

supra, and that the Northeast transaction lacked economic

substance.   Given those concessions, and the fact that the record

here plainly shows that the overvaluation of the recyclers was

the principal reason for the disallowance and concession of the

investment tax credits, we conclude that the deficiency caused by

the disallowance of the investment credits was attributable to

the overvaluation of the Sentinel EPE recyclers.

     Finally, we consider petitioners' express argument as to

waiver of the penalty.   At trial and on brief, petitioners

contested imposition of the section 6659 addition to tax on the

grounds that respondent erroneously failed to waive the penalty.

Section 6659(e) authorizes respondent to waive all or part of the

addition to tax for valuation overstatements if taxpayers

establish that there was a reasonable basis for the adjusted

bases or valuations claimed on the returns and that such claims
                                - 26 -

were made in good faith.    Respondent's refusal to waive a section

6659 addition to tax is reviewable by this Court for abuse of

discretion.    Krause v. Commissioner, supra at 179.

     Petitioners urged that they relied on Grant, Roberts, and

the offering memorandum in deciding on the valuation claimed on

their tax return.    Petitioners contend that such reliance was

reasonable and, therefore, respondent should have waived the

section 6659 addition to tax.

     We have found that petitioner's purported reliance on Grant,

Roberts, and the offering memorandum was not reasonable.    Grant

and Roberts were promoters of Northeast and knew nothing about

plastics or plastics recycling.    See Vojticek v. Commissioner,

T.C. Memo. 1995-444, to the effect that advice from such persons

"is better classified as sales promotion".    The evaluators whose

reports were appended to the offering memorandum each owned

interests in partnerships which leased Sentinel EPE recyclers.

The offering memorandum contained numerous caveats, including the

following:    NO OFFEREE SHOULD CONSIDER THE CONTENTS OF THIS

MEMORANDUM *** AS *** EXPERT ADVICE.     EACH OFFEREE SHOULD CONSULT

HIS OWN PROFESSIONAL ADVISERS.    Petitioner did not see a Sentinel

EPE recycler prior to investing in Northeast, nor did he

independently investigate the recyclers.

     Petitioners did not have a reasonable basis for the adjusted

bases or valuations reflected on their 1981 return with respect

to their investment in Northeast.    Accordingly, in this case
                              - 27 -

respondent was correct in finding that petitioner's reliance on

the appraisal in the promotional materials was unreasonable.     The

record in this case does not establish an abuse of discretion on

the part of respondent but supports respondent's position.     We

hold that respondent's refusal to waive the section 6659 addition

to tax is not an abuse of discretion.   Petitioners are liable for

the section 6659 addition to tax at the rate of 30 percent of the

underpayment of tax attributable to the disallowed credits for

1981.   Respondent is sustained on this issue.


                                    Decision will be entered

                               under Rule 155.
