                        T.C. Memo. 1997-29



                      UNITED STATES TAX COURT



                 ALBERT J. HENRY, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

                    MARY HENRY, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 27188-91, 1987-92.          Filed January 16, 1997.



     Timothy M. Hughes, Charles F. Gibbs, and William G.

Cavanaugh, for petitioners.

     June Y. Bass and Valerie N. Larson, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     GERBER, Judge:   Respondent determined a deficiency in

petitioners' 1982 Federal income tax in the amount of $2,099,534
                              - 2 -


and additions to tax pursuant to sections 6653(a)(1)1 and 6661 in

the amounts of $104,976.70 and $524,883.50, respectively.

     The issues remaining for our consideration concern whether

petitioners are liable for additions to tax under section

6653(a)(1) and (2) and section 6661 for the taxable year 1982.

The parties have stipulated that the conclusions in Cramer v.

Commissioner, 101 T.C. 225 (1993), affd. 64 F.3d 1406 (9th Cir.

1995), control as to the underlying income tax deficiency.

     In Cramer v. Commissioner, supra, the taxpayers, like

petitioner Albert J. Henry, were shareholders and officers in a

corporation that issued certain stock options subject to

restrictions on vesting and transfer in connection with their

performance of services for the corporation.   For certain of the

options, the taxpayers filed "section 83(b) elections" in which

they reported the fair market value of the options as zero.     Upon

the sale of the options to an unrelated company in 1982, the

taxpayers misstated the transactions on their returns, reporting

them as gains from the sale of capital assets.   We sustained

respondent's determination that the proceeds from such options

were taxable as ordinary income at the time of disposition

because the options did not have "readily ascertainable fair

market values" as defined in section 1.83-7, Income Tax Regs.


     1
       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, unless otherwise
indicated.
                                - 3 -


                          FINDINGS OF FACT2

     Petitioners Albert J. Henry and Mary Henry resided in San

Diego, California, and Scarborough, North Yorkshire, England,

respectively, at the time of filing petitions in these cases.

Petitioners' 1982 joint Federal income tax return was prepared by

their accountant, Robert E. Douglas (Douglas), who signed it as

the preparer on April 15, 1983.

     Albert J. Henry (Henry) has a bachelor of science degree in

civil engineering as well as a master's degree in business

administration.    Between 1962 and 1968, Henry worked as a lending

officer at First National City Bank (First National) in New York

City.    In that capacity, subject to approval, he reviewed and

prepared credit lines for businesses.

     After his tenure with First National, Henry worked in Los

Angeles and New York City for firms that were members of the New

York Stock Exchange.    In that regard, Henry prepared

institutional research reports on growth companies for use by

entities like mutual and pension funds, as well as banks.

     Institutional reports are intended to cover a particular

company's products, what the projected growth rate might be, and

what sort of proprietary advantages the company might have.

These reports were designed to give money managers an idea of the

value of a company's stock.    These reports do not incorporate


     2
       The parties' stipulation of facts and exhibits are
incorporated by this reference.
                               - 4 -


information on tax matters involving the particular company in

question.

IMED Corp. (IMED)

     Richard A. Cramer (Cramer) founded IMED, a company engaged

in the design, manufacture, and sale of electronic medical

instruments, primarily a device known as an "infusion pump", and

related disposable devices.   From 1972 through August 1982,

Cramer was a shareholder, president, chairman of the board of

directors, and chief executive officer of IMED.   From 1972

through August 1982, Warren K. Boynton (Boynton) was vice

president of IMED.   Boynton was on the board from 1972 through

October 1973 and from December 1974 through August 1982.

     Kevin P. Monaghan (Monaghan) served as outside general

counsel to IMED from its inception in 1972 until August 1982.

From August 1975 through August 1982, Monaghan was assistant

secretary of the board of directors of IMED (the board).

Monaghan was an attorney admitted to practice in California.

Cramer, Boynton, and Monaghan were close friends as well as

business associates.

     Dan R. Hendrickson (Hendrickson) was hired as a corporate

controller of IMED on March 8, 1976, and became treasurer of IMED

on February 14, 1978.   Hendrickson previously had prepared

Cramer's personal income tax returns for a number of years.    At

IMED, Hendrickson reported directly to Cramer on the financial

condition of the company and the associated tax liabilities.
                                 - 5 -


     The stock of IMED was neither publicly traded on an

established stock market exchange nor registered with the

Securities and Exchange Commission from 1978 through 1981.       The

directors and three or four key officers owned approximately 75

percent of the outstanding IMED stock.

     On March 1, 1978, Henry joined IMED as vice president-

finance and chief financial officer (CFO).     Initially, Henry was

expected to raise equity for IMED and to institute financial

controls.    Later on, Henry was in charge of determining IMED's

capital needs, preparing cash-flow forecasts, and raising cash as

necessary.    As IMED's CFO, Henry was directly responsible to

Cramer and met with him daily.    At IMED, Henry was one of the

IMED officers who could meet with Cramer on an unscheduled basis.

Also, occasionally Cramer and Henry would go out to dinner and

discuss business.    Henry also saw Boynton, who was number two in

IMED's hierarchy, on a daily basis since his office was nearby.

However, Henry did not have frequent contact with Monaghan at

IMED.

     When Henry became the CFO of IMED, Hendrickson was

responsible for the accounting department.     As IMED's CFO, Henry

was Hendrickson's direct supervisor.     Hendrickson's office,

however, was located in another building at the same office

compound.    When Henry began work for IMED, the accounting

department had approximately 10 people who reported to
                               - 6 -


Hendrickson.   Later, the department expanded to approximately 50

people.

     In general, Henry considered Hendrickson to be competent,

diligent, and responsible.   Henry believed Hendrickson would

apprise him of important financial matters within the ambit of

the accounting department.   Also, Henry socialized with

Hendrickson once every couple of months, as well as having lunch

with him on a regular basis.   Otherwise, Henry did not regularly

socialize with the other officers and directors of IMED.

     IMED also maintained outside auditors, Arthur Young & Co.

(Arthur Young), which performed audits of the financial

statements at the end of the fiscal year.   From 1974 until 1980,

the principal contact at Arthur Young was Kim Rutledge

(Rutledge), an accountant.   Rutledge primarily had contact with

Hendrickson and his predecessor at IMED.

     On March 1, 1981, Henry became a member of IMED's board of

directors (the board) and remained in that position until August

1982.   When Henry joined the board, Cramer, Boynton, Monaghan,

and two other individuals were on it.   On occasion, prior to

joining the board, Henry would present financial statements for

review and brief the directors on company operations.

IMED Stock Options

     IMED instituted a stock option plan that it granted to

certain employees.   The stock options granted were intended to

enable employees to participate in IMED's growth and prosperity.
                                - 7 -


This particular program was managed by Cramer, Monaghan, and

Hendrickson.

     In the process of granting stock options to its employees,

IMED required the participants to file elections pursuant to

section 83(b) (section 83(b) elections).3   Generally, IMED did

not issue Forms W-2 or 1099 to any option grantee for the year in

which the option was issued.    Subsequent to the section 83(b)

election, IMED did not deduct the costs of the stock options it

granted to its employees because that might result in the

realization of ordinary income by the recipients.

     On August 17, 1979, Henry received his first stock options

(1979 options).   The 1979 options granted Henry the right to

purchase 29,250 shares of IMED's common stock.    The par value of

the common stock was 15 cents per share.    Henry could exercise

his options to purchase stock at $13 per share.

     On September 14, 1979, Hendrickson presented Henry with a

section 83(b) form to sign.    Hendrickson further informed him

that this document was required to be signed in order to obtain

long-term capital gains on the 1979 stock options.    The document

contains the note that, as a condition of exercising these


     3
       Sec. 83(a) provides generally that if property is
transferred to an individual as compensation for services,
recognition of income will be deferred if the property is not
transferable or is subject to a substantial risk of forfeiture.
     Sec. 83(b) provides, in relevant part, that the employee may
elect within 30 days of receipt to include the value of the
property for the year he receives it, despite the fact that such
property is nontransferable and forfeitable.
                               - 8 -


particular stock options, continued employment with IMED was a

requirement.   The document also includes the provision that the

fair market value was "none" and there were no amounts currently

paid in.

     The 1979 options provided that the optionee could exercise

the options "in 20% increments through the fifth-year end

anniversary hereof, so long as he is, at such anniversary date,

still an employee or consultant to IMED".      The 1979 options also

contained the following vesting schedule:

  Percentage of
  Shares Underlying       Earliest Date Upon      Last Date Upon
  the Options That        Which Optionee May      Which Optionee
  May Be Exercised        Exercise                May Exercise
        20                  Dec. 31, 1979         June 30, 1984
        40                  Dec. 31, 1980         June 30, 1984
        60                  Dec. 31, 1981         June 30, 1984
        80                  Dec. 31, 1982         June 30, 1984
       100                  Dec. 31, 1983         June 30, 1984


The 1979 options were transferable, subject to the vesting

provisions, only to persons approved by the board as "qualified

offerees".   The approval of the board was stated to be contingent

on the receipt of a favorable opinion of counsel and could be

refused if the transfer would require registration under section

5 of the Securities Act of 1933, ch. 38, 48 Stat. 74, 77, as

amended, 15 U.S.C. sec. 77a (1988).

     Simultaneously with his signing of the section 83(b)

election for the 1979 options, Henry was provided with a copy of

a letter from IMED.
                                 - 9 -


     Dear Option Holder:

     Congratulations on your recent stock option.

     The enclosed election, which is necessary to provide
     for capital gain treatment upon ultimate stock sale by
     you, should be signed by you (and your spouse where
     applicable) and returned to Dan R. Hendrickson, at IMED
     before September 30, 1979.

     The original will be filed with the Internal Revenue
     Service and a copy retained in the files of IMED. The
     second copy enclosed is for your records.

     You have no income to report at this time, as the
     election is protective only.

     Very truly yours,

     [signed]
     Dan R. Hendrickson
     Treasurer

     Sometime in March 1980, Henry exercised a portion of the

1979 options to the extent that he acquired 4,000 shares of IMED

common stock at $13 per share.    The 1979 options still conferred

on Henry the right to purchase the remaining 25,250 shares.    On

October 16, 1980, Henry sold the 4,000 shares of IMED common

stock for $190,000.

     In December 1980, John Stine (Stine) replaced Rutledge as

the Arthur Young tax principal performing corporate tax work for

IMED.   Stine's main contact at IMED was Hendrickson.   Stine also

talked with Monaghan on occasion.    As tax principal for Arthur

Young, Stine did not consult with Henry on tax matters.

     On May 29, 1981, IMED and IMED International Corp.

(International), a Cayman Islands, British West Indies,
                               - 10 -


corporation, formed a trust with a Swiss corporation as trustee.4

The Swiss trustee was entitled to exercise stock options (the

1981 options) on behalf of certain enumerated individuals

designated as the "Beneficiaries".      The 1981 options were

allocated as follows:

                            Number of
      Name1               Paired Shares       Exercise Price
     Cramer                  50,000               $100
                            100,000                200
     Boynton                 50,000                100
     Henry                   50,000                100
     Monaghan                25,000                100
     1
      There are two other beneficiaries who were members of
IMED's board, but they are not part of these cases, and hence,
need not be identified.

The trust agreement was signed by Cramer, as chairman of both

IMED and International.    Subsequently, Henry was informed by

Cramer that he would receive additional stock options.      Henry did

not sign or receive certificates or documents with respect to the

1981 options.

     On May 27, 1981, Monaghan wrote to Hendrickson, noting that

stock options in IMED had been granted to certain employees, and

requesting that the aforementioned individuals sign section 83(b)

elections and file them by June 17, 1981.

     On October 28, 1981, Stine, of Arthur Young, sent both

Monaghan and Hendrickson a letter which stated:


     4
       On Oct. 3, 1980, the outstanding shares of IMED and
International were "paired" so that the stock of neither company
could be issued or sold without the simultaneous issuance or sale
of an equal number of shares of the other company.
                                - 11 -


     IMED currently takes the position that its stock
     options are governed by Section 83 and therefore the
     present tax treatment is * * * no income to the
     employee on grant or exercise and no compensation
     deduction to IMED. However, Regulation 1.83-7 states
     that an option must have a "readily ascertainable fair
     market value" before Section 83 will apply. Since the
     definition of "readily ascertainable fair market value"
     is virtually impossible to meet, IMED's present
     position is subject to challenge. * * *

     On November 12, 1981, Monaghan informed Hendrickson that

certain IMED employees had obtained options on IMED stock, but

that the options "should not be delivered to the holders until

their Section 83 elections have been prepared and are ready to

file."

     In an undated form letter from Robert Reiss, president of

IMED, employees participating in the stock option plan were

informed that the section 83(b) elections were "necessary to

provide for capital gain treatment upon ultimate stock sale by

you".     This document further states that the recipient has "no

income to report at this time, as the [section 83(b)] election is

protective only."

IMED's Sale

        In early 1982, Cramer, along with the majority of IMED's

stockholders, met with investment bankers to proceed with the

sale of IMED.     Henry was always present with Cramer when

prospective purchasers came to perform due diligence

investigations with respect to IMED.
                              - 12 -


     On May 6, 1982, the management of Warner-Lambert Corp.

(Warner-Lambert) approached the officers and directors of IMED to

propose a transaction whereby Warner-Lambert would acquire all

the outstanding stock of IMED and its subsidiaries.   Initially,

Warner-Lambert offered $480 million, subject to a due diligence

investigation.

     As part of the negotiations, Cramer, Monaghan, Boynton, and

Henry, as IMED's executive officers, went to Warner-Lambert's

corporate offices in New Jersey.   As IMED's CFO, Henry was

required to supply financial analyses, as well as discuss the

projected market and product forecasts.   At some point during the

sale negotiations, Henry told Cramer that he thought that the

stock options should be long-term capital gains.

     In the IMED sale negotiations, the executives from both

companies recognized that there would be a problem with IMED's

employee stock options.   Warner-Lambert realized that if the

options were not exercised, then IMED would not have $30 million

to $40 million in its treasury at the time of sale.

Consequently, in New Jersey, Cramer met with Ward Hagen, the

chief executive officer of Warner-Lambert.   When the meeting

ended, Cramer told Monaghan, Boynton, and Henry that the option

holders would obtain long-term capital gain treatment and

instructed Monaghan to structure the transaction to achieve such

long-term capital gain.   Warner-Lambert was persuaded to purchase

the employee stock options and to forgo a deduction in its 1982
                              - 13 -


Federal income tax return for the cost of purchasing the options.

However, Warner-Lambert reduced the offer for IMED from $480

million to $465 million.

     During the final negotiations, the officers and directors of

IMED met with the law firm Skadden, Arps, Slate, Meagher & Flom

(Skadden, Arps), which represented Warner-Lambert in New York

City.   After a meeting with the attorneys from Skadden, Arps in

Manhattan, Monaghan informed Henry that he had structured the

options as long-term capital gain.     Subsequently, Monaghan told

Boynton, in response to Boynton's question, that the option

proceeds would be treated as long-term capital gain.

     On July 8, 1982, the Swiss trust that held the 1981 options

was dissolved.   The assets of the trust, the 1981 options,

reverted to IMED.   In August 1982, Warner-Lambert purchased all

of the outstanding stock of IMED for approximately $163 per

paired share of stock in IMED and International.    Warner-Lambert

paid a total of $465 million for all of the outstanding stock

plus the extant stock options belonging to employees of IMED.

     Warner-Lambert, through IMED, issued Henry a 1982 Form W-2

that was filed as part of petitioners' 1982 Federal income tax

return declaring $92,874.60 as income.    Neither Warner-Lambert

nor IMED provided Henry with another Form W-2 or 1099 or other

form or statement that declared his stock option proceeds as

income.

Robert E. Douglas
                              - 14 -


     Douglas, a certified public accountant, prepared

petitioners' 1982 Federal income tax return.   He was licensed in

California and, since 1977, a partner in the firm of Jassoy,

Graff & Douglas.   Henry was introduced to Douglas by Hendrickson,

who informed him that Douglas was an "excellent, very careful

accountant".   Between 1968 and 1974, Douglas worked in the tax

department of Price Waterhouse.   While at Price Waterhouse,

Douglas was an instructor in its national tax course. Between

1974 and 1977, Douglas practiced with George Peterson & Co.

     As petitioners' accountant, Douglas prepared their 1977

through 1982 joint Federal income tax returns.   Petitioners'

1978, 1979, and 1980 returns were audited by respondent.    Douglas

represented petitioners in these audits, which resulted in minor

adjustments to petitioners' returns.   Generally, Henry was

satisfied with the manner in which Douglas handled the audits.

     Henry informed Douglas that IMED had been sold, and that it

was Henry's understanding that Monaghan, as IMED's counsel, had

structured the stock options as long-term capital gain.    Henry

also advised Douglas that if there were any questions regarding

the handling of the options to contact Monaghan or Hendrickson.

     Douglas agreed with his partner, Robert W. Jassoy Jr., that

the option proceeds should be classified as long-term capital

gain on the income tax returns he prepared for petitioners.     In

reaching this decision, Douglas considered as a factor that there

were no Forms W-2 or 1099, nor any other form, issued by either
                               - 15 -


Warner-Lambert or IMED, declaring the option proceeds as income.

Also, based on an earlier discussion with Hendrickson regarding

IMED's stock option plan, Douglas surmised that Arthur Young

approved the tax treatment of the stock option proceeds based on

the legislative history of section 83.      In addition, Douglas

believed that the attorneys representing Warner-Lambert and IMED

had structured the transaction to accomplish long-term capital

gain for the option holders.   Finally, in reaching his decision,

Douglas relied on the fact that Hendrickson had informed him

about the section 83(b) elections.      Douglas concluded that the

elections put respondent on notice regarding the stock options.

However, Douglas knew that there was a distinct possibility that

respondent might challenge the classification of Henry's stock

option proceeds as long-term capital gain.

     Douglas prepared petitioners' 1982 joint Federal income tax

return.   Henry provided Douglas with the Form W-2 that he

obtained, through IMED, from Warner-Lambert.      Douglas, however,

did not review the option documents or the option plan.

     Petitioners' 1982 Federal income tax return reported income

from wages of $92,875 and capital gain of $3,462,345.      On the

Schedule D included with their 1982 Federal income tax return,

petitioners reported a short-term loss of $3,796 and long-term

capital gains of $8,636,553, the net of which resulted in the

$3,462,345 after considering the deduction for capital gains.
                                                - 16 -


Next to both entries was the following reference: "SEE ATTACHED

COMPUTER D".

         On Schedule D, a schedule petitioners included with their

1982 Federal income tax return, they listed their capital gains.

Petitioners reported:
     Productive                   Date           Date       Gross Sale       Cost or       Gain or1
       Assets                   Acquired         Sold          Price      Other Basis     (Loss)
10,000 shares IMED Corp.          1980          1982        $1,638,100        -0-        $1,638,100
25,250 options IMED Corp.         1978          8/19/82       3,807,953       -0-         3,807,953
50,000 options IMED Corp.         1981          8/19/82       3,190,500       -0-         3,190,500
         1
             This column reflects gains reported under the category of "More than 1, 5 years or
less".

Petitioners reported a total of $8,636,553 as long-term capital

gain in the "FEDERAL TOTALS" column.                        On the second page of the

Schedule D, petitioners reported a net gain of $8,655,862.

         Hendrickson had overall corporate tax responsibility within

IMED.         Hendrickson apprised Henry concerning matters related to

petitioners' personal taxes but believed that was not

specifically part of his duties at IMED.                          Hendrickson stated that

it became apparent, sometime in 1977 or 1978, that with respect

to the stock options, unless something was changed, long-term

capital gain was not a possibility.                        Hendrickson also believed

that it would be difficult to overturn the particular regulation

in question.            Hendrickson warned some of the option holders that

capital gain was not guaranteed.                      At the time of IMED's sale in

1982, Hendrickson knew that the stock option proceeds were not

entitled to long-term capital gain treatment.

         Monaghan was aware of "ongoing discussions" regarding the

proper tax treatment of the stock options throughout the
                               - 17 -


corporate life of IMED.   Monaghan believed that members of the

board would have been aware of these discussions, as well as

Rutledge at Arthur Young.    Monaghan discussed the stock options

with Henry.

     Monaghan believed that upon analyzing the tax provisions

related to stock options, a section 83(b) election would ensure

that the proceeds would be treated as long-term capital gain.

However, Monaghan understood that there were some risks

associated with the section 83(b) election for the stock

optionees.

     Boynton believed that there had been no discussions among

the officers and directors of IMED who were negotiating the sale

of the company to Warner-Lambert regarding the taxation of the

employee stock options.   However, Boynton was aware of

discussions of how Warner-Lambert would acquire the outstanding

employee stock options.   Boynton discussed the tax treatment of

the proceeds of the IMED options only with Monaghan.   Boynton was

otherwise unaware of the possibility that respondent might

challenge the long-term capital gain treatment of his stock

option proceeds and considered it Hendrickson's responsibility to

handle tax matters as well as the stock option plan.

     As the chief executive officer of IMED and majority

stockholder, Cramer considered Henry to be an important

individual in the company.   However, Cramer considered Henry to

be "the one outsider" in IMED.   The 1981 options granted to Henry
                              - 18 -


were for services rendered, although Cramer noted that Henry had

not yet accomplished anything of substance at the time of the

grant.

                              OPINION

     Petitioners concede that they are liable for the underlying

income tax deficiency but contend that they are not liable for

the additions to tax.   In that regard, petitioners bear the

burden of proof with respect to the additions to tax.   Rule

142(a); Luman v. Commissioner, 79 T.C. 846, 860-861 (1982).

     Respondent argues that petitioners were negligent inasmuch

as they knew that:   (1) When granted, the options did not have

readily ascertainable fair market values; (2) the options did not

have fair market values of zero at the time they filed their

section 83(b) elections; and (3) at the time the 1982 Federal

income tax returns were filed, their positions were subject to

challenge.   Petitioners, on the other hand, contend that they did

not misrepresent the sale of the options, relied on professional

advisers, and acted in good faith in reporting the sales of the

options.   The success of petitioners' contentions is dependent in

part on their claim that they were unaware of the concerns of

other top echelon officers of IMED, even though Henry was a

director and part of that group.

     For 1982, section 6653(a)(1) provides for an addition to tax

equal to 5 percent of the underpayment in tax if any part of the

underpayment is due to negligence or intentional disregard of
                               - 19 -


rules and regulations.    Section 6653(a)(2) provides for an

addition to tax equal to 50 percent of the interest payable under

section 6601 on that portion of the underpayment in tax

attributable to such negligence or intentional disregard.

     Negligence is defined as the failure to exercise the due

care that a reasonable and ordinarily prudent person would employ

under the circumstances.    Zmuda v. Commissioner, 731 F.2d 1417,

1422 (9th Cir. 1984), affg. 79 T.C. 714 (1982); Niedringhaus v.

Commissioner, 99 T.C. 202, 221 (1992); 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).    We also consider the

taxpayer's experience and knowledge in determining whether he

acted negligently or intentionally disregarded rules and

regulations.   Vandeyacht v. Commissioner, T.C. Memo. 1994-148;

DeRochemont v. Commissioner, T.C. Memo. 1991-600.

     A taxpayer may avoid liability for the additions to tax

under section 6653(a)(1) and (2) by relying on competent

professional advice if it was reasonable to rely on such advice.

United States v. Boyle, 469 U.S. 241, 250-251 (1985); Freytag v.

Commissioner, 89 T.C. 849, 888 (1987), affd. 904 F.2d 1011, 1017

(5th Cir. 1990), affd. 501 U.S. 868 (1991).    Reliance on

professional advice, standing alone, is not an absolute defense
                              - 20 -


to negligence but rather a factor to be taken into consideration.

In order for reliance on professional advice to excuse a taxpayer

from the additions to tax for negligence, the taxpayer must show

that the professional had the expertise and knowledge of the

pertinent facts to provide valuable and dependable advice on the

matter at hand.   Goldman v. Commissioner, 39 F.3d 402, 408 (2d

Cir. 1994), affg. T.C. Memo. 1993-480; Freytag v. Commissioner,

supra; Kozlowski v. Commissioner, T.C. Memo. 1993-430, affd.

without published opinion 70 F.3d 1279 (9th Cir. 1995).

     There were three taxpayers before this Court in Cramer v.

Commissioner, 101 T.C. 225 (1993).     Two of the taxpayers claimed

millions of dollars’ worth of basis for their options, and the

third reported his sale of the options as a straightforward sale

of stock.   We found in Cramer that the options, when granted, did

not possess a readily ascertainable fair market value.    The

taxpayers in Cramer filed section 83(b) elections while knowing

that the options did not have fair market values of zero.

Finally, they knew at the time they filed their 1982 Federal

income tax returns that their position was subject to being

challenged.   Consequently, we held that the taxpayers in Cramer

were subject to the additions to tax for negligence in part

because they signed 1982 returns that they knew, at the time,

contained material misrepresentations.    The Court of Appeals for

the Ninth Circuit affirmed the imposition of the negligence

addition.   64 F.3d at 1414-1415.
                               - 21 -


     Here, petitioners argue that they were in a different

position from the Cramer taxpayers in that they properly relied

on the professional evaluation and advice of their independent

certified public accountant, Douglas, when they reported a basis

of zero in the stock options on their 1982 joint income tax

return.   Petitioners also contend that they did not know that the

proceeds from the stock options were not long-term capital gain.

Based on these claimed differences, they argue that they were not

negligent.

     Under the circumstances here, petitioners' reliance was not

reasonable.    We agree with respondent that petitioners were

negligent in reporting the proceeds from the sale of the options

as long-term capital gain on their 1982 return.     Their claims of

good faith are not supported by the record.

     Petitioners contend that Douglas alone made the decision to

classify the option proceeds as long-term capital gain.

Petitioners further contend that they had no reason to question

Douglas' classification of the option proceeds as long-term

capital gain.    Petitioners explain that when Douglas was hired as

their accountant, Henry was informed that Douglas had an

impressive professional background.     In addition, petitioners

were pleased with Douglas’ representation in several audits of

prior years.    Accordingly, petitioners argue that, at the time

Douglas started work on petitioners' joint 1982 Federal income
                              - 22 -


tax return, they had every reason to rely on his professional

acumen.

     Respondent points out, however, that Henry was a

sophisticated businessman who functioned in a highly competitive

environment and should not be allowed to claim reliance on his

adviser if he failed to provide the adviser with correct and

complete information.   See Pessin v. Commissioner, 59 T.C. 473,

489 (1972).   Specifically, in preparing the 1982 returns, Douglas

was not provided with copies of the relevant IMED options.

     Douglas stated that he alone determined that the stock

option proceeds were long-term capital gain in petitioners' joint

1982 Federal income tax return.   In his testimony, Douglas

discussed various factors that he incorporated in his ultimate

conclusion that the stock option proceeds were capital gain.

Douglas, however, was not sufficiently informed to reach that

conclusion.   He knew that there was a chance that respondent

would challenge the tax treatment.     Henry told Douglas to ask for

more information from either Monaghan or Hendrickson with respect

to the stock option plan.   However, Henry specifically informed

Douglas that long-term capital gain treatment for the stock

option proceeds was warranted.

     Douglas admitted that petitioners did not provide him with

certain relevant information such as copies of the 1979 or the

1981 IMED options.   Petitioners did not provide an explanation as

to why these particular documents were not produced to their
                              - 23 -


accountant.   In other words, petitioners failed to provide their

accountant with sufficient information to render a fully informed

opinion concerning the relevant facts and law.   See United States

v. Boyle, supra; Freytag v. Commissioner, supra.   Moreover, blind

reliance on another for the accuracy of a return is generally

insufficient to avoid liability for negligence additions to tax.

See Bailey v. Commissioner, 21 T.C. 678, 687 (1954).   Here, it

was not reasonable to rely on Douglas’ conclusion because he was

not fully informed by petitioners.

     Henry contends that he reasonably believed that the stock

option proceeds were long-term capital gain, for the following

reasons:   (1) Because of IMED's section 83(b) program; (2) the

fair market value of the stock options was entered as zero in the

election that Henry signed; (3) IMED provided Henry with a letter

that stated that the election "is necessary to provide for

capital gain treatment upon ultimate stock sale"; (4) Hendrickson

informed Henry that the election was necessary to obtain long-

term capital gain treatment; (5) Henry was informed that the

option proceeds were long-term capital gain by both Cramer and

Monaghan; (6) subsequent to IMED's sale, Henry did not possess

Forms W-2 or 1099 that reflected the stock option proceeds as

income.

     Although there were many self-serving assertions that

capital gains were the proper treatment, the record supports our

finding that petitioners were aware that the stock option
                               - 24 -


proceeds were not properly characterized as long-term capital

gain.    In particular, in March 1980, Henry exercised the right to

acquire 4,000 shares of IMED common stock for $13 per share.

Later, Henry sold these shares of stock on October 16, 1980, for

$190,000.    Thus, petitioners sold the shares for $47.50 per

share, some $34.50 more than the option price.     Moreover, Henry's

education and work experience enabled him to value stock and

growth projections for companies.    Consequently, Henry knew or

should have known that the section 83(b) election, which he

signed in September of 1979, was invalid insofar as it stated

that the fair market value of the 1979 options was zero.

        Also, petitioners cannot rely on Hendrickson's statements

made concerning the election nor the IMED form letter obtained on

September 14, 1979, to negate additions to tax for negligence

attributable to their 1982 return.      In general, petitioners had

an obligation to independently verify their own proper income tax

liability.    In other words, petitioners failed to ask pertinent

questions or even make a cursory investigation beyond the

information provided to them concerning the IMED stock options.

See 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); see generally sec. 1.6661-6(b), Income

Tax Regs.    Moreover, the duty of filing accurate tax returns
                              - 25 -


cannot be avoided simply by delegating responsibility to an

agent.   Pritchett v. Commissioner, 63 T.C. 149, 174 (1974).

     Henry argues that he was not part of the core group that

controlled IMED and that he would not be privy to the "ongoing"

discussions with Cramer, Monaghan, and Boynton regarding the

stock options.   Respondent, however, points to the fact that

Hendrickson was responsible to Henry in the organizational scheme

within IMED.   In other words, Hendrickson's responsibility as the

head of IMED's accounting department included conveying his

interpretations of the Internal Revenue Code to Henry.

     Hendrickson's responsibilities in the corporation included

informally advising Henry with respect to his own taxes.     Henry

and Hendrickson socialized once every couple of months, as well

as having lunch with each other on a regular basis.   In

connection with the sale negotiations with Warner-Lambert, Henry

was required to supply financial analyses, as well as discuss the

projected market and product forecasts.   Although Henry's

responsibilities did not specifically encompass taxation issues,

the tax treatment of the stock options was a critical

consideration.   In particular, we note that a major item that was

negotiated involved Warner-Lambert’s forgoing a deduction on its

1982 Federal income tax return for the payment of the option

purchase proceeds.   That issue was important enough for Cramer to

meet with the head of Warner-Lambert.   Also, Henry admitted,

during the sale negotiations, he expressed his belief to Cramer
                                - 26 -


that the stock option proceeds should be long-term capital gain.

At the very least, Henry was aware that Warner-Lambert chose to

coordinate with IMED on the issue of the proper taxation of the

outstanding stock options.

     Hendrickson introduced Douglas to Henry and gave Douglas an

excellent recommendation.    Douglas had been in contact with

Hendrickson regarding the IMED stock option plan when it was set

up, and he gave Douglas the impression that Arthur Young had

approved of the tax treatment of IMED's stock option plan.

Hendrickson addressed important tax matters with Henry and also

likely apprised him of the issue of the proper characterization

of the stock option proceeds.

     It should also be noted that in 1981 Hendrickson was placed

on notice by the Stine letter that because "the definition of

'readily ascertainable fair market value' is virtually impossible

to meet, IMED's present position [that section 83 governed IMED's

stock options] is subject to challenge."    The top executives and

officers of IMED believed that the proper treatment of the stock

option proceeds was as long-term capital gain.    Yet the record

does not reflect that their belief was based on thorough research

or analysis.   Nor did they consult their tax professionals

concerning the section 83 option issue.    In this setting, the

Stine letter is the only in-depth inquiry concerning the proper

taxation of the income from the option proceeds.    It appears

improbable that the significance of the Stine letter would escape
                              - 27 -


Henry and Hendrickson, especially because it contained an opinion

contrary to their hoped-for capital gains reporting of the IMED

stock options.

     Finally, Cramer and Monaghan informed Henry at the IMED

sale negotiations in New Jersey that the stock option proceeds

would be structured as capital gain.   In general, tax reduction

is an acceptable goal as long as the reduction involves

transactions with substance and is by legal means.    Frank Lyon

Co. v. United States, 435 U.S. 561, 583-584 (1978).   It does not,

however, enable a taxpayer to ignore relevant information.

     There were numerous opportunities for petitioners to learn

of the questionable status of the capital gain tax treatment of

the stock options.   Hendrickson warned at least some of the IMED

stock optionees at the time they signed their section 83(b)

elections that the IMED options program was contrary to the

regulations promulgated by respondent.   Monaghan knew there was a

possibility that the Commissioner would challenge IMED's

treatment of the stock option proceeds, and he initiated

"ongoing" discussions among the officers and directors of IMED

concerning this particular issue.   Also, Cramer advised the other

three IMED negotiators (which included Henry), subsequent to a

meeting with the chief executive officer of Warner-Lambert, that

the option proceeds would be deemed long-term capital gain.    This

rebuts petitioners' contention that the options were not

considered in the sale negotiations with Warner-Lambert.
                               - 28 -


Additionally, Henry did not provide any other reasonable

explanation as to why Warner-Lambert decreased the final purchase

price paid for IMED from $480 million to $465 million.    In these

circumstances, Henry’s plea of ignorance does not ring true.

Henry’s involvement at the top level of IMED and in the Warner-

Lambert negotiations undermines his plea of ignorance, and we so

find.    Cf. United States v. Aleman, 728 F.2d 492, 494 (11th Cir.

1984); United States v. Jewell, 532 F.2d 697, 700 (9th Cir. 1976)

(defining “‘wilful blindness’”).

        In Cramer v. Commissioner, 101 T.C. 225 (1993), we decided

Cramer, Boynton, and Monaghan were liable for additions to tax

for negligence because they deliberately disregarded rules and

regulations.    In that opinion, it was indicated that Boynton was

aware of the potential risk that the Commissioner might challenge

the treatment of the stock option proceeds because of his close

friendship with Cramer and Monaghan.    "Cramer and Monaghan would

have had to have actively misled Boynton for him to have been

unaware of the risk associated with his 1982 tax return

position", and this event was unlikely to have occurred "in view

of * * * [the taxpayers'] friendship and business relationship".

Id. at 253.

        Although Cramer referred to Henry as "the one outsider" on

IMED's board, he met with Henry on a daily basis and occasionally

went out to dinner with him.    Also, Henry was involved in the

negotiations regarding the sale of IMED to Warner-Lambert and was
                              - 29 -


one of the four IMED executives who were delegated to pursue the

sale negotiations with Warner-Lambert.    Henry and the other top

level IMED officers possessed significant amounts of the 1981

options.   The potential value and possible tax treatment of the

options to the IMED officers was certain to be a prominent topic

of conversation.   We find it difficult to believe that IMED's

chief financial officer would not be privy to this and/or be

oblivious to the concerns of the other officers, who, along with

Henry, ran IMED.   Henry may have entered the top echelon of IMED

after Cramer and his nucleus of associates, but he was not an

"outsider" regarding IMED's daily business operations.

     Respondent's determination that petitioners were negligent

is sustained.   Petitioners' claims of good faith are undermined

by the totality of the circumstances.    Based on the testimony

from Hendrickson, Monaghan, and Douglas, the record demonstrates

that Henry was aware of the risks involved in reporting all of

the proceeds from the sale of the 1979 and 1981 stock options as

long-term capital gain.   Moreover, Henry did not provide Douglas

with all the information Henry knew about the 1979 or 1981

options.   For example, if Douglas had been made aware of the fact

that the value of the 1979 options was not zero, that would

likely have had a profound effect on the accountant’s evaluation

of the proper tax treatment of the option proceeds.    Finally, the

fact that Henry referred Douglas to either Hendrickson or

Monaghan if there were any questions regarding IMED's stock
                                - 30 -


option program does not obviate Henry's responsibility to ensure

that the 1982 return was accurately filed.   See LaVerne v.

Commissioner, 94 T.C. at 652-653; Pritchett v. Commissioner, 63

T.C. at 174; see generally sec. 1.6661-6(b), Income Tax Regs.

Accordingly, we hold that petitioners are liable for the

additions to tax for negligence.

Substantial Understatement Addition to Tax

     Next, petitioners contend that respondent erred in

determining additions to tax for substantial understatements

under section 6661.   Section 6661(a) imposes an addition to tax

when there is a "substantial understatement of income tax for any

taxable year".   As applicable here, the addition to tax under

section 6661(a) is equal to 25 percent of the underpayment

attributable to the substantial understatement.    Pallottini v.

Commissioner, 90 T.C. 498 (1988).    Petitioners bear the burden of

proving that the addition to tax under section 6661 is not

applicable.   Rule 142(a).

     Section 6661(b)(2)(A) defines "understatement" as the

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

over the amount of tax actually reported on the return.    This

understatement will be "substantial" if the amount of such

understatement exceeds the greater of 10 percent of the amount of

tax required to be shown on the return for the taxable year, or

$5,000.   Sec. 6661(b)(1)(A).
                             - 31 -


     The section 6661 addition to tax is not applicable,

however, if there was substantial authority for the position

taken on the taxpayer's return, or adequate disclosure in the

return of the relevant facts affecting the treatment of the item.

Sec. 6661(b)(2)(B)(i) and (ii).

     Petitioners have not contended that there was substantial

authority for their reporting position.    Petitioners contend that

the tax treatment of the proceeds of the sale of IMED's stock

options was adequately disclosed in their return as filed.

Respondent disputes that petitioners adequately disclosed the

item in question.

     In Schirmer v. Commissioner, 89 T.C. 277, 285-286 (1987),

we explained that the regulations provide for two types of

adequate disclosure for purposes of section 6661(b)(2)(B)(ii):

Disclosure in a statement attached to the return or disclosure on

the return pursuant to the Commissioner's revenue procedures.

Sec. 1.6661-4(b) and (c), Income Tax Regs.    In addition, we noted

that a taxpayer may satisfy the adequate disclosure requirement

of section 6661(b)(2)(B)(ii) by providing on the return

sufficient information to enable the Commissioner to identify the

potential controversy involved.

     Petitioners' expert witness, John J. Monaco (Monaco), was

previously Assistant Commissioner (Examination) for respondent,

where he was an employee for 33 years.    Monaco opined that the

zero basis reported on the return would be adequate disclosure of
                                - 32 -


the relevant facts.     Monaco concluded that such disclosure was

sufficient to apprise respondent of the facts and the nature of

the potential controversy concerning the tax treatment of the

item.    Monaco decided that the zero basis "would be a clear

indication that the options had been awarded to the employee as

compensatory stock options and that no value had been reflected

in * * * [Henry's] income either at the time the options were

received or at any other time prior to the sale of such option."

Monaco stated that there was no other likely explanation for a

zero basis.     Monaco opined that the zero basis reported on

petitioners' 1982 return was sufficient to apprise respondent of

the tax treatment of the item in question.     Based on his

experience, Monaco believed that a return with a reported zero

basis for employee stock options and claimed capital gain

treatment would be selected for examination.

        In the present cases, petitioners' 1982 return identified

the property in question and clearly distinguished between stocks

and options.5    Furthermore, the return disclosed the dates the

shares and options were acquired and sold, sales price, a basis

of zero, and the gain involved.     It appears likely that the items



     5
       It should be noted that in Cramer v. Commissioner, 101
T.C. 225, 255-256 (1993), affd. 64 F.3d 1406 (9th Cir. 1995), the
returns, unlike petitioners’, “contained misrepresentations that
actually concealed the true nature of the option proceeds”; i.e.,
a false claim of basis or, in the Boyntons’ case, a
mischaracterization of the options as stock. See also 64 F.3d at
1415.
                               - 33 -


reported generated respondent's audit.   The information reported

was sufficient to apprise respondent of and enable respondent to

identify the potential controversy involved here; that is,

whether petitioners properly treated the stock option proceeds as

long-term capital gain.

      We hold that petitioners adequately disclosed the

information and are not liable for the addition to tax under

section 6661.6

Interest

      Petitioners argue that we should abate interest on the

income tax deficiency pursuant to section 6404(e) because of

respondent's delay in issuing the notice of deficiency.

Specifically, petitioners assert that respondent was dilatory in

issuing the notice of deficiency, thus increasing the interest

payable.

      The United States Tax Court is a court of limited

jurisdiction.    See sec. 7442; Wilt v. Commissioner, 60 T.C. 977,

978 (1973).   New section 6404(g), added to the Internal Revenue

Code by section 302 of the Taxpayer Bill of Rights 2, Pub. L.

104-168, 110 Stat. 1452, 1457 (1996), authorizes this Court to

review the Secretary's failure to abate interest only with

respect to requests for abatement made after July 30, 1996.

Because these cases do not involve a request for abatement made


     6
       Accordingly, we do not reach petitioners' argument with
respect to sec. 6661(c).
                              - 34 -


after July 30, 1996, we lack jurisdiction to abate interest

herein.   See Commissioner v. McCoy, 484 U.S. 3, 7 (1987); 508

Clinton Street Corp. v. Commissioner, 89 T.C. 352, 354 (1987);

Coffield v. Commissioner, T.C. Memo. 1996-365.

     To reflect the foregoing,

                                    Decisions will be entered for

                               respondent as to the deficiency and

                               the additions to tax under sec.

                               6653(a), and for petitioners as to

                               the addition to tax under sec.

                               6661.
