                        T.C. Memo. 2000-184



                      UNITED STATES TAX COURT



          DANIEL L. AND INGRID N. CARROLL, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 19403-89.             Filed June 23, 2000.



     David G. Ebert, for petitioners.

     Lori J. Balboni, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     DAWSON, Judge:   This case was assigned to Special Trial

Judge Robert N. Armen, Jr., pursuant to the provisions of section

7443A(b)(5) of the Internal Revenue Code in effect at the time of

assignment and Rules 180, 181, and 183.1   The Court agrees with


     1
         Unless otherwise indicated, all subsequent section
                                                    (continued...)
                               - 2 -


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

forth below.

               OPINION OF THE SPECIAL TRIAL JUDGE

     ARMEN, Special Trial Judge:   Respondent determined a

deficiency with respect to petitioners' Federal income tax for

1981 in the amount of $26,639, as well as additions to tax under

section 6659 in the amount of $7,992, under section 6653(a)(1) in

the amount of $1,344, and under section 6653(a)(2) in the amount

of 50 percent of the portion of the underpayment that is

attributable to negligence.   Respondent also determined that

petitioners are liable for additional interest under section

6621(c) for interest on the entire underpayment to be computed at

120 percent of the rate otherwise applicable under section

6621(a).

     The issues for decision are as follows:

     (1) Whether petitioners are entitled to a partnership loss

and investment and energy credits flowing from the Sentinel EPE

recycler leasing program entered into by Clearwater Group.   We

hold that they are not.




(...continued)
references are to the Internal Revenue Code in effect for the
taxable year in issue, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
                                  - 3 -


      (2) Whether petitioners are liable for additions to tax

under section 6653(a)(1) and (2) for negligence or intentional

disregard of rules or regulations.        We hold that they are.

      (3) Whether petitioners are liable for the addition to tax

under section 6659 for an underpayment of tax attributable to a

valuation overstatement.    We hold that they are.

      (4) Whether petitioners are liable for additional interest

under section 6621(c).   We hold that they are.

                           FINDINGS OF FACT

      Some of the facts have been stipulated, and they are so

found.   The stipulated facts and attached exhibits are

incorporated herein by this reference.        Petitioners resided in

Garden City, New York, at the time that their petition was filed

with the Court.

A.   The Recycling Transactions

      This case is a part of the Plastics Recycling group of

cases.   In particular, the deficiency, additions to tax, and the

additional interest arise from the disallowance of losses,

investment credits, and energy credits claimed by petitioners

with respect to the Clearwater Group partnership (Clearwater).

      For a detailed discussion of the transactions involved in

the Plastics Recycling group of cases, see Provizer v.

Commissioner, T.C. Memo. 1992-177, affd. per curiam without

published opinion 996 F.2d 1216 (6th Cir. 1993).        The underlying
                               - 4 -


transactions involving the Sentinel recycling machines

(recyclers) in petitioners’ case are identical to the

transactions in Provizer, and, with the exception of certain

facts that we regard as having minimal significance, petitioners

have stipulated substantially the same facts concerning the

underlying transactions that were described in Provizer v.

Commissioner, supra.

     In transactions described in the Provizer case and

stipulated by the parties herein, Packaging Industries of

Hyannis, Massachusetts (PI), manufactured and sold2 six Sentinel

EPE3 recyclers to ECI Corporation (ECI) for $981,000 each.    PI

manufactures thermoplastic and other types of packaging

machinery, as well as energy saving devices.     PI holds itself out

as the world’s largest manufacturer of blister packaging

machinery and as fabricating the industry’s widest line of

thermoforming machinery.   EPE recyclers are batch type machines

designed to convert expanded low density polyethylene foam into a

densified form called “popcorn” that can be further processed to

produce resin pellets suitable for some uses in the plastics

industry.


     2
        Terms such as sale, lease, license, and sublicense, as
well as their derivatives, are used for convenience only and do
not imply that the particular transaction was in fact a sale,
lease, license, or sublicense.
     3
         EPE stands for expanded polyethylene.
                               - 5 -


     The sales of the recyclers from PI to ECI were financed with

nonrecourse notes.   Approximately 7 percent of the sales price of

the recyclers sold by PI to ECI was paid in cash, with the

remainder financed through a 12-year nonrecourse note requiring

equal monthly installments of $100,917, including annual interest

at 19.8 percent with the first payment due 7 months after

closing.   ECI’s purchase was subject to Clearwater’s leasing

agreement and FMEC’s licensing agreement as set out below.

     In the second part of the transaction, ECI resold the

recyclers to F&G Corporation (F&G) for $1,162,667 each, of which

less than about 7 percent was paid in cash.   The balance   was

paid by a 12-year partial recourse note requiring equal monthly

installments of $100,917, including annual interest at 15.4

percent.   These notes provided that 10 percent of the notes were

recourse but that the recourse portion of the notes was due only

after the nonrecourse portion, 90 percent, was paid in full.      The

first payment on the note was due 7 months after the closing.

     F&G’s purchase was subject to Clearwater’s agreement to

enter into a lease with F&G and was subject to FMEC’s agreement

to enter into the license as set out below.

     In the third part of the transaction, F&G leased the

recyclers to Clearwater for 12 years, a lease term equal to 150

percent of the class life of the assets.   Under the lease, the

monthly rental payment was $100,917, with an initial amount of
                                - 6 -


$605,500 to be prepaid at the closing as rental for the first 6

months.

     In the fourth step of the transaction, Clearwater licensed

the recyclers to First Massachusetts Equipment Corp. (FMEC) for

12 years at a guaranteed minimum royalty of $100,917 per month

beginning with the seventh month of the license plus a prepaid

nonrefundable $20,500 advance royalty.    After the recyclers were

placed in service, the license required additional royalty

payments based on a percentage of profits that might be realized

on the sale or use of the resin pellets produced by the

recyclers.

     In the fifth step of the transaction, FMEC sublicensed the

recyclers back to PI, the manufacturer, on a month-to-month basis

for a royalty of $100,917 per month.    The sublicense to PI was

subject to most of the terms of the license from Clearwater to

FMEC.

     In the final step of the transaction, PI was to sublicense

the recyclers to end-users who would use the recyclers to do the

actual converting of their low density thermoplastic foam or

film.    The terms of the sublicense generally required the end-

user to pay PI 100 percent of the recycled foam in exchange for a

payment from FMEC based on the quality and amount of recycled

scrap.    PI was to control and be responsible for placing the

recyclers with end-users and for arranging to collect or dispose
                               - 7 -


of the product of the recyclers.    Service and installation costs

were to be borne by the end-user.    End-users were also required

to use their best efforts to recycle 220 pounds an hour for 16

hours per week.   Only PI was to service or repair the recyclers.

     No arm's-length negotiations for the price of the Sentinel

EPE recyclers took place among PI, ECI, and F&G.    All of the

monthly payments required among the entities in the above

transactions offset each other.    These transactions occurred

simultaneously.

     Clearwater leased Sentinel EPE recyclers from F&G and

licensed those recyclers to FMEC.    For convenience, we refer to

the series of transactions among PI, ECI, F&G, Clearwater, and

FMEC as the Clearwater transactions.

     By private placement memorandum dated November 17, 1981,

Clearwater offered subscriptions for 16 limited partnership units

at $50,000 per unit.   The limited partners owned 99 percent of

Clearwater, and the general partner, Samuel L. Winer, owned the

remaining 1 percent.   Each limited partner was required to have a

minimum net worth, exclusive of his principal home, furnishings,

and automobiles, in the amount of $200,000 per limited

partnership unit.   In addition, each partner was required to have

enough income during the 1981 taxable year to place the limited

partner in an income tax bracket of at least 50 percent.
                                 - 8 -


     In addition to the Clearwater transactions, a number of

other limited partnerships entered into transactions similar to

the Clearwater transactions.

B.   Individuals Involved

     Samuel L. Winer (Winer) was the general partner of

Clearwater and paid $1,000 for a 1-percent interest in all items

of income, gain, deduction, loss, and credit arising from the

operations of Clearwater.   Winer received $60,000 out of the

proceeds of the Clearwater group private offerings as

compensation for his services.

     In 1981 Richard Roberts (Roberts) was a businessman and the

general partner in a number of limited partnerships that leased

EPE recyclers.   Roberts was also the general partner in a number

of other limited partnerships that leased and licensed Sentinel

recyclers.   He also was a 9-percent shareholder in F&G, the

corporation that leased the recyclers to Clearwater.    From 1982

through 1985, Roberts and Raymond Grant (Grant) were in the

business of promoting tax sheltered investments.   Grant was an

investment banker, attorney, accountant, and the president and

100-percent owner of ECI.   Roberts and Grant together were

general partners in other partnerships.   Prior to the Clearwater

transactions, Roberts and Grant were clients of the accounting

firm H.W. Freedman & Co. (Freedman & Co.).
                                - 9 -


     Harris W. Freedman (Freedman), a certified public accountant

and the named partner in Freedman & Co., was the president and

chairman of the board of F&G.   Freedman was experienced with

leveraged leasing, and he owned 94 percent of a Sentinel EPE

recycler.

     Freedman & Co. prepared the tax returns for ECI, F&G, and

Clearwater.   Although Freedman & Co. did not prepare the initial

financial projections included in the offering memorandum,

Freedman did review the financial projections and made

suggestions as to both format and substance.

     Freedman & Co. also provided tax services to John D. Bambara

(Bambara).    Bambara was the 100-percent owner of FMEC, as well as

its president, treasurer, clerk, and director.     Bambara was also

the president of PI and a member of its board of directors.     He,

his wife, and his daughter also owned directly or indirectly 100

percent of the stock of PI.

     Elliot I. Miller (Miller) was the corporate counsel to PI.

In 1981, Miller was also a shareholder of F&G.     Miller

represented Grant personally and Grant’s clients who invested in

other programs that Grant promoted.     Miller was also an

acquaintance of Winer.

     John Y. Taggert (Taggert) was a well-known tax attorney and

an adjunct professor at the New York University Law School.

Taggert had been acquainted with Miller for about 15 years prior
                              - 10 -


to 1981.   Miller recommended that Roberts employ Taggert and his

firm as counsel to the general partner of Hyannis Recycling

Associates, the initial plastics recycling partnership.   Taggert

and other members of his firm, Windels, Marx, Davies & Ives

(WMDI), prepared private offering memoranda, tax opinions, and

other legal documents for Clearwater and over 15 other plastics

recycling partnerships.   Taggert acquired a 6.66-percent interest

in a second-tier Plastics Recycling partnership but only after

his representation of Clearwater and other recycling partnerships

had ended.

     Robert Gottsegen (Gottsegen) was a businessman active in the

plastics industry and a long-time business associate of Bambara.

Miller represented Gottsegen and Bambara in several business

transactions.

C.   The Private Offering Memorandum

     Clearwater distributed to potential limited partners a

private placement memorandum dated November 17, 1981.   The

offering memorandum listed significant business and tax risk

factors associated with an investment in Clearwater.

Specifically, the offering memorandum stated: (1) There was a

substantial likelihood of audit by the Internal Revenue Service

(IRS), and the purchase price paid by F&G to ECI probably would

be challenged as being in excess of fair market value; (2) the

partnership had no prior operating history; (3) the general
                             - 11 -


partner had no prior experience in marketing recycling or similar

equipment; (4) the limited partners would have no control over

the conduct of the partnership's business; (5) there was no

established market for the Sentinel recyclers; (6) there were no

assurances that market prices for virgin resin would remain at

their current costs per pound or that the recycled pellets would

be as marketable as virgin pellets; and (7) certain potential

conflicts of interest existed.   The private offering memorandum

also informed investors that the business of the partnership

would be conducted in accordance with six simultaneous

transactions.

     The private offering memorandum stated that the projected

tax benefits for the initial year of investment for an investor

contributing $50,000 would be investment credits and energy

credits in the aggregate amount of $86,328, plus deductions in

the amount of $39,399.

     The offering memorandum also included a discussion of the

tax aspects of the transactions and a tax opinion prepared by

WMDI concerning the tax issues involved in the Plastics Recycling

Program.

     Also included in the offering memorandum were the reports of

the “F&G evaluators", Samuel Z. Burstein (Burstein) and Stanley

Ulanoff (Ulanoff).
                              - 12 -


     At the time Ulanoff prepared the report, he was a professor

of marketing at Baruch College.    Ulanoff is also the author of

numerous books on technical and marketing subjects.    His report

covered the marketing value and potential of the recyclers and

expressed the conclusion that the sales price paid by F&G for the

recyclers and the rental payment made by Clearwater were fair and

reasonable.   His conclusion allegedly was based on his personal

observation of the Sentinel EPE recycler prototype during a visit

to PI, discussions with PI employees, the needs of the plastics

industry, and his analysis of the economic projections provided

in the offering memorandum.

     Burstein was an associate professor of mathematics at New

York University.   Allegedly based on his visit to PI, discussions

with PI personnel, an evaluation of the technical value of the

recycler, the recycler's history of performance, and information

concerning the use of recycled polyethylene as a raw material,

Burstein concluded that the Sentinel EPE recycler was capable of

recycling on a continuous basis.

     The offering memorandum represented that the Sentinel

recyclers were unique machines.    However, they were not.   Several

machines capable of densifying low density materials were already

on the market in 1981.   Other plastics recycling machines

available at that time ranged in price from $20,000 to $200,000,

including the Foremost “Densilator", the Nelmor/Weiss
                             - 13 -


Densification System (Regenolux), the Buss-Condux Plastcompactor,

and the Cumberland Granulator.   See Provizer v. Commissioner,

T.C. Memo. 1992-177, and the discussion regarding expert

testimony, infra.

D.   Expert Testimony

     The parties did not agree on the value of the Sentinel EPE

recyclers, and petitioners did not stipulate to be bound by the

value of the Sentinel EPE recyclers that we found in Provizer v.

Commissioner, supra.

     At trial, petitioners did not offer expert testimony

regarding the value of the recyclers.   In contrast, respondent

offered expert testimony from Steven Grossman (Grossman) and

Richard S. Lindstrom (Lindstrom).

     1.   Grossman

     Grossman is a professor in the Plastics Engineering

Department at the University of Massachusetts at Lowell.    He has

a bachelor of science degree in chemistry from the University of

Connecticut and a doctorate degree in polymer science and

engineering from the University of Massachusetts.   He also has

more than 15 years of experience in the plastics industry,

including more than 4 years of experience as a research and

development scientist at the Upjohn Company in its Polymer

Research Group.
                              - 14 -


     Grossman is also a partner in the law firm of Hayes,

Soloway, Hennessey, Grossman & Hage, P.C., which firm practices

in the area of intellectual property, including patents,

trademarks, copyrights, and trade secret protection.

     Grossman's reports concerning the value of the Sentinel EPE

recyclers discuss the limited market for the recycled plastic

material.   Grossman concluded that these recyclers were unlikely

to be successful products because of the absence of any new

technology, the absence of a continuous source of suitable scrap,

and the absence of any established market.   Grossman suggested

that a reasonable comparison of the products available in the

polyethylene industry in 1981 with the Sentinel EPE recyclers

reveals that the recyclers had very little commercial value and

were similar to comparable products available on the market in

component form.   For these reasons, Grossman opined that the

Sentinel EPE recyclers did not justify the “one-of-a-kind"

pricetag that they carried.

     Specifically, Grossman reported that there were several

machines on the market as early as 1981 that were functionally

equivalent to, and significantly less expensive than, the

Sentinel EPE recyclers.   These machines included: (1) The Japan

Repro recycler, available in 1981 for $53,000; (2) the Buss-

Condux Plastcompactor, available before 1981 for $75,000; (3)

Foremost Machine Builders' “Densilator", available from 1978-1981
                              - 15 -


for $20,000; and (4) the Midland Ross Extruder, available in 1980

and 1981 for $120,000.   Grossman observed that all of these

machines were “widely available".

     Grossman's opinion regarding the Sentinel EPE recycler was

based on the descriptions of such recycler as set forth in the

writings of other professionals.    Grossman neither tested nor

examined the Sentinel EPE recycler.

     Finally, Grossman reported on the relationship between the

plastics industry and the petrochemical industry.    Grossman noted

that although the development of the petrochemical industry is a

contributing factor in the growth of the plastics industry, the

two industries have a “remarkable degree of independence".

Grossman observed that the “oil crisis" in 1973 triggered “dire"

predictions about the future of plastics that had not been

fulfilled in 1981.   Grossman stated that the cost of a plastic

product depends, in large part, on technology and the price of

alternative materials.   Grossman's studies concluded that a 300-

percent increase in oil prices results in a 30-40 percent

increase in the cost of plastic.

     Grossman did not specifically value the Sentinel EPE

recycler.   However, as previously stated, Grossman concluded that

existing technology was available that provided equivalent

capability of recycling polyethylene.
                              - 16 -


     2.   Lindstrom

     Lindstrom graduated from the Massachusetts Institute of

Technology with a bachelor's degree in chemical engineering.

From 1956 until 1989, Lindstrom worked for Arthur D. Little,

Inc., in the areas of process and product evaluation and

improvement and new product development, with special emphasis on

plastics, elastomers, and fibers.   At the time of trial,

Lindstrom continued to pursue these areas as a consultant.

     In his report, Lindstrom determined that in 1981 several

different types of equipment capable of recycling expanded

polyethylene were available and priced at approximately $50,000.

Lindstrom found that, on the basis of his research, “there were

available in 1981 commercial units that could be purchased for

$50,000 or less that were totally equal to the Sentinel EPE

recycler in function, product quality, and capacity."

     Lindstrom examined the Buss-Condux Plastcompactor and the

Regenolux.   Lindstrom found that these machines were functionally

equivalent to the Sentinel EPE recycler and were available in the

years and at the prices reported by Grossman, detailed supra.

Lindstrom also reported that various equipment companies, such as

the Cumberland Engineering Division of John Brown Plastics

Machinery, were willing to provide customized recycling programs

to companies at a minimum cost of $50,000.
                                - 17 -


     Lindstrom found that in “average-use situations" the

Sentinel EPE recycler could process 200 pounds of plastic per

hour.

     Lindstrom observed a Sentinel EPE recycler in operation at

PI, and he was allowed to take photographs of it and examine its

blueprints.     Based on his observations and study, Lindstrom

estimated that the manufacturing cost of the Sentinel EPE

recycler was approximately $20,000.      Lindstrom concluded that the

market value of the Sentinel EPE recycler did not exceed $50,000.

     Lindstrom also reported that information was available in

1981 regarding state-of-the-art foamed plastic recycling

machines.     Lindstrom described several approaches that might have

been taken by a layman of average intelligence to obtain such

information, even in a small town library.

E.   Petitioners and Their Introduction to Clearwater

        Petitioners acquired a 1.547-percent interest in Clearwater

in 1981 for $12,500.

        Petitioner husband (petitioner) has a bachelor of science

degree in chemical engineering.     During college, petitioner was

employed during 2 summers by the Scott Paper Company.     There, he

became familiar with batch type paper pulp machines used to

process wood chips or recycled paper or cardboard into pulp.
                             - 18 -


     Petitioner also has a J.D. degree.   While in law school,

petitioner was employed by a patent attorney and conducted

numerous patent searches.

     Petitioner was an associate, and subsequently a partner, of

the law firm of Shea and Gould from 1966 until 1989.    Petitioner

wife (Mrs. Carroll) was not employed outside the home.

     Petitioner was introduced to Clearwater and its general

partner, Winer, by Mr. Hirschfield, a partner at Shea & Gould.

Petitioner read the offering memorandum and the reports contained

therein and discussed the investment with other partners at his

firm, including Alan Parker, the senior tax attorney at the firm,

who were investing, or considering investing, in the Plastics

Recycling Program.

     Petitioners had no knowledge concerning the plastics

industry and/or plastics recycling.   Petitioners did not see a

Sentinel EPE recycler prior to their investment in Clearwater nor

did they do a patent search on the EPE recyclers.   Rather,

petitioner was aware that the promoters had not applied for a

patent for the recyclers but concluded it was because they wanted

to keep their invention a trade secret.   Petitioner relied almost

exclusively on the Clearwater offering memorandum (and the

reports of Burstein, Ulanoff and WMDI, contained therein) and

Petitioner’s assessment of those reports as accurate.    Petitioner

considered the caveats and warnings contained in the Clearwater
                                - 19 -


memorandum but concluded that for the most part they were boiler-

plate and overstated, included only to protect the promoters.

     Petitioners never made any profit from their investment in

Clearwater.   Petitioners did not contact the general partner,

Winer, at any time after their investment to inquire why the

investment did not generate the profits projected.

     The projected tax benefits for the initial year of

investment described in Clearwater’s offering memorandum greatly

exceeded petitioners’ investment in Clearwater.     In fact, the tax

benefits actually claimed by petitioners on their tax return for

the initial year of investment in Clearwater greatly exceeded

their investment in the partnership.     For 1981, petitioners

claimed a loss of $9,995 as their distributive share of

Clearwater’s losses for the year, and they claimed an investment

tax credit in the amount of $11,542 and an energy tax credit in

the amount of $10,785.

     In the notice of deficiency, respondent disallowed all the

claimed deductions and credits relating to petitioners’

Clearwater investment.

F.   Ultimate Finding of Fact

     At all relevant times, the fair market value of the Sentinel

EPE recyclers did not exceed $50,000 per machine.
                              - 20 -


                              OPINION

     We have decided many Plastics Recycling cases.     The majority

of these cases presented issues regarding additions to tax for

negligence and valuation overstatement.     See Greene v.

Commissioner, T.C. Memo. 1997-296;      Kaliban v. Commissioner, T.C.

Memo. 1997-271; Sann v. Commissioner, T.C. Memo. 1997-259 n.13

(and cases cited therein), affd. Addington v. Commissioner, 205

F.3d 54 (2d Cir. 2000).   We found the taxpayers liable for the

addition to tax for valuation overstatement in all of those cases

and liable for the additions to tax for negligence in the

overwhelming majority of those cases.     In a limited number of

cases, the taxpayers also contested the underlying deficiency

arising from the disallowance of the losses and various credits

with respect to their Plastics Recycling investment.     We

sustained the Commissioner on the issue of the underlying

deficiency in every one of those cases.

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

case for the Plastics Recycling group of cases, 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) sustained the additions to tax for negligence under

section 6653(a)(1) and (2); (4) sustained the addition to tax for

valuation overstatement under section 6659 because the
                                - 21 -


underpayment of taxes was directly related to the overvaluation

of the Sentinel EPE recyclers; and (5) held that losses and

credits claimed with respect to the Clearwater Group were

attributable to tax-motivated transactions within the meaning of

section 6621(c).    In reaching the conclusion that the transaction

lacked business purpose, this Court relied heavily upon the

overvaluation of the Sentinel EPE recyclers.

     In the notice of deficiency, respondent disallowed all of

the claimed deductions and credits relating to petitioners’

Clearwater investment.    Respondent’s determination is

presumptively correct, and petitioners bear the burden of proving

otherwise.    See Rule 142(a); INDOPCO, Inc. v. Commissioner, 503

U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S.

435, 440 (1934).

Issue 1.     The Underlying Deficiency

     Respondent determined that the integrated series of

transactions involved in the Plastics Recycling Program, of which

Clearwater was a part, was an economic sham.    Petitioners must

therefore prove otherwise in order to prevail.

     There is a complete failure by petitioners to prove that the

Plastics Recycling Program in which Clearwater participated was

not an economic sham.     As in Provizer v. Commissioner, supra, we

rely heavily on the fact that the Sentinel EPE machines were

highly overvalued, an issue with respect to which petitioners
                              - 22 -


bear the burden of proof but on which they provided no expert or

other persuasive testimony.   In this regard they rely simply on

the Clearwater offering memorandum and ineffective cross-

examination of respondent’s expert witnesses to establish the

value of the Sentinel EPE recyclers.

     Similarly, petitioners failed to introduce persuasive

evidence on pertinent factors to establish the economics of the

transaction, such as the presence of arm's-length price

negotiations, see Helba v. Commissioner, 87 T.C. 983, 1005-1007

(1986), affd. 860 F.2d 1075 (3d Cir. 1988); the relationship

between the sales price and fair market value, see Zirker v.

Commissioner, 87 T.C. 970, 976 (1986); the structure of the

financing, see Helba v. Commissioner, supra at 1007-1011; the

degree of adherence to contractual terms, see id. at 1011; and

the reasonableness of the income projections, see Rice's Toyota

World, Inc. v. Commissioner, 81 T.C. 184, 204-207 (1983), revd.

in part and remanded on other issues 752 F.2d 89 (1985).

     Petitioners contend that although they stipulated

substantially the same facts concerning the underlying

transactions that were described in Provizer v. Commissioner,

supra, they did not agree to be bound by any findings or

conclusions in Provizer.   Although we do not hold petitioners to

the Provizer decision as a matter of stipulation, there is

nothing in this record to persuade us to reach a different
                              - 23 -


conclusion.   Rather, there is ample evidence on the record in the

present case to establish independently that the series of

Plastics Recycling transactions, of which petitioners’ Clearwater

transaction was a part, constituted an economic sham.     However,

because petitioners have provided no further evidence nor any

novel contention with respect to the underlying deficiency not

previously considered in Provizer, we shall not revisit that

opinion.   Accordingly, we sustain respondent’s determination for

substantially identical reasons as in Provizer.

Issue 2.   Section 6653(a)(1) and (2) Negligence

     Respondent determined that petitioners are liable for

additions to tax under section 6653(a)(1) and (2) with respect to

the underpayment attributable to petitioners’ investment in

Clearwater.   Petitioners have the burden of proof to show that

they were not negligent.   See Addington v. Commissioner, 205 F.3d

54 (2d Cir. 2000), affg. Sann v. Commissioner, T.C. Memo. 1997-

259; Goldman v. Commissioner, 39 F.3d 402, 407 (2d Cir. 1994),

affg. T.C. Memo. 1993-480; Luman v. Commissioner, 79 T.C. 846,

860-861 (1982); Bixby v. Commissioner, 58 T.C. 757, 791-792

(1972).

     Section 6653(a)(1) and (2) imposes additions to tax if any

part of the underpayment of tax is due to negligence or

intentional disregard of rules or regulations.     Negligence is

defined as the failure to exercise the due care that a reasonable
                              - 24 -


and ordinarily prudent person would exercise under the

circumstances.   See Neely v. Commissioner, 85 T.C. 934, 947

(1985).   The pertinent question is whether a particular

taxpayer's actions are reasonable in light of the taxpayer's

experience, the nature of the investment, and the taxpayer's

actions in connection with the transactions.    See Henry Schwartz

Corp. v. Commissioner, 60 T.C. 728, 740 (1973).    In this regard,

the determination of negligence is highly factual.   “When

considering the negligence addition, we evaluate the particular

facts of each case, judging the relative sophistication of the

taxpayers as well as the manner in which the taxpayers approached

their investment."   Turner v. Commissioner, T.C. Memo. 1995-363.

     Petitioners claimed operating losses and investment and

energy tax credits relying almost exclusively on representations

in the Clearwater offering memorandum.   Petitioners did not hire

an independent industry expert to evaluate the profitability of

their investment, nor did they employ an accountant to verify the

correctness of the position on their tax return.

     Petitioners contend that because of petitioner’s background

in chemical engineering and patent law, he possessed sufficient

expertise to evaluate the Clearwater transaction, making it

unnecessary to hire an expert to do the same.   Petitioners claim

that petitioner drew on his background to conclude that the EPE

recyclers were unique (based on the purportedly unique blade
                              - 25 -


angle design of the EPE recyclers and the purportedly unique

chemical process used to recycle the material) and warranted the

$1,162,667 price tag.

     Although petitioner may have been more familiar with

chemical processes because of his college degree--or with machine

designs because of his limited patent law experience–-than the

average investor, it is clear that he did not have adequate

plastics industry knowledge to evaluate the investment.     See

Addington v. Commissioner, supra.   Petitioner did not have any

expertise in plastics recycling or evaluation of machinery,

including plastics recycling equipment, to evaluate competently

the profitability of the Clearwater transaction.

     We have found that the EPE recyclers did not have a fair

market value of more than $50,000 and that the recyclers did not

have any unique features warranting their exorbitant pricetag.

By simply relying on petitioner’s limited knowledge and

experience, without independent research or consultation,

petitioners never made an adequate effort to learn that the EPE

recyclers were highly overvalued or the true nature of the

transaction as a sham.

     There is also no indication that petitioners invested the

necessary time to gain the requisite expertise to evaluate their

investment.   Petitioners claim that petitioner discussed the

investment with several partners in his firm, the majority of
                                - 26 -


whom were also investing in Clearwater or related plastics

partnerships.    We have not been convinced that these were any

more than half-hearted inquiries, or that any of these other

individuals were qualified to opine on the profitability of the

transaction.    See id.

     Petitioners also assert that because of petitioner’s

background, it was reasonable for them to rely simply on the

Clearwater offering memorandum, including the reports of

Burstein, Ulanoff, and the tax opinion prepared by WMDI.

Petitioners claim that petitioner was sufficiently knowledgeable

to decipher those reports and to find their conclusions

reasonable.     Petitioners contend that after reading those

reports, petitioner concluded that the reports were accurate, and

that there was nothing more an independent expert, or independent

research, could tell petitioners that was not already in these

reports.

     We think it unreasonable for an educated and sophisticated

investor, such as petitioner, to conclude that an independent

expert cannot evaluate a deal more objectively than the

individuals retained by insiders to draft the offering memorandum

and the tax opinions contained therein.     “It is unreasonable for

taxpayers to rely on the advice of someone who they should know

has a conflict of interest.”     Id. at 59; see Goldman v.

Commissioner, 39 F.3d at 408; LaVerne v. Commissioner, 94 T.C.
                              - 27 -


637, 652-653 (1990), affd. without published opinion 956 F.2d 274

(9th Cir. 1992), affd. in part without published opinion sub nom.

Cowles v. Commissioner, 949 F.2d 401 (10th Cir. 1991).

     It is also clear that petitioners could not reasonably rely

on the advice of the Plastics Recycling promoters with respect to

the substantive merits or the tax treatment of items in

connection with their investment in Clearwater.   See Patin v.

Commissioner, 88 T.C. 1086, 1131 (1987), affd. without published

opinion 865 F.2d 1264 (5th Cir. 1989), affd. sub nom. Gomberg v.

Commissioner, 868 F.2d 865 (6th Cir. 1989), affd. sub nom. Skeen

v. Commissioner, 864 F.2d 93 (9th Cir. 1989), affd. per curiam

without published opinion sub nom. Hatheway v. Commissioner, 856

F.2d 186 (4th Cir. 1988); Kleiger v. Commissioner, T.C. Memo.

1992-734.   Advice from such individuals “is better classified as

sales promotion".   Vojticek v. Commissioner, T.C. Memo. 1995-444.

     Petitioners also claim that their decision to invest was

greatly influenced by the nature of the transaction, guaranteeing

them a profit based on “conservative” assumptions regarding the

price of resin and minimal output by the recyclers.   Based on

these assumptions, petitioners claim to have concluded that the

circular nature of the transaction in fact guaranteed them a

profit.   In this regard, petitioners claim that the circuitous

nature of the transaction did not alarm them because petitioner
                                - 28 -


concluded that the Clearwater transaction was set up to satisfy

the safe harbor leasing rules.

     Petitioners’ contention is completely circular and flawed.

Petitioners reached the conclusion that the Clearwater

transaction virtually guaranteed them a profit based on

assumptions contained in the Clearwater offering memorandum.

Petitioners did not perform adequate research nor obtain advice

from an independent expert regarding the price of resins, the

quality of the resin processed by the EPE recyclers, or the

quality of the EPE recyclers.    What is more, petitioners’

argument completely ignores any fair market value consideration.

     The standard for measuring fair market value is the price at

which the property would change hands between a hypothetical

willing buyer and seller, neither being under any compulsion to

buy or sell and both having reasonable knowledge of the relevant

facts.    See United States v. Cartwright, 411 U.S. 546, 551

(1973).    We have held that the fair market value of the Sentinel

EPE recyclers did not exceed $50,000.

     If petitioners had made any reasonable effort to determine

the fair market value of the recyclers, they would have

determined, as we have found, that the recyclers’ pricetage of

$1,162,667 was grossly inflated.4    At that point, petitioners


     4
          There were many factors to indicate that the Sentinel
                                                     (continued...)
                               - 29 -


would have become skeptical of the manner in which payments for

the recycler were to be made through a complex series of

offsetting payments.   Petitioners would also have inquired why

the partnership would be willing to “invest” in machines at far

in excess of their fair market value when it could invest in

other much less expensive machines performing virtually the same

functions as the EPE recyclers.   Inquiry may also have spurred

petitioners to take more seriously the tax and business warnings

in the offering memorandum which, for the most part, petitioners

cavalierly dismissed as overly cautious and boilerplate.

     Petitioners claim that petitioner closely studied the

Clearwater offering memorandum and was aware of the nature of the

transaction.   What petitioner should have realized, or what an

independent expert would have told him, is that the Sentinel EPE

recyclers were not offered to the general public, and therefore

the $1,162,667 pricetag did not result from traditional supply

and demand pricing.    See Provizer v. Commissioner, T.C. Memo.


     4
      (...continued)
recyclers were highly overvalued. For example, the Sentinel
recyclers were not unique. Respondent's experts identified other
machines that were not only functionally equivalent to the
Sentinel recyclers but that were also significantly less
expensive. We have found that information regarding comparable,
less expensive recyclers was widely available. If a potential
purchaser, especially a sophisticated one, had conducted a due
diligence investigation into the Sentinel EPE recyclers, such
potential purchaser should have learned that comparable, less
expensive equipment existed and that the Sentinel EPE recyclers
were overvalued.
                              - 30 -


1992-177.   Rather, the promoters were free to assign arbitrarily

a value to the recyclers to be used for the Plastics Recycling

transactions.

     The circular nature of the transaction offered an

opportunity for abuse.   With the exception of a minimal

downpayment for the machines, the majority of the purchase price

was in the form of a series of offsetting payments realized only

through bookkeeping entries, there being no disincentive for the

promoters to exaggerate the value of the recyclers.   To the

contrary, the high price of the machines assured high tax write-

offs and was sure to attract investors for that very reason.

     In fact, we are convinced that petitioners’ investment in

Clearwater was purely tax driven.   The Clearwater offering

memorandum emphasized projected tax savings.   For the year in

issue, for each $50,000 invested, the purchaser was projected to

receive $86,328 in investment and energy tax credits and $39,399

in tax deductions.   Petitioners claimed a reduction of taxes in

the year of investment of over twice the amount of their

investment.   “A reasonably prudent person would have asked a

qualified tax adviser if this windfall were not too good to be

true.”   Provizer v. Commissioner, supra; see McCrary v.

Commissioner, 92 T.C. 827 (1989).   Petitioners did not act

reasonably in claiming those benefits on their tax return without
                              - 31 -


making further inquiry and intentionally disregarded rules and

regulations.

     In view of his sophistication and educational background,

petitioner should have been able to determine that the Sentinel

EPE recyclers were not unique, that they were not worth the

amount ascribed to them, and that Clearwater lacked economic

substance and had no potential for profit.   Taking all of the

above factors into consideration, we think it is more likely than

not that petitioners invested in Clearwater in an effort to

generate tax benefits, rather than to make a profit.   Therefore,

under the circumstances of this case, petitioners failed to

exercise due care in claiming loss deductions and tax credits

with respect to Clearwater.

     Upon consideration of the entire record, we hold that

petitioners are liable for the additions to tax for negligence

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

this issue.

Issue 3.   Section 6659 Valuation Overstatement

     Petitioners also contest the addition to tax for valuation

overstatement under section 6659.

     A value claimed on a return that exceeds the correct value

by 150 percent or more constitutes a valuation overstatement.

See sec. 6659(c).   The Sentinel EPE recyclers were valued at
                              - 32 -


$1,162,667 each, but they did not, as we have found, have a value

exceeding $50,000 per machine.

     Although petitioners declined to stipulate the value of the

Sentinel recyclers at issue, petitioners presented no probative

evidence by way of expert testimony or otherwise to contradict

the conclusions reached by respondent's experts.   The record is

devoid of any evidence indicating that petitioners conducted a

meaningful investigation to value the Sentinel recyclers.    We

have extensively considered the value of the Sentinel EPE

recycler and have concluded as an ultimate fact that the

recyclers did not have a fair market value in excess of $50,000.

See Provizer v. Commissioner, T.C. Memo. 1992-177.   Having so

concluded, it follows that there was a valuation overstatement

under section 6659.

     In view of the foregoing, we sustain respondent's

determination that petitioners are liable for the addition to tax

for valuation overstatement under section 6659.

Issue (4)   Section 6621(c) Additional Interest

     Respondent determined that petitioners are liable for

additional interest with respect to the underpayment attributable

to petitioners’ investment in Clearwater.

     Section 6621(c), formerly section 6621(d), provides for an

increased rate of interest if the underpayment of tax exceeds

$1,000 and is attributable to a tax-motivated transaction as
                                - 33 -


defined in section 6621(c)(3).    The increased rate of interest is

effective only with respect to interest accruing after December

31, 1984, notwithstanding that the transaction was entered into

before that date.    See Solowiejczyk v. Commissioner, 85 T.C. 552

(1985), affd. per curiam without published opinion 795 F.2d 1005

(2d Cir. 1986); Provizer v. Commissioner, supra.

         As we held in Provizer, a tax-motivated transaction

includes any sham or fraudulent transaction.       See sec.

6621(c)(3)(A)(v).     We have held that the Plastics Recycling

Program to which petitioners’ 1981 underpayment is attributable

was a sham transaction.     The tax-motivated increased rate of

interest is therefore clearly applicable.     Accordingly, we

sustain respondent’s determination on this issue.5

     Petitioners have made other arguments that we have

considered in reaching our decision.     To the extent that we have

not discussed these arguments, we find them to be without merit.

     To reflect our disposition of the disputed issues,

                                      Decision will be entered

                                 for respondent.


     5
        We note that a tax-motivated transaction also includes
any valuation overstatement within the meaning of sec. 6659(c).
See sec. 6621(c)(3)(A)(i). It is apparent that there was such a
valuation overstatement in the present case. See the discussion
supra, under Issue (3), regarding sec. 6659. Accordingly,
respondent's determination could also be sustained on this
alternative basis.
