                         T.C. Memo. 2002-56



                       UNITED STATES TAX COURT



         ANTHONY N. AND MARIE M. FINAZZO, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 5727-00.                Filed February 27, 2002.


     Robert S. Schriebman and Patrick E. McGinnis, for

petitioners.

     Timothy S. Sinnott, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


     ARMEN, Special Trial Judge:    In a so-called affected items

notice of deficiency, respondent determined additions to tax to

petitioners’ Federal income tax for the year and in the amounts

as shown below:
                                  - 2 -


                                 Additions to Tax
                   Sec.1            Sec.             Sec.
                                                      3
     Year          6653(a)(1)       6653(a)(2)        6661
                                    2
     1983           $618              $12,355        $3,089

            1
           Throughout this opinion and unless otherwise
    indicated, all section references are to the Internal
    Revenue Code in effect for the taxable year in issue.
            2
            The first page of the notice of deficiency
    mistakenly equates the amount of this addition to tax with
    the amount of the deficiency in income tax (see infra,
    subdivision “I” of the Findings of Fact). Prior to trial,
    respondent amended his answer to claim an increased
    addition to tax pursuant to sec. 6214(a). The increase,
    in the amount of $17,877, is purely computational in
    nature.
            3
            The first page of the notice of deficiency
     mistakenly references sec. 6662(d), which section is the
     successor to sec. 6661 and is applicable for returns the
     due date for which (determined without regard to
     extensions) is after December 31, 1989. See Omnibus
     Budget Reconciliation Act of 1989, Pub. L. 101-239, sec.
     7721(a), (c)(2), (d), 103 Stat. 2395-2400.

     After a concession by petitioners,1 the issues for decision

are as follows:

     (1) 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 petitioners are

liable for such additions.

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

under section 6661 for substantial understatement of tax

liability.      We hold that petitioners are liable for such


     1
       Petitioners concede that the notice of deficiency is
valid. Cf. Scar v. Commissioner, 814 F.2d 1363 (9th Cir. 1987),
revg. 81 T.C. 855 (1983).
                               - 3 -

addition.

     The foregoing two issues relate to the participation of

Anthony N. Finazzo (petitioner) as a limited partner in a jojoba

partnership known as San Nicholas Research, Ltd.

                         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 Fontana, California, at the time that

their petition was filed with the Court.

A.   Petitioners’ Background and Experience

     Petitioner graduated in 1953 from Chaffey Junior College in

Ontario, California, with an associate of arts degree.    He then

attended the University of California at Los Angeles for 1 year

where he took basic courses in business administration, including

accounting, economics, and investing.    Petitioner never took

courses in either Federal or State taxation, nor did he ever take

courses related to either farming or agriculture.

     Petitioner is a successful businessman.    Prior to 1983,

petitioner served for 11 years as chairman of the board of

directors of Fontana First National Bank; he also served as

branch manager for several other financial institutions.    In

1983, the taxable year in issue, petitioner was the general

manager and 25-percent owner of Midway Honda-GMC Inc., a highly
                               - 4 -

profitable automobile and truck dealership.   In July 1983,

petitioner sold his ownership interest in the dealership and

later became executive vice president of Monitor Dynamics, a

corporation specializing in electronic security systems for both

civilian and military use.

     During the year in issue, petitioner Marie M. Finazzo was

employed by the Fontana Unified School District as secretary for

the budget commission.

     In 1983, petitioner was financially well off and

sophisticated.   For that year, he received compensation from

Midway Honda-GMC, Inc. in the amount of $170,085, gain from the

sale of stock in the dealership in the amount of $245,160, and

interest in the amount of $8,445.   In addition, petitioner had

equity interests in: (1) A partnership known as Fontana Bancorp

Development; (2) a partnership known as Carousel Video; (3) San

Nicholas Research, Ltd. (see infra “C” through “F”); and (4) an S

corporation known as Classic Touch, Inc., that manufactured

convertible tops for automobiles in Palm Springs, California.

B.   Petitioner’s Friend and Associate William G. Kellen

     William G. Kellen (Mr. Kellen) was petitioner’s close

personal friend and business associate.

     Mr. Kellen was a general partner and tax matters partner of

four limited jojoba partnerships: Utah Jojoba Research, Ltd.

(Utah Jojoba); Blythe Jojoba I Research, Ltd. (Blythe Jojoba I);
                               - 5 -

Blythe Jojoba II Research, Ltd. (Blythe Jojoba II); and Desert

Center Jojoba Research, Ltd. (Desert Center Jojoba).    Each of

these partnerships was similar, if not identical, to San Nicholas

Research, Ltd., described infra in “C” through “F”.

      Prior to 1982, Mr. Kellen did not have any experience in

growing jojoba, nor did he have any experience in either the

research or development of jojoba.     Prior to 1982, Mr. Kellen’s

knowledge concerning jojoba was limited to articles that he had

read in various magazines and a general familiarity with the

existence of an experimental jojoba plantation located at the

University of California at Riverside.

      In 1983, Mr. Kellen was actively engaged in the practice of

law, specializing in the formation of financial institutions such

as banks, savings and loan associations, and thrift and loan

associations.   Mr. Kellen did not have any expertise in

accounting or tax matters, nor did he ever attempt to render

advice on those subjects.

C.   Petitioner’s Investment in San Nicholas Research, Ltd.

      Petitioner was introduced to jojoba in the fall of 1983 by

Mr. Kellen, who provided petitioner with a copy of a private

placement memorandum dated October 10, 1983 (see infra “D” and

“F”) for San Nicholas Research, Ltd. (San Nicholas or the

partnership).   Thereafter, on December 29, 1983, petitioner

signed a subscription agreement and purchased 10 limited
                                - 6 -

partnership units (a 7.8-percentage interest) in San Nicholas.2

     The general partner and tax matters partner of San Nicholas

was Alfred M. Clancy, an individual whom petitioner did not know,

nor whom he had ever met, at the time that he invested in San

Nicholas.

     Petitioner purchased the partnership units pursuant to the

aforementioned private placement memorandum.   Petitioner paid

$2,790 per limited partnership unit, or a total of $27,900, for

his 10 units in San Nicholas.   Of this amount, $1,140 per unit,

or $11,400 for 10 units, was paid in cash.   The balance, $1,650

per unit or $16,500 for 10 units, was payable pursuant to a 10-

year promissory note.3

     Prior to investing in San Nicholas, petitioner did not have

any expertise in either farming or agriculture in general or

jojoba in particular, nor did petitioner have any expertise in

the area of research and development.


     2
       The parties stipulated that petitioners acquired the
partnership interest in San Nicholas. However, at trial, the
parties proceeded as if petitioner himself was the only one who
had acquired the partnership interest. Our findings of fact
reflect the approach taken by the parties at trial. We hasten to
add that if we had taken the other approach, our decision in this
case would not have been different in any regard. We also hasten
to add that petitioners expressly declined to raise any issue
under sec. 6015.
     3
        The note, which was recourse in form, contemplated
payments of interest only for the first 5 years. As matters
actually transpired, in 1989, the limited partners were given the
option of paying a steeply discounted percentage of the principal
in cash. Petitioner elected this option.
                                - 7 -

       Prior to investing in San Nicholas, petitioner did not

consult any expert in either farming or agriculture or jojoba,

nor did petitioner consult any expert in research and

development.

       Prior to investing in San Nicholas, petitioner did not

consult any attorney or accountant.4

       Prior to investing in San Nicholas, petitioner did not visit

the plantation site, nor did he know where it was located.

       Petitioner was influenced to invest in San Nicholas by the

fact that Mr. Kellen, his friend and business associate, had done

so.5   Indeed, prior to investing, petitioner spoke with no

individual other than Mr. Kellen.   Petitioner was also influenced

to invest by his belief that an investment in San Nicholas

offered tax benefits.




       4

 Although Mr. Kellen was an attorney, he never rendered any legal
advice to petitioner concerning either San Nicholas or the
advisability of investing therein. Indeed, petitioner never
consulted Mr. Kellen in his capacity as an attorney; rather,
petitioner consulted Mr. Kellen solely as a friend and business
associate.
     In addition, although petitioner may have shown the private
placement memorandum dated Oct. 10, 1983, see infra “D” and “F”,
to his accountant and return preparer Lloyd Maryanov, see infra
“G”, petitioner only did so after investing in San Nicholas.
       5

 Mr. Kellen’s investment in San Nicholas also culminated in a
case in this Court. See Kellen v. Commissioner, T.C. Memo. 2002-
19; see also Utah Jojoba I Research v. Commissioner, T.C. Memo.
1998-6, discussed infra in subdivision “I” of the Findings of
Fact, regarding Mr. Kellen’s involvement in another jojoba
partnership.
                               - 8 -

D.   Putative Nature of San Nicholas’ Business

     According to the private placement memorandum dated October

10, 1983 (the offering memorandum), San Nicholas was formed in

order “to undertake a comprehensive research and development

program on the plant Simmondsia Chinesis (Jojoba).”   The offering

memorandum described how this program was to be carried out:

     The Partnership will enter into a research and
     development contract * * * with U.S. Agri Research and
     Development Corp. (the “R & D Contractor”), who will
     conduct the experiments in various test sites * * * as
     well as its laboratory or greenhouse facilities that it
     in its sole discretion deems advisable. In addition,
     the R & D Contract sets forth that a site in the
     vicinity of Desert Center and Blythe, California of
     from 30-50 acres will be delineated as the applied
     research site upon which all technology and improved
     cultivars developed on behalf of the Partnership during
     the term of the contract will be placed “in field.”
     The Partnership will also have the right but not be
     obligated to enter into a License Agreement * * * to
     license to U.S. Agri Research and Development Corp. all
     technology developed on behalf of the Partnership for a
     period of forty (40) years and receive therefrom an
     amount equal to 85% of the products produced from the
     developed technology.[6]

     Copies of the research and development (R&D) contract and

the license agreement referred to in the preceding paragraph were

attached as exhibits to the offering memorandum.   The R&D

contract identified U.S. Agri Research and Development Corp.

     6
        Although San Nicholas may not have been obligated to
enter into a license agreement with U.S. Agri Research and
Development Corp., it was a foregone conclusion that it would do
so. Indeed, the research and development (R&D) contract and the
license agreement were executed concurrently. Notably, execution
of the license agreement by San Nicholas served to automatically
terminate the R&D contract pursuant to the terms of the latter
contract. See infra, subdivision “I” of the Findings of Fact.
                                 - 9 -

(U.S. Agri) as a party to the contract and the R&D contractor

thereunder.   The license agreement identified U.S. Agri as a

party to the contract and the licensee thereunder.

E.   U.S. Agri and Eugene Pace

     As previously indicated, the offering memorandum identified

U.S. Agri as the R&D contractor under the R&D contract and as the

licensee under the license agreement.    U.S. Agri was also the R&D

contractor and the licensee for Utah Jojoba, Blythe Jojoba I,

Blythe Jojoba II, and Desert Center Jojoba.

     The president of U.S. Agri was Eugene Pace (Mr. Pace), who

was also a member of its board of directors.   Mr. Kellen also

served as a member of U.S. Agri’s board until he became general

partner of Utah Jojoba, Blythe Jojoba I, Blythe Jojoba II, and

Desert Center Jojoba in late 1982.

     Mr. Pace and Mr. Kellen were close personal friends and

business associates for a number of years before the formation of

San Nicholas in late 1983.   In contrast, neither in 1983 nor at

any other time relevant to this case did petitioner ever meet Mr.

Pace.

F.   Cautionary Language in the San Nicholas Offering Memorandum

     The face of the offering memorandum warned, in block

letters, that “THIS OFFERING INVOLVES A HIGH DEGREE OF RISK”.

The offering memorandum also included the following cautionary

language in block letters:

     PROSPECTIVE INVESTORS ARE CAUTIONED NOT TO CONSTRUE
                                     - 10 -

     THIS MEMORANDUM OR ANY PRIOR OR SUBSEQUENT
     COMMUNICATIONS AS CONSTITUTING LEGAL OR TAX ADVICE.
     * * * INVESTORS ARE URGED TO CONSULT THEIR OWN COUNSEL
     AS TO ALL MATTERS CONCERNING THIS INVESTMENT.

                 *       *       *        *       *       *       *

     THERE IS NO PUBLIC OR OTHER MARKET FOR THE UNITS, NOR
     WILL SUCH MARKET DEVELOP.

                 *       *       *        *       *       *       *

     THE PURCHASE OF SUCH UNITS DESCRIBED IN THIS MEMORANDUM
     INVOLVES A HIGH DEGREE OF RISK (SEE “RISK FACTORS”) AND
     SHOULD BE CONSIDERED ONLY BY PERSONS WHO CAN AFFORD THE
     TOTAL LOSS OF THEIR INVESTMENT.

             *       *       *        *       *       *       *

     EACH PURCHASER OF THE UNITS HEREIN SHOULD AND IS
     EXPECTED TO CONSULT WITH HIS OWN TAX ADVISOR AS TO THE
     TAX ASPECTS.


     In addition, the offering memorandum limited the sale of

partnership units to investors with a net worth (exclusive of

home, furnishings, and automobiles) of at least $150,000, or

investors whose net worth was at least $50,000 (exclusive of

home, furnishings, and automobiles) and who anticipated that, for

the taxable year of the investment, they would have gross income

of at least $65,000 or taxable income, a portion of which, but

for tax-advantaged investments, would be subject to Federal

income tax at a marginal rate of 50 percent.

     The offering memorandum included a section entitled “Risk

Factors”, which was the single longest section.               It began with a

general warning:

     The purchase of the interests offered hereby involves
                               - 11 -

     various risk factors. Investment in the Partnership    *
     * * involves an extremely high degree of risk.
     Investors should consider carefully the various risk
     factors set forth in this and other portions of this
     Memorandum. Investment in the Partnership is suitable
     only for persons of substantial financial means who will
     not require liquidity in the investment. Investors must
     be prepared for the possible loss of their entire
     investment.

     The offering memorandum then proceeded to discuss a number of

specific, and significant, risk factors associated with an

investment in San Nicholas.   Among those risks, the offering

memorandum warned: (1) Research and development risks were so

great that an investment in San Nicholas should be considered

“highly speculative”; (2) the general partner had no previous

experience in dealing in jojoba; (3) there was no structured

market or distribution system for jojoba; (4) there were no

facilities dedicated to the processing of jojoba; (5) commercial

applications of jojoba are not extensive; (6) the general partner

had not conducted any market analysis or similar studies; (7)

there was no assurance of any increase in marketing or production

facilities or in the demand for jojoba; (8) in the absence of any

such increase, the production of jojoba might be unprofitable,

regardless of any technology that might be developed by the R&D

contractor; and (9) there was the likelihood of audit by the

Internal Revenue Service.   Indeed, the discussion concerning the

tax risks associated with an investment in San Nicholas

constituted half of the section on “Risk Factors”.

     The offering memorandum also included projections of revenue,
                                - 12 -

cashflow, and taxable income or loss.    Investors were warned,

however, that those projections, which had been prepared for the

general partner, had not been audited and that they should not be

relied on to indicate the actual results that might be attained.

G.   Petitioners’ Accountant and Return Preparer Lloyd Maryanov

      Lloyd Maryanov (Mr. Maryanov), a certified public accountant

and a named partner in the accounting firm of Maryanov, Madsen,

Gordon & Campbell of Palm Springs, California, prepared

petitioners’ income tax return for 1983.    In preparing

petitioners’ return, Mr. Maryanov relied on the Schedule K-1 given

to him by petitioner.   See infra “H”.

H.   Petitioners’ 1983 Schedule K-1 and Income Tax Return

      Petitioner received a Schedule K-1, Partner’s Share of

Income, Credits, Deductions, etc., from San Nicholas for 1983.

The Schedule K-1 reported that petitioner’s distributive share of

partnership loss from San Nicholas was $24,710 for the year.

      Petitioners timely filed a joint Federal income tax return,

Form 1040, for 1983.    Petitioners attached to their return page 2

of Schedule E, Supplemental Income and Loss, and claimed thereon a

loss from San Nicholas in the amount of $24,710.    Petitioners then

offset this loss against their other income.    See supra “A”.

I.   Jojoba Partnership Litigation

      San Nicholas was examined by the Internal Revenue Service,
                               - 13 -

and a notice of final partnership administrative adjustment, FPAA,

was ultimately issued to the partnership.   In December 1991,

Alfred M. Clancy (Mr. Clancy), the general partner and tax matters

partner of San Nicholas, commenced a TEFRA partnership proceeding

in this Court.7   Subsequently, in November 1993, Mr. Clancy and

the Commissioner agreed to be bound by the decision to be entered

in Utah Jojoba I Research v. Commissioner, docket No. 7619-90, a

TEFRA partnership proceeding involving Utah Jojoba that had

commenced by Mr. Kellen in his capacity as tax matters partner of

that partnership.

     In Utah Jojoba I Research v. Commissioner, T.C. Memo. 1998-6,

the Court made detailed findings of fact related to the jojoba

limited partnerships,8 Mr. Kellen, U.S. Agri, and Mr. Pace.     The

Court described the R&D contract between the partnerships and U.S.

Agri as “mere window dressing” and held that the partnerships did

not, directly or indirectly, engage in research or experimentation

and that the partnerships lacked a realistic prospect of entering

into a trade or business.   In upholding the Commissioner’s


     7
       The TEFRA partnership proceeding was assigned docket No.
29994-91. TEFRA stands for the Tax Equity and Fiscal
Responsibility Act of 1982, Pub. L. 97-248, 96 Stat. 324. See
secs. 6221-6232; N.C.F. Energy Partners v. Commissioner, 89 T.C.
741, 744 (1987); Maxwell v. Commissioner, 87 T.C. 783, 789
(1986).
     8
       At least 18 docketed cases were bound by stipulation to
the outcome of Utah Jojoba I Research v. Commissioner, docket No.
7619-90.
                               - 14 -

disallowance of research and experimental expenditures, the Court

concluded that the agreements between the partnerships and the R&D

contractor (U.S. Agri) had been designed and entered into solely

to provide a mechanism to disguise the capital contributions of

limited partners as currently deductible expenditures.9   The Court

stated that the activities of the partnerships were “another

example of efforts by promoters and investors in the early 1980s

to reduce the cost of commencing and engaging in the farming of

jojoba by claiming, inaccurately, that capital expenditures in

jojoba plantations might be treated as research or experimental

expenditures for purposes of claiming deductions under section

174.”        Id.

     In November 1998, Mr. Clancy, acting in his capacity as tax

matters partner of San Nicholas, consented to entry of decision

against the partnership.   Subsequently, in December 1998, the

Court entered decision against San Nicholas pursuant to the

Commissioner’s Motion for Entry of Decision under Rule 248(a).10

Thereafter, the Commissioner assessed a deficiency in petitioners’

income tax for 1983 in the amount of $12,355 and mailed a so-

called affected items notice of deficiency to petitioners


        9
       In other words, in order to decrease the limited partners’
cost of investing in the jojoba partnerships, large upfront
deductions were manufactured from expenditures that were actually
capital contributions.
        10
       All Rule references are to the Tax Court Rules of
Practice and Procedure.
                               - 15 -

determining additions to tax for negligence and substantial

understatement of tax liability.   See sec. 6230(a); N.C.F. Energy

Partners v. Commissioner, 89 T.C. 741, 744 (1987); Maxwell v.

Commissioner, 87 T.C. 783, 792 n.9 (1986).    It is those additions

to tax that are in issue in the present case.

J.   Epilogue: Demise of the Jojoba Partnerships

     The jojoba partnerships proved to be financial failures.     In

October 1991, some 30 to 40 jojoba partnerships under contract

with U.S. Agri were consolidated into one large limited

partnership, Jojoba Plantation Ltd.     Sometime thereafter, Jojoba

Plantation Ltd. filed a petition in bankruptcy under chapter 7 of

the Bankruptcy Act.   See Utah Jojoba I Research v. Commissioner,

T.C. Memo. 1998-6.

     At trial, petitioners’ witness, Mr. Kellen, testified that

the jojoba partnerships failed because of the Internal Revenue

Service.   At a previous trial, Mr. Kellen testified that “the

collapse, basically, of the tax incentive for doing jojoba”

contributed to the partnerships’ failure.     Id.
                               - 16 -

                              OPINION

     We have decided many jojoba cases involving additions to tax

for negligence and substantial understatement of tax liability.11

We have found the taxpayers liable for additions to tax for

negligence in all of those cases; likewise, we have found the

taxpayers liable for the addition to tax for substantial

understatement of tax liability in all of those cases that have

presented that issue.

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

      The first issue for decision is whether petitioners are

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

respect to the underpayment of tax attributable to petitioner’s

investment in San Nicholas.   Petitioners bear the burden of proof

to show that they are not liable for these additions to tax.12

      11
       See, e.g., Kellen v. Commissioner, T.C. Memo. 2002-19;
Lopez v. Commissioner, T.C. Memo. 2001-278; Christensen v.
Commissioner, T.C. Memo. 2001-185; Serfustini v. Commissioner,
T.C. Memo. 2001-183; Carmena v. Commissioner, T.C. Memo. 2001-
177; Nilsen v. Commissioner, T.C. Memo. 2001-163; Ruggiero v.
Commissioner, T.C. Memo. 2001-162; Robnett v. Commissioner, T.C.
Memo. 2001-17; Harvey v. Commissioner, T.C. Memo. 2001-16; Hunt
v. Commissioner, T.C. Memo. 2001-15; Fawson v. Commissioner, T.C.
Memo. 2000-195; Downs v. Commissioner, T.C. Memo. 2000-155;
Glassley v. Commissioner, T.C. Memo. 1996-206; Stankevich v.
Commissioner, T.C. Memo. 1992-458.
      12
       It must be acknowledged that respondent bears the burden
of proof to show that petitioners are liable for the increase in
the addition to tax under sec. 6653(a)(2). Rule 142(a); see
supra, p. 2, table, note 2. However, in the present case, the
increase is purely computational in nature, and respondent has
convincingly demonstrated the proper amount of the addition to
tax. Accordingly, our analysis proceeds on the basis that
                                                    (continued...)
                                 - 17 -

See Addington v. Commissioner, 205 F.3d 54, 58 (2d Cir. 2000),

affg. Sann v. Commissioner, T.C. Memo. 1997-259; Bixby v.

Commissioner, 58 T.C. 757, 791-792 (1972); Anderson v.

Commissioner, T.C. Memo. 1993-607, affd. 62 F.3d 1266 (10th Cir.

1995).     See generally Rule 142(a); INDOPCO, Inc. v. Commissioner,

503 U.S. 79, 84 (1992); Welch v. Helvering, 290 U.S. 111, 115

(1933).13

     Section 6653(a)(1) imposes an addition to tax in an amount

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

underpayment is due to negligence or intentional disregard of

rules or regulations.    Section 6653(a)(2) imposes another addition

to tax in an amount equal to 50 percent of the interest due on the

portion of the underpayment attributable to negligence or

intentional disregard of rules or regulations.

     Negligence is defined as the failure to exercise the due care

that a reasonable and ordinarily prudent person would exercise

under like circumstances.    See Anderson v. Commissioner, 62 F.3d

1266, 1271 (10th Cir. 1995), affg. T.C. Memo. 1993-607; Neely v.

Commissioner, 85 T.C. 934, 947 (1985).    The focus of inquiry is


     12
      (...continued)
petitioners bear the burden of proof regarding their liability
for this addition to tax. In any event, we would resolve this
issue for respondent based on a preponderance of the evidence.
      13
        Cf. sec. 7491(c), effective for court proceedings
arising in connection with examinations commencing after July 22,
1998. In the present case, the examination of petitioners’
income tax return for 1983 commenced well before July 22, 1998.
                                - 18 -

the reasonableness of the taxpayer’s actions in light of the

taxpayer’s experience and the nature of the investment.    See Henry

Schwartz Corp. v. Commissioner, 60 T.C. 728, 740 (1973); see also

Sacks v. Commissioner, 82 F.3d 918, 920 (9th Cir. 1996) (whether a

taxpayer is negligent in claiming a tax deduction “depends upon

both the legitimacy of the underlying investment, and due care in

the claiming of the deduction.”),    affg. T.C. Memo. 1994-217;

Turner v. Commissioner, T.C. Memo. 1995-363.     In this regard, the

determination of negligence is highly factual.

     Under some circumstances, a taxpayer may avoid liability for

negligence if reasonable reliance on a competent professional

adviser is shown.    See 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 (5th Cir. 1990), affd. on another issue 501

U.S. 868 (1991).    However, reliance on professional advice,

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

rather a factor to be considered.    See Freytag v. Commissioner,

supra.   For reliance on professional advice to excuse a taxpayer

from negligence, the taxpayer must show that the professional had

the requisite expertise, as well as knowledge of the pertinent

facts, to provide informed advice on the subject matter.    See

David v. Commissioner, 43 F.3d 788, 789-790 (2d Cir. 1995), affg.

T.C. Memo. 1993-621; Goldman v. Commissioner, 39 F.3d 402, 407 (2d
                                 - 19 -

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

supra.

     The facts pertinent to the present case relating to the

structure, formation, and operation of San Nicholas are as found

above and as discussed in Utah Jojoba I Research v. Commissioner,

T.C. Memo. 1998-6.   The offering memorandum identified U.S. Agri

as the contractor under the R&D contract.   In addition, a license

agreement between San Nicholas and U.S. Agri granted U.S. Agri the

exclusive right to use all technology developed for the

partnership for 40 years in exchange for a royalty of 85 percent

of the products produced from such technology.    The R&D contract

and the license agreement were executed concurrently.

     According to its terms, the R&D contract expired upon the

partnership’s execution of the license agreement.   Because the two

contracts were executed concurrently, amounts paid by the

partnership to U.S. Agri were not paid pursuant to a valid R&D

contract but rather were passive investments in a farming venture

under which the investors’ return, if any, was to be in the form

of royalties pursuant to the license agreement.   Thus, as the

Court held in Utah Jojoba I Research v. Commissioner, supra, the

partnership was never engaged in research or experimentation,

either directly or indirectly.    Moreover, the Court found that

U.S. Agri’s attempt to farm jojoba commercially did not constitute

R&D, thereby concluding that the R&D contract was designed and
                               - 20 -

entered into solely to decrease the limited partners’ cost of

investing in an jojoba partnership through large, upfront

deductions for expenditures that were actually capital

contributions.   The Court further concluded that the partnership

was not involved in a trade or business and had no realistic

prospect of entering into a trade or business with respect to any

technology that was to be developed by U.S. Agri.   Id.

     Notwithstanding the foregoing, petitioners contend that

petitioner’s investment in San Nicholas was motivated solely by

the potential to earn a profit.   Petitioners also contend that,

taking into account petitioner’s experiences as a successful

businessman and the nature of petitioner’s investment, petitioner

exercised the due care that a reasonable and ordinarily prudent

person would have exercised under like circumstances.     Finally,

petitioners contend that reliance on Mr. Kellen, Mr. Pace, a

professor at the University of California, and Mr. Maryanov should

absolve petitioners of liability for negligence in this case.     For

the following reasons, we disagree with petitioners’ contentions.

     First, the principal flaw in the structure of San Nicholas

was evident from an examination of the R&D contract and the

license agreement.   Both of these documents were a part of the

offering memorandum.   A reading of the R&D contract and the
                                - 21 -

license agreement demonstrates that the license agreement

canceled, or rendered ineffective, the R&D contract because of the

concurrent execution of the two documents.   Accordingly, San

Nicholas was never engaged in, either directly or indirectly, any

research or experimentation.   Rather, San Nicholas was merely a

passive investor seeking royalty returns pursuant to the license

agreement.    See Kellen v. Commissioner, T.C. Memo. 2002-19; Lopez

v. Commissioner, T.C. Memo. 2001-278; Christensen v. Commissioner,

T.C. Memo. 2001-185; Serfustini v. Commissioner, T.C. Memo. 2001-

183; Carmena v. Commissioner, T.C. Memo. 2001-177; Nilsen v.

Commissioner, T.C. Memo. 2001-163;    Fawson v. Commissioner, T.C.

Memo. 2000-195.   Any experienced attorney capable of reading and

understanding the subject documents should have understood the

legal ramifications of the licensing agreement's canceling the R&D

agreement.    Petitioner failed to consult an attorney and, further,

failed to carefully scrutinize the offering himself.

     Second, we are unable to accept uncritically petitioners’

contention that petitioner invested in San Nicholas solely to earn

a profit.14   Rather, at the time that petitioner signed the


      14
       It is the duty of the Court to listen to testimony,
observe the demeanor of witnesses, weigh the evidence, and
determine what to believe. The Court is not required to accept
testimony at face value, and the Court may discount a party’s
self-interested testimony and place reliance on other evidence
that is believed to be more reliable. See Christensen v.
                                                    (continued...)
                               - 22 -

subscription agreement, he believed that his investment in San

Nicholas offered tax benefits, and his decision to invest was

influenced, in part, by that belief.

     Third, we do not think that petitioner, a sophisticated

investor, exercised due care at the time that he signed the

subscription agreement.   In this regard we are again unable to

accept uncritically petitioners’ contention that petitioner

reasonably relied on the offering memorandum.   The short answer to

this contention is that petitioner either did not read the

offering memorandum in its entirety or chose to ignore portions

thereof.   See Goldman v. Commissioner, supra at 407-408, holding

that the taxpayer’s reliance on offering materials was not

reasonable; see also Pasternak v. Commissioner, 990 F.2d 893, 903

(6th Cir. 1993), affg. Donahue v. Commissioner, T.C. Memo. 1991-

181, holding that claims that are probably “too good to be true”

should be investigated by a reasonably prudent person.15

     The offering memorandum was replete with caveats and warnings

regarding the business and tax risks associated with an investment



     14
      (...continued)
Commissioner, 786 F.2d 1382, 1383-1384 (9th Cir. 1986), affg. in
part and remanding in part T.C. Memo. 1984-197; Niedringhaus v.
Commissioner, 99 T.C. 202, 212 (1992); Duralia v. Commissioner,
T.C. Memo. 1994-269; see also Tokarski v. Commissioner, 87 T.C.
74, 77 (1986).
      15
       In the present case, the parties stipulated to a
promotional videotape produced by U.S. Agri that described jojoba
as “liquid gold” and “the industrial crop of the future”, which
would be cultivated in “some of the most hostile land anywhere”.
                               - 23 -

in San Nicholas.   The cover page cautioned that “THIS OFFERING

INVOLVES A HIGH DEGREE OF RISK” and warned prospective investors

“NOT TO CONSTRUE THIS MEMORANDUM OR ANY PRIOR OR SUBSEQUENT

COMMUNICATIONS AS CONSTITUTING LEGAL OR TAX ADVICE.”   Potential

inventors were urged “TO CONSULT THEIR OWN COUNSEL AS TO ALL

MATTERS CONCERNING THIS INVESTMENT” and were advised “TO CONSULT

WITH [THEIR] OWN TAX ADVISOR AS TO THE TAX ASPECTS.”   The single

longest section of the offering memorandum was devoted to “risk

factors” and warned of numerous risks, specifically including tax

risks, the lack of a structured market and distribution system for

jojoba, and the highly speculative nature of the investment.

Petitioner ignored these warnings, reasoning that “for the amount

of investment that I made here, I didn’t think it was necessary to

go hire an attorney to find out if this was * * * legitimate”.16




     16
       In the alternative, petitioners assert that petitioner
did in fact consult an attorney; i.e., Mr. Kellen. However,
there is simply nothing in the record to suggest that petitioner
ever questioned Mr. Kellen concerning the details of San Nicholas
or that petitioner ever compensated Mr. Kellen for whatever
advice may have been rendered. More to the point, the record is
clear that petitioner consulted Mr. Kellen not as an attorney but
rather as a close personal friend and business associate.
                                 - 24 -

     On brief, petitioners painstakingly attempt to dissect

portions of the offering memorandum in an attempt to show that

petitioner carefully perused what he calls a “business plan”.

Petitioners’ piecemeal approach to the offering memorandum ignores

the existence of the strong cautionary language.   A careful review

of the offering memorandum, especially the portion discussing the

tax risks, would have caused a prudent investor to question the

propriety of the tax benefits.    We would certainly expect no less

from a sophisticated businessman such as petitioner.17

     Fourth, petitioners contend that reliance on Mr. Kellen, Mr.

Pace, a professor at the University of California, and Mr.

Maryanov should absolve petitioners of liability for negligence in

this case.   We disagree that any such reliance was reasonable;

rather, the record demonstrates that petitioners failed to obtain

competent, independent, professional advice before investing in

San Nicholas.

     Petitioners contend that petitioner reasonably relied on

advice from Mr. Kellen.   In this regard petitioners argue that Mr.

Kellen was qualified as an expert in jojoba and that he (i.e., Mr.

Kellen) conducted an extensive “analysis” of San Nicholas.

However, the record establishes that Mr. Kellen only became


     17
       We find it curious that petitioners would emphasize
petitioner’s significant business experience as evidence of due
care. To the contrary, petitioner’s significant business
experience should have caused petitioner to delve deeper into the
nature of his investment.
                                - 25 -

involved in the farming of jojoba in or about 1982, so his

experience was limited, and there is nothing to suggest that he

was knowledgeable about research and development of jojoba.   See

Kellen v. Commissioner, T.C. Memo. 2002-19; see also Freytag v.

Commissioner, 89 T.C. at 888.   Further, we have found that Mr.

Kellen’s “analysis” of San Nicholas was not based on anything

other than the projections set forth in the offering memorandum.

Kellen v. Commissioner, supra; see Tokarski v. Commissioner, 87

T.C. 74, 77 (1986).

     The record also establishes that Mr. Kellen was the general

partner and tax matters partner of four other jojoba partnerships,

including Utah Jojoba.   See supra “B”.   Mr. Kellen was also the

close personal friend and business associate of Mr. Pace, the

president (and a director) of U.S. Agri, which was the R&D

contractor and licensee of San Nicholas and other jojoba

partnerships.   Indeed, at one time, Mr. Kellen was also a director

of U.S. Agri.   Accordingly, any advice that Mr. Kellen may have

given can be analogized to that of an insider or promoter, which

advice is inherently suspect.   E.g., Addington v. Commissioner,

205 F.3d at 59; Pasternak v. Commissioner, 990 F.2d at 903.

     In Glassley v. Commissioner, T.C. Memo. 1996-206, we found

that the taxpayers:

     acted on their fascination with the idea of
     participating in a jojoba farming venture and their
                                 - 26 -

     satisfaction with tax benefits of expensing their
     investments, which were clear to them from the
     promoter’s presentation. They passed the offering
     circular by their accountants for a “glance” * * *.

The record in the present case suggests that whatever advice Mr.

Kellen may have given was nothing more than a generalized

affirmation to invest in jojoba.    Indeed, at trial, petitioner

testified as follows:

     Bill was probably a major influence on our investment
     with jojoba. You know, Bill was very excited about it
     and, you know, he talked to us like a Dutch uncle, you
     might say. He was very, very high on the jojoba
     investment.

     Petitioners also contend that petitioner reasonably relied on

advice from Mr. Pace.    The short answer to this contention is that

at no time relevant to this case did petitioner ever meet Mr.

Pace.     But if what petitioners mean is that petitioner relied on a

videotape in which Mr. Pace appeared, see supra note 15, then

suffice it to say that reliance on a promotional videotape

produced by the sole contractor (here, U.S. Agri) of the promoter

does not constitute due care, see, e.g., Addington v.

Commissioner, 205 F.3d at 59 (“It is unreasonable for taxpayers to

rely on the advice of someone who they know has a conflict of

interest.”).

        Petitioners also contend that petitioner reasonably relied on

advice from a professor at the University of California at

Riverside, a Dr. Yermanos, an individual whom petitioners regard
                                 - 27 -

as an expert in jojoba.18    Yet the record demonstrates that

petitioner never spoke with this individual.19    At best, petitioner

merely visited the university and “looked at some of the

documentations that Dr. Yermanos had prepared” regarding the

jojoba plant.   In short, there is simply nothing in the record to

indicate that this individual provided any advice to petitioner

that would absolve petitioners from liability for the additions to

tax for negligence.

     Petitioners contend that petitioner reasonably relied on

advice from Mr. Maryanov concerning the proper tax treatment of

the partnership loss at the time that their 1983 tax return was to

be filed.   However, this individual did not testify at trial, so

we do not know first hand what knowledge or experience he may have

had regarding either jojoba or the deductibility of R&D expenses,

what advice he may have given, or on what basis any such advice

may have been rendered.     The record establishes only that Mr.

Maryanov prepared petitioners’ tax return, relying on the Schedule




     18
       We note that this individual did not testify at trial, so
we know essentially nothing about him. We also note that no
mention is made of a “Dr. Yermanos” in Utah Jojoba I Research v.
Commissioner, T.C. Memo. 1998-6.
     19
       Although Mr. Kellen may have spoken to this individual,
there is nothing in the record to even suggest that this
individual knew about the existence of San Nicholas, much less
the details regarding the promotion.
                               - 28 -

K-1 that petitioner had received from San Nicholas.20

     Finally, petitioners rely heavily on Krause v. Commissioner,

99 T.C. 132 (1992), affd. sub nom. Hildebrand v. Commissioner, 28

F.3d 1024 (10th Cir. 1994).   That case, however, is distinguishable

on its facts.

     In Krause v. Commissioner, supra, we held for the taxpayers

on the issue of negligence.   We did so in the context of oil

recovery technology based on special or unusual circumstances

related to the energy and oil crisis of the late 1970s and early

1980s:

          In evaluating the imposition of the additions to
     tax in this case, and in light of the above facts
     (encouraging investments in and the development of
     tertiary oil recovery methods such as * * * [enhanced
     oil recovery] technology), we are somewhat understanding
     of the individual investments that were made in * * *
     Partnerships. In the context of the hysteria relating
     to the energy crisis, the oil price increases of the
     late 1970s, the industry and the governmental interest
     in * * * [enhanced oil recovery] technology, the heavy
     and sophisticated promotion of these investments * * *
     we conclude that petitioners are not liable for the
     additions to tax and the



     20
       Although petitioner testified that he provided Mr.
Maryanov with a copy of the offering memorandum, there is nothing
in the record to indicate whether Mr. Maryanov either read or
considered it before he prepared petitioners’ 1983 tax return.
In addition, even though, as petitioner testified, Mr. Maryanov
may have been “involved with some jojoba growers in the Palm
Springs area”, there is nothing in the record to indicate that
Mr. Maryanov was knowledgeable about the nontax aspects of the
San Nicholas promotion. See Barlow v. Commissioner, T.C. Memo.
2000-339 (“A taxpayer may not reasonably rely on the advice of an
accountant who knows nothing about the nontax business aspects of
the contemplated venture.”).
                                    - 29 -

      additional interest element for negligence under sections
      6653(a), 6653(a)(1) and (2). [Id. at 178.]

      None of the circumstances that were determinative in Krause

v. Commissioner, supra, are present in the instant case.

Petitioners’ reliance on the cited case is misplaced.

      In view of the foregoing, we hold that petitioners are liable

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

negligence.     Respondent’s determination is sustained.

II.   Section 6661(a) Substantial Understatement of Tax Liability

      The second issue for decision is whether petitioners are

liable for an addition to tax under section 6661(a).       That

section, as amended by the Omnibus Budget Reconciliation Act of

1986, Pub. L. 99-509, sec. 8002, 100 Stat. 1951, provides for an

addition to tax of 25 percent of the amount of any underpayment

attributable to a substantial understatement of income tax.

Petitioners bear the burden of proving that they are not liable

for the addition to tax.        Monahan v. Commissioner, 109 T.C. 235,

257 (1997); Kellen v. Commissioner, T.C. Memo. 2002-19; Mueller v.

Commissioner, T.C. Memo. 2001-178.21

      A substantial understatement of income tax exists if the

amount of the understatement exceeds the greater of 10 percent of

the tax required to be shown on the return, or $5,000.       Sec.

6661(b)(1)(A).     Generally, the amount of an understatement is



      21
           See supra note 13.
                                - 30 -

reduced by the portion of the understatement that the taxpayer

shows is attributable to either (1) the tax treatment of any item

for which there was substantial authority or (2) the tax treatment

of any item with respect to which the relevant facts were

adequately disclosed on the return.      See sec. 6661(b)(2)(B).

Substantial authority exists when “the weight of the authorities

supporting the treatment is substantial in relation to the weight

of authorities supporting contrary positions.”      Sec. 1.6661-

3(b)(1), Income Tax Regs.   Adequate disclosure of the tax

treatment of a particular item may be made either in a statement

attached to the return or on the return itself.      Sec. 1.6661-4(b)

and (c), Income Tax Regs.

     If an understatement is attributable to a tax shelter item,

then different standards apply.   First, in addition to showing the

existence of substantial authority, a taxpayer must show that he

or she reasonably believed that the tax treatment claimed was more

likely than not the proper treatment.      Sec. 6661(b)(2)(C)(i)(II).

Second, disclosure, whether or not adequate, will not reduce the

amount of the understatement.   Sec. 6661(b)(2)(C)(i)(I).

     Petitioners appear to concede that there was a substantial

understatement of income tax within the meaning of section
                                 - 31 -

6661(a).22    Petitioners do not contend, however, that there was

substantial authority supporting the deduction of the partnership

loss that they claimed on their return.    Nor do petitioners

contend that there was adequate disclosure of the facts related to

that loss.    Rather, petitioners contend that they should be

absolved of liability for the addition to tax by virtue of section

6661(c).

     Section 6661(c) vests the Commissioner with discretion to

waive the addition to tax under section 6661(a) if the taxpayer

shows that he or she acted with reasonable cause and in good

faith.     The Commissioner’s failure to waive the addition to tax is

reviewed by this Court for abuse of discretion.     Martin Ice Cream

Co. v. Commissioner, 110 T.C. 189, 235 (1998).

     There is nothing in the record to suggest that petitioners

ever requested that respondent waive the addition to tax under

section 6661(a).    Indeed, petitioners do not even allege that they

requested such a waiver.    For that reason alone, petitioners are

not entitled to relief from liability.    See McCoy Enters., Inc. v.

Commissioner, 58 F.3d 557, 563-564 (10th Cir. 1995), affg. T.C.

Memo. 1992-693; Kellen v. Commissioner, T.C. Memo. 2002-19;


      22
       We note that the understatement of tax on which
respondent determined the addition to tax is $12,355. The amount
required to be shown as tax on petitioners’ return is $103,069.
The understatement is therefore “substantial” because it exceeds
the greater of 10 percent of the amount required to be shown on
the return, or $5,000. Sec. 6661(a).
                               - 32 -

Klieger v. Commissioner, T.C. Memo. 1992-734; sec. 1.6661-6,

Income Tax Regs.

     Even if petitioners had requested a waiver under section

6661(c), the record demonstrates that they failed to act

reasonably and in good faith in deducting the claimed loss from

San Nicholas.   Petitioner’s limited discussions with Mr. Kellen, a

promoter of other, similar jojoba partnerships and a close

personal friend and business associate of U.S. Agri’s president,

are insufficient to demonstrate reasonable cause and good faith.

Similarly, petitioners’ failure to establish the extent of any tax

advice received, as well as the basis on which such advice may

have been rendered, is further evidence of petitioners’ lack of

reasonable cause and good faith.   See DePlano v. Commissioner,

T.C. Memo. 1998-303.

     In view of the foregoing, we hold that petitioners are liable

for the addition to tax under section 6661(a) for substantial

understatement of tax liability.   Respondent’s determination is

sustained.
                                - 33 -

III.   Conclusion

       To reflect our disposition of the disputed issues, as well as

petitioners’ concession, see supra note 1,



                                          Decision will be entered

                                     for respondent as to the

                                     additions to tax under sections

                                     6653(a)(1) and 6661 as

                                     determined in the notice of

                                     deficiency and as to the

                                     addition to tax under section

                                     6653(a)(2) as claimed in the

                                     amended answer.
