Morris A. WEINER, Plaintiff, v. UNITED STATES of America, Defendant., United States District Court, S.D. Texas, Houston Division., 255 F.Supp.2d 673, No. CIV.A.H-00-1297., December 30, 2002
Morris A. WEINER, Plaintiff, v. UNITED STATES of America, Defendant.
United States District Court, S.D. Texas, Houston Division.
255 F.Supp.2d 673
December 30, 2002.
Thomas E. Redding, Redding & Associ╜ates, Houston, TX, for Morris A. Weiner, plaintiff.
Michael D. Powell, Dept of Justice Tax Division, David B. Coffin, Dept of Justice Tax Division, Dallas, TX, for United States of America, defendant.
MEMORANDUM AND ORDER
ATLAS, District Judge.
A bench trial was held before this Court on December 17, 2002, on Plaintiff Morris Weiner's claim for a refund of interest for the tax year 1984 assessed by the IRS pursuant to 226 U.S.C. ╖ 6621(c), the In╜ternal Revenue Code ("IRC") provision au╜thorizing enhanced interest on a substan╜tial underpayment of tax attributable to a tax motivated transaction. 1 After hearing the evidence and argument of counsel, the Court took the matter under advisement. The Court now finds that Weiner had a profit motive in investing in the Travertine Flame Associates ("TFA") partnership in 1984 and therefore concludes that imposi╜tion of ╖ 6621(c) interest is not appropriate in this case.
1. The Fifth Circuit recently referred to ╖ 6621(c) enhanced interest as a "punitive interest provision." Copeland v. Commission╜er, 290 F.3d 326, 336 (5th Cir.2002).
I. FACTUAL AND PROCEDURAL BACKGROUND
Weiner seeks a refund of ╖ 6621(c) in╜terest he paid to the IRS for the tax year 1984. 2 Weiner invested $40,000 cash in TFA in 1984, and took a $85,683 deduction on his personal income tax return for that year as his share of partnership losses from TFA. In 1991, the IRS issued a No╜tice of Final Partnership Administrative Adjustment ("FPAA") with respect to TFA for the year 1984 disallowing all of the farming losses and other deductions claimed by TFA. The FPAA included as one of several explanations for the adjust╜ments that the partnership's activities were sham transactions. Defendant's Ex╜hibit ("DX") 7. In 1997, Weiner offered to settle his share of the adjustments and the IRS accepted the offer. Weiner agreed to an additional tax assessment of $15,851 above the taxes he previously paid for 1984. This Court ruled earlier in this case that Weiner's settlement did not resolve the issue of whether ╖ 6621(c) interest ap╜plied. See Amended Memorandum Opin╜ion [Doc. # 79], at 55-57. When the IRS made the tax assessment against Weiner pursuant to the settlement, it also assessed ╖ 6621(c) interest, which Weiner paid or bonded.
2. Based upon the parties' agreement, the Court severed the claims for the 1984 tax year from Weiner's claims related to the 1985 and 1986 tax years. See Order to Sever [Doc. # 89].
Weiner asserts that there is no basis for the IRS's assessment ╖ 6621(c) interest against him, and seeks a refund of the 20% interest component assessed over the stan╜dard rate imposed by 26 U.S.C. ╖╖ 6601 and 6621(a). In this litigation, the IRS contends more specifically that TFA's farming transactions during 1984 were sham transactions and therefore Weiner's underpayment of taxes is attributable to a "tax-motivated transaction" justifying the enhanced interest.
II. THE STATUTE AT ISSUE
The version of ╖ 6621(c) applicable in this case authorized the IRS to assess interest at 120% of the ordinary interest rate established by ╖╖ 6601 and 6621(a) on any substantial underpayment attributable to a tax motivated transaction. 3 Section 6621(c), as applicable to this case, provides in relevant part:
3. The provision at issue was originally enact╜ed as part of the Tax Reform Act of 1984 as ╖ 6621(d). It was amended by the Tax Reform Act of 1986 and redesignated as ╖ 6621(c). It was repealed in 1989 for re╜turns due after December 31, 1989.
(1) In General.-In the case of interest payable under section 6601 with re╜spect to any substantial underpay╜ment attributable to tax motivated transactions, the annual rate of in╜terest established under this section shall be 120 percent of the under╜payment rate established under this section.
(2) Substantial Underpayment Attribut╜able to Tax Motivated Transac╜tions.-For purposes of this subsection, the term 'substantial underpay╜ment attributable to tax motivated transactions' means any underpay╜ment of taxes imposed by subtitle A for any taxable year which is attrib╜utable to 1 or more tax motivated transactions if the amount of the un╜derpayment for such year so attrib╜utable exceeds $1,000.
(3) Tax Motivated Transactions. -
(A) In General.-For purposes of this subsection, the term `tax motivated transaction' means -
(i) any valuation overstatement (within the meaning of section 6659(c)),
(ii) any loss disallowed by reason of section 465(a) and any credit disal╜lowed under section 46(c)(8),
(iii) any straddle (as defined in sec╜tion 1092(c) without regard to sub╜sections (d) and (e) of section 1092),
(iv) any use of an accounting meth╜od specified in regulations pre╜scribed by the Secretary as a use which may result in a substantial distortion of income for any period, and
(v) any sham or fraudulent transac╜tion.
(B) Regulatory Authority.-The- Sec╜retary may by regulations specify other types of transactions which will be treated as tax motivated for purposes of this subsection and may by regulations provide that speci╜fied transactions being treated as tax motivated will no longer be so treated.
* ═══ * ═══ * ═══ * ═══ * ═══ * ═══ *
(C) Effective Date of Regulations.-Any regulations prescribed under subparagraph (A)(iv) or (B) shall apply only to interest accruing after a date (specified in such regula╜tions) which is after the date on which such regulations are pre╜scribed.
(4) Jurisdiction of Tax Court.-In the case of any proceeding in the Tax Court for redetermination of a defi╜ciency, the Tax Court shall also have jurisdiction to determine the portion (if any) of such deficiency which is a substantial underpayment attribut╜able to tax motivated transactions.
Tax Reform Act of 1986, Pub.L. No. 99╜514, ╖╖ 1511, 1535, 100 Stat. 2085, 2744, 2750 (1986). 4 Thus, if more than $1,000 of Weiner's 1984 underpayment was attribut╜able to a tax motivated transaction, then that attributable underpayment is subject to ╖ 6621(c) enhanced interest. The only type of tax motivated transaction asserted by the IRS as the basis for its assessment of ╖ 6621(c) is "sham transaction" as pro╜vided for in ╖ 6621(c)(3)(A)(v).
4. The wording of subsection (c)(1) above re╜flects a slight modification effected by the 1986 amendment that was applicable only to interest accruing after December 31, 1986. This change is not relevant to the issues before the Court as to the 1984 tax year. The addition of subsection (c)(3)(A)(v) was made applicable to interest accruing after Decem╜ber 31, 1984, and is the crucial section in this case.
A. Burden of Proof
As a threshold matter, the Court must determine where the burden of proof in this case lies. As a general rule, an IRS assessment is presumed to be correct and the taxpayer bears the burden of proving both the excessiveness of the assessment and the correct amount of any refund to which he is entitled. Melton v. Teachers Ins. & Annuity Ass'n of America, 114 F.3d 557, 560 (5th Cir.1997); Portillo v. Commissioner, 932 F.2d 1128, 1133 (5th Cir.1991). This burden applies to the application of ╖ 6621(c) interest. See Heas╜ley v. Commissioner, 902 F.2d 380, 382 (5th Cir.1990) (stating "[w]e presume that the IRS correctly determined the Heas╜leys' taxes and penalties. The Heasleys bear the burden of proving otherwise." (citations omitted)).
The parties agree that there is an exception to this general rule in the case of a "naked assessment . . . without any foun╜dation whatsoever." United States v. Jan╜ is, 428 U.S. 433, 441, 96 S.Ct. 3021, 49 L.Ed.2d 1046 (1976); Portillo, 932 F.2d at 1133. The IRS's assessment in this case was based on its Settlement Agreement with Weiner that resulted from its issu╜ance of an FPAA disallowing all of TFA's farming expenses and deductions for 1984. Weiner does not contend that the assess╜ment of the tax was a naked assessment. Instead, he contends that the assessment of ╖ 6621(c) interest was naked because the IRS never made a determination re╜garding Weiner's individual profit motive. Whether individual profit motive is a nec╜essary element of the "sham transaction" determination is discussed in detail below. For purposes of assigning the burden of proof, it is only necessary for the IRS to demonstrate that its assessment has some factual predicate for the determination. See Portillo, 932 F.2d at 1133.
The presumption of correctness general╜ly prohibits a court from looking behind the Commissioner's determination even though it may be based on hearsay or other evidence inadmissible at trial. Justification for the presumption of cor╜rectness lies in the government's strong need to accomplish swift collection of revenues and in the need to encourage taxpayer record keeping. The need for tax collection does not serve to excuse the government, however, from provid╜ing some factual foundation for its as╜sessments. The tax collector's pre╜sumption of correctness has a herculean muscularity of Goliath like reach, but we strike an Achilles' heel when we find no muscles, no tendons, no ligaments of fact. 5
5. The IRS contends that this exception is lim╜ited to cases involving unreported income. See Portillo, 932 F.2d at 1133 (stating "[s]ev╜eral courts, including this one, have noted that a court need not give effect to the pre╜sumption of correctness in a case involving unreported income if the Commissioner can╜not present some predicate evidence support╜ing its determination."). The Fifth Circuit in Sealy Power, Ltd. v. Commissioner, 46 F.3d 382, 387 (5th Cir.1995), specifically held that the burden-shifting principle of unreported income cases such as Portillo does not extend to cases in which the Commissioner rejects deductions or credits claimed by a taxpayer. See also Karme v. Commissioner, 673 F.2d 1062, 1065 (9th Cir.1982) (explaining "[w]hen the Commissioner attempts to include unre╜ported income, the Commissioner should have the burden of proving his case 'because the taxpayer may face practical difficulties in attempting to refute the Commissioner's as╜sertion that the taxpayer received unreported income.' That problem does not exist when, as in this case, the Commissioner questions a deduction. In this situation the taxpayer re╜tains the burden of proof."). Nonetheless, the Fifth Circuit has not addressed directly whether the "naked assessment" exception applies to the interest assessment under ╖ 6621(c). In any event, the Court holds that Weiner has the burden to prove that the as╜sessment is incorrect even under the burden-shifting scheme of Janis and Portillo because the IRS has demonstrated through its proffer and documents in evidence that the assess╜ment was not without "ligaments of fact," as discussed in the text.
Id. (citations and internal quotation marks omitted). There thus must be at least some "ligaments of fact" to support an enhanced interest assessment under ╖ 6621(c). See id.
It is a matter of record that the IRS began a criminal investigation of AMCOR and its partners in 1988 or 1989 and confis╜cated AMCOR's partnership records in March 1989. The IRS made a determina╜tion that the farming expenses claimed on Schedule F of the TFA return for 1984 were not allowable. This determination was the basis for the IRS's issuance of the FPAA in 1991. The FPAA lists several reasons for the disallowance, including that the partnership's activities were sham transactions. See DX 7. The IRS also relies on its determination in the Summary of AMCOR Appeals Settlement Offer ("SAASO") that "interest is to be computed under Code Section 6621(c)." The IRS claims to have sent the SAASO to all the TFA partners, including Weiner, along with the Form 870-P(AD) for his consider╜ation for settlement. Weiner, however, does not acknowledge receiving the SAA╜S0. The dispute about whether Weiner received the SAASO is immaterial. The question is whether the IRS had a factual╜ly-based rationale for its ╖ 6621 (c) interest assessment, not whether Weiner under╜stood it or agreed with it.
Moreover, the IRS has presented evi╜dence that it analyzed the accuracy of rep╜resentations by TFA about its farming transactions. Weiner does not argue that no such analysis was conducted. Weiner acknowledges that he knew when he set╜tled that the IRS intended to assess ╖ 6621(c) interest. See, e.g., DX 9. The FPAA makes it clear that the farming deductions, in the IRS's view, were not proper for numerous reasons, including that they were tax-motivated transactions and were shams. Whether or not the IRS's decision to impose ╖ 6621 (c) i nterest is correct, or was the product of a legally sufficient determination, is not the thresh╜old issue. At this stage, the Court is concerned only with whether the IRS had any factual basis for its determination. 6 See Portillo, 932 F.2d at 1133.
6. Unlike a negligence interest penalty, there is no statutory requirement that the IRS set forth in detail the legal grounds for an assessment of ╖ 6621 (c) interest in a notice of defi╜ciency or otherwise prior to its assessment.
The circumstances at bar have nothing in common with Janis, the Supreme Court case establishing the "naked assessment" exception, or Portillo . In Janis, the only evidence the IRS had on which to support its assessment consisted of gambling ledg╜ers that were illegally obtained pursuant to a defective search warrant. Absent the illegally seized materials, the IRS had no factual basis for an assessment. Thus, the Supreme Court ruled that the IRS's deter╜mination of the tax due was without ration╜al foundation, excessive, and was not prop╜erly subject to the usual rule with respect to the burden of proof in tax cases. Janis , 428 U.S. at 441, 96 S.Ct. 3021. In Portillo, the IRS concluded that the taxpayer had unreported income based on his employ╜er's Form 1099, which reflected income in excess of that reported by the taxpayer on his Form 1040. However, the taxpayer denied the accuracy of the Form 1099, and the employer could provide no evidence to support most of the cash payments it al╜legedly made to the taxpayer. Thus, the IRS's decision to accept the Form 1099 as true was arbitrary and without the neces╜sary "ligaments of fact." Portillo, 932 F.2d at 1134.
Further, Weiner does not contend that the determination on which the as╜sessment of the tax deficiency was based was a "naked assessment." Weiner cites no case in support his burden shifting proposition that involves the assessment of interest on an uncontested tax deficiency assessment. The Court concludes that the interest assessment was not a "naked as╜sessment" and the burden of proof to es╜tablish that the interest assessment was incorrect remains on Weiner, as in the ordinary refund case.
B. Standards for Sham Transaction under ╖ 6621(c)(3)(A)(v)
The next question confronting the Court is what standard governs a "sham transac╜tion" determination. The phrase "sham transaction" is not defined in ╖ 6621(c) or elsewhere in the Internal Revenue Code. Thus, the Court must look to case law for the proper standard for making a "sham transaction" determination.
The IRS contends that a transaction can be a sham "in fact," i.e. , one that never even occurred, citing Compaq Com╜puter Corp. and Subsidiaries v. Commis╜sioner, 277 F.3d 778, 781 n. 1 (5th Cir. 2001), or a sham "in substance," i.e. , one that lacks economic substance, citing Kill╜i ngsworth v. Commissioner, 864 F.2d 1214, 1216-17 (5th Cir.1989). The IRS, citing Copeland v. Commissioner, 290 F.3d 326, 338 (5th Cir.2002), argues that the focus of the Court's sham transaction analysis should be on the partnership's conduct, not the individual partners. However, in acknowledgment of the Court of Appeals' discussion in Copeland, the IRS, somewhat inconsistently, asserts that in the partnership context, a sham trans╜action also exists where the partner in╜vested in the partnership without an indi╜vidual profit motive. Id .
Weiner contends that the Fifth Circuit has consistently required both lack of eco╜nomic substance of the partnership trans╜actions and lack of individual profit motive in finding an assessment of ╖ 6621(c) in╜terest justified. While the Fifth Circuit has not explicitly decided this issue, the Court is persuaded that Weiner's analysis of the available authorities is more sound than the IRS's contrary position.
Case law analyzing sham transactions in the wake of the Supreme Court case of Frank Lyon Co. v. United States, 435 U.S. 561, 98 S.Ct. 1291, 55 L.Ed.2d 550 (1978), has left the issue somewhat muddled. In Frank Lyon, the Supreme Court held that a transaction cannot be treated as a sham unless it is shaped solely by tax-avoidance features. 435 U.S. at 583-84, 98 S.Ct. 1291 (emphasis added). In Rice's Toyota World, Inc. v. Commissioner, 752 F.2d 89, 91-92 (4th Cir.1985), the Fourth Circuit interpreted the Frank Lyon decision to require a two-prong analysis:
To treat a transaction as a sham, the court must find that the taxpayer was motivated by no business purpose other than obtaining tax benefits in entering the transaction, and that the transaction has no economic substance because no reasonable possibility of profit exists.
The Fifth Circuit in Compaq recognized the tension between those circuits that ap╜ply the two-prong test of Rice's Toyota World and those that collapse the prongs into a "factors" test. ═ 7 The Fifth Circuit found it unnecessary in Compaq to rule definitively as to the proper standard be╜cause in that case the taxpayer met its burden on both prongs. See Compaq, 277 F.3d at 781-82.
7. See ACM Partnership v. Commissioner , 157 F.3d 231, 247 (3d Cir.1998) (holding that "these distinct aspects of the economic sham inquiry do not constitute discrete prongs of a rigid two-step analysis, but rather represent related factors both of which inform the anal╜ysis of whether the transaction had sufficient substance, apart from its tax consequences, to be respected for tax purposes."); James v. Commissioner , 899 F.2d 905, 908-09 (10th Cir.1990).
It is significant that Compaq was not a case arising from a taxpayer's investment in a partnership, let alone a limited partnership as presented in this case. Thus, the question of how a partner's indi╜vidual profit motive fits into the sham in╜quiry was not at issue in that case. This distinction is important because generally the economic substance and profit motive inquires are inextricably linked because the plaintiff-taxpayer and the entity that engaged in the transaction are one and the same. See id, at 785-86. Plaintiff Com╜paq engaged in a foreign stock transaction involving the purchase and resale of Amer╜ican Depository Receipts ("ADRs"). The Court found that Compaq's ADR transac╜tion had economic substance, and that even assuming Compaq sought primarily to get otherwise unavailable tax benefits from the transaction, tax avoidance was not Com╜paq's sole motivation. In contrast, in the context of a limited partnership, the entity engaging in the transaction and the tax╜payer are entirely different, and the lack of economic substance of the partnership transaction that led to the partner's sub╜stantial underpayment of taxes in fact may be completely unknown to the taxpayer-partner. 8 Therefore, it is not surprising that in determining "sham transaction" in a passive investor's action for a refund of ╖ 6621(c) interest, the Fifth Circuit has repeatedly looked to the individual profit motive of the taxpayer. 9
8. In addition, as discussed in more detail below, in a TEFRA case, there are serious jurisdictional hurdles presented by the re╜quirement that a district court determine the economic substance of partnership transactions in a partner-level proceeding. Thus, conflation of the two-prongs in analyzing ╖ 6621(c) with respect to a partnership in╜vestment is unwieldy, if not impossible.
9. In Thompson v. United States, 223 F.3d 1206, 1212-13 (10th Cir.2000), and Thomas v. United States, 166 F.3d 825, 832-34 (6th Cir. 1999), the Tenth and Sixth Circuits, respec╜tively, refused to conduct inquiries into the partners' motives. However, in each of those cases the partner had conceded that the part╜nership transactions were "sham transac╜tions." Thus, to the extent profit motive is an element of a sham transaction, any inquiry into motive was moot in those cases, and the courts simply refused to add an additional factor beyond "sham" to the test for en╜hanced interest under ╖ 6621(c)(3)(A)(v). This approach is materially different from the Fifth Circuit's.
In Heasley v. Commissioner, 902 F.2d 380 (5th Cir.1990), the taxpayers appealed a Tax Court decision upholding penalties and interest assessed by the IRS, includ╜ing ╖ 6621(c) interest imposed, in part, on the grounds that the energy conservation program in which they invested at the recommendation of their financial consul╜tant was not engaged in for profit and thus was tax-motivated. The Fifth Circuit held that the Tax Court erred in not consider╜ing that the Heasleys' individual intent in investing in the program was to earn in╜come, not to avoid tax liability, and there╜fore erred in finding that the Heasleys' investment was tax-motivated.
Similarly, in Lukens v. Commissioner, 945 F.2d 92 (5th Cir.1991), the Tax Court upheld the imposition of ╖ 6621(c) interest. Lukens invested in a partnership 10 formed to purchase time-share units in vacation homes. In Lukens, the Fifth Circuit stat╜ed that "[a] sham or fraudulent transaction includes transactions in the partnership context that were not entered into for profit and are without economic sub╜stance." 11 945 F.2d at 99. The Fifth Circuit considered the Tax Court finding that Lukens' personal intent in investing was tax-driven and he was without any profit-motive "independent of tax sav╜ings." 12 Id. at 100. The Tax Court there╜fore found that the transaction was a sham, which finding the Fifth Circuit con╜cluded was not clearly erroneous.
10. There is no indication that Lukens invested in a limited partnership.
11. The Lukens court cites Patin v. Commis╜sioner, 88 T.C. 1086, 1987 WL 49318 (1987), for this proposition. In Patin, the Tax Court analyzed the taxpayers' profit motive as part of its holding that the transactions in issue lacked economic substance. 1987 WL 49318, 88 T.C. at 1129.
12. The Tax Court found that "the motivating factor in these cases was the extravagant tax write-off petitioners received as compared to their cash outlay. Without the tax write-offs, petitioners would have received no benefit from the purchase of the timeshares." Luk╜ens, 945 F.2d at 100. In contrast, Weiner received a tax write off approximately equal to twice his investment in the first year, not an extravagant write-off in comparison.
The decision in Chamberlain v. Com╜missioner, 66 F.3d 729 (5th Cir.1995), also is instructive. In that case, the taxpayers challenged interest and penalties assessed by the IRS following disallowance of claimed partnership losses. In Chamber╜ lain, there was no dispute that the trans╜action engaged in by the partnership was a sham. 13 The Tax Court sustained the Commissioner's assessment of additional penalty interest on the basis of the sham transaction. In so doing, the Tax Court found that Chamberlain became a partner without the required profit motive. Id. at 732. The Tax Court addressed this issue despite its view that the taxpayers' profit motive was irrelevant to the imposition of additional interest under ╖ 6621(c). Chamberlain, 66 F.3d at 731. In evaluat╜ing the Tax Court's decision, the Fifth Circuit noted that "[i]n determining a prof╜it motive we focus on the intent of the taxpayer, not that of the underlying entity or activity." Id. at 732 n. 13. The Fifth Circuit declined to find the Tax Court's decision clearly erroneous, because that decision "[o]bviously ... [was] based in large part on the trier's credibility deter╜mination." Id.
13. In Chamberlain, the taxpayers stipulated that the transaction at issue was the same as that determined to be a sham in Freytag v. Commissioner, 904 F.2d 1011 (5th Cir.1990).
The taxpayer-plaintiffs in Durrett v. Commissioner, 71 F.3d 515, 517 (5th Cir. 1996), were among several thousand investors in the same tax shelter program that was involved in Chamberlain and Freytag. The Durretts went to trial in the Tax Court only on the assessment of penalty interest that the IRS based on a substan╜tial tax underpayment attributable alleged╜ly to a tax-motivated transaction. Id . Just as in Chamberlain, the Fifth Circuit af╜firmed the Tax Court's finding that the taxpayer did not have a profit motive de╜spite his contrary testimony. Id . at 517. Also as in Chamberlain, the Fifth Circuit affirmed based on the Tax Court's finding as to the taxpayer's individual motivation.
Nowhere in any of these decisions did the Court of Appeals say that the taxpay╜er's profit motive or lack thereof was not relevant. The IRS nevertheless asserts that Copeland v. Commissioner, 290 F.3d 326 (5th Cir.2002), is inconsistent with this analysis. The Court disagrees and instead concludes that Copeland is inapposite to the case at bar. In Copeland the Tax Court found that the partnerships at issue were "sham transactions" under 26 U.S.C. ╖ 183 and imposed ╖ 6621(c) interest. The Fifth Circuit reversed and held that the IRS could not impose ╖ 6621(c) inter╜est because the IRS did not disallow the deductions under ╖ 183 (which does not apply to partnerships) and because the IRS had proffered during the administra╜tive process no alternative basis for imposing such interest. The Fifth Circuit's holding did not depend on any ruling about the partnership's economic substance or anyone's profit motive. The Court did not find that the taxpayers' individual profit motive was irrelevant to a sham transac╜tion inquiry, as the IRS contends here. Rather, the Court of Appeals held that the profit motive question was irrelevant to the inquiry presented because the IRS had not based its imposition of enhanced inter╜est on a legal theory applicable to partner╜ships. Copeland, 290 F.3d at 333. In dicta, the Court said "[i]t is equally accept╜ed that in the partnership context, the profit motive inquiry focuses on the part╜nership, not the individual partners." Id . at 335. However, the Court made that statement in the context of explaining why deductions of partnership expenses in that case could not be construed as having been disallowed under ╖ 183. The Court was not addressing the standards for assess╜ment of ╖ 6621(c) interest against an indi╜vidual partner pursuant to the judicially defined "sham transaction" of ╖ 6621(c)(3)(A)(v). 14 Significantly, the Court expressly stated that "[h]ere, we never reach the question of whether profit motive is to be tested at the individual or partnership level." Id. at 337. The Court then went on to distinguish Lukens, Chamberlain, and Durrett, on the grounds that in those case the IRS was seeking to impose the increased interest rate by means of ╖ 6621(c)(3)(A)(v), the provision relied upon by the IRS in this case, and noted that in all three of those sham trans╜action cases, the Court of Appeals' affir╜mance was based at least in part on the Tax Court's factual finding that the indi╜vidual taxpayers lacked a profit motive when they engaged in the transaction of investing in the partnerships in issue. Id . Thus, Copeland is not inconsistent with this Court's decision to rely on the prece╜dent of those Fifth Circuit cases specifical╜ly dealing with assessment of increased interest against a partner pursuant to ╖ 6621(c)(3)(A)(v).
14. Copeland cites Tallal v. Commissioner, 778 F.2d 275, 276 (5th Cir.1985). Tallal was a case about whether to allow a partnership deduction under ╖ 702(b), not a partner-level proceeding about the assessment of ╖ 6621 (c) interest. Similarly, in Holladay v. Commis╜sioner, 649 F.2d 1176, 1180 (5th Cir.1981), the Fifth Circuit found that "the allocation of all of the venture's losses to Holladay lacked economic substance and was clearly a sham under IRC ╖ 704(a)." Again, the Court was addressing only the decision to disallow the loss deduction, not the application of en╜hanced interest under the "sham transaction" test of ╖ 6621(c). Copeland cautions against importing a test from one statutory provision into an inquiry under an unrelated provision. For this reason, Copeland criticizes Hill v. Commissioner, 204 F.3d 1214, 1218 (9th Cir. 2000), which holds that under a ╖ 183 analy╜sis, the determination of an existing profit motive is made at the partnership level and does not address the subjective intent of the particular partner in question. In Hill, the Ninth Circuit held that application of ╖ 6621 (c) interest against a partner was prop╜er if the partnership lacked a profit motive under ╖ 183. Id. at 1219. Copeland criti╜cizes Hill for not applying the requirement that the deductions be actually disallowed un╜der ╖ 183.
The Court concludes that if Weiner proves by a preponderance of the evidence that he had an individual profit motive, or that the TFA partnership transactions had economic substance, then the sham trans╜action subset of tax-motivated transactions under ╖ 6621(c)(3)(A)(v) is inapplicable and ╖ 6621(c) interest is not warranted. 15
15. The Court recognizes the dichotomy in the two Rice Toyota elements, i.e., that one focus╜es on the investor's motivation to invest in the business entity in issue, whereas the other element focuses on the economic substance of the entity's transactions, which is in effect the entity's profit motive. See Lukens, 945 F.2d at 100. In many cases, this issue is insignifi╜cant. However, in the context of limited part╜nerships, the disparity in the focus of the respective elements is more problematic, as explained elsewhere in this opinion.
C. Economic Substance of the Partnership Transactions
For different reasons, neither party wants this Court to make a determination under the Rice's Toyota test on the "eco╜nomic substance," or lack thereof, of the TFA partnership's farming transactions disallowed by the IRS. The IRS contends that Weiner is bound by the decision of the Tax Court in the TFA proceeding that TFA's farming transactions "lacked eco╜nomic substance, as described in former I.R.C. ╖ 6621(c)(3)(A)(v)." DX 12, at 2. Weiner contends that the economic sub╜stance of the partnership transactions is a "partnership item" beyond this Court's jurisdiction. 16 This case presents a proce╜dural quandary that results from Weiner's decision to settle the tax deficiency issue, but to contest the ╖ 6621(c) interest issue while attempting to participate in the TFA Tax Court proceeding. In that proceed╜ing, the ╖ 6621(c) interest issue was decid╜ed adversely as to non-settling partners, see DX 12, apparently as part of a global agreement with the TFA Tax Matters Partner ═ 17 who took the lead in the Tax Court litigation.
16. The statutory framework under the Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA") is explained in the Court's Amended Memorandum Opinion, at 7-10. Under TEFRA, the treatment of all "partner╜ship items" must be determined in a partner╜ship level proceeding. 26 U.S.C. ╖ 6221.
17. TEFRA requires partnerships to designate a Tax Matters Partner to act as a liaison between the IRS and the partnership in any tax-related proceedings. 26 U.S.C. ╖ 6227.
The Court, with reservation, de╜clines to hold that Weiner is bound by the Tax Court decision on lack of economic substance. While the Court is unpersuad╜ed by Weiner's argument that the Tax Matters Partner had a conflict of interest in entering the settlement, there is an unresolved legal issue about the Tax Court's jurisdiction once a limited partner settles certain issues through an 870-P(AD), as Weiner did. 18
18. See Amended Memorandum Opinion, at 32 n. 24. As the Court noted in its Amended Memorandum Opinion, at 33-35, the evi╜dence at trial leads the Court to believe it would not be unfair to hold Weiner to have waived his right to object to the TMP's Tax Court settlement because Weiner elected not to even attempt to participate in the partner╜ship level proceeding. This perception was confirmed by Weiner's testimony at trial. Weiner testified that he knew ╖ 6621 (c) inter╜est was not included in his settlement with the IRS, that he entered that agreement in╜tending to contest the anticipated IRS assess╜ment of that interest, and that, nevertheless, he did not attempt to participate in the Tax Court proceeding, which was still pending in 1997 when he settled with the IRS. Weiner chose instead to wait and seek a refund in district court where he would claim, in part, that the IRS could not assess ╖ 6621(c) inter╜est because the district court lacked jurisdic╜tion over the partnership item of the econom╜ic substance of the partnership's transactions. This process highlights the difficulty present╜ed by TEFRA in practice.
The IRS has filed a Notice of Supplemental Authority [Doc. # 92] to bring to the Court's attention Field v. United States, No. 01 CIV.3000 SAS, 2002 WL 1300249 (S.D.N.Y. June 12, 2002). In Field, the district court held that the plaintiffs' suit for refund of interest paid under ╖ 6621(c) raised no individualized claims that re╜quired partner-level adjudication. Id . at *5. The plaintiffs in Field had the right to join in the Tax Court proceeding and did not settle with the IRS. Because the Tax Court determined that the partnership's activities were tax-motivated, and the plaintiffs did not raise any partner-level defense to the imposition of the penalty interest, the plain tiffs' refund suit "founder[ed] on the shoals of the jurisdictional bar of I.R.C. ╖ 7422(h)." Id . at *5. In contrast, in its Amended Memorandum Opinion, this Court concluded that it has jurisdiction to deter╜mine the ╖ 6621(c) interest issue. That is╜sue was not raised by the IRS at the bench trial on October 17, 2002. However, this Court has a continuing obligation to assess its jurisdiction. This Court concludes that the Field court's analysis is inapposite. Weiner settled his tax liability with the IRS. Also, unlike the plaintiffs in Field, Weiner asserts a partner-level defense to the impo╜sition of ╖ 6621(c) interest. Thus, the pro╜cedural quandary discussed above was not presented in Field.
At trial in this Court, the IRS made a proffer that if permitted by the Court it would prove that the partnership transactions were nothing more than "check swaps," that no seeds were pur╜chased and no crops were grown or sold. However, even if the Court were inclined to exercise jurisdiction over the merits of the economic substance issue, it is unclear that this proffer mandates a finding that the transactions lacked economic sub╜stance for purposes of assessing ╖ 6621(c) interest. The partnership cases in which the Fifth Circuit has allowed such interest involve transactions that on their face lacked economic substance beyond tax avoidance at the time the taxpayer made the investment, or were cases in which the taxpayer did not contest the partnership's transactions' lack of economic substance. 19 The lack of economic substance of the partnership transaction in this case, i.e. , the economics apparent to the limited partner-investor, poses a different ques╜tion. In any event, it is unnecessary for the Court to resolve these thorny jurisdictional and substantive issues. Weiner bad the but'den of proof at trial to show economic substance. He did not do so. Whether because the Court lacks jurisdiction, or because he completely failed to produce any evidence, Weiner cannot meet his bur╜den on this issue.
19. See Lukens, 945 F.2d at 94 n. 2 (purchase of an ownership interest equal to one day's use of a vacation home at a price far in excess of its value, providing an interest deduction for years and including the ability to termi╜nate the ownership interest without making the final balloon payment necessary to ac╜quire title); Chamberlain, 66 F.3d at 731 n. 3 (taxpayers stipulated to the tax-motivated na╜ture of transaction); Durrett, 71 F.3d at 517 (same). The Court notes that each of these cases was an appeal of a Tax Court decision in which the issue of the court's jurisdiction to decide the economic substance of the part╜nership transactions was not at issue.
The Court next turns to the issue of whether Weiner has proven he had a profit motive when he invested in the TFA part╜nership in 1984.
D. Weiner's Individual Profit Motive
The Fifth Circuit has not estab╜lished a definitive list of factors to consider in making a determination of the individual taxpayer's profit motive. At minimum, the inquiry is whether the taxpayer was moti╜vated by no business purpose other than obtaining tax benefits in entering the transaction. See Rice's Toyota World, 752 F.2d at 91-92. The IRS contends that profit motive should be determined pri╜marily by these objective factors, with less weight given to the taxpayer's subjective statement of his intent in investing in the partnership. See Westbrook v. Commis╜sioner, 68 F.3d 868, 875 (5th Cir.1995) (citing standards for profit-motive inquiry under IRC ╖ 183). The IRS further pro╜poses that, if the Court finds Weiner's individual profit motive relevant, the fac╜tors to be considered are the purpose of the partnership; how the partnership was expected to provide a profit; the partner's understanding of the partnership program; the partner's reliance on upon others in investing in the partnership, and the back╜ground and experience on the persons re╜lied upon; and the partner's sophistica╜tion. 20 The Fifth Circuit has recognized that profit motive is an inherently fact╜based inquiry that will focus in large part on the credibility of the taxpayer. See Durrett, 71 F.3d at 517; Chamberlain, 66 F.3d at 732. The Court considers the objective factors identified by the IRS in making its determination.
20. The IRS gleans these factors from the un╜derlying Tax Court decisions affirmed by the Fifth Circuit in Chamberlain and Durrett .
Weiner testified at trial and called La╜mont Grogan, his accountant, as his only other witness. The Court credits these witnesses' testimony. Grogan testified that he began working on Weiner's tax returns in 1983. At that time, Weiner had recently completed his residency and was beginning his practice as a physician. Grogan characterized Weiner as a novice investor at the time who had not made many investments. Over his years of working with Weiner, Grogan developed an opinion of him as careful, prudent, and thof-ough. Grogan has never known Wein╜er to invest in something solely because of the tax aspects of the investment.
When Weiner brought his records to Grogan for preparation of his 1984 tax returns, Grogan had "routine" concerns about the TFA investment. One of these routine concerns was whether the invest╜ment was expected to generate write-offs well in excess of Weiner's cash investment, which could indicate a tax-motivated in╜vestment. Grogan was satisfied that TFA was not such an investment. Grogan asked Weiner whether he was at risk in excess of his $40,000 cash investment be╜cause Weiner could claim a partnership loss only up to the amount he was at risk in the investment. The TFA losses shown on the partnership's K-1 for 1984 were $85,683. Weiner informed Grogan that he had signed a note for $66,000. 21 Surpris╜ingly, Grogan did not do any independent due diligence to investigate the partner╜ship or to confirm that Weiner was actual╜ly at risk for the $66,000 debt. Grogan prepared Weiner's 1984 individual tax re╜turn and included a deduction of $85,683 related to TFA. Grogan testified that this deduction resulted in a tax savings of ap╜proximately $42,000 in 1984. Over the years, Weiner declared approximately $45,000 in income from TFA and paid ap╜proximately $15,000-$20,000 in taxes on that income over the life of the invest╜ment. 22
21. At trial, the assumption agreement (i.e., the loan guaranty), Weiner signed revealed that Weiner was at risk for only $44,000 of the TFA debt. His deduction for TFA losses in 1984 should have been limited to $84,000. This discrepancy has no bearing on the issues before the Court.
22. The parties agreed that the income tax rates declined over the 11 or 12 years of the partnership.
Weiner's own testimony confirms that his investment experience and financial so╜phistication were extremely limited in 1984. Weiner is a doctor of interventional radiology at the Methodist Hospital in Houston. He completed his residency in 1982 and began his private practice at Methodist in 1983. Prior to 1984 he had an IRA and bank accounts. In 1984, Weiner started getting cold-calls from in╜vestment advisors. He invested in an oil and gas deal on his own and realized he did not know what he was doing. He decided to obtain professional investment help. He interviewed several potential ad╜visors before choosing Walter Sheffield as his financial planner. Weiner chose Shef╜field in part because he was a fee-based service provider and Weiner thought his advice would be objective. Sheffield brought the TFA investment opportunity to Weiner. Weiner realized at the time that Sheffield would earn a commission on the investment, but did not place signifi╜cance on this fact.
Weiner received the TFA prospectus, but did not read it in detail. He was work╜ing 50-60 hours per week plus periodic on╜call duty. He relied on Sheffield's expla╜nations and interpretation of the prospec╜tus. Weiner had no experience in farming or grape growing. Weiner's understand╜ing of the investment was that he would put in $40,000 in cash, sign a loan for $66,000 (now revealed to be $44,000), and that he was at risk if the crops failed. He understood that the money from the first year's crop sales was to be used to pur╜chase land in Southern California on which to grow Travertine grapes. He believed-not unreasonably-that the land value would appreciate, and that it could gener╜ate a capital gain when sold. Weiner un╜derstood that in the first year, he would receive a tax deduction for the partnership expenses to buy seed and grow the initial crops. Nothing in the prospectus indicat╜ed the farming would not occur. Weiner believed that the first-year crops' proceeds would be used to generate funds to pur╜chase the speed or other suitable land. Weiner was not looking for immediate in╜come and did not expect to see any profit from his investment for several years. It was his understanding that the partner╜ship was projected to provide a 10% to 15% return on his investment after the vineyards matured. Weiner was aware that an entity called AMCOR would oper╜ate the partnership, but was not aware of its legal relationship to the TFA partner╜ship. Sheffield told Weiner that the IRS had reviewed similar deals and confirmed his belief that this one was legal. Weiner subsequently invested in TFA and other AMCOR partnerships.
Weiner first learned of possible prob╜lems with the TFA partnership in the late 1980s when he read an article in the Wall Street Journal about the IRS's investiga╜tion of the AMCOR partnerships. 23 In approximately 1990, Weiner received a no╜tice from the IRS about taxes and interest he owed. Grogan advised him to pay the assessment in order to prevent the accrual of interest. Eventually, Weiner agreed, on the advice of his counsel, to enter a settle╜ment with the IRS.
23. By this time, Weiner had ended his rela╜tionship with Sheffield because he suggested to Weiner only limited partnerships and "load" mutual funds as investments.
Other than Sheffield, the September 17, 1984 "Confidential Private Placement Memorandum" (DX.2), which the parties call the prospectus, was the primary source of Weiner's information about the partnership prior to his investment. 24 As the IRS pointed out at trial, careful analy╜sis of the prospectus raises some red flags about the profit potential of the invest╜ment. The IRS's analysis requires finan╜cial acumen well above Weiner's abilities. The matters on which the IRS focuses are "red flags" for an investor's lack of profit motive only if the investor has experience in limited partnerships or true financial sophistication. 25
24. A "Preliminary Marketing Summary," DX 1, also existed, but Weiner does not specifical╜ly recall seeing it at the time he invested. At the Court's request, counsel has investigated the source of DX 1 and represents that it did not come from Weiner's or Grogan's files. See Plaintiff's Exhibit ("PX") 14. Thus, there is no proof that Weiner ever saw the docu╜ment and it is not relevant to the determina╜tion of Weiner's individual profit motive.
25. For instance, the land to be purchased was "desert" land, making acquisition of water imperative if the land were to be used to grow grapes. However, the prospectus did identify a budget for this purpose. The prospectus includes under risk factors the caution that potential investors should evaluate the tax consequences of an investment, including the possibility that the limited partner's pro rata share of partnership losses may be disallowed for "profit motive" reasons. Weiner perceives that the inclusion of "risk factors" is standard and a reader reasonably could con╜strue the "profit motive" risk factor as a cau╜tion included to be comprehensive, but in fact only remotely likely to occur. Third, while cash distributions were to be 99% to limited partners and 1 % to the general partner, on termination of the partnership, one third of the distributions would go to the general part╜ner, reducing any ultimate profit distribution. However, this division seems favorable to the general partner but not unreasonable on its face. The IRS also points out that the pro forma financial statement included in the pro╜spectus contains projections only through 1991, although the partnership term was rep╜resented to be twelve years. Again, given the uncertainties of projections and the many var╜iables involved in the transaction, the absence of projections for the last four or five years of the partnership is not necessarily an indica╜tion of a lack of legitimacy.
Weiner testified that he saw the risk factors in the prospectus, but invested in the partnership anyway, in the hope of realizing income and capital gains over the long-term. He had more than enough in╜come for his living needs, and expected to be in that situation for many years. He hoped to diversify his investments from merely stocks and bonds. He relied on his then-new investment advisor to achieve his goals. As for the warning regarding "profit motive" in the prospectus, he con╜sidered it much like a warning about the risks of a medical procedure: patients are warned of all potential risks, no matter how remote the likelihood of the risk actually occurring. This approach was under╜standable.
The IRS argues that even accept╜ing the optimistic financial scenario ex╜pressed in the prospectus, the partnership would not yield a profit for the limited partners. The IRS argues that this is objective evidence that Weiner's invest╜ment -was based solely on tax consider╜ations. The Court disagrees. The IRS's analysis is based on detailed after-the-fact scrutiny by a knowledgeable tax attorney with a high level of expertise in limited partnerships and apparently sophisticated accounting staff. Weiner's motivation must be judged based on a reasonable review of what the prospectus disclosed, and what his advisor told him, at or about the time he made the TFA investment. As the Fifth Circuit stated in Heasley.
[I]nvestors need not pore over every word in a prospectus or in closing docu╜ments. They exercise reasonable care by reading pertinent portions and hav╜ing their advisors explain the rest. This rule particularly applies to unsophisti╜cated investors, such as the Heasleys. In these cases, financial advisors, more than the investors, understand the ad╜vantages and disadvantages of particular investments and can explain them to investors.
902 F.2d at 386.
While Weiner was a highly educat╜ed doctor in 1984 when he invested in TFA, he was a novice investor with no business or financial training. 26 In the few years prior to 1984, Weiner earned from $13,000 to $26,000 as a resident and in a fellowship program. Weiner was the child of a single mother and had put himself through school. In 1984, having just joined a successful medical practice, Wein╜er recognized he would earn a skyrocket╜ing salary over the foreseeable future. He admittedly was looking for ways to reduce his tax burden. But, he testified credibly that he thought of TFA as an investment with short-term tax advantages and the potential for future income, profit, and capital gains. 27
26. This distinguishes Weiner from the taxpay╜er in Durrett, 1994 WL 139382, 67 T.C.M. (CCH) 2735 (1994), who owned his own suc╜cessful business buying and selling fuel oil, and in Chamberlain v. Commissioner, 1994 WL 199220, 67 T.C.M. (CCH) 2992 (1994), who had extensive experience buy and selling interests in various refineries. In Lukens, the plaintiff was one of the eighteen individuals who formed the partnership at issue. 945 F.2d at 94.
27. Weiner believed that after several years, his initial investment would generate income from the grape growing operations described in the prospectus, and would generate profit and capital gains upon the sale of the land. Weiner told Grogan in 1984 that he hoped to earn a profit from the eventual sale of the land purchased by the partnership to grow grapes. The evidence establishes that Wein╜er did not understand the detailed financial projections of the partnership, but he had a general understanding of the partnership program based on his limited review of the prospectus and his discussions with Shef╜field. As to the details and reasonableness of the specifics of the investment, Weiner relied on Sheffield's opinion, a financial planning professional. While there is evidence that Weiner knew Sheffield would earn a com╜mission on his investment, there is no evi╜dence that Sheffield was working essentially as a promoter for AMCOR or was hawking this investment only to collect the commis╜sion without regard to its legitimacy. Even if that is the case, there is no evidence that Weiner knew it.
The purpose of the TFA partnership as expressed in the prospectus was "to en╜gage in the business of agriculture-principally growing crops on leased acreage in various locations and -acquiring up to 500 acres of undeveloped desert agricultural land in Southern California's Coachella Valley, and developing those acres for pro╜duction of Flame Seedless table grapes" for the "early (May-June) market." DX 2, at 1. The prospectus anticipated a 210% tax write-off in the first year due to the expenses associated with growing the ini╜tial crops on leased land. Weiner actually reported an approximately 214% write-off. Grogan testified that given the prevailing tax climate at the time, this was not a write-off percentage that raised concerns for him about the legitimacy of the invest╜ment, as he had seen deals with write-offs of five or six times the investment amount. 28 The IRS has presented no con╜trary evidence.
28. In Lukens, the taxpayer claimed a deduc╜tion approximately seven times his invest╜ment. 945 F.2d at 95.
The prospectus reflected a highly risky investment, but it did not reveal "no rea╜sonable possibility of profit" for the limited partners. See Rice's Toyota World, 752 F.2d at 91-92. The Court finds Weiner has met his burden to prove that his in╜vestment in TFA in 1984 was not intended solely to obtain tax benefits. 29 Thus, the objective evidence on which the IRS relies does not outweigh Weiner's credible testi╜mony that he made his investment in TFA in 1984 with the hope of making money, albeit in a risky investment. A consider╜ation of all relevant factors leads this Court to find that Weiner was not motivat╜ed solely by tax-avoidance and that he had a profit motive in making his 1984 invest╜ment in TFA.
29. Nothing in the prospectus revealed that the crops would never be planted at all or that key transactions would be merely "check swaps," as the IRS contends actually oc╜curred. The IRS's contentions in this regard-made through a proffer-are based on post hoc investigation several years after Weiner's decision to invest. The IRS does not argue that Weiner knew or could have known about this potential fraud at the time he in╜vested in TFA.
IV. CONCLUSION AND ORDER
The Court finds that the interest assess╜ment by the IRS is not a "naked assess╜ment" and therefore Weiner bears the burden of proof to establish that the as╜sessment is incorrect. The Court further concludes that the imposition of ╖ 6621(c) enhanced interest based on "sham transac╜tion" requires both lack of economic sub╜stance of the partnership transactions and lack of profit motive on the part of Weiner. The Court finds that Weiner invested in the partnership with a profit motive and thus Weiner has met his burden to prove that he is entitled to a refund of the en╜hanced interest assessed against him pur╜suant to ╖ 6621(c).
"The IRS should not exact every penalty possible in every case where tax╜payers pay less than the full amount of tax due." Heasley, 902 F.2d at 386. "Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes." Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir.1934) (Hand, J. Learned), aff'd, 293 U.S. 465, 55 S.Ct. 266, 79 L.Ed. 596 (1935). It is therefore
ORDERED that Weiner is entitled to recover judgment against the IRS in the amount of $3,668.71 as a refund of enhanced interest erroneously assessed against him pursuant to ╖ 6621(c). The Court will issue a separate final judgment
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