Summary of a Recent
Judicial Development in
Estate Planning and Taxation

Partnership Deemed Negligent for Acting Without Reasonable Care
in Investing and Claiming Tax Deductions

Eric H. Foy
National AgLaw Center Research Associate

Summary of Decision

In Heller v. Commissioner of Internal Revenue, T.C. Memo 2008-232, 2008 WL 4628238 (T.C. Oct. 20, 2008), the United States Tax Court ruled in favor of the Internal Revenue Service (IRS) because the petitioner taxpayers failed to show that they acted with reasonable cause by investing in a jojoba project without seeking professional advice. The petitioners argued that they reasonably relied on professional advice, which they alleged was a defense to the additional tax liability for negligence. The court also held that the petitioners were liable for additional taxes for substantially understating their tax liability.

Background

On November 30, 1983, the petitioners acquired 10 units of a limited partnership called Contra Costa Jojoba Research Partners (CCJRP) for $27,500. Id. at *1. They paid $11,000 in cash and signed a promissory note for the remaining $16,500. Id. On January 5, 1998, the Tax Court issued Utah Jojoba I Research v. Commissioner, T.C. Memo. 1998-6, in which it held that the partnership could not deduct its losses for research and development expenditures. Id. On April 11, 2005, the court entered a decision against the partnership upholding the partnership item adjustments for the 1983, 1984, and 1985 tax years, which was not appealed. Id. In June 2006, the IRS issued notices of deficiency for the three tax years at issue. Id. In response, the petitioners filed a timely petition with the instant court. Id.

Arguments

The IRS argued that the petitioners failed to act reasonably because, before investing in CCJRB, they should have sought independent advice about the viability of growing jojoba in southwestern United States. Id. at *3.

The petitioners argued that they were not negligent because they invested in the jojoba project only after receiving advice from their independent CPA. Id. at *2. In addition, they argued that one of the partners researched the jojoba project thoroughly before the partnership invested in it. Id. at *2.

Analysis and Holdings

Section 6653(a)(1) and (2) of the United States Tax Code impose an additional tax if any part of an underpayment is due to negligence or disregard of rules and regulations. Id. at *2. Negligence is defined as a lack of due care or failing to act as a reasonably prudent person under the circumstances. Id. The Ninth Circuit Court of Appeals previously held that a determination as to negligence for the purposes of 6653(a) depends upon the legitimacy of the underlying investment and the due care taken in claiming the deduction. Id. Prior to this adjudication, the court held that the partnership's underlying activity lacked legitimacy. Id. In the instant adjudication, the court held that the partnership failed to demonstrate that it acted with due care with respect to the investment in CCJRB. Id. at *3. Additionally, the court held that petitioners were negligent in claiming the deductions for 1983, 1984, and 1985 for losses related to the investment. Id.

The case was decided on October 20, 2008.