United States 9th Circuit Court of Appeals Reports

Petitioners-Appellants, v. COMMISSIONER OF INTERNAL
REVENUE, Respondent-Appellee. No. 05-70658, No. 25191-96.
United States Court of Appeals, Ninth Circuit. Argued
September 15, 2006. Filed December 18, 2006.

Appeal from a Decision of the United States Tax Court.

Terri A. Merriam, Pearson Merriam, P.C., Seattle,
Washington, for the petitioner-appellants.

Eileen J. O’Connor, Assistant Attorney General, Richard
Farber, Anthony T. Sheehan, Attorneys, Tax Division, U.S.
Department of Justice, Washington D.C., for the respondent



BEA, Judge.

Gary and Johnean Hansen (“Hansens”) appeal the judgment of
the Tax Court in Hansen v. Commissioner, T.C.M. (RIA)
2004-269 (2004), upholding the Commissioner of Internal
Revenue’s (“Commissioner”) imposition of a negligence
penalty pursuant to I.R.C. § 6662(a) for claiming
losses in 1991 from a cattle partnership in which they had
invested. The Hansens claim error, asserting that the Tax
Court ignored relevant facts, applied an improper
negligence standard, and inadequately considered the
Hansens’ own victimization as members of the partnership. We
have jurisdiction pursuant to 26 U.S.C. § 7482(a)(1)
and affirm the Tax Court’s decision upholding the
negligence penalty.


The Hansens were partners in a total of six cattle breeding
and taxshelter partnerships promoted and run by Walter J.
Hoyt, III (“Hoyt”) from 1987 through 1996. In 1991, the
Hansens claimed $32,306 in losses based on their
participation in the Hoyt partnership Durham Shorthorn
Breed Syndicate 1987-C (“DSBS87-C”). These losses, combined
with losses from other Hoyt partnerships, reduced the
Hansens’ adjusted gross income (“AGI”) in 1991 from $70,266
to $17,471, thereby lowering the Hansens’ 1991 taxes from
$11,852 to $799. In 1995, the Commissioner issued a Notice
of Final Partnership Administrative Adjustment for the 1991
tax year of DSBS87-C and made computational adjustments on
the Hansens’ 1991 tax return. These adjustments altered the
Hansens’ $32,306 loss in DSBS87-C to income of $8,586,
thereby increasing the Hansens’ 1991 tax liability from
$799 to $8,523. Simultaneously, the Commissioner asserted
an I.R.C. § 6662(a) negligence penalty against the
Hansens for the DSBS87-C deductions that resulted in the
$7,724 underpayment in 1991. Section 6662(a) allows for a
negligence penalty of 20% of the underpayment, which
resulted in a negligence penalty of $1,545.

A. Hoyt Partnerships

DSBS87-C was one of over one hundred cattle and
sheepbreeding partnerships that Hoyt organized, promoted
and operated from 1971 through 1998.[fn1] Hoyt enticed
investors by marketing the partnerships not only as
investment opportunities but also as tax shelters. Beyond
marketing and running the partnerships, Hoyt acted as the
tax matters partner (“TMP”)[fn2] in each of the
partnerships subject to the Tax Equity & Fiscal
Responsibility Act of 1982, 26 U.S.C. § 6231(a)(7).
Further, from approximately 1980 through 1997, Hoyt was a
licensed enrolled agent qualified to represent taxpayers
before the IRS. See 26 C.F.R. § 601.502(b)(3).

In Hoyt’s capacities as TMP and as an enrolled agent, and
through tax preparation companies that he owned and ran
(“Tax Office of W.J. Hoyt Sons,” “AgriTax,” and “Laguna Tax
Service”), Hoyt directed the preparation of the tax returns
of each partnership. He usually signed and filed the tax
returns on behalf of the partners such as the Hansens.
Adams, 355 F.3d at 1182.

In 1980, the IRS began auditing the Hoyt partnerships. This
led to numerous Tax Court cases. One of the more prominent
cases, and one that Hoyt utilized as support for the
legitimacy of all his partnerships and their accompanying
tax benefits, was Bales v. Commissioner, T.C. Memo.
1989-568, 58 T.C.M. (CCH) 431. The Bales decision ruled
against the IRS. Bales found that pre-1980 Hoyt
partnerships were not economic shams. Therefore, the
deductions claimed through partnership expenses were
legitimate. Id. at 447-51. Bales specifically found that
during the years before 1980, Hoyt was operating a
legitimate and, at times, thriving cattle business. Id. at

Despite the setback of the Bales decision, the IRS
continued its investigations into Hoyt partnerships, which
led to the freezing of income tax refunds to Hoyt partners
in February 1993. At this time, the IRS also disallowed
individual Hoyt partners’ claimed benefits and ceased
issuing tax refunds stemming from the Hoyt partnerships. By
1997, the Hoyt partnerships entered bankruptcy, and, in
1998, the Bankruptcy Court consolidated all the assets and
liabilities of the cattle and sheep partnerships and sold
off the little remaining livestock.[fn3]

B. The Hansens’ Investments

Petitioner Gary Hansen graduated from California
Polytechnic State University with a degree in architecture
and construction engineering. Petitioner Johnean Hansen
works as a respiratory therapist. The Hansens have no
formal business training or experience in farming, ranching,
or investment partnerships. Their investment experience
prior to their investments in Hoyt partnerships included
purchasing a home, owning rental property, buying
government bonds, opening bank accounts, holding term life
insurance, selling Amway products, and participating in the
retirement program sponsored by Mr. Hansen’s employer.

The Hansens first learned of the Hoyt partnerships through
a coworker and attended a Hoyt information presentation in
Pasco, Washington in late fall 1986. The Hansens talked
with other partners at this time and received informational
materials. One of the materials the Hansens received, and
subsequently relied upon in making their investment
decision, was a document entitled “Hoyt and Sons: the 1,000
lb. Tax Shelter.” This document explained how the Hoyt
partnerships were designed to provide profits over time and
emphasized that the primary return on investment is
realized through tax savings.[fn4] Based on the information
in this document, partners were to profit from their
investment in two ways: first, Hoyt would distribute
partnership expenses among the partners, which the partners
could use as a deduction to offset other sources of income;
and second, the livestock would eventually be liquidated,
which was expected to return a profit on the initial
investment. See Adams, 355 F.3d at 1181-82.

The “1,000 lb. Tax Shelter” document contained a discussion
of risks and statements regarding the legality of the tax
savings. One such statement exclaimed: “If you’re like
most, your first impression of our program was, ‘This deal
looks too good to be true!’ ” One section of the document
discussed the potential of IRS audits and stated that the
IRS will brand the partnerships “an ‘abuse’ ” and will
subject the partnerships to “automatic” and “constant”
audit.[fn5] Because of these “constant” audits, the
document contained an explanation of why Hoyt’s
organization alone should be trusted to prepare tax returns
for the partners:

You will feel better when you see our name on your
return, stating that all information is true. Then you
have an affiliate of the Partnership preparing all
personal and Partnership returns and controlling all
audit activity with the Internal Revenue Service.

The document referred to this strategy as “circling the
wagons” and depicted the IRS in an illustration as a Native
American about to attack the “HS ‘Circle of Wagons.’ ” This
strategy allowed Hoyt to distribute partnership losses
among the partners as needed to minimize partners’ tax

If a Partner needs more or less Partnership loss any
year, it is arranged quickly within the office, without
the Partner having to pay a higher fee while an outside
preparer spends more time to make the arrangements.

Finally, in a section entitled “Tax Aspects,” the document
warned investors as follows:

Out here, tax accountants don’t read brands, and our
cowboys don’t read tax law. If you don’t have a tax man
who knows you well enough to give you specific personal
advice as to whether or not you belong in the cattle
business, stay out. The cattle business today cannot be
separated from tax law any more than cattle can be
separated from grass and water. Don’t have anything to do
with any aspect of the cattle business without thorough
tax advice. . . .

After reviewing this and other Hoyt promotional materials
and talking with existing partners, but without any
assistance or advice from a “tax man” independent of Hoyt,
the Hansens invested in the Hoyt partnerships in late 1986.
Upon joining the Hoyt partnerships, the Hansens signed
documents giving Hoyt permission to incur debt for which
they would be personally liable. Mrs. Hansen testified that
at the time of their investment, she and her husband
believed it would provide not only tax benefits but also a
retirement income.

During the course of their investment, the Hansens
participated in the partnerships. Beginning as early as
1989, the Hansens attended monthly meetings of local Hoyt
partners at which guest speakers were sometimes present.
Mrs. Hansen consistently read the materials obtained from
the Hoyt organization, which included independent materials
that discussed the aspects of the Hoyt business such as
cattle figures. Mrs. Hansen attended two ranch tours (in
1990 and 1993) at which she, along with other Hoyt
partners, visited Hoyt ranches and saw cattle and
equipment. Mrs. Hansen made frequent telephone calls to the
Hoyt organization when questions arose, particularly when
questions arose involving tax matters.

The Hoyt organization prepared the Hansens’ tax returns and
refund claims from 1987 through 1991. In 1987, the Hansens
reported on Schedule K-1[fn6] losses of $142,950. These
losses eliminated the Hansens’ 1987 tax liability, and they
filed a Form 1045, Application for Tentative Refund, to
carry back the excess loss in 1987 (the amount left over
after reducing 1987 tax liability to zero) to 1984 and 1985.
By so doing, the Hansens received refunds of all the income
tax they had paid during these years. The Hansens continued
to allow the Hoyt organization to fill out the tax returns
and apportion partnership losses through 1991. The Hansens
never sought verification of the information by a tax
adviser or accountant, independent of Hoyt, on the Schedules
K-1 or on their tax returns. The Hansens estimate that from
1987 through 1998, they sent the Hoyt organization over
$100,000, which included payment on notes, partnership
“assessments,” contributions to Hoyt sponsored partnership
retirement accounts, and 75% of the tax savings the Hoyt
organization claimed to have generated.

C. IRS Involvement

In December 1988 the IRS sent a letter informing the
Hansens their 1987 return had been selected for audit.[fn7]
By letter dated April 25, 1989, the Hansens received
further notice that the partnership DSBS87-C’s 1988 tax
year was under review. The letter stated in relevant part:

Based upon our review of the partnership’s tax shelter
activities, we have apprised the Tax Matters Partner that
we believe the purported tax shelter deductions and/or
credits are not allowable and, if claimed, we plan to
examine the return and disallow the deductions and/or
credits. The Internal Revenue Code provides, in
appropriate cases, for the application of a negligence
penalty under section 6653(a) . . . with respect to the

By the time they filed their 1991 tax return, the Hansens
had received eight notices informing them the IRS was
beginning an examination of various Hoyt partnerships in
which they had been involved, including DSBS87-C.

Hoyt had warned the partners the IRS might undertake such
action. Regarding the IRS’s April 25, 1989 letter, Hoyt
sent a letter to the partners informing them to not worry
about the IRS’s threats of disallowance. On another
occasion, Hoyt sent a letter to partners expressly
contradicting information the IRS earlier had provided the
partners regarding the time spent by partners which they
claimed as material participation in the partnership.[fn8]
The IRS responded to Hoyt’s letter, pointed out the
problems in the letter, and urged partners to seek
independent advice if still confused.

Despite these warnings and letters and express urging to
seek advice independent of Hoyt, the Hansens continued to
claim the deductions on their tax returns. Mrs. Hansen
testified that she often corresponded with the Hoyt
organization when questions arose and that she read all the
materials the Hoyt organization sent her. Mrs. Hansen
further testified that she relied on the assurances offered
by Hoyt and others within his organization, particularly
when issues with the IRS arose. Because Hoyt loudly
proclaimed the reach and authority of the Bales decision as
vindication of the partnerships’ activities and tax claims,
particularly whenever tax complications with the IRS arose,
the Bales decision greatly influenced the Hansens’ decision
to maintain their investment. Mrs. Hansen testified she
read the Bales decision many times and that in her mind, it
legitimized the partnership activities.

D. Procedural History

In 1995 the Commissioner issued a Notice of Final
Partnership Administrative Adjustment (“FPAA”) for the 1991
tax year of the DSBS87-C partnership. Following Hoyt’s
failure timely to petition the Tax Court for a
redetermination of the adjustments in the FPAA, the
Commissioner adjusted the DSBS87-C partners’ individual
1991 returns and applied a negligence penalty against the
partners for claiming a deduction arising from DSBS87-C.
Pursuant to this negligence penalty, the Hansens were
charged a $1,545 penalty because of their understatement of
$7,724 in their 1991 tax return.

The Hansens brought suit challenging the negligence penalty
in the United States Tax Court. Special Trial Judge
Goldberg held a trial at which Mrs. Hansen was the only
witness to testify. Following the trial, the Tax Court
issued an opinion upholding the negligence penalty. Hansen
v. Commissioner, T.C.M. (RIA) 2004-269 (2004). The court
specifically found that the Hansens were negligent in using
their Hoyt partnership losses virtually to eliminate their
1984, 1985 and 1987 through 1991 income taxes because they
had relied solely on the Hoyt organization (which stood to
receive the bulk of the tax savings generated) and had
failed independently to verify the returns, despite
repeated IRS warnings. Id. at 25. Further, the court found
the Hansens negligent in claiming losses on their 1991
return because they had relied on the Schedules K-1 issued
by the Hoyt organization without knowledge of how the
losses were generated and without seeking tax advice
independent of Hoyt, despite repeated warnings to do so.
Id. at 25-26.

The Tax Court also rejected the Hansens’ contentions that
they had acted with reasonable cause and in good faith. Id.
at 26-37. The court found that any reliance on tax advice
from the Hoyt organization alone or partners in the Hoyt
organization was insufficient because of the blatant
conflicts of interest inherent in such advice, i.e., the
Hoyt organization was promoting the scheme and receiving
75% of the tax benefit from the Hansens’ investment.[fn9]
Id. at 27-29, 32-34. The court also rejected the Hansens’
contention that the Bales decision provided reasonable
cause to claim the 1991 deduction because the Bales case
involved different investors, partnerships, years, and
issues. Id. at 34-36. Finally, the court ruled that although
the Hansens were indeed victims of Hoyt’s fraud, such
victimization did not grant them license to act negligently
in claiming such large tax deductions. Id. at 36- 37.

Because the Hansens do not challenge the Commissioner’s
disallowance of the various deductions, the sole issue
before us is whether the Tax Court correctly determined the
Hansens are liable under I.R.C. § 6662(a) for
negligently understating their tax liability on their 1991
return. We hold that the Tax Court did not clearly err in
upholding the negligence penalty.



We review findings of negligence by the Tax Court under the
“clear error” standard. Zachary H. Sacks v. Commissioner,
82 F.3d 918, 920 (9th Cir. 1996). Accordingly, regarding
the Tax Court’s weighing of the evidence, “[w]e must uphold
the tax court’s finding unless we are ‘left with the
definite and firm conviction that a mistake has been
committed.’ ” Wolf v. Commissioner, 4 F.3d 709, 712 (9th
Cir. 1993) (quoting United States v. United States Gypsum
Co., 333 U.S. 364, 395 (1948)).


[1] The Internal Revenue Code (“Code”) imposes an accuracy
related penalty on underpayments of tax arising from the
taxpayer’s negligence, which is equal to 20 percent of the
amount of the underpayment caused by taxpayer negligence.
I.R.C. § 6662(a), (b). The Code defines negligence
as “any failure to make a reasonable attempt to comply with
the provisions of [the Code],” Id. § 6662(c), and
requires the taxpayer to prove he acted with due
care.[fn10] See Collins v. Commissioner, 857 F.2d 1383,
1386 (9th Cir. 1988) (stating the “Commissioner’s decision
to impose negligence penalties is presumptively correct”).
Due care is an objective standard by which the taxpayer
must show that he acted as a reasonable and prudent person
would act under similar circumstances. See id.; Treas. Reg.
§ 1.6662-3(b)(1). Negligence is “strongly indicated”
when “[a] taxpayer fails to make a reasonable attempt to
ascertain the correctness of a deduction, credit or
exclusion on a return which would seem to a reasonable and
prudent person to be ‘too good to be true’ under the
circumstances.” Treas. Reg. § 1.6662-3(b)(1),
(b)(1)(ii). We look at both the underlying investment and
the taxpayer’s position taken on the tax return in
evaluating whether a taxpayer was negligent. Z.H. Sacks, 82
F.3d at 920.

[2] The Code provides an exception to the negligence
penalty when a taxpayer can demonstrate both reasonable
cause for the underpayment and good faith in acting
pursuant to such cause. I.R.C. § 6664(c)(1); Treas.
Reg. § 1.6664-4(a).[fn11] The regulations further
provide that the determination of reasonable cause and good
faith “is made on a case-by-case basis, taking into account
all pertinent facts and circumstances,” thereby adding a
subjective element in determining whether the exception
applies. Treas. Reg. § 1.6664-4(b)(1). Most
important in this determination “is the extent of the
taxpayer’s effort to assess the taxpayer’s proper tax
liability.” Id.

[3] Before examining the facts of this case, we note here
the determination by two of our sister circuits that the
Tax Court correctly upheld the negligence penalty imposed
by the IRS on other partner investors in DSBS87-C for the
tax year 1991. Both Mortensen v. Commissioner, 440 F.3d 375
(6th Cir. 2006) and Van Scoten v. Commissioner, 439 F.3d
1243 (10th Cir. 2006) considered many of the arguments
before us in this appeal and concluded the partner
investors were negligent. Because the facts of this case
are remarkably similar to the facts of both Mortensen and
Van Scoten, we are guided in part by these holdings.


The Hansens put forth a variety of arguments as to why the
Tax Court clearly erred and as to why they acted with
reasonable cause and in good faith in their investments in
the Hoyt partnerships and in their tax deductions. Many of
these arguments are overlapping. As our analysis will show,
none of the Hansens’ arguments demonstrate the Tax Court
clearly erred in upholding the negligence penalty. Because
“negligence in the claiming of a deduction depends upon
both the legitimacy of the underlying investment, and due
care in the claiming of the deduction,” we examine both the
Hansens’ initial investment and their actions throughout
the course of the investment. Z.H. Sacks, 82 F.3d at 920.


Regarding both the objective negligence standard in I.R.C.
§ 6662(a) and the more subjective reasonable cause
and good faith exception in I.R.C. § 6664(c), the
Hansens fail to demonstrate the Tax Court clearly erred in
finding they failed to act as would a reasonable investor,
or a reasonable unsophisticated investor, faced with
similar circumstances when the Hansens invested in the Hoyt

[4] First, although warned to consult a “tax man”
independent of Hoyt ab initio, at no time before their
investment did the Hansens seek to verify the legitimacy of
the tax benefits of the investment from a source
independent of Hoyt. From the beginning of the investment,
the Hansens were on notice that the investment took an
extremely aggressive tax posture that could lead to
frequent IRS audits. The Hansens admittedly relied on the
“1,000 lb. Tax Shelter” document, which contained warnings
to seek their own tax advice and to “stay out” of the
investment absent such advice. The document further warned
that the IRS considered the partnerships abusive and would
subject them to “constant” audit.

[5] Other facts dating to the time of the investment
suggested the investment was highly suspicious. For
example, the Hansens were informed that all their tax
returns should be prepared by Hoyt to effectuate sound
defenses against IRS attacks. The Hansens further learned
that Hoyt promised to secure a refund of their prior three
years of taxes based on their investment. Despite these
warnings and suspicious facts, the Hansens invested in the
partnership without seeking verification of the
partnerships and their accompanying tax strategies from a
source independent of Hoyt.

[6] We have consistently held that given similar warning
signals, investors must undertake adequate investigations
at the time of investment to avoid the negligence penalty.
In a similar action contesting negligence penalties based
on business deductions, we stated that “[t]he discussions
in the prospectuses of high writeoffs and the risk of
audits should have alerted taxpayers that their deductions
were questionable at best. Despite these warning signals,
taxpayers did not reasonably investigate the venture before
investing.” Collins, 857 F.2d at 1386. We came to the same
conclusion in Z.H. Sacks, where the prospectus warned of
the risk of investment, yet the investors failed to conduct
an adequate investigation. 82 F.3d at 920. Similarly, in
Allen v. Commissioner, we held that a “plethora of warning
signals surrounding the transaction were sufficient to
force the [investors] reasonably to investigate the
contribution scheme before they went forward.” 925 F.2d
348, 353 (9th Cir. 1991).

The Hansens argue the warning signals were insufficient to
put them on notice to conduct further investigation into
the scheme. They point to other information in the “1,000
lb. Tax Shelter” discussing the legitimate nature of the
business and argue that announcing the risk of audit does
not mandate a negligence penalty. The Hansens further argue
that the Tax Court ignored evidence that they reviewed
independent magazines prior to investing.

[7] However, these arguments do not negate the fact that
clear warning signals were actually present at the time of
investment; therefore, nothing the Hansens put forth
demonstrates the Tax Court committed clear error in finding
inadequate the Hansens’ investigation regarding the tax
benefits prior to investing.[fn12] Each of the Tax Court’s
findings is sup ported in the record, and it makes no
unwarranted inferences concerning the Hansens’ knowledge or
action at the time of investment. Considering both the
Sixth Circuit in Mortensen and the Tenth Circuit in Van
Scoten affirmed the Tax Court’s determination, the Tax
Court’s findings here should likewise be upheld. See
Mortensen, 440 F.3d at 380-81; Van Scoten, 439 F.3d at


[8] Next, the Tax Court found the Hansens’ actions during
the course of investment insufficient to establish they
acted with reasonable care. The record indicates that
throughout their investment, the Hansens relied on the Hoyt
organization to prepare their individual tax returns. The
Hoyt organization also reported the Hansens’ share of
partnership losses on Schedule K-1, which the Hansens never
verified by recourse to a source independent of Hoyt. Based
on the tax returns prepared by the Hoyt organization and
the refunds the Hansens received, during the years 1984
through 1991, the Hansens paid only $6,511 in taxes on
$406,645 of non Hoyt related income.

[9] Additionally, the IRS sent the Hansens numerous
warnings regarding the propriety of the deductions based on
the Hoyt partnerships. From June 1989 through February
1992, the Hansens received eight notices from the IRS
informing them the IRS was beginning audits of partnerships
such as DSBS87-C. Without any investigation or advice
independent of Hoyt regarding these notices, other than to
discuss the matters with members of the Hoyt organization,
the Hansens claimed $59,476 in partnership losses in 1991,
$32,306 attributable to DSBS87-C. According to the Tax
Court, such action, in light of the numerous warnings from
the IRS and the disproportionately large tax savings in
relation to the investment, was enough to constitute

The Tax Court did not commit clear error in so holding. The
Hansens put forth the following arguments as to why they
acted reasonably in claiming the 1991 deduction from
DSBS87-C: (1) Hoyt was an enrolled agent; (2) the Hansens
discussed the state of the partnership with other Hoyt
partners; (3) the Hansens indirectly relied on
professionals consulted by other partners and by the Hoyt
organization; (4) the Hansens personally monitored the Hoyt
business by reading information sent to them and
participating in ranch tours; and (5) the Hansens received
refunds after the IRS notified them it might audit their
returns. However, each of these alleged defenses involves
either pure reliance on the Hoyt organization or large
assumptions regarding the state of the partnerships based
both on information from the Hoyt organization (and in some
instances independent articles) and on IRS inaction.

[10] As the Tax Court explained, the Hansens’
“investigation into the partnership went no further than
members of the Hoyt organization and other Hoyt partner
investors.” Hansen v. Commissioner, T.C.M. (RIA) 2004-269,
33 (2004) We have previously held that a taxpayer cannot
negate the negligence penalty through reliance on a
transaction’s promoters or on other advisors who have a
conflict of interest. See Neely v. United States, 775 F.2d
1092, 1095 (9th Cir. 1985) (“Reasonable inquiry as to the
legality of the tax plan is required, including the
procurement of independent legal advice when it is common
knowledge the plan is questionable.” (emphasis added));
accord Zmuda v. Commissioner, 731 F.2d 1417, 1422 (9th Cir.
1984). Although the Hansens may have done some things to
keep track of the Hoyt partnerships, it was not clear error
for the Tax Court to conclude that even a taxpayer with
similar characteristics as the Hansens in a similar
situation would seek further advice based on the warning
signs present throughout the investment. Given facts
analogous to the present case, the Sixth Circuit in
Mortensen concluded the investor’s actions constituted
little more than “hunker[ing] down.” 440 F.3d at 389. The
Tenth Circuit held the same. Van Scoten, 439 F.3d at 1256
(holding that “the Van Scotens[sic] investment monitoring
efforts, which mostly consisted of reviewing information
provided by the Hoyt organization” did not cure the failure
to seek independent tax advice regarding the validity of the
cattle partnerships and the concomitant tax deductions). We
agree and decline to find clear error in the Tax Court’s


We address two final arguments: (1) whether the Bales
decision justifies the Hansens’ actions,[fn13] and (2)
whether the Hansens’ victimization precludes a finding of

[11] We agree with the Sixth Circuit’s discussion of Bales
in Mortensen. See 440 F.3d at 391-92.[fn14] Mortensen ruled
that seeking professional advice, or reading a court
opinion, may be a defense to a charge of negligence. 440
F.3d at 392. However, reliance on any type of professional
advice must be reasonable given the circumstances of the
taxpayer. Factors such as the differences between the Bales
partnerships and those in which Mortensen had invested and
the lack of any preclusive effect of Bales in prohibiting
the Commissioner from challenging Hoyt partnership
deductions persuaded the Sixth Circuit from finding clear
error on the part of the Tax Court. Id.

[12] Although we recognize that “good faith reliance on
professional advice is a defense” to the negligence
penalty, like the Sixth Circuit we also examine the
circumstances surrounding the advice to determine whether
the taxpayer’s actions were reasonable. See Collins, 857
F.2d at 1386. Any reliance on the Bales decision, therefore,
must be viewed not only in light of the numerous warning
signs present throughout the investment, as discussed
above, but also in recognition of the problems associated
with such reliance as explained by the Sixth Circuit, i.e.,
lack of preclusive effect of Bales, and the Commissioner’s
continuing challenges to partnership deductions, etc. In
addition, a review of the record confirms the Tax Court’s
determination that although Mrs. Hansen read the Bales
decision, no evidence proves she had any understanding or
reliance on the decision independent of what Hoyt explained
the decision to mean.[fn15] Thus, the Tax Court did not
clearly err in holding Bales did not justify the Hansens’

[13] Finally, the Hansens contend that Hoyt’s massive
deceptions made it impossible for them to uncover the true
status of the partnerships. They argue that because it was
extremely difficult for the IRS to uncover the full extent
of Hoyt’s fraud, the possibility of the Hansens uncovering
the fraud, even with professional legal and tax advice, was
nil. The Hansens weave the thread of victimization
throughout their argument, claiming that the victims should
not be further punished. In so doing, however, the Hansens
misunderstand the nature of the negligence penalty. As the
Mortensen court explained, “the issue is not whether a
taxpayer is wholly successful in determining the tax
legitimacy of a desired investment, but whether he is
negligent for not reasonably investigating in the first
place.” 440 F.3d at 390. Our sole inquiry is whether the
Tax Court clearly erred in its finding the Hansens failed
to exercise the due care that is to be expected of a
reasonable and prudent person under the circumstances in
filing their tax return. See Allen, 925 F.2d at 353. Had
the Hansens sought verification of the legitimacy of their
investment and the associated tax deductions from a source
independent of Hoyt, their victimization arguments would be
more persuasive, even if the independent advice had failed
to uncover the full extent of Hoyt’s scam. With the record
before us, however, we conclude that while the Hansens put
forth evidence of their good faith and victimization, they
put forth nothing that proves the Tax Court’s determination
they were negligent was clearly erroneous.


In sum, we affirm the decision of the Tax Court upholding
the negligence penalty imposed on the Hansens for their
1991 deductions stemming from their investment in the Hoyt
partnership DSBS87-C. In light of the numerous warning
signals brought home to the Hansens, the arguments
concerning their diligence prior to investing and
throughout the investment fail to demonstrate the Tax Court
committed clear error. Further, the Bales decision and the
fact of the Hansens’ victimization, while unfortunate, do
not constitute sufficient evidence to demonstrate the Tax
Court’s negligence finding constituted clear error.


[fn1] A detailed history of the Hoyt partnerships is
available in numerous other cases involving the
organization. See, e.g., River City Ranches #1 Ltd. v.
Commissioner, T.C. Memo. 2003-150, 85 T.C.M. (CCH) 1365,
aff’d in part, rev’d in part, vacated in part, & remanded,
401 F.3d 1136 (9th Cir. 2005); Adams v. Johnson, 355 F.3d
1179, 1181-83 (9th Cir. 2004); Bales v. Commissioner, T.C.
Memo. 1989-568, 58 T.C.M. (CCH) 431.

[fn2] A TMP is a general partner designated to act as the
TMP, or, in the event the partnership fails to designate a
TMP, a partner who has the largest profits interest at the
end of the taxable year. I.R.C. § 6231(a)(7)(A)(B).

[fn3] By this time, Hoyt had been indicted on multiple
counts of conspiracy and fraud in violation of multiple
federal laws. In 2001, Hoyt was found guilty on each charge
and was sentenced to almost 20 years in federal prison and
ordered to pay over $100 million in restitution. United
States v. Hoyt, No. 98cr529 (D. Or. 2001), aff’d by
unpublished opinion, 47 Fed. Appx. 834 (9th Cir. 2002),
cert. denied, 537 U.S. 1212 (2003). The district court
judgment lists the Hansens as victims of Hoyt’s fraud.

[fn4] The tax savings were generated primarily through
depreciation and interest expenses associated with the
various cattle herds. However, the sheep and cattle
breeding tax shelters were, in reality, largely economic
shams. At the time of the Hansens’ investment, for example,
the IRS suspected that the partnerships’ stated purchase
price of the animals exceeded the animals’ fair market
value. Hoyt thus began depreciating the cattle at a much
higher dollar amount than the actual cost, which led to
greater depreciation deductions. Further, the IRS discovered
that as early as 1980 Hoyt was selling and reporting cattle
that did not, in fact, exist. Because investors did not
have an interest in specific herds, cattle were
indiscriminately shuffled between partnerships for tax
purposes. Hoyt’s practices combined to enable him to report
grossly exaggerated depreciation expenses on the partners’
tax returns and to “plug in” fake interest expenses, which
expenses were conveniently sufficient to reduce to zero
partners’ tax liability.

[fn5] Hoyt included this warning because, as explained supra
in footnote 4, the IRS already had long suspected Hoyt’s
cattle and sheep-breeding partnerships were economic shams
and therefore abusive tax shelters. See River City Ranches
#1 Ltd., 85 T.C.M. at 1370-72.

[fn6] A Schedule K-1 is used as part of the tax return to
report the partner’s share of income, credits, deductions
and other items resulting from the partnership.

[fn7] The Hansens received this letter prior to receiving
the 1987, 1984, and 1985 refunds. Mrs. Hansen testified
that when she and her husband received these refunds
without further correspondence from the IRS, they felt that
everything was “okay” with the deductions.

[fn8] Under I.R.C. § 469, such participation is
necessary to claim deductions for partnership losses.

[fn9] The court explained that reliance on professional
advice must be “objectively reasonable”: “To be objectively
reasonable, the advice generally must be from competent and
independent parties unburdened with an inherent conflict of
interest, not from the promoters of the investment.” Id. at
27 (citations omitted).

[fn10] Pursuant to amendments to the Code in 1998, see
Internal Revenue Service Restructuring and Reform Act of
1998, Pub.L. No. 105-206, 112 Stat. 685, the burden of
production of evidence of taxpayer negligence with respect
of penalties is now on the Commissioner. See I.R.C.
§ 7491(c). However, since this case precedes the
effective date of § 7491(c), the burden of
production of evidence of lack of negligence remains with
the taxpayer. See Act of July 22, 1998, Pub.L. No. 105-206,
§ 3001(a), 112 Stat. 726. The process prior to the
amendments following imposition of the penalty consisted of
the taxpayer contesting the penalty in Tax Court before
paying the penalties; at Tax Court, the taxpayer carried
the burden to demonstrate reasonable cause for the

[fn11] The Hansens’ 1991 return is subject to Treas. Reg.
§ 1.6664-4 as it existed on April 1, 1995. See
Treas. Reg. § 1.6664-1(b)(2)(i).

[fn12] There is no evidence in the record to suggest that
either the Hansens’ discussions with other partners or
their reviews of independent magazines prior to investing
concerned tax advice.

[fn13] The Hansens claim the Tax Court clearly erred in not
finding Bales either controlling or evidence of reasonable
cause by pointing to numerous similarities between the
partnerships at issue in Bales and the partnerships of
which they were members.

[fn14] The Tax Court’s discussion of Bales in this case is
identical to its discussion of Bales in Mortensen. Compare
Mortensen v. Commissioner, 88 T.C.M. (CCH) 278, 252-53
(2004), with Hansen v. Commissioner, T.C.M. (RIA) 2004-269

[fn15] Furthermore, the record shows that the Hansens
continued to receive notices from the IRS that they planned
to audit the partnerships, even after the Bales decision.
In fact, as noted above, prior to filing their 1991 tax
return, the Hansens had received eight notices informing
them the IRS was beginning an examination of various Hoyt
partnerships in which they had been involved.