Pearson and Merriam, P.C
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Tel. No: (206) 382-0590

RESPONSE TO IRS "GENERAL INFORMATION REGARDING HOYT PARTNERS"

 This memorandum is intended to respond to the IRS document that has recently been provided to Congressmen concerning the Hoyt partners.  Some of the information provided by the IRS is either inaccurate or incomplete.  This memorandum is intended to clarify the facts and circumstances concerning the audits of the Hoyt partnerships.

Generally, Walter J. Hoyt ("Jay Hoyt"), a well-known cattle breeder, sold interests in cattle and sheep partnerships to individual investors.  He apparently organized and sold over 118 partnerships.  After the fact, it has been determined that Jay Hoyt grossly violated his fiduciary duties as Tax Matters Partner concerning these partnerships.  The IRS was aware of many of Jay Hoyt’s improper actions and yet continued to deal with him as the fiduciary for the individual investors.  On the other hand, the majority of the individual investors were completely unaware of Jay Hoyt’s fraudulent activities and/or breaches of his fiduciary duty to them.

While many of Jay Hoyt’s actions were improper, the subject cattle-breeding business was nonetheless a bona fide business with actual expenses and income.  We understand that the IRS continues to dispute the bona fide nature of the Hoyt partnership businesses and that their statement on this case reflects that position.  However, the "General Information Regarding Hoyt Partners" provided by the IRS is inaccurate or incomplete as follows:

1. IRS Statement:

"For the years 1985 and 1986 Mr. [partner] did not accept the IRS proposed settlement, choosing to enter litigation and abide by the court’s decision.  The tax years were decided by the court in favor of the government, and additional assessments were made for the tax years 1985 and 1986."

Response:

The only issue decided by the Tax Court for the 1985 and 1986 years concerned "special allocations" made by Jay Hoyt.  This issue is not a typical "abusive tax shelter" issue.  The remainder of the issues, i.e., the value of the cattle, the number of the cattle, allowable expenses, etc., was determined by a settlement, signed May 23, 1993, between the IRS and Jay Hoyt.  At the time Jay Hoyt settled these issues with the IRS, the IRS was actively investigating him for tax return preparer penalties concerning the returns impacted by the settlement.  During the audit of these returns, Jay Hoyt was under criminal investigation by the IRS.  He had also been under criminal investigation between the periods 1983 through 1987 and again from October/November 1989 to November 1991.  There is also evidence that the IRS Criminal Investigation Division was working with the Postal Inspector when it "raided" the Hoyt business offices in 1995.  It is unclear if the IRS ever stopped its criminal investigation of Jay Hoyt.  He was never notified that the criminal investigation had been terminated.
 

The concessions in the MOU resulted in huge tax liabilities for the individual partners.  However, Jay Hoyt’s family, including Jay Hoyt’s wife, directly benefited from the settlement.  By Jay Hoyt’s actions, the investor partnerships conceded large interest payments made to an entity owned by the Hoyt family, Hoyt amp Sons Ranches ("Ranches").  These interest payments apparently had not been included in Ranches’ income.  Thus, while the MOU created huge tax liabilities for the individual partners, the Hoyt family’s tax liability was actually significantly reduced.

It is clear from the outcome of the settlement (especially in light of the fact that the taxpayers prevailed on numerous issues in Bales v. Commissioner) that Jay Hoyt was incapable of fulfilling his fiduciary duties to the partnerships and to the individual investors due to these severe conflicts of interest.  The IRS was aware of these conflicts.  Indeed, the IRS was a direct cause of many of the conflicts and yet continued to deal with Jay Hoyt as the representative of the partnerships, when the IRS had the ability to remove Hoyt as the Tax Matters Partner pursuant to I.R.C. § 6231(c).   (See ¶ 5, below.)

2.  IRS Information:

"A cash bond or advance payment could have been posted at any time during the process to stop the running of interest.  Mr. [partner] may wish to do this at this time as interest will continue to accrue from the date the tax was due until paid in full."

Response:

For the majority of the partners, the tax liabilities are too large for either a cash bond or an advance payment to be made.  For most, payment of the current liabilities will cause bankruptcy.

3.  IRS Information:

"The ‘Bales ruling’ related specifically to investments prior to 1980.   In this case, one of the issues before the court was whether the activity was engaged in for profit.  Because the Tax Court found the partnership to be a bone [sic] fide business the investors claimed they had won the Case.  They failed to recognize that the Tax Court decision also found that deductions and investment credits were overstated."

Response:

These statements are, at best, misleading.  In Bales v. Commissioner, T.C. Memo. 1989-568,
the Tax Court found:

a) The stated sales price for the cattle was reasonable;
b) The financing had economic substance;
c) The "benefits and burdens" of ownership passed to the individual partners;
d) The transactions had economic substance;
e) The activity was entered into for a profit;
f) The debt was bona fide;
g) The expenses incurred were ordinary and necessary (i.e., allowed);
h) That the investment tax credit was allowed; and
i) That I.R.C.§ 6621(c) (tax motivated interest assessment) was not applicable.

More specifically, the Tax Court did not find that the deductions and investments credits were overstated.  The taxpayers won on every substantive issue in front of the Tax Court.  However, after trial but prior to opinion, Jay Hoyt conceded that the individual partners were not "at risk" on the promissory notes.  This concession is what limited the expenses and deductions that the individual partners could take on their individual returns.  While the Tax Court did not specifically rule on the "at risk" issue, it did find that these same promissory notes had economic substance and that the benefits and burdens of ownership passed to the investors.   Nothing in the Tax Court opinion indicates that the IRS could have won the "at risk" issue, if it had been presented to the Court.

What the individual partners saw in the Bales case was a total victory.  The impact of Jay Hoyt’s concessions on the Bales partners’ individual returns is not evident in the Bales opinion.  And, most partners did not know and were not told by Jay Hoyt, that he made any concessions after trial. (Note: The opinion reflects the judge’s analysis of the substantive legal issues and does not reflect the final adjustments made to the taxpayers account.)  However, notwithstanding the Bales opinion, the IRS continued to offer the Hoyt partners the traditional "abusive tax shelter" settlement.  A settlement that would have forced the majority of the partners into bankruptcy, if they accepted it.

Rather than relying on our evaluation of the case, we request that you review the actual opinion and determine whose analysis of the case is more accurate.

4.  IRS Information:

"After receipt of the Pre-filing Notices, some of the partners filed new Forms W-4, Employee’s Withholding Allowance Certificate, which included excessive allowances based on the partnership deductions and/or credits.  These Forms W-4 were filed to purposefully circumvent the effect of the previously issued Pre-Filing Notices.   Therefore, it was determined that they did not meet the requirements of the Internal Revenue Code Section 3402 and related Employment Tax Regulations.  Thus, their employers were directed to disregard the subsequently filed Forms W-4 and to withhold at the Single rate with zero allowances."

"Although there were no formal or administrative procedures for appealing the IRS’s decision concerning the withholding allowances, the taxpayers were able to request a redetermination.  Upon the taxpayer’s request, they were allowed a reasonable amount of allowances, once proper substantiation was provided."  [Emphasis added.]
 
 

Response:

On the advice of Jay Hoyt, Hoyt partners did make changes to their Forms W-4.   However, the method described and used by the IRS to correct any allegedly improper W-4s was not in accord to their own IRS Manual provisions.   The Internal Revenue Service Manual § 4299 describes the procedures used concerning "questionable" Forms W-4.  The Manual states that a form letter will be sent to the taxpayer informing the taxpayer that their Form W-4 has been selected for review.  The IRS employee reviewing the Form W-4 is suppose to contact the taxpayer, interview the taxpayer, and document the final conclusion using "all the facts and circumstances that lead up to [the conclusion]."

Instead of following this procedure, the IRS changed the Hoyt partner Forms W-4, without prior notification to the partners and, apparently, without even reviewing the taxpayer’s income tax returns to determine marital status.  The IRS uniformly changed all the challenged Form W-4s to Single and Zero.

After contact by the partner, the IRS did redetermine the appropriate allowances, often increasing the allowances.  However, the IRS information implies that the IRS only changed the Forms W-4 once, after the taxpayer had filed a new Form W-4 requesting "excessive allowances."  However, the IRS made many changes to an individual Hoyt partner’s Form W-4 and often not in response to a change made by the Hoyt Partner.  For example, the IRS would change exemptions that it had previously determined to be correct in its "redetermination" process.  The following is an actual example of change made by the IRS to one couples allowances.  Documents are available to substantiate this conduct.

Prior to  Husband changed his Form W-4 to Married with 19 exemptions
10/11/93 Wife changed her Form W-4 to Married with 11 exemptions
  (The partners made no additional changes to their Forms W-4 after this date.
All later changes were made by IRS.)

10/11/93 IRS changed Wife’s W-4 from Married w/ 11 exempt. to Married w/ 9 exempt.
3/24/94 IRS changed Wife’s W-4 from Married w/ 9 exempt. to Single w/ 0 exempt.
4/20/94 IRS changed Wife’s W-4 from Single w/0 exempt. to Married w/ 1 exempt.
2/22/96 IRS changed Wife’s W-4 from Married w/1 exempt. to Single w/ 0 exempt.
11/02/97 IRS changed Wife’s W-4 from Single w/0 exempt. to Married w/ 2 exempt.

3/17/94 IRS changed Husband’s W-4 from Married w/ 19 exempt. to Single w/ 0 exempt.
4/20/94 IRS changed Husband’s W-4 from Single w/ 0 exempt. to Married w/ 6 exempt.
2/22/96 IRS changed Husband’s W-4 from Married w/6 exempt. to Single w/ 0 exempt.
11/01/97 IRS changed Husband’s W-4 from Single w/ 0 exempt. to Married w/ 4 exempt.

The justification provided by the IRS does not explain all of the above changes to this couple’s Forms W-4.  It certainly does not explain changing the wife’s W-4 from a very reasonable Married with 1 exemption to single with zero exemptions.   Further, the partners

who called about changing their W-4s were directed to speak with the IRS Sacramento District, where the case has been managed by the IRS and Chief Counsel.  Hoyt partners would then be asked about settling their individual tax liability.  This is an inappropriate use of the W-4 program.

5.  IRS Information:

"Many of the partners have expressed their anger and frustrations over the continuation of the partnerships.  Although the IRS is mandated by congress to take appropriate action against the promoters of abusive tax shelters, IRC section 6103 protects the results of such actions from being disclosed."

Response:

The IRS failed to take any effective action as "mandated by congress."   I.R.C. § 6103 did not prohibit the IRS from removing Jay Hoyt as the Tax Matters Partner while he was under criminal investigation.  In fact, the IRS is required to remove Tax Matters Partners that are under criminal investigation because the "criminal investigation for the violation of the internal revenue laws relating to income tax will interfere with the effective and efficient enforcement of the internal revenue laws." Temp. Reg. § 301.6231(c)-5T.    Jay Hoyt’s removal would have effectively alerted the partners to many of the problems.  It is unlikely that Jay Hoyt would have continued to sell partnerships interests, if he was removed as the Tax Matters Partner each time the IRS began auditing a different partnership.  A partner(s), without Jay Hoyt’s conflicts, would have replaced Jay Hoyt and dealt with the IRS.  The partners would have at least had the opportunity to discover Jay’s deceptive practices in a timely manner.

I.R.C. § 6103 also did not prohibit the IRS from enjoining Jay Hoyt from promoting "abusive tax shelters" under I.R.C. § 7408.  The IRS determined that the Hoyt partnerships were "abusive tax shelters" and used this determination as justification for many of its actions against the individuals.  However, the IRS never attempted to enjoin Jay Hoyt for conduct concerning promoting abusive tax shelters or for aiding and abetting the understatement of tax as permitted under I.R.C. 7408.   An injunction also would have effectively alerted the individual partners to Jay Hoyt’s fraudulent and deceptive activities.  As a minimum, it would have stopped the sale of additional partnerships.  The IRS began auditing the Hoyt partnerships in 1977 (or earlier).  However, Jay Hoyt was allowed to continue organizing and selling partnership from 1977 to 1997.  The majority of the individual tax liabilities would not have even existed, if the IRS had acted as permitted by law.
 

 If you have any additional questions or would like to discuss this matter, please contact us.  Pearson ® Merriam, P.C. does not represent partners that have settled their case with the IRS.  Therefore, we did not address the Form 906 and Bankruptcy Court issues.  This lack of comment in no way reflects any opinion on those issues.