T.C. Memo. 2013-182
UNITED STATES TAX COURT
BEN BARTLETT AND TAMMY R. BARTLETT, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 19031-11. Filed August 8, 2013.
Charles Robert Brown and D. Loren Washburn, for petitioners.
David Wayne Sorensen, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
KERRIGAN, Judge: Respondent determined the following deficiencies and
penalties with respect to petitioners’ Federal income tax for tax years 2006 and
2007:
-2-
Penalty
[*2] Year Deficiency sec. 6662(a)
2006 $39,510 $7,902
2007 51,076 10,215
Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect for the years at issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure. All monetary amounts are rounded to
the nearest dollar.
The issues for consideration are (1) whether the passive activity loss rules of
section 469 limit the loss deductions petitioners claimed for 2006 and 2007 with
respect to petitioner husband’s bull breeding activity and (2) whether petitioners
are liable for accuracy-related penalties under section 6662(a).
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulation of
facts and the attached exhibits are incorporated herein by this reference.
Petitioners resided in Wyoming when they filed the petition.
Petitioner husband was raised on a farm in Texas. When he was a child, his
chores included taking care of farm animals. Petitioner husband went to rodeos
-3-
[*3] when he was young, and he rode bulls and other animals in some small
rodeos while in high school and college.
Petitioner husband earned a bachelor’s degree in agriculture with a focus in
horticulture. While in college he helped manage the university agriculture farm.
His responsibilities on the agriculture farm included hauling hay, feeding
livestock, and prepping the livestock for shows, as well as managing the
greenhouse and the arboretum. Petitioner husband also spent time with his older
brother, who held advanced degrees in animal science husbandry and worked on
embryo transfer in cattle. Petitioner husband learned about the mechanics of and
the theory behind embryo transfer from his brother.
In 1988 petitioner husband started a design and landscape business in Texas
called Growin’ Green (Growin’ Green Texas), which became successful. In 2000
petitioner husband sold Growin’ Green Texas, and petitioners moved to Jackson,
Wyoming. Petitioner husband then started Growin’ Green Co., a sole
proprietorship, in Jackson, Wyoming, which provides landscape services and
design as well as snow removal. Since 2000 Growin’ Green Co. has become very
successful. In tax years 2006 and 2007 Growin’ Green Co. had gross receipts of
over $1 million and over $3 million, respectively. Petitioner husband received
-4-
[*4] business income from Growin’ Green Co. of over $400,000 in tax year 2006
and over $1 million in tax year 2007.
In 2005 petitioner husband started a bull breeding operation, which
petitioners called Rainbow Ranch. Petitioners acquired a 1,941-acre ranch near
Burley, Idaho, and purchased 40 or 50 calves from a breeder specializing in rodeo-
quality cows and bulls. Rainbow Ranch is approximately 220 miles from Jackson,
Wyoming.
When petitioners acquired the ranch, there were no buildings on the land,
but the property was fenced to contain livestock. When petitioner husband was on
the ranch, he would sleep in his truck, a nearby motel, or a doublewide trailer
parked on the ranch.
In tax years 2006 and 2007 petitioner husband employed three of his
Growin’ Green Co. workers to stay on the ranch during the winter months, from
approximately November to March. These ranch hands worked 40 hours per week
on Rainbow Ranch. Petitioner also made a business arrangement with Cameron
Tuckett that allowed Mr. Tuckett to graze his horses on Rainbow Ranch in
exchange for providing services pertaining to the stock on Rainbow Ranch.
Mr. Tuckett lived near Rainbow Ranch and operated a farm and livestock
operation.
-5-
[*5] In evidence for the tax years at issue are (1) credit card statements for a
credit card that petitioner husband used for Rainbow Ranch and (2) two schedules,
one for each tax year at issue, of the hours petitioner husband claims he worked on
the ranch. Petitioner husband created the schedules of hours worked several years
after the tax years at issue.
Petitioner husband did not maintain a contemporaneous log, a diary, notes,
or other records of the work he performed day to day relating to Rainbow Ranch--
whether performed in Wyoming or at the ranch in Idaho.
Petitioners’ 2006 joint Federal income tax return was prepared on their
behalf by a certified public accountant. Petitioners’ 2007 joint Federal income tax
return was prepared on their behalf by a second certified public accountant. On
the Schedules F, Profit or Loss From Farming, for both Federal income tax returns
petitioners stated that they materially participated in the operation of a bull
breeding activity. Petitioners claimed loss deductions for the bull breeding
activity of $105,515 for tax year 2006 and $134,763 for tax year 2007.
The notice of deficiency disallowed the loss deductions claimed related to
the bull breeding activity and determined the $39,510 and $51,076 deficiencies in
petitioners’ 2006 and 2007 Federal income tax, respectively, and section 6662
accuracy-related penalties.
-6-
[*6] OPINION
I. Section 469 Passive Activity Losses
Generally, a taxpayer bears the burden of proving the Commissioner’s
determinations in a notice of deficiency are erroneous. Rule 142(a)(1); Welch v.
Helvering, 290 U.S. 111, 115 (1933). Pursuant to section 7491(a)(1) the taxpayer
may shift the burden of proof to the Commissioner if the taxpayer complies with
the relevant substantiation requirements in the Internal Revenue Code, maintains
all required records, and cooperates with the Commissioner with respect to
witnesses, information, documents, meetings, and interviews. Sec. 7491(a)(2)(A)
and (B). The taxpayer bears the burden of proving compliance with the conditions
of section 7491(a)(2)(A) and (B). See, e.g., Winslow v. Commissioner, 139 T.C.
270, 271 n.2 (2012); Hill v. Commissioner, T.C. Memo. 2010-200, aff’d per
curiam, 436 Fed. Appx. 410 (5th Cir. 2011).
Petitioners contend that they have met this burden because (1) respondent
did not allege that petitioners failed to cooperate with respondent and (2)
petitioners claim that they introduced credible evidence. However, there were
discrepancies and inconsistencies in their evidence. Petitioners have failed to
persuasively argue that the burden of proof shifts to respondent. The burden of
proof remains with petitioners.
-7-
[*7] Respondent contends that petitioners’ losses related to their bull breeding
activity should be disallowed because petitioners did not materially participate in
the bull breeding activity.
Section 469(a) disallows the passive activity loss of an individual taxpayer.
The term “passive activity loss” means the amount, if any, by which the aggregate
losses from all passive activities for the taxable year exceed the aggregate income
from all passive activities for such year. Sec. 469(d)(1); see also Dirico v.
Commissioner, 139 T.C. 396, 402 (2012). A passive activity is a trade or business
in which a taxpayer does not materially participate. Sec. 469(c)(1). A taxpayer
materially participates in an activity when he or she is involved on a regular,
continuous, and substantial basis. Sec. 469(h)(1). Participation generally means
all work done in connection with an activity by an individual who owns an interest
in the activity. Sec. 1.469-5(f), Income Tax Regs.
A taxpayer establishes material participation by satisfying any one of seven
tests provided in the regulations. Sec. 1.469-5T(a), Temporary Income Tax Regs.,
53 Fed. Reg. 5725-5726 (Feb. 25, 1988); see also Lum v. Commissioner, T.C.
Memo. 2012-103. Petitioners assert that the following three tests are relevant to
this case:
-8-
[*8] (1) The individual participates in the activity for more than 500
hours during such year;
* * * * * * *
(3) The individual participates in the activity for more than 100
hours during the taxable year, and such individual’s participation in
the activity for the taxable year is not less than the participation in the
activity of any other individual (including individuals who are not
owners of interests in the activity) for such year; [or]
* * * * * * *
(7) Based on all of the facts and circumstances * * * , the
individual participates in the activity on a regular, continuous, and
substantial basis during such year.
Sec. 1.469-5T(a)(1), (3), (7), Temporary Income Tax Regs., supra.1 To satisfy the
facts and circumstances test under section 1.469-5T(a)(7), Temporary Income Tax
Regs., supra, a taxpayer must participate in an activity for more than 100 hours
1
Respondent contends that petitioners are precluded from arguing that they
meet the requirements of the 100-hour test and the facts and circumstances test
because, respondent claims, petitioners first discussed these issues in their
amended pretrial memorandum. We disagree.
Respondent raised both the 100-hour test and the facts and circumstances
test in the notice of deficiency, writing under “Explanation of Adjustments”:
“You have not met any of the seven tests for material participation as outlined
under Treasury Regulation 1.469-5T(a).” Petitioners also raised both tests in their
petition, writing: “The taxpayer meets at least one of the material participation
tests as outlined in Treasury Regulation 1.469-5T(a).”
Accordingly, petitioners’ arguments regarding the 100-hour test and the
facts and circumstances test are properly before us.
-9-
[*9] during the taxable year. Sec. 1.469-5T(b)(2)(iii), Temporary Income Tax
Regs., 53 Fed. Reg. 5726 (Feb. 25, 1988).
A taxpayer can prove participation by any reasonable means. Sec. 1.469-
5T(f)(4), Temporary Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988).
Reasonable means “may include but are not limited to the identification of
services performed over a period of time and the approximate number of hours
spent performing such services during such period, based on appointment books,
calendars, or narrative summaries.” Id. While the regulations permit some
flexibility with respect to the evidence required to prove material participation, we
are not required to accept postevent “ballpark guesstimates”, nor are we bound to
accept the unverified, undocumented testimony of taxpayers. See, e.g., Lum v.
Commissioner, T.C. Memo. 2012-103; Estate of Stangeland v. Commissioner,
T.C. Memo. 2010-185.
Petitioner husband testified that he spent a total of more than 1,000 hours on
the bull breeding activity during the tax years at issue. There is no indication in
the record that petitioner husband engaged in any recreational activities while he
was on the ranch. Likewise, there is no indication that petitioner wife traveled
with petitioner husband to the ranch or was otherwise involved in Rainbow Ranch.
During the years at issue she earned wages from other sources.
- 10 -
[*10] With respect to tax year 2006 petitioner husband testified that he worked on
the ranch repairing fences; cross-fencing the land; building corrals, shelters, and
solar wells; installing “bucking shoots” for training young bulls to buck; and
improving the range land by reseeding, cutting sagebrush, planting wheat crops for
feed, and planting a more desirable bud-style grass. He also testified that he
traveled to South Dakota to pick up a particular bull and then drove that bull from
South Dakota to Rainbow Ranch.
With respect to tax year 2007 petitioner husband testified that he helped his
cows during calving season. Petitioner husband described calving season as
“intense”; he recalled being very involved in the calving process. He further
testified that he started training the young bulls that year, sorting them, developing
their bucking skills, and training them to buck properly.
For each tax year at issue petitioner husband estimated that he spent 7 to 10
hours per week researching the bull breeding business and studying live auctions
online. He also testified that he spent time managing the bull breeding activity
from Wyoming, deciding what items to purchase, from which bloodlines to breed,
and where to build the corrals, among other things. He further testified that he
made several emergency trips to Rainbow Ranch.
- 11 -
[*11] Petitioners admit that they did not keep any records regarding petitioner
husband’s work on Rainbow Ranch or his research. Petitioners, however,
provided two schedules that allegedly detail the numbers of hours petitioner
husband spent on the bull breeding activity for each tax year. Petitioner husband
testified that he created these schedules in 2009 when petitioners’ returns were
audited. He used his credit card statements to determine his work schedule during
the tax years at issue. Petitioner husband first determined which days he made
purchases in or around Burley, Idaho. Then he tried to recall what he was
purchasing on those days and what task he was doing on Rainbow Ranch. Finally,
he assigned a number of hours to each task. Petitioner husband testified that the
schedules do not reflect all of the work he did for Rainbow Ranch; rather, he
included only up to 500 hours of work each year.
At trial Mr. Tuckett on behalf of petitioners testified that he had an
arrangement with petitioner husband: Mr. Tuckett could graze his livestock on
Rainbow Ranch, and in exchange he would help petitioner husband with the
ranch. As part of this agreement, when Mr. Tuckett checked on his livestock on
Rainbow Ranch--which he did daily--he would also check on petitioner husband’s
livestock. Mr. Tuckett further testified that even though he helped petitioner
- 12 -
[*12] husband with tasks around the ranch, he was not paid to work for petitioner
husband.
Mr. Tuckett recalled seeing petitioner husband at the ranch, but petitioner
husband usually had workers with him when he was there. Petitioner husband
estimated that the three ranch hands worked 40 hours per week while they stayed
on the ranch. Petitioner husband testified that he supervised the ranch hands while
he was in Wyoming.
Mr. Tuckett did not estimate how many hours he saw petitioner husband on
the ranch during the tax years at issue.
Petitioners’ son also testified for petitioners. In particular, petitioners’ son
recalled researching the bull breeding activity with his father, determining which
bloodlines to use and studying the auctions online. Petitioners’ son testified that
he accompanied his father on the trip to South Dakota in 2006. Petitioners’ son
did not estimate how many hours he saw petitioner husband working on the bull
breeding activity during the tax years at issue.
Kerry Friedrich, a longtime employee at Growin’ Green Co., testified for
petitioners. Mr. Friedrich testified that petitioner husband was the hardest worker
at Growin’ Green Co., keeping the most hours and doing whatever was necessary
to finish a job. Mr. Friedrich remembered that petitioner husband was at Rainbow
- 13 -
[*13] Ranch “a couple times a month” during Growin’ Green Co.’s busy season
and “more often” than that during Growin’ Green Co.’s off-season. Mr. Friedrich,
however, could not provide any exact dates when petitioner husband was away,
nor did he provide a more definite estimate of how often petitioner husband was at
Rainbow Ranch.
Although petitioners provide a credible narrative summary of petitioner
husband’s participation, they maintained no contemporaneous records or
documentation of his participation such as appointment books, calendars, or logs.
Contemporaneous daily time reports, logs, or similar documents are not required if
other reasonable means of establishing a taxpayer’s participation exist. Sec.
1.469-5T(f)(4), Temporary Income Tax Regs., supra. Petitioners claim that their
schedules of hours worked reasonably establish petitioner husband’s participation.
We disagree.
The credit card statements provide no information regarding how many
hours petitioner husband spent on a given day on the bull breeding activity.
Therefore, the hours petitioner husband claims he worked are merely
“guesstimates”. Moreover, petitioners’ schedules are riddled with contradictions.
On several occasions the credit card statements place petitioner husband in
Wyoming or Utah when the schedules of hours claim he was working in Burley,
- 14 -
[*14] Idaho. Also, on at least one occasion petitioner husband claimed he spent
28 hours on the bull breeding activity during a 24-hour period.
Our analysis of the time petitioner husband spent in tax years 2006 and
2007 working on matters relating to Rainbow Ranch is made difficult by the lack
of any contemporaneous records or other records and documentation regarding
what he did specifically day to day and how much time he spent on matters
relating to the bull breeding activity. In this case the lack of records and
documentation is not cured by estimates made years after the fact in writing or by
testimony. See, e.g., Iversen v. Commissioner, T.C. Memo. 2012-19; Fowler v.
Commissioner, T.C. Memo. 2002-223; Goshorn v. Commissioner, T.C. Memo.
1993-578.
Petitioner husband, Mr. Tuckett, petitioners’ son, and Kerry Friedrich were
credible witnesses. We do not doubt that petitioner husband spent time on
Rainbow Ranch activities while in Wyoming. We also acknowledge that
petitioner husband participated in and/or assisted with the bull breeding operation,
ranch maintenance, and improvements while in Idaho.
The weight of the evidence before us, however, does not establish that
during each of the tax years at issue (1) petitioner husband spent 500 hours on the
- 15 -
[*15] bull breeding activity;2 or (2) petitioner husband worked more than Mr.
Tuckett, who was at the ranch every day, or the ranch hands, who worked on the
ranch 40 hours per week for approximately four months, regardless of whether
petitioner husband worked more than 100 hours on the bull breeding activity. See
Iversen v. Commissioner, T.C. Memo. 2012-19. Petitioners have failed to meet
the criteria of the 500-hour or 100-hour tests.
The weight of the evidence before us also fails to establish that petitioner
husband worked on the bull breeding activity in a regular, continuous, and
substantial manner. During the tax years at issue petitioner husband ran Growin’
Green Co., a highly successful, full-time business over 200 miles from Rainbow
Ranch. He was actively involved with and in charge of Growin’ Green Co. The
evidence shows that petitioner husband was at the ranch approximately 58 days in
tax year 2006 and approximately 35 days in tax year 2007. Petitioner husband’s
sporadic trips to Rainbow Ranch coupled with his intense work ethic
2
Petitioners contend that petitioner husband’s driving back and forth
between Wyoming and Idaho should count towards the 500 hours required by sec.
1.469-5T(a)(1), Temporary Income Tax Regs., 53 Fed. Reg. 5725-5726 (Feb. 25,
1988). We do not discuss this issue because even if we include petitioner
husband’s driving time in the 500-hour calculation, there is not enough evidence
to support petitioner husband’s claim that he spent 500 hours on the bull breeding
activity.
- 16 -
[*16] with respect to Growin’ Green Co. do not suggest that he worked on the bull
breeding activity in a regular or continuous manner.
Petitioners, however, claim that petitioner husband spent 7 to 10 hours per
week researching for Rainbow Ranch while also managing the ranch from
Wyoming. If petitioner husband were researching, running, supervising,
managing, and involved with all significant activities of Rainbow Ranch, as
petitioners seem to claim, we would expect petitioners to have offered into
evidence extensive research notes, files, to-do lists, home and mobile phone
records, business plans, project descriptions, instructions to employees, and the
like, documenting and establishing petitioner husband’s active involvement in the
regular, continuous, and substantial management and day-to-day activities of the
bull breeding activity. That documentary evidence is absent.
Even if petitioners had provided documentary evidence regarding petitioner
husband’s management activities, we would not take into account those
management activities under the facts and circumstances test. A taxpayer’s
management activities are not taken into account under the facts and
circumstances test (1) if another person also receives compensation for
management services relating to the activity or (2) if another person spends more
time on management services relating to the activity than the taxpayer.
- 17 -
[*17] Sec. 1.469-5T(b)(2)(ii)(A) and (B), Temporary Income Tax Regs., supra; cf.
sec. 1.469-5T(f)(2)(ii)(A) and (B), Temporary Income Tax Regs., 53 Fed. Reg.
5727 (Feb. 25, 1988) (stating that an individual’s investor activities, including
studying and reviewing financial statements or reports on operations as well as
monitoring the finances or operations of the activity in a nonmangerial capacity,
do not qualify as participation in an activity unless the individual is directly
involved in the day-to-day management of the activity).
On petitioners’ 2006 Federal income tax return petitioners included $16,750
of management fees in their calculation of Schedule F expenses. On petitioners’
2007 Federal income tax return petitioners included $13,509 of management fees
and “outside service” in their Schedule F calculation of expenses. Petitioner
husband testified that these fees were paid to Mr. Tuckett. Although Mr. Tuckett
claims that he was never paid by petitioner husband and petitioner husband claims
that the payments made to Mr. Tuckett were merely reimbursements, petitioner
husband wrote a letter to the Internal Revenue Service during his audit stating that
the bull breeding activity incurred “management cost throughout the year”. The
record therefore contains substantial inconsistency on the question whether
petitioner paid Mr. Tuckett for management services.
- 18 -
[*18] Petitioner husband did not engage in the bull breeding activity in a regular,
continuous, and substantial manner. On this record we conclude that petitioners
have failed to meet the criteria of the facts and circumstances test, regardless of
whether petitioner husband worked more than 100 hours on Rainbow Ranch.
Petitioners did not materially participate in the bull breeding activity as
required under section 469 and the related regulations. Accordingly, we sustain
respondent’s determination regarding petitioners’ bull breeding activity.
II. Section 6662(a) Accuracy-Related Penalty
Respondent determined that petitioners are liable for accuracy-related
penalties pursuant to section 6662(a) for tax years 2006 and 2007. Section
6662(a) adds to the tax required to be shown on the taxpayer’s return 20% of any
underpayment attributable to, among other things, any substantial understatement
of income tax within the meaning of section 6662(b)(2). The phrase “substantial
understatement of income tax” means an understatement that exceeds the greater
of $5,000 or 10% of the income tax required to be shown on the tax return for the
taxable year. Sec. 6662(d)(1)(A).
Under section 7491(c) the Commissioner bears the burden of production
regarding the taxpayer’s liability for any penalty. See also Higbee v.
Commissioner, 116 T.C. 438, 446-447 (2001). Once the Commissioner has met
- 19 -
[*19] this burden, the taxpayer must provide persuasive evidence that the
Commissioner’s determination is incorrect. See Rule 142(a); Higbee v.
Commissioner, 116 T.C. at 447.
Respondent determined that petitioners should have reported income tax
liabilities of $145,628 and $311,160 on their 2006 and 2007 Federal income tax
returns, respectively. Respondent also determined that petitioners understated
their income tax by $39,510 for tax year 2006 and by $51,076 for tax year 2007,
both of which exceed 10% of the income tax petitioners should have reported on
their 2006 and 2007 Federal income tax returns. Respondent has shown that
petitioners substantially understated their income tax liabilities for tax years 2006
and 2007.
Petitioners therefore are liable for the accuracy-related penalties unless they
can show they had reasonable cause for and acted in good faith regarding part of
each of the underpayments. See sec. 6664(c)(1); sec. 1.6664-4(a), Income Tax
Regs. For purposes of section 6664(c) a taxpayer may establish reasonable cause
and good faith by showing reliance on professional advice. Sec. 1.6664-4(b)(1),
Income Tax Regs. A taxpayer relies reasonably on professional advice if he or she
proves the following by a preponderance of the evidence: (1) the adviser was a
competent professional who had sufficient expertise to justify reliance, (2) the
- 20 -
[*20] taxpayer provided necessary and accurate information to the adviser, and (3)
the taxpayer actually relied in good faith on the adviser’s judgment. See
Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299
F.3d 221 (3d Cir. 2002); see also Rule 142(a); Welch v. Helvering, 290 U.S. at
115.
Petitioners failed to provide any evidence about the information they
provided to their tax return preparers, both of whom were certified public
accountants, regarding Rainbow Ranch. Moreover, neither tax return preparer
testified at trial. Petitioners have not shown that they had reasonable cause or
acted in good faith.
Accordingly, petitioners are liable for the accuracy-related penalties under
section 6662(a). Any contentions we have not addressed are irrelevant, moot, or
meritless.
To reflect the foregoing,
Decision will be entered
for respondent.