T.C. Memo. 1995-574
UNITED STATES TAX COURT
BERNARD MICHAEL REED, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 23518-93. Filed December 4, 1995.
Bernard Michael Reed, pro se.
Paul L. Dixon, for respondent.
MEMORANDUM OPINION
GOLDBERG, Special Trial Judge: This case was heard pursuant
to section 7443A(b)(3) and Rules 180, 181 and 182.1 Respondent
determined a deficiency in petitioner's 1991 Federal income tax
in the amount of $1,504, and an accuracy-related penalty pursuant
to section 6662(b)(1) in the amount of $300.80.
The issues for decision are: (1) Whether petitioner's real
estate and water purifier activities were engaged in for profit
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for 1991, and all Rule
references are to the Tax Court Rules of Practice and Procedure.
2
within the meaning of section 183, and, if so, whether petitioner
can substantiate claimed business expenses; and (2) whether
petitioner is liable for an accuracy-related penalty.
Some of the facts have been stipulated and are so found.
The stipulation of facts and attached exhibits are incorporated
by this reference. Petitioner resided in Stateline, Nevada, at
the time the petition was filed in this case.
During the past 20 years, petitioner purports to have been
an accountant, a principal in an architectural firm, a real
estate investor, a taxi driver, a bank auditor, and a salesperson
of water purifiers. During 1991, petitioner drove a taxi for
Whittlesea Cabs, ran a water purifier franchise, and operated a
real estate investment firm under the name of NSA. Petitioner
conducted both the water purifier business and NSA from his one-
bedroom apartment at the Desert Club in Nevada.
Petitioner's water purifier franchise was based on a
"pyramid" incentive system, whereby participants earn income
through direct sales and through the recruitment of additional
franchisors. The primary objective is to recruit additional
salespersons, with the sale of individual units used as one
method of recruitment. Petitioner was unable to sell any of the
water purifiers and, after giving several away, disposed of
several units at a garage sale held in November 1991. He did not
include the aggregate proceeds from the garage sale ($30-$40) in
his gross income for the taxable year at issue.
3
In 1990, petitioner formed NSA, and, according to his
testimony, began looking for real estate investments. In 1991,
petitioner passed his real estate agent examination and
associated NSA with Marilyn Taylor, a real estate broker.
Petitioner did not invest in, sell, or renovate any real estate
during 1991. On November 8, 1991, while on disability leave from
Whittlesea Cabs and receiving worker's compensation, petitioner
traveled to Alaska for the purported purpose of investing in real
estate.
From November 12 until November 19, 1991, petitioner stayed
at the Best Western Hotel in Juneau, Alaska. On November 26,
petitioner entered into a 6-month lease with Patrick Macksey as
co-tenant for a three-bedroom house at a monthly rent of $1,100.
Under the terms of the lease, petitioner agreed not to paint,
paper, or otherwise redecorate or make alterations to the
premises without prior written consent of the owner. The initial
payment, including security deposit and first month's rent, was
$1,883.33.
Due to a lack of available treatment for his ongoing medical
problems, petitioner departed Alaska on December 24 and returned
to Nevada on or about December 27, 1991. Petitioner did not
invest in any real estate or attend any business meetings with
bankers or realtors while in Alaska.
On Schedule C attached to his 1991 Federal income tax
return, petitioner claimed the following business deductions:
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Expense Amount Claimed
Car and truck $329
Employee benefit program 1,413
Insurance 1,246
Rental of business property 8,890
Travel 515
Utilities 1,899
Bank service charges 337
Miscellaneous 1,241
Total $15,870
On a revised Schedule C dated October 17, 1992, petitioner
increased his deductions for travel expenses claimed to
$5,931.30, and claimed additional expenses for entertainment
($202.94) and meals ($1,014.70). Petitioner reported no income
in 1991 other than the wages and tips he earned while driving a
taxi-cab for Whittlesea Cabs.
Respondent determined that petitioner's business activities
were not engaged in for profit, and therefore disallowed all of
the deductions claimed attributable thereto.2 Alternatively,
respondent determined that petitioner failed to substantiate the
deductions and to prove that the expenditures were ordinary and
necessary to his businesses. The determinations of respondent
are presumed correct, and petitioner bears the burden of proving
otherwise. Rule 142(a).
All taxpayers are required to keep sufficient records to
enable respondent to determine their correct tax liability. Sec.
2
Although not addressed in the notice of deficiency, respondent
also disputes the additional expenses claimed on petitioner's
revised Schedule C.
5
6001; Meneguzzo v. Commissioner, 43 T.C. 824, 831-832 (1965).
Moreover, deductions are strictly a matter of legislative grace,
and a taxpayer has the burden of establishing that he or she is
entitled to any deduction claimed on a return. Deputy v. du
Pont, 308 U.S. 488, 493 (1940); New Colonial Ice Co. v.
Helvering, 292 U.S. 435, 440 (1934).
Section 162(a) allows as a deduction "all the ordinary and
necessary business expenses paid or incurred during the taxable
year in carrying on any trade or business". Where an individual
conducts an activity that is not engaged in for profit, section
183 limits the allowable deductions. To be engaged in a trade or
business within the meaning of section 162, "the taxpayer must be
involved in the activity with continuity and regularity and * * *
the taxpayer's primary purpose for engaging in the activity must
be for income or profit." Commissioner v. Groetzinger, 480 U.S.
23, 35 (1987).
Whether petitioner engaged in the water purifier or real
estate business for profit depends on whether the activity was
undertaken with an "actual and honest objective" of making a
profit. Elliott v. Commissioner, 90 T.C. 960, 970 (1988), affd.
without published opinion 899 F.2d 18 (9th Cir. 1990); Fuchs v.
Commissioner, 83 T.C. 79, 98 (1984); Dreicer v. Commissioner, 78
T.C. 642, 644-645 (1982), affd. without opinion 702 F.2d 1205
(D.C. Cir. 1983). While a reasonable expectation of a profit is
not required, petitioner must have entered into the activity, or
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continued it, with the bona fide objective of making a profit, as
judged by all the facts and circumstances. Taube v.
Commissioner, 88 T.C. 464, 478-479 (1987); Poast v. Commissioner,
T.C. Memo. 1994-399; sec. 1.183-2(a), Income Tax Regs.
The regulations set forth nine non-exclusive factors for
consideration in determining whether an activity is engaged in
for profit. Sec. 1.183-2(b), Income Tax Regs. These factors
are: (1) The manner in which the taxpayer carries on the
activity; (2) the expertise of the taxpayer or his advisers; (3)
the time and effort expended by the taxpayer in carrying on the
activity; (4) the expectation that assets used in the activity
may appreciate in value; (5) the success of the taxpayer in
carrying on other activities; (6) the taxpayer's history of
income or losses with respect to the activity; (7) the amount of
occasional profit, if any, which is earned; (8) the financial
status of the taxpayer; and (9) whether elements of personal
pleasure or recreation are involved. Furthermore, if a taxpayer
has substantial income from sources other than the activity in
question, it may be an indication that the activity is not
engaged in for profit, particularly if the losses from the
activity generate substantial tax benefits. Sec. 1.183-2(b)(8),
Income Tax Regs.
No single factor is controlling. Abramson v. Commissioner,
86 T.C. 360, 371 (1986); Golanty v. Commissioner, 72 T.C. 411,
426 (1979), affd. without published opinion 647 F.2d 170 (9th
7
Cir. 1981). The taxpayer's stated intention to make a profit is
not determinative; greater weight is given to objective factors
rather than the taxpayer's mere statement of intent. Engdahl v.
Commissioner, 72 T.C. 659, 666 (1979).
Section 262 precludes a taxpayer from deducting personal,
living, or family expenses that are not incurred in the conduct
of a trade or business or for the production of income.
Based upon the record in this case, we find that petitioner
lacked the requisite profit objective in carrying on his business
activities. Petitioner claims to have operated a water purifier
franchise, yet he failed to produce any receipts for inventory
purchases, advertisement, or related records. He was also unable
to sell any of the units; in fact, he testified at trial that he
eventually gave units away at no charge.
Petitioner operated NSA in a similarly offhand manner.
While he presented a ledger at trial, it failed to differentiate
between personal and business expenses. Furthermore, although
petitioner substantiated the expense of the real estate agent
examination and the payment to the State Industrial Insurance
System, he offers no evidence, such as business cards, a
telephone listing, a client list, or documentation of previous
investments, that he was actively engaged in the real estate
business, or that he conducted the activity with a profit motive.
Petitioner contends that the only expenses he deducted were
ordinary and necessary to his business activities. However, his
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"business expenses" include his annual rent for his one-bedroom
apartment at the Desert Club, complete with clubhouse, theatre,
and meeting facilities (rental of business property), the entire
phone, cable, and utilities bills every month (utilities), the
cost of his dental work (employee benefit program), numerous
meals at local restaurants (meals and entertainment), auto
insurance and maintenance costs on his only vehicle (insurance
and car and truck expenses), and the entire cost, including
lodging, of his trip to Alaska (travel).
With respect to his trip to Alaska, petitioner claimed that
the initial payment on the house in Juneau was an "investment" in
a lease with an option to purchase, and he intended to renovate
the property for resale. However, the documentation produced by
petitioner clearly indicates that the property was to be used
solely for residential purposes. The lease included no option to
purchase and prohibited any alteration or renovation.
It is well settled that we are not required to accept self-
serving testimony in the absence of corroborating evidence.
Lerch v. Commissioner, 877 F.2d 624, 631-632 (7th Cir. 1989),
affg. T.C. Memo. 1987-295; Niedringhaus v. Commissioner, 99 T.C.
202, 212 (1992). Based on the foregoing, we conclude that
petitioner's activities were not engaged in for profit.
Petitioner is not entitled to deduct the Schedule C expenses he
claimed for 1991.
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The second issue for decision is whether petitioner is
liable for a penalty under section 6662(a). This section, in
conjunction with subsection (b)(1), imposes an accuracy-related
penalty equal to 20 percent of the portion of any underpayment of
tax that is due to negligence. Under section 6662(c), negligence
is any failure to make a reasonable attempt to comply with the
provisions of the Internal Revenue Code.
Petitioner failed to maintain regular and consistent records
of his activities, attempted to deduct personal items under the
guise of "business expenses", failed to substantiate a portion of
the deductions claimed, and misrepresented the purpose behind the
expenditures at trial. On this record, we conclude that
petitioner was negligent within the meaning of section 6662(b)(1)
with respect to the entire underpayment of tax and is liable for
an accuracy-related penalty under section 6662(a). Respondent is
sustained on this issue.
To reflect the foregoing,
Decision will be entered
for respondent.