Booker v. Commissioner

T.C. Memo. 1996-347

UNITED STATES TAX COURT

DERWYN JOSEPH BOOKER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 14110-87. Filed July 30, 1996.

Derwyn Joseph Booker, pro se.

Julie M.T. Foster, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

WRIGHT, Judge: Respondent determined deficiencies in and

additions to petitioner's Federal income tax as follows:1

1
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.
 - 2 -

Additions to Tax
Sec. Sec. Sec.
Year1
Deficiency 6653(a)(1) 6653(a)(2) 6659

1980 $4,898.17 $244.91 2
$1,469.45

1981 5,791.00 289.55 2
1,737.30

1982 934.83 46.74 2
--

1983 6,108.00 305.40 2
1,832.40

Increased interest under sec. 6621(c) was imposed.
1

50 percent of the interest payable with respect to the
2

portion of the underpayment attributable to negligence.

After concessions, the issues for decision are:

(1) Whether petitioner is entitled to claimed deductions

and a claimed investment tax credit for taxable year 1983 in

connection with his participation in the Century Concepts, Inc.,

Master Video Game Leasing Program. We hold that he is not.

(2) Whether petitioner is liable for the negligence

additions to tax under section 6653(a)(1) and (2) for the taxable

years at issue. We hold that he is.

FINDINGS OF FACT

Some of the facts have been stipulated and are found

accordingly. The stipulation of facts and the attached exhibits

are incorporated herein. Petitioner resided in Corpus Christi,

Texas, at the time the petition was filed in the instant case.

In 1983, petitioner participated in the Century Concepts,

Inc. Master Video Game Leasing Program. In 1983, Century

Concepts, Inc. (Century Concepts or Century), was ostensibly in
 - 3 -

the business of leasing master computer video games from which

the lessee could reproduce copies and offer such copies for sale

to retail establishments either directly or through a

distributor. Century Concepts acquired low-quality master video

games manufactured by General Masters Corp. of Los Angeles

(General Masters) that were not designed for commercial use.

Using promissory notes, Century acquired the masters at highly

inflated values. Century then leased the masters to its

"investors" for the sole purpose of allowing these individuals

to, as its brochure explains, "benefit from large investment tax

credits with a one time lease payment." Century elected to have

the investment tax credit flow to its lessees. The investment

tax credit is based upon the value of the equipment leased.

Century assigned highly inflated values to the subject masters.

The lessees are required to make a one-time payment upon entering

into the lease transaction. The lessees then enter into an

agreement with a distributor provided to them by Century for the

alleged marketing of the video games.

Century's brochure, explaining the leasing of master video

games, specifically states that Century Concepts was founded for

the purpose of marketing tax-advantaged equipment leases to its

investors. The brochure totals three pages discussing only in

general terms the video game market. The brochure does not

specifically address the master video games that Century intends

to lease, their quality, nor any other facets of the program.
 - 4 -

The brochure does, however, strongly emphasize the benefits to be

derived from the investment tax credit.

Also included in Century's promotional materials was a

"Legal Opinion" and a document entitled "Closing Documents".

The "Legal Opinion" totals 16 pages and is entirely devoted to

the tax consequences of entering into the Century Concepts

leasing program including the tax benefits, possible challenge by

the IRS, litigation, and the various Federal tax penalties that

may be applicable. The "Closing Documents" totals 20 pages of

which nine pages are devoted solely to tax considerations, one

page discusses how to lease a master, five pages consist of

sample tax forms, and the remainder consists of other sample

forms and a table of contents. In the "Closing Documents"

Century states that the fair market value of the masters equals

$375,000 and goes on to mention that the "the total write-off

[ratio] is approximately 4.9:1, based on the * * * [investment

tax credit] and total business expense write-offs."

There is no meaningful analysis contained anywhere in the

promotional materials of the potential nontax, economic

profitability of the Century Concepts leasing program. Also, the

materials are devoid of any information of substance regarding

the marketability of the masters, or any information concerning

how master video games can be marketed.

On December 20, 1983, petitioner entered into an equipment

lease with Century Concepts for the lease of a master video game
 - 5 -

called Techno Sport Toboggan. Petitioner entered into the lease

transaction under the entity name B.B.B., Ltd. Petitioner had a

30-percent interest in the lease. The lease required an initial

payment of $15,000; petitioner's portion totaled $4,500.

Petitioner executed a promissory note in the amount of $4,500 for

his participation under the lease agreement.

Also on December 20, 1983, petitioner entered into a

Computer Program Employment Agreement (agreement) with ALA

Enterprises, Inc. (ALA), providing for distribution of Techno

Sport Toboggan. The agreement provided that ALA manufacture 500

copies of the video game for an advance payment of $3,900.

Petitioner's share of that payment totaled $1,170.

On December 23, 1983, petitioner entered into an equipment

lease with Century for the lease of a master video called

Monsoon. Petitioner entered into the lease transaction through

the entity name BAYS Enterprises, Ltd. (BAYS). The lease

required an initial payment of $15,000; petitioner's portion of

that payment totaled $1,250. Petitioner executed a promissory

note in the amount of $1,250 for his participation under the

lease agreement.

Also on December 23, 1983, petitioner entered into a

Computer Program Employment Agreement (agreement) with ALA

Enterprises, Inc. (ALA), providing for distribution of Monsoon.

The terms are identical to those under the agreement covering

Techno Sport Toboggan.
 - 6 -

Before entering into the lease and distribution agreements,

petitioner made no independent investigation of Century Concepts

beyond reviewing the promotional materials provided by Century.

Petitioner did not obtain a lawyer, an accountant, a C.P.A., or

any other professional to review the documents before signing.

Petitioner obtained no independent appraisals of the masters

before signing the agreements and received the appraisals

provided by Century only after entering into the lease and

distribution agreements.

Century provided lessees two appraisals for each master

video game. On February 23, 1984, VidElect, Inc., provided

Century with an appraisal of Techno Sport Toboggan with a listed

fair market value of $379,250. On June 1, 1984, WBW Appraisals

provided Century with an appraisal of Techno Sport Toboggan with

a listed fair market value of $2,333,760. On October 8, 1983,

VidElect, Inc., provided Century with an appraisal of Monsoon

with a listed fair market value of $379,250. NSO, Inc., provided

Century with an undated appraisal of Monsoon listing as its fair

market value $375,000. VidElect's appraisals are identical with

the exception of the names of the masters.

Petitioner never received a copy of the Monsoon master.

Petitioner did receive three copies of the Techno Sport Toboggan

master; one was given to the IRS, and the other two are unopened

in their original packaging. Petitioner had no experience in the

computer video game market before his involvement with Century
 - 7 -

Concepts and, in fact, describes himself as "not computer

literate."

Petitioner made no attempt to market either of the video

games other than through ALA. No video games were sold in 1983.

On April 5, 1985, petitioner received the first and only payment

from ALA in the amount of $3.59 representing income earned from

the sale of copies of the video games.

On his 1983 Federal income tax return, petitioner computed

an investment tax credit in connection with his involvement with

Century Concepts in the amount of $14,375, of which $2,751 was

claimed with respect to 1983. The unused portion was carried

back to taxable years 1980 through 1982. Petitioner claimed

deductions in the amount of $12,718 on Schedule C of his 1983

return with respect to Century Concepts. Petitioner received a

refund in the amount of $18,105 with respect to taxable year

1983.

OPINION

Issue 1. Century Concepts

Section 162 allows a deduction for ordinary and necessary

expenses paid or incurred during the taxable year in carrying on

a trade or business. In order to establish entitlement to

deductions and credits, taxpayers have the burden of proving that

they meet the statutory requisites. New Colonial Ice Co. v.

Helvering, 292 U.S. 435 (1934).
 - 8 -

Section 38 allows a credit for investment in certain

depreciable property. The amount of the credit is limited to a

percentage of a taxpayer’s qualified investment in section 38

property. Sec. 46(a). Qualified investment in new property is a

percentage of the property’s basis, generally its cost. Secs.

46(c)(1), 1012. The lessor of the property, here Century

Concepts, may elect to pass through the credit to the lessee,

here petitioner, and the lessee generally is treated as having

acquired the property for its fair market value. Sec. 48(d).

It is well settled that to constitute a trade or business,

the activity must be engaged in with an "actual and honest

objective of making a profit." Agro Science Co. v. Commissioner,

934 F.2d 573 (5th Cir. 1991), affg. T.C. Memo. 1989-687; Levy v.

Commissioner, 91 T.C. 838, 871 (1988); Drobny v. Commissioner, 86

T.C. 1326, 1340 (1986). Absent an actual and honest profit

objective, tax deductions relating to an investment are limited

under section 183 to the income generated from the activity.

Dreicer v. Commissioner, 78 T.C. 642, 644-646 (1982), affd.

without opinion 702 F.2d 1205 (D.C. Cir. 1983).

Although a reasonable expectation of profit is not required,

the taxpayer must have the objective of realizing a profit.

Drobny v. Commissioner, supra at 1341; Engdahl v. Commissioner,

72 T.C. 659, 666 (1979). In this context, profit means economic

profit, independent of tax savings. Drobny v. Commissioner,

supra at 1341; Herrick v. Commissioner, 85 T.C. 237 (1985).
 - 9 -

The existence of the required profit objective is determined

by the objective of the entity which has control over the

activity under scrutiny. Drobny v. Commissioner, supra at 1341.

Thus, the existence of a profit objective of a partnership is

determined at the partnership level, Agro Science Co. v.

Commissioner, supra at 576; the existence of a profit objective

of a joint venture is determined at the joint venture level,

Brannen v. Commissioner, 78 T.C. 471, 501-505 (1982), affd. 722

F.2d 695 (11th Cir. 1984).

Resolution of whether a taxpayer engages in an activity with

the requisite intention of making a profit is one of fact to be

resolved on the basis of all the facts and circumstances. Agro

Science Co. v. Commissioner, supra at 576; Hulter v.

Commissioner, 91 T.C. 371, 393-394 (1988); Drobny v.

Commissioner, supra at 1341. In making this determination, more

weight must be given to the objective facts than to the

taxpayer's mere after-the-fact statements of intent. Agro

Science Co. v. Commissioner, supra at 576; Beck v. Commissioner,

85 T.C. 557, 570 (1985); sec. 1.183-2(a), Income Tax Regs.

Petitioner made no independent investigation of Century

Concepts prior to his participation. He did not obtain the

services of any professional to review the leasing documents

before signing. Petitioner failed to obtain any independent

appraisals of the masters and, in fact, never received a copy of

one master and never opened the copy he did have of the other.
 - 10 -

The appraisals provided by Century were wholly inadequate. The

VidElect appraisals are identical word for word with the only

exception being the names of the different games. One appraisal

is not even dated. Petitioner testified that he has no

experience in the computer game market and is in fact "not

computer literate." Petitioner made no attempt to market the

video games other than through ALA and, in fact, received no

income from the sale of any games until April 1985, at which time

he received a total of $3.59.

The promotional materials petitioner relied upon prior to

participating in the lease program focus extensively on the tax

benefits of entering into such a venture and contain no

substantive analysis of the economic profitability of the

program. The materials advertise a "write-off" ratio of at least

4.9:1 with a one-time lease payment and essentially no further

action on the part of the investor.

Respondent submitted the report of Mr. Joshua W. Denham of

Rancho Palos Verdes, California, as her expert witness in the

instant case. We evaluate expert opinions in light of the

demonstrated qualification of the expert and all other evidence

of value. Estate of Christ v. Commissioner, 480 F.2d 171, 174

(9th Cir. 1973), affg. 54 T.C. 493 (1970); Parker v.

Commissioner, 86 T.C. 547, 561 (1986). We find Mr. Denham's

report and testimony to be credible. We find that, based upon
 - 11 -

Mr. Denham's expert report and testimony, the master video games

at issue had little or no value.

Mr. Denham stated in his report that the games were not of

commercial quality. The play of the games is too slow, the sound

effects and graphics are poor, and the challenge is minimal and

simplistic. In short, the games were not manufactured with the

intent of marketing them commercially. In fact, as Mr. Denham

states, the game packages did not contain any trademarks or any

other evidence indicating that the games were protected from

being copied by other game producers. We find that the absence

of a trademark implies that the producer or owner placed no value

on the games; any serious producer would have his or her product

protected. Century obtained the masters from General Masters

Corp. Mr. Denham found that General Masters primarily developed

video games for the purpose of selling them for use in tax

shelters.

Based upon the facts and circumstances of the instant case,

we conclude that petitioner has failed in his burden of proving

that he participated in the Century Concepts leasing program with

an actual and honest objective of making a profit. Instead, we

find that petitioner engaged in the leasing program primarily, if

not exclusively, to obtain tax deductions and credits, thereby

reducing the tax he would otherwise owe on income from other

sources. Accordingly, respondent is sustained on this issue.
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Issue 2. Negligence

Section 6653(a)(1) provides for an addition to tax equal to

5 percent of any underpayment if any part of the underpayment is

due to negligence or intentional disregard of rules and

regulations. Section 6653(a)(2) provides for an addition to tax

of 50 percent of the interest on that portion of the

underpayment attributable to negligence.

Negligence is defined as a lack of due care or the failure

to act as a reasonable person would act under similar

circumstances. Chamberlain v. Commissioner, 66 F.3d 729, 732

(5th Cir. 1995), affg. in part and revg. in part T.C. Memo. 1994-

228; Heasley v. Commissioner, 902 F.2d 380, 383 (5th Cir. 1990),

revg. T.C. Memo. 1988-408; Neely v. Commissioner, 85 T.C. 934,

947 (1985). Petitioner bears the burden of proving that no part

of the underpayment for the year at issue is due to negligence or

intentional disregard of rules and regulations. Rule 142(a);

Bixby v. Commissioner, 58 T.C. 757 (1972). The addition to tax

for negligence under section 6653 is correctly assessed in cases

where claimed deductions are not supported by the facts.

Sandvall v. Commissioner, 898 F.2d 455 (5th Cir. 1990), affg.

T.C. Memo. 1989-56 and T.C. Memo. 1989-189; Marcello v.

Commissioner, 380 F.2d 499 (5th Cir. 1967), affg. in part and

remanding in part 43 T.C. 168 (1964).
 - 13 -

Under some circumstances, a taxpayer may avoid liability for

the additions to tax under section 6653(a)(1) if reasonable

reliance on a competent professional adviser is shown. United

States v. Boyle, 469 U.S. 241 (1985); Freytag v. Commissioner, 89

T.C. 849, 888 (1987), affd. 904 F.2d 1011 (5th Cir. 1990), affd.

501 U.S. 868 (1991). In order for reliance on professional

advice to excuse a taxpayer from the negligence additions to tax,

the reliance must be reasonable, in good faith, and based upon

full disclosure. Freytag v. Commissioner, supra. Reliance on

representations by insiders, promoters, or offering materials

ordinarily constitutes an inadequate defense to negligence.

LaVerne v. Commissioner, 94 T.C. 637, 652-653 (1990), affd.

without published opinion 956 F.2d 274 (9th Cir. 1992), affd.

without published opinion sub nom. Cowles v. Commissioner, 949

F.2d 401 (10th Cir. 1991); Marine v. Commissioner, 92 T.C. 958,

992-993 (1989), affd. without published opinion 921 F.2d 280 (9th

Cir. 1991). Reliance on a professional adviser can be inadequate

when the taxpayer and his adviser knew nothing about the nontax

business aspects of the venture. Beck v. Commissioner, 85 T.C.

557 (1985); Flowers v. Commissioner, 80 T.C. 914 (1983).

The facts in the instant case speak for themselves.

Petitioner failed to adequately investigate Century Concepts and

failed to elicit the services of a professional adviser before

participating in the leasing program. We will not belabor the
 - 14 -

issue or give undue dignity to petitioner's argument by

reiterating what has been set forth above. As we stated in

Harris v. Commissioner, T.C. Memo. 1981-46, “To anyone * * * not

incorrigibly addicted to the ‘free lunch’ philosophy of life, the

entire scheme had to have been seen as a wholly transparent

sham."

Based upon the record in the instant case, we find that

petitioner’s actions do not approach the actions that a

reasonable and ordinarily prudent person would have taken under

the circumstances. See Chamberlain v. Commissioner, supra at

733. Accordingly, petitioner is liable for the additions to

taxdue to negligence under section 6653(a)(1) and (2) for the

taxable years at issue. Respondent is sustained on this issue.

To reflect the foregoing,

Decision will be entered

under Rule 155.