T.C. Memo. 1996-363
UNITED STATES TAX COURT
GEORGE KUKES AND MARGARET KUKES, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 19832-94. Filed August 8, 1996.
George Kukes, pro se.1
Michelle D. Korbas, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
PARR, Judge: Respondent determined deficiencies in, an
addition to, and penalties on income taxes of petitioners as
follows:
1
Margaret Kukes did not appear for trial.
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Addition to Tax and Penalties
Year Deficiency Sec. 6651 Sec. 6662(a)
1991 $4,566 -0- $913
1992 11,268 $330 2,254
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable years in
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
The issues for decision are:
(1) Whether petitioners are entitled to deduct a net
operating loss (NOL) consisting of estimated potential wages lost
when George Kukes (petitioner) was terminated by his employer in
1984. We hold they are not.
(2) Whether petitioner was in a trade or business concerning
his music activities in 1992. We hold he was not.
(3) Whether petitioners are subject to an addition to tax
for delinquent filing of their 1992 income tax return. We hold
that they are.
(4) Whether petitioners are subject to a negligence penalty
for 1991 and 1992. We hold they are.
Petitioners have conceded the remaining issues raised in the
notice of deficiency.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
When they filed their petition in this case, petitioners resided
in Roseville, California.
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Net Operating Loss
Petitioner filed a wrongful termination suit against a
former employer in 1984, claiming lost wages and benefits of
$209,367 based upon his attorney's calculations. The lawsuit was
settled for $27,500, which petitioners correctly reported as
taxable income in the year received. In 1987, petitioners began
deducting, as an NOL, the difference between $209,367 and
$27,500. Petitioners have never included in taxable income, nor
been subject to tax on, the amounts which they are deducting as
an NOL ($29,506 in 1991 and $26,880 in 1992).
Trade or Business
During the late 1970's, petitioner formed the Presto Co., a
sole proprietorship which involved various musical activities.
Petitioners reported gross receipts on their Schedules C for tax
years through 1985 consisting of income from teaching piano
lessons, piano sales, and piano tuning and repair. In 1985,
petitioners' Schedule C showed gross receipts of $448 from piano
lessons; petitioner ceased teaching piano lessons in that year.
Petitioners reported no gross receipts from music activities
on their Schedules C for 1986, 1987, 1988, 1989, 1990, and 1992
tax years. (Gross receipts shown on petitioners' Schedule C for
1991 in the amount of $650 consisted of income from consulting
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work related to a safety program, unrelated to the music
business.2)
At some indeterminate point petitioner conceived of a unique
keyboard instruction system, which he called "Presto". Presto is
a system of teaching keyboard techniques revolving around
flexible lesson plans. Petitioner thought that his system could
be marketed in the form of a video, software, written material,
or another interactive form. He hoped it could be sold to school
systems. However, petitioner did not actually produce any
marketable video, software, or written material but instead
continued to consider and investigate various possibilities.
Petitioners have never received any gross income from the
sale of any product associated with Presto. Petitioners reported
losses on their Schedule C related to Presto for at least 8
consecutive years (1985 through 1992), claiming expenses during
those years of more than $65,000. During 1992 and up to and
including the time of trial, petitioner was still in the process
of developing Presto. In 1992, petitioners maintained no
separate bank account, had no customers, and kept no books for
the Presto activity. Petitioners stipulated: “During the 1992
tax year there was no need for petitioners to maintain a separate
bank account for the Presto activity because it was not an income
2
Respondent made no adjustments in the notice of
deficiency regarding petitioners’ Schedule C for 1991. We
therefore make no findings concerning it.
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generating business.” They also stipulated that “During the 1992
tax year, Presto was not an operational 'going-concern'”.
In 1992, petitioner's Form W-2 wages were $45,128 from full-
time employment as an engineer.
The most significant expense claimed on petitioners' 1992
Schedule C is for depreciation of petitioners' entire residence
in Santa Maria, California, in the amount of $17,226.30. In
December of 1991, petitioners moved from Santa Maria to Merced,
California, where they rented an apartment closer to petitioner's
place of employment. During 1992, petitioners were attempting to
sell their Santa Maria residence. Mrs. Kukes periodically stayed
in Santa Maria to maintain the yard and residence. Most of
petitioners’ furniture and personal belongings remained at the
Santa Maria property, including petitioner’s piano, organ,
computer, and Presto work product. The cost of the Santa Maria
home in 1984 was approximately $161,000. Petitioners treated the
Santa Maria residence as their principal residence for purposes
of rolling over the gain on the sale of the home in 1994.
In addition to depreciation, on their 1992 Schedule C
petitioners deducted $238.90 for home insurance, $6,122.05 for
mortgage interest, $1,780.54 for property taxes, and $965.41 for
utilities related to their Santa Maria residence.
Addition to Tax and Penalties
Petitioners concede they filed their 1992 income tax return
late. The stipulated copy of the return shows it was received by
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the Internal Revenue Service Center in Fresno, California, on
April 27, 1993.
From 1987 through 1992, petitioners prepared their own tax
returns. When they began using a paid preparer in 1993, they
discontinued deducting the NOL. They also discontinued filing a
Schedule C with their 1993 income tax return. Although
petitioner called the Internal Revenue Service (IRS) to ask about
the mechanics of calculating the NOL, he did not tell anyone at
the IRS that the NOL he was planning to deduct involved lost
anticipatory wages.
OPINION
Determinations made by the Commissioner in the notice of
deficiency are generally presumed correct; the burden of proof is
on the taxpayers to show those determinations are wrong. Rule
142(a); Welch v. Helvering, 290 U.S. 111 (1933).
Net Operating Loss
Deductions are a matter of legislative grace. New Colonial
Ice Co. v. Helvering, 290 U.S. 435, 440 (1934). It is well
established in case law that no deduction is allowed under
section 165 or any other Code section for loss of potential
income. See, e.g., Hort v. Commissioner, 313 U.S. 28, 33 (1941)
(since unrealized rent is not includable in taxpayer's gross
income, taxpayer has no grounds for deduction); Stephens v.
Commissioner, T.C. Memo. 1980-131 (no deduction allowed for wages
that could have been earned had an individual's employment not
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been terminated); Johnson v. Commissioner, T.C. Memo. 1978-395
(no deduction allowed for mere expectation).
Thus, petitioner is not entitled to deduct the anticipated
wages lost because of his termination.
Trade or Business
Section 162 provides that "There shall be allowed as a
deduction all the ordinary and necessary expenses paid or
incurred during the taxable year in carrying on any trade or
business". Respondent contends that petitioner was not in a
trade or business with regard to Presto, because (1) he did not
have an "actual and honest objective of making a profit";3 or (2)
even if petitioner had the requisite profit objective, he was not
engaged in an active trade or business in 1992, but was only, at
most, in the startup phase of a trade or business. Respondent
further contends that, even if petitioner was in an active trade
or business, section 280A limits depreciation of a dwelling unit
used by the taxpayer during the year as a residence to the gross
income derived from such use for the tax year, less certain
allocable deductions. Thus, since petitioners have no gross
income, they are allowed no deduction for depreciation.
Section 195(a) provides, in relevant part, that "Except as
otherwise provided in this section, no deduction shall be allowed
for start-up expenditures." It is clear from the record that in
3
See Dreicer v. Commissioner, 78 T.C. 642 (1982), affd.
without opinion 702 F.2d 1205 (D.C. Cir. 1983).
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1992 (and up until the time of trial), petitioner had not yet
developed a product for sale, had not advertised such a product,
had no bank account books or records, and had never received any
income from Presto, and that Presto has never been a going
concern. Petitioner simply had a concept that had not yet taken
a concrete, marketable form. We therefore need not delve into
petitioner's state of mind regarding profit objective, because it
is clear that, at most, petitioner was merely in the startup
phase of a potential business.4
Courts have consistently denied deductions for startup or
preopening expenses incurred by taxpayers prior to beginning
business operations. Courts have articulated two rationales for
concluding that such expenses are not deductible under section
162(a): (1) That the taxpayer was not “carrying on” a trade or
business, Kantor v. Commissioner, 998 F.2d 1514, 1518 (9th Cir.
1993), affg. in part and revg. in part T.C. Memo. 1990-380;
Aboussie v. United States, 779 F.2d 424, 428 (8th Cir. 1985);
Richmond Television Corp. v. United States, 345 F.2d 901, 907
(4th Cir. 1965), vacated and remanded per curiam on other grounds
382 U.S. 68 (1965), or (2) that preopening expenses were not
“ordinary” but capital in nature, Madison Gas & Elec. Co. v.
Commissioner, 633 F.2d 512, 517 (7th Cir. 1980), affg. 72 T.C.
521 (1979); Hardy v. Commissioner, 93 T.C. 684 (1989). However,
4
If, however, we were to consider respondent’s other
arguments, we would find them well taken.
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because petitioner’s own statements with regard to his activities
make it clear that his expenditures were incurred in organizing,
developing, or starting up a business, we need not choose one
rationale over the other.5 Petitioner’s expenditures would be
nondeductible under either analysis.6
We therefore agree with respondent that the loss shown on
petitioners' Schedule C for 1992 must be disallowed.7
Addition to Tax and Penalties
Section 6651 provides that in case of failure to file a
timely return (including extensions), unless it is shown that
such failure is due to reasonable cause and not due to willful
neglect, there shall be added to the amount required to be shown
as tax on such return 5 percent of the amount of such tax if the
failure is for not more than 1 month. Petitioners did not
request an extension. Their 1992 income tax return was due April
15, 1993, but was filed on April 27, 1993. Thus, petitioners are
5
Petitioner has characterized his Presto activities as
“research and development”, apparently in an attempt to bring
them under sec. 174. Even if we were to find that his activities
came within that rubric (which we do not), petitioner is not
helped. He has not demonstrated a “realistic prospect” of
subsequently entering a business in connection with the fruits of
the research; i.e., by manifesting both the objective intent to
enter such a business and the capability of doing so. Kantor v.
Commissioner, 998 F.2d 1514, 1518 (9th Cir. 1993), affg. in part
and revg. in part T.C. Memo. 1990-380.
6
See also Pino v. Commissioner, T.C. Memo. 1987-28.
7
Respondent allowed the mortgage interest and real estate
taxes on petitioners’ residence, plus State taxes and
contributions, as Schedule A deductions in the notice of
deficiency.
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liable for the addition, unless they can show that the delay was
due to reasonable cause. Petitioners’ only explanation is that
they expected to receive a refund, and thus thought there would
be no penalty. The expectation of receiving a refund is not
reasonable cause to fail to do what the law requires, and the law
does not provide for any such exception. Petitioners are liable
for the addition to tax under section 6651.
Respondent also determined a penalty for negligence for each
of the years in issue. Section 6662 applies a penalty of 20
percent of the portion of any underpayment which is attributable
to negligence or disregard of rules or regulations. Sec.
6662(b)(1). The term “negligence” includes any failure to make a
reasonable attempt to comply with the provisions of the income
tax laws, and the term “disregard” includes any careless,
reckless, or intentional disregard. Petitioner did not seek
advice from either the respondent or any tax professional about
the propriety of deducting his lost anticipatory wages as an NOL,
an issue that is well settled. Neither did he seek advice about
treating his personal residence as a Schedule C expense for a
business that was, at most, in the startup phase. We believe a
reasonable person would have sought advice before taking the
positions taken by petitioners on their return. Petitioners have
the burden of proof on this issue. Inasmuch as petitioners
conceded the remaining adjustments raised in the notice of
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deficiency, we find that they were negligent as to the entire
amount of the underpayment.
In light of the foregoing,
Decision will be entered
for respondent.