T.C. Memo. 1996-388
UNITED STATES TAX COURT
CLARENCE A. HUNT, JR., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 23753-94. Filed August 20, 1996.
Clarence A. Hunt, Jr., pro se.
Elizabeth L. Groenewegen, for respondent.
MEMORANDUM OPINION
COUVILLION, Special Trial Judge: This case was heard
pursuant to section 7443A(b)(3)1 and Rules 180, 181, and 182.
Respondent determined a deficiency of $6,787 in petitioner's
1990 Federal income tax and an accuracy-related penalty of $1,357
1
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the year at issue. All Rule
references are to the Tax Court Rules of Practice and Procedure.
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under section 6662(a) for negligence or disregard of rules or
regulations under section 6662(b)(1) and for a substantial
understatement of income tax under section 6662(b)(2).
The issues for decision are: (1) Whether petitioner's horse
racing activity was an activity "not engaged in for profit" under
section 183(a), and (2) whether petitioner is liable for the
accuracy-related penalty under section 6662(a).
Some of the facts were stipulated, and those facts, with the
annexed exhibits, are so found and are incorporated herein by
reference. At the time the petition was filed, petitioner's
legal residence was Oakland, California.
Petitioner grew up near the Fairgrounds, a thoroughbred
horse racing track in New Orleans, Louisiana. His cousin, who
was a groom at the track, introduced petitioner to the grooming,
training, and racing of thoroughbred horses. Petitioner
developed a love for racehorses and fantasized of one day owning
the winning horse in the Kentucky Derby. Petitioner realized
that accomplishing such a goal would require a great deal of
capital. In the meantime, petitioner frequented different horse
racing tracks, met with trainers, and began studying horses.
In 1980, petitioner began a temporary employment business
called Allied Temporaries (Allied). Through the success of this
business, petitioner accumulated the resources necessary to begin
a horse racing activity. In 1985, petitioner obtained a license
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to be a horse owner and purchased his first thoroughbred racing
horse. He later acquired other horses but never owned more than
three horses at any given time. Prior to acquisition of his
first horse, petitioner did research as to the cost of
maintaining and training a racehorse, the potential revenue that
could be made if a horse won a "certain caliber of race", and the
rules and regulations of horse racing. Petitioner hired horse
trainers and boarded his horses at various race tracks. In 1990,
the year at issue, petitioner owned three thoroughbreds. None of
these were able to race during 1990 because they were all
injured. From 1985 to 1990, horses owned by petitioner won a few
minor races. The activity never realized a profit. Following
1990, petitioner continued the activity with no greater degree of
success until 1992 or 1993.
On his 1990 Federal income tax return, petitioner reported
expenses for training and veterinarians of $22,100, no gross
income, and a net loss of $22,100 from his horse racing activity.
Petitioner reported wage income of $91,423 from Allied.
In the notice of deficiency, respondent disallowed the horse
racing activity loss, determining the horse racing activity was
an activity not engaged in for profit under section 183, and that
petitioner had not properly substantiated the claimed expenses.
At trial, respondent conceded that the claimed expenses had been
substantiated.
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Section 183(a) provides generally that, if an activity is
not engaged in for profit, no deduction attributable to such
activity shall be allowed. Section 183(b)(1), however, provides
that deductions that are allowable without regard to whether the
activity is engaged in for profit shall be allowed. Section
183(b)(2) further provides that deductions that would be
allowable only if the activity were engaged in for profit shall
be allowed, "but only to the extent that the gross income derived
from such activity for the taxable year exceeds the deductions
allowable by reason of" section 183(b)(1).
Section 183(c) defines an activity not engaged in for profit
as "any activity other than one with respect to which deductions
are allowable for the taxable year under section 162 or under
paragraph (1) or (2) of section 212." The Court inquires whether
the taxpayer is engaged in the activity with the "actual and
honest objective of making a profit." Ronnen v. Commissioner, 90
T.C. 74, 91 (1988); Dreicer v. Commissioner, 78 T.C. 642, 645
(1982), affd. without published opinion 702 F.2d 1205 (D.C. Cir.
1983). The taxpayer's expectation of profit need not be a
reasonable one, but there must be a good faith objective of
making a profit. Dreicer v. Commissioner, supra at 645; sec.
1.183-2(a), Income Tax Regs. The determination of whether the
requisite profit objective exists is to be resolved on the basis
of all the surrounding facts and circumstances of the case.
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Golanty v. Commissioner, 72 T.C. 411, 426 (1979), affd. without
published opinion 647 F.2d 170 (9th Cir. 1981); sec. 1.183-2(b),
Income Tax Regs. Greater weight is to be given to the objective
facts than to the taxpayer's mere statement of his intent.
Dreicer v. Commissioner, supra at 645; sec. 1.183-2(a), Income
Tax Regs. The taxpayer has the burden of proving the requisite
intent, and that the Commissioner's determination that the
activity was not engaged in for profit is incorrect. Rule
142(a); Welch v. Helvering, 290 U.S. 111 (1933).
Although the question of the taxpayer's profit objective is
a subjective one, objective indicia may be considered to
establish the taxpayer's true intent. Sec. 1.183-2(a), Income
Tax Regs. Section 1.183-2(b), Income Tax Regs., sets forth a
nonexclusive list of nine objective factors to be considered when
ascertaining a taxpayer's intent. 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 the assets used in the activity may
appreciate in value; (5) the success of the taxpayer in carrying
on other similar or dissimilar activities; (6) the taxpayer's
history of income or losses with respect to the activity; (7) the
amount of occasional profits, if any; (8) the financial status of
the taxpayer; and (9) the elements of personal pleasure or
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recreation involved in the activity. These factors are not
merely a counting device where the number of factors for or
against the taxpayer is determinative, but rather all facts and
circumstances must be taken into account, and more weight may be
given to some factors than to others. Cf. Dunn v. Commissioner,
70 T.C. 715, 720 (1978), affd. 615 F.2d 578 (2d Cir. 1980). Not
all factors are applicable in every case, and no one factor is
controlling. Abramson v. Commissioner, 86 T.C. 360, 371 (1986);
Allen v. Commissioner, 72 T.C. 28, 34 (1979); sec. 1.183-2(b),
Income Tax Regs.
In considering the objective factors relevant to this case,
the Court is satisfied, based on the record, that petitioner has
not sustained his burden of establishing that he conducted his
horse racing activity with an actual and honest objective of
making a profit in 1990. Petitioner did not present any
documentary or other evidence to show that his activity was
carried on in a businesslike manner or that he maintained
complete and accurate books and records of the activity. Nor did
petitioner present any evidence of the amount of time he expended
on the activity. On the other hand, it is clear from the record
that petitioner's employment with Allied was full time. Further,
the Court cannot ignore the fact that petitioner realized only
nominal gross income and never realized a profit from the
activity over the period from 1985 to 1990 and thereafter.
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Petitioner acknowledged at trial that "I didn't have any success
at all." However, he produced no evidence to show that he
changed the manner in which he operated his activity in order to
make the activity profitable. It is quite evident that
petitioner derived tremendous pleasure from the activity. He had
a great love for horses and fantasized winning the Kentucky
Derby. Despite that fantasy, however, he failed to conduct the
activity with an intent that, at some realistic point, it would
attain a profitable status. Respondent, therefore, is sustained
on this issue.
The next issue is whether petitioner is liable for the
addition to tax under section 6662(a). Section 6662(a) provides
that, if that section is applicable to any portion of an
underpayment in taxes, there shall be added to the tax an amount
equal to 20 percent of the portion of the underpayment to which
section 6662 applies. Under section 6664(c), no penalty shall be
imposed under section 6662(a) with respect to any portion of an
underpayment if it is shown that there was a reasonable cause,
and that the taxpayer acted in good faith with respect to the
underpayment.
Section 6662(b)(1) provides that section 6662 shall apply to
any underpayment attributable to negligence or disregard of rules
or regulations. Negligence is defined as lack of due care or
failure to do what a reasonable and ordinarily prudent person
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would do under like circumstances. Neely v. Commissioner, 85
T.C. 934 (1985). The term "negligence" includes any failure to
make a reasonable attempt to comply with the provisions of the
Internal Revenue laws, and the term "disregard" includes any
careless, reckless, or intentional disregard of rules or
regulations.
Section 6662(b)(2) provides that section 6662 shall apply to
any portion of the underpayment attributable to any substantial
understatement of income tax. There is a substantial
understatement of income tax if the amount of the understatement
exceeds the greater of (1) 10 percent of the tax required to be
shown on the return, or (2) $5,000. Sec. 6662(d)(1)(A). For
purposes of section 6662(d)(1), "understatement" is defined as
the excess of tax required to be shown on the return over the
amount of tax that is shown on the return reduced by any rebates.
Petitioner improperly claimed on his 1990 Federal income tax
return a $22,100 net loss from his horse racing activity.
Furthermore, petitioner presented no evidence to establish that
he was not negligent or did not disregard rules or regulations.
The Court concludes that petitioner was negligent or in disregard
of rules or regulations for purposes of section 6662(b)(1).
Petitioner has not established that any of the reductions under
section 6662(d)(2)(B) would apply to show that he did not have a
substantial understatement of income tax for 1990 for purposes of
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section 6662(b)(2) relating to the penalty for any portion of the
underpayment attributable to any substantial understatement of
income tax.
The maximum accuracy-related penalty imposed on an
underpayment of tax may not exceed 20 percent of such
underpayment, notwithstanding that such portion is attributable
to more than one of the types of misconduct described in section
6662(a). Sec. 1.6662-2(c), Income Tax Regs. Therefore, although
the underpayment of tax required to be shown on petitioner's 1990
income tax return was attributable to both negligence and a
substantial understatement of income tax, the maximum accuracy-
related penalty petitioner is liable for is 20 percent.
Petitioner did not make a showing that there was a
reasonable cause for the understatements of income under section
6664(c). Accordingly, respondent is sustained on the imposition
of the accuracy-related penalty under section 6662(a).
Decision will be entered
for respondent.