Hart v. Commissioner

T.C. Memo. 1997-11

UNITED STATES TAX COURT

HUMES HOUSTON HART, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 20452-94. Filed January 7, 1997.

Humes Houston Hart, pro se.

George D. Curran, for respondent.

MEMORANDUM OPINION

VASQUEZ, Judge: Respondent determined deficiencies in and

additions to petitioner's Federal income taxes as follows:

Additions to Tax
Year Deficiency Sec. 6651(a)(1)

1987 $10,221 $100
1988 14,219 1,235
1989 635 ---
 - 2 -

The issues for decision are: (1) Whether petitioner was a

"dealer", a "trader", or an "investor" with respect to losses he

sustained in buying and selling stock during 1987, 1988, and

1989;1 (2) alternatively, whether losses petitioner sustained in

1987 from the sale of stock to satisfy a margin call requirement

are deductible as either a casualty or theft loss; (3) whether

petitioner may deduct a $58,462 net operating loss (NOL) in 1988;

(4) whether petitioner may deduct, as charitable contributions,

certain payments he made in 1987 and 1988; (5) whether petitioner

is entitled to a deduction under section 215(a)2 for amounts paid

to his former spouse in 1988 prior to the entry of a State court

order for support; and (6) whether petitioner is liable for the

addition to tax under section 6651(a)(1) for the years 1987 and

1988.

For convenience, we combine our findings of fact and opinion

under each separate issue heading. We note that for all of the

issues, petitioner has the burden of proving error in

respondent's determinations. Rule 142(a); Welch v. Helvering,

290 U.S. 111 (1933). Some of the facts have been stipulated and

are so found. The stipulation of facts and the accompanying

1
Related issues are the classification of dividend income
received on the stock, margin interest, and other investment
expenses related to holding the stock. Petitioner reported these
items on a Schedule C, Profit or (Loss) From Business or
Profession.
2
All section references are to the Internal Revenue Code
in effect for the years in issue. Rule references are to the Tax
Court Rules of Practice and Procedure.
 - 3 -

exhibits are incorporated herein by this reference. At the time

the petition was filed, petitioner maintained a permanent legal

address in Waynesville, North Carolina.

1. Dealer, Trader, or Investor

During the years in issue, petitioner was employed full time

as an information systems engineer--first by General Electric Co.

until August 1988 and then by Systems Planning Corp. until March

1989. Petitioner began investing in the stock market in 1975.

Until June 1987, petitioner considered himself an investor, after

which he considered himself a "securities trader and dealer".

Beginning with his 1987 individual Federal income tax return,

petitioner reported all activity relating to his stock purchases

and sales, such as dividend income, investment expenses, and

gains and losses, on Schedule C.

Petitioner considered his stock activity a part-time

endeavor during his full-time employment with General Electric

Co. and Systems Planning Corp. Petitioner committed

approximately 10-20 hours of his free time each week to this

activity. Petitioner listened to the radio for stock reports and

prices during his lunch hour. During the evenings at home, he

studied newspaper quotations, books, magazine articles, ran

commercial software on his computer, and analyzed stock market

data. Petitioner gave his trading instructions to his broker in

the morning, prior to the market opening.
 - 4 -

Petitioner did not hold any licenses or other professional

certifications in the securities industry. Petitioner conducted

all of his purchases and sales of securities either through a

full service or discount broker. Petitioner maintained brokerage

accounts with Ferris & Co., Inc., PaineWebber, Inc., and First

Union Brokerage Services, Inc., during the years in issue.

All of petitioner's stock transactions were engaged in

solely for his own account. Petitioner's stock activity is

summarized as follows:
1987
Month Account Purchases Sales
1/87 Ferris & Co. 1 1
2/87 Ferris & Co. 1 0
3/87 Ferris & Co. 1 3
4/87 Ferris & Co. 0 0
5/87 Ferris & Co. 0 0
6/87 Ferris & Co. 0 0
7/87 Ferris & Co. 3 3
8/87 Ferris & Co. 5 2
PaineWebber 2 0
9/87 Ferris & Co. 2 3
10/87 Ferris & Co. 1 7
PaineWebber 2 2
11/87 Ferris & Co. 0 1
PaineWebber 7 8
12/87 Ferris & Co.1 0 0
PaineWebber 14 6

1988
Month Account Purchases Sales
1/88 PaineWebber 4 10
2/88 PaineWebber 7 8
3/88 PaineWebber 4 4
4/88 PaineWebber 5 5
5/88 PaineWebber 0 2
6/88 PaineWebber 2 0
7/88 PaineWebber 0 0
8/88 PaineWebber 0 0
9/88 PaineWebber 1 0
10/88 PaineWebber 0 0
11/88 PaineWebber 0 0
12/88 PaineWebber 0 1

1989
Month Account Purchases Sales
1/89 PaineWebber 1 1
 - 5 -
2/89 PaineWebber 2 2
3/89 PaineWebber 1 0
4/89 PaineWebber 0 1
5/89 PaineWebber 2 0
First Union 1 0
6/89 PaineWebber 1 0
7/89 PaineWebber 3 1
First Union 0 1
8/89 PaineWebber 4 9
9/89 PaineWebber 0 0
10/89 PaineWebber2 0 0
1
Petitioner closed his Ferris & Co. brokerage account in December 1987.
2
Petitioner closed his PaineWebber brokerage account in October 1989.

Petitioner reported Schedule C losses of $123,801 in 1987,

$11,604 in 1988, and $5,349 in 1989 resulting from his stock

activity. Respondent disallowed petitioner's Schedule C losses

for 1987, 1988, and 1989. Respondent determined that petitioner

was not a "dealer" or "trader" in securities and that the net

losses he realized were capital losses subject to the limitations

of sections 165(f) and 1211(b). Respondent also determined that

petitioner's stock transactions were reportable on Schedule D,

his investment expenses were reportable on Schedule A, and his

dividend income was reportable on Schedule B. Petitioner argues

that he was either a "dealer" or "trader" in securities, and the

losses and related items therefrom were properly reportable on

Schedule C.

Section 165 generally provides a deduction for any loss

sustained during the taxable year and not compensated by

insurance or otherwise. Section 165(f), however, provides that

losses from the sales of capital assets should be allowed only to

the extent allowed under sections 1211 and 1212. Section 1221

defines capital assets as any property held by the taxpayer,
 - 6 -

whether or not connected with his trade or business. Section

1221(1), however, creates an exception to the definition of a

capital asset:

Stock in trade of the taxpayer or other property of a
kind which would properly be included in the inventory
of the taxpayer if on hand at the close of the taxable
year, or property held by the taxpayer primarily for
sale to customers in the ordinary course of his trade
or business * * *

Consequently, taxpayers, unless they are dealers, generally

recognize capital gain or loss upon the sale or exchange of their

stock, rather than ordinary gains or losses. In determining

whether a taxpayer who is purchasing and selling securities is

engaged in a trade or business, courts have distinguished between

a dealer, a trader, and an investor. See Estate of Yaeger v.

Commissioner, 889 F.2d 29 (2d Cir. 1989), revg. on another issue,

affg. in part, and remanding T.C. Memo. 1988-264; see also

Moller v. United States, 721 F.2d 810, 813 (Fed. Cir. 1983).

A dealer does not hold securities as capital assets if held

in connection with his trade or business. A dealer falls within

the section 1221(1) exception to capital asset treatment because

he deals in property held primarily for sale to customers in the

ordinary course of his trade or business. A trader, on the other

hand, holds securities as capital assets whether or not such

assets are held in connection with his trade or business. A

trader does not have customers and is therefore not considered to

fall within an exception to capital asset treatment. King v.

Commissioner, 89 T.C. 445, 458 (1987); Kemon v. Commissioner, 16
 - 7 -

T.C. 1026, 1032-1034 (1951). Petitioner concedes on brief and on

stipulation that he did not hold his stock as inventory; he did

not sell to customers; and he did not hold any licenses or

certifications within the securities industry. We hold that

petitioner was not a dealer. Therefore, the stocks petitioner

purchased and sold were capital assets in his hands, and the net

losses were capital losses.

Consequently, if petitioner was engaged in the trade or

business of buying and selling stocks, it was as a "trader"

rather than as a "dealer". Unlike an investor, a trader's

expenses are deducted in determining adjusted gross income rather

than as itemized expenses.3 Moreover, interest paid on loans

used to purchase or carry the trader's positions is not subject

to the investment interest limitations of section 163(d). See

King, supra; Paoli v. Commissioner, T.C. Memo. 1988-23.

In determining whether a taxpayer who manages his own

investments is a trader, we consider the following nonexclusive

factors: (1) The taxpayer's investment intent; (2) the nature of

the income to be derived from the activity; and (3) the

frequency, extent, and regularity of the taxpayer's securities

transactions. Moller v. United States, supra at 813; Mayer v.

Commissioner, T.C. Memo. 1994-209. Thus, a taxpayer is engaged

3
In contrast to trade or business expenses, a taxpayer's
investment-related expenses that are deductible under sec. 212
are subject to a limitation under sec. 67(a) and do not reduce
alternative minimum taxable income.
 - 8 -

in carrying on a trade or business as a securities trader only

where both of the following are true:

(1) The taxpayer's trading activity is substantial. King v.

Commissioner, supra at 458-459; Mayer v. Commissioner, supra. In

this regard, the taxpayer's trading activity must be frequent,

regular, and continuous enough to constitute a trade or business;

sporadic trading does not constitute a trade or business.

Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987).

(2) The taxpayer seeks to catch the swings in the daily

market movements, and to profit from these short-term changes,

Moller v. United States, supra at 813; Purvis v. Commissioner,

530 F.2d 1332, 1334 (9th Cir. 1976), affg. T.C. Memo. 1974-164;

Liang v. Commissioner, 23 T.C. 1040, 1043 (1955), rather than to

profit from the long-term holding of investments, Estate of

Yaeger v. Commissioner, supra at 33; Mayer v. Commissioner,

supra. In connection with this, courts look at whether the

taxpayer's securities income is principally derived from frequent

and substantial sale of securities rather than from dividends,

interest, or long-term appreciation. Moller v. United States,

supra at 813; King v. Commissioner, supra at 458-459; Liang v.

Commissioner, supra at 1043.

Petitioner does not meet the first prong of this two-part

test. In each year in issue, his trading was not substantial;

petitioner was not frequent, regular, or continuous in his

trading, as shown by the above summary. We conclude that
 - 9 -

petitioner was an investor in securities and not a trader. As

such, he was not conducting a trade or business. See, e.g.,

Purvis v. Commissioner, supra at 1334 (taxpayer was merely an

investor where, among other things, his sales of stock were not

regular and continuous); Paoli v. Commissioner, T.C. Memo. 1991-

351 (taxpayer consummated 326 securities sales during the year at

issue involving approximately $9 million worth of stock or

options; however, taxpayer was merely an investor where sales of

stocks were not sufficiently regular and continuous during the

entire year to constitute a trade or business).

2. Casualty or Theft Loss

On October 19, 1987 (Black Monday), the Dow Jones Industrial

Average substantially declined. Petitioner's Ferris & Co.

account likewise declined in value. Petitioner's broker at

Ferris & Co. made a margin call on petitioner on October 20,

1987. Petitioner was required to sell various stocks in his

Ferris & Co. account to meet his margin requirement. Petitioner

argues that he is entitled to deduct the loss which he incurred

on the sale of this stock to satisfy his margin requirement as

either a casualty or theft loss.

Petitioner contends that he suffered a casualty loss in that

he suffered a sudden and catastrophic loss in the value of his

stock portfolio, which was realized the following day when he was

required to liquidate his trading account to meet his margin

requirement. Petitioner contends that the events of October 1987
 - 10 -

were a "once only occurrence. No stock market decline in history

* * * has been so sudden or extensive." Whatever the historical

significance of Black Monday may be, petitioner must nevertheless

prove that this loss arose from a "casualty" within the meaning

of section 165(c)(3). Petitioner has failed to do so.

The loss sustained by petitioner resulted not from a

casualty but from the sale of his stock to satisfy his margin

requirement. This sale was not a casualty loss within the

meaning of the statute, which generally contemplates some

physical damage to the taxpayer's property. See White v.

Commissioner, 48 T.C. 430, 435 (1967); Citizens Bank of Weston v.

Commissioner, 28 T.C. 717, 720 (1957), affd. 252 F.2d 425 (4th

Cir. 1958). We also note that losses which result from the mere

fluctuation in value are not deductible as casualty losses. See,

e.g., Pulvers v. Commissioner, 407 F.2d 838 (9th Cir. 1969),

affg. 48 T.C. 245 (1967); sec. 1.165-4(a), Income Tax Regs.

Alternatively, petitioner argues that the losses he

sustained from meeting his margin call were the result of theft

perpetrated by Ferris & Co. or one of its agents. Section 165(a)

allows a deduction for any loss "sustained" during the taxable

year and not compensated for by insurance or otherwise, including

losses arising from theft. Sec. 165(c)(3). Petitioner has the

burden of showing that a theft loss occurred. Rule 142(a). A

deduction for a theft loss can only be sustained if a theft

occurred under the applicable State law. Paine v. Commissioner,
 - 11 -

63 T.C. 736, 740 (1975), affd. without published opinion 523 F.2d

1053 (5th Cir. 1975). Petitioner did not introduce any evidence

at trial which would support a finding that any of his stock or

securities were stolen. To the contrary, the record shows that

the loss petitioner sustained resulted from the sale of his stock

to satisfy his margin requirement. Petitioner has failed to

establish that he is entitled to a theft loss. See, e.g., Marr

v. Commissioner, T.C. Memo. 1995-250.

3. Net Operating Losses

On his return for 1988, petitioner claimed a net operating

carryover deduction in the amount of $58,462. In her notice of

deficiency, respondent disallowed the NOL deduction for 1988.

Petitioner offered no evidence or testimony at trial with

respect to the source or how he arrived at this deduction.

Petitioner's 1988 tax return simply shows "Net Operating Loss

(1987) $58,461.95". Furthermore, petitioner's return for the

1987 year reflects that his $123,801 loss from his stock activity

was fully offset by his wages and other income.

Petitioner contends that he sustained the NOL from his stock

activity in which he was either a dealer or a trader. Respondent

contends that petitioner is not entitled to the NOL deduction

claimed for 1988 because he presented no evidence to substantiate

the claimed NOL carryover from 1987. We agree with respondent.
 - 12 -

We have found that petitioner was not a dealer or a trader

but an investor for the 1987, 1988, and 1989 years.

Consequently, petitioner's losses from his stock activity were

capital losses. Petitioner's entry on his 1987 return is not

evidence that a loss has been incurred. See Wilkinson v.

Commissioner, 71 T.C. 633, 639 (1979); Roberts v. Commissioner,

62 T.C. 834, 837 (1974). Petitioner has failed to sustain his

burden of proving that he is entitled to an NOL deduction for

1988. Consequently, respondent's disallowance is sustained.

4. Charitable Contribution Deduction

We must consider whether petitioner is entitled to

additional charitable contribution deductions in the amounts of

$500 and $750 for the 1987 and 1988 taxable years, respectively.

Petitioner deducted $2,000 and $1,500, respectively, for

contributions made by cash or check on his 1987 and 1988 income

tax returns. Respondent allowed charitable contributions of

$1,500 and $750 for 1987 and 1988, respectively. Respondent

contends that petitioner substantiated only $25 of his charitable

contributions for 1987 and none for 1988. Petitioner argues

that, although he does not have the canceled checks or supporting

documentation, the claimed amounts are deductible as they are

based on his estimates from past years' patterns of charitable

giving.

In general, a taxpayer is entitled to deduct charitable

contribution payments made during the taxable year to or for the
 - 13 -

use of certain types of organizations. Sec. 170(a)(1), (c). A

taxpayer is required to substantiate charitable deductions;

records must be maintained. Sec. 6001; sec. 1.6001-1(a), Income

Tax Regs. Petitioner testified that he cannot substantiate the

claimed amounts because his former spouse took his tax records

when they divorced, including his canceled checks and bank

statements. We find petitioner's argument unpersuasive.

Petitioner has failed to substantiate his charitable

contributions. Respondent's determination with respect to this

issue is sustained.

5. Alimony Deduction

We must decide whether petitioner is entitled to a deduction

of $4,903 for alimony paid during 1988. Petitioner's wife filed

for divorce on August 26, 1988. On December 12, 1988, a hearing

was held with respect to the pending divorce action before the

Master of Chancery for Howard County, Maryland. Based upon the

record established at that hearing, the Circuit Court for Howard

County entered a pendente lite support order (ordering support

payments during a pending suit for divorce, hereinafter the

order) on January 23, 1989. The divorce became final in April

1990. Petitioner substantiated that he made $2,903 in support

payments during 1988. Petitioner also claimed as alimony $2,000

that his former spouse withdrew from their joint savings account

in 1988. Petitioner argues that he is entitled to deduct this

amount pursuant to the order. We disagree.
 - 14 -

Section 215(a) permits a deduction for the payment of

alimony during a taxable year. Section 215(b) defines alimony as

alimony which is includable in the gross income of the recipient

under section 71. Section 71(b)(1) defines alimony or separate

maintenance as any cash payment meeting the four criteria

provided in subparagraphs (A) through (D) of that section.

Accordingly, if any portion of the payments made by petitioner

fails to meet the four enumerated criteria, that portion is not

alimony and is thus not deductible by petitioner.

Respondent contends that the requirement of subparagraph (A)

has not been satisfied. Section 71(b)(1)(A) defines alimony or

separate maintenance payments as any payment made in cash if such

payment is received by a spouse under a divorce or separation

instrument. "Divorce or separation instrument" is defined in

section 71(b)(2) as a decree or written instrument meeting any of

the requirements in subparagraphs (A), (B), or (C). The order

issued by the circuit court is a decree ordering petitioner to

make support payments to his wife. Sec. 71(b)(2)(C). However,

payments made prior to the entry of a support decree are not

deductible under section 215. Healey v. Commissioner, 54 T.C.

1702 (1970), affd. without published opinion, 71-2 USTC par.

9536, 28 AFTR 2d 71-5217 (4th Cir. 1971); Jachym v. Commissioner,

T.C. Memo. 1984-181; see also White v. Commissioner, T.C. Memo.

1984-65. There is no evidence in the record of any other

instrument satisfying the requirements of section 71(b)(2).
 - 15 -

These payments, therefore, are considered voluntary in nature as

they were not mandated by a qualifying divorce instrument at the

time they were made. Thus, they do not qualify as alimony for

Federal income tax purposes, even though the instrument is made

retroactive to the date of the earlier payments. See, e.g.,

White v. Commissioner, supra. All of the claimed alimony

payments were made before the circuit court entered the order.

Accordingly, the payments are not deductible, and we sustain

respondent's determination with respect to this issue.

6. Delinquency Penalty

Petitioner filed Federal income tax returns for the taxable

years 1987 and 1988 on September 5, 1991. Respondent determined

that petitioner is liable for an addition to tax under section

6651(a)(1) because he failed to timely file his 1987 and 1988

Federal income tax returns or show that his delinquent filing was

due to reasonable cause.

Section 6651(a)(1) imposes a monthly charge equal to 5

percent of the amount of tax that should have been shown on the

return, subject to a maximum charge of 25 percent. The addition

to tax imposed under section 6651(a)(1) does not apply if

petitioner can prove that his failure to file was (1) due to

reasonable cause, and (2) not due to willful neglect. Sec.

6651(a); United States v. Boyle, 469 U.S. 241, 245 (1985). A

failure to file timely a Federal income tax return is due to

reasonable cause if the taxpayer exercised ordinary business care
 - 16 -

and prudence and, nevertheless, was unable to file the return

within the prescribed time. Sec. 301.6651-1(c)(1), Proced. &

Admin. Regs. Willful neglect means a conscious, intentional

failure, or reckless indifference. United States v. Boyle, supra

at 245.

Petitioner's 1987 and 1988 Federal income tax returns were

due, with extensions, on August 15, 1988, and August 15, 1989,

respectively. Petitioner filed his 1987 and 1988 returns on

September 5, 1991, in response to an inquiry from the Collection

Division of the Internal Revenue Service, well after the due

dates. Petitioner argues that he could not have filed his 1987

and 1988 returns on time because he was involved in an

adversarial divorce and that his wife had possession of his tax

records. Petitioner also argues that since he estimated that he

was due a refund for the 1987 and 1988 taxable years, it was not

a priority for him to file these returns.

We are not persuaded by petitioner's arguments. The

unavailability of records does not necessarily establish

reasonable cause for failure to file timely. See Crocker v.

Commissioner, 92 T.C. 899 (1989) (delinquency penalty upheld

where petitioner did not show what documents were still needed or

what actions were taken to obtain such documents). An individual

must file a timely return based on the best information

available; he may then file an amended return, if necessary.

Estate of Vriniotis v. Commissioner, 79 T.C. 298, 311 (1982).
 - 17 -

Petitioner testified that he could have secured all of the

necessary information to prepare and timely file his 1987 and

1988 returns from other sources. Petitioner has failed to prove

that his untimely filing was due to reasonable cause and not due

to willful neglect. Accordingly, we sustain respondent's

determination that petitioner is liable for the addition to tax

under section 6651(a)(1) for 1987 and 1988.

We have considered all arguments made by petitioner and, to

the extent not addressed above, find them to be without merit.

To reflect the foregoing,

Decision will be

entered for respondent.