T.C. Memo. 1997-71
UNITED STATES TAX COURT
THOMAS B. DRUMMOND, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 16958-94. Filed February 10, 1997.
William F. Krebs and Mark E. Kellogg, for petitioner.
Susan T. Mosley, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
CHIECHI, Judge: Respondent determined the following
deficiencies in, additions to, and accuracy-related penalties on
petitioner's Federal income tax:
Additions to Tax Accuracy-Related Penalties
Year Deficiency Sec. 6651(a)(1)1 Sec. 6662(a)
1989 $23,141.00 $1,053.80 $5,544.00
1990 30,954.00 7,738.47 5,340.60
1991 25,657.00 -- 4,778.20
1
All section references are to the Internal Revenue Code (Code)
in effect for the years at issue. All Rule references are to the
Tax Court Rules of Practice and Procedure.
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The issues remaining for decision are:
(1) Was the drawing that petitioner sold during 1989
"property held by the taxpayer primarily for sale to customers in
the ordinary course of his trade or business" within the meaning
of section 1221(1)? We hold that it was not, and we further hold
that the gain that petitioner realized from the sale of that
drawing is long-term capital gain.2
(2) Did petitioner engage in his horse activity during
1989, 1990, and 1991 and his cattle activity during 1990 and 1991
with the objective of making a profit within the meaning of
section 183? We hold that he did not.
(3) Is petitioner liable for 1989 and 1990 for the addition
to tax under section 6651(a)(1)? We hold that he is not for 1989
and that he is for 1990 to the extent stated herein.
(4) Is petitioner liable for 1989, 1990, and 1991 for the
accuracy-related penalty under section 6662(a)? We hold that he
is to the extent stated herein.
2
The parties agree that the Court's holding on the character-
ization of petitioner's gain from that sale will be dispositive
of the remaining issues presented under secs. 404(h)(1)(C) and
4972(a).
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FINDINGS OF FACT3
Some of the facts have been stipulated and are so found.
Petitioner resided in The Plains, Virginia, at the time the
petition was filed.
During all relevant periods, petitioner, who holds a bache-
lor's degree in philosophy, a master's degree in clinical psy-
chology, and a Ph.D. degree in psychology, practiced as a psy-
chologist and his income from that practice provided his support.
Throughout the years at issue, petitioner devoted an average of
58 hours a week to his psychology practice.
From the late 1970's through sometime in 1987, petitioner
served as a director of several mental health clinics that are
part of the Prince George’s County, Maryland, health system.
From sometime in 1987 through 1989, petitioner practiced as a
psychologist at the Saint Luke Institute, a private psychiatric
hospital in Suitland, Maryland. From 1988 through 1994, peti-
tioner provided psychological testing and counseling services
under the name Psychological Testing Services. From 1989 through
1994, petitioner provided psychological services at the New Life
3
At the conclusion of the trial herein, the Court ordered the
parties to file simultaneous opening and answering briefs. Both
of petitioner's briefs failed to comply with Rule 151(e)(3). For
example, petitioner's opening brief did not contain proposed
findings of fact as required by that Rule. However, his answer-
ing brief contained what amounted to proposed findings of fact to
which respondent did not have the opportunity to object. Conse-
quently, we did not use the proposed findings of fact contained
in petitioner's answering brief as an aid in finding the facts in
this case.
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Center (New Life Center), a residential center for psychiatric
patients, which he and another psychologist founded in March
1989.
The Drawing in Question
During the 1970's, petitioner, who at all relevant times has
had an interest in and enjoyed art, purchased at least six draw-
ings through auctions, galleries, or private sales, including one
entitled “Three Feminine Heads” (drawing in question) that he
purchased during the early 1970's for $1,300 from a gallery in
Washington, D.C., and that had been attributed to the artist
Michelangelo Anselmi (Anselmi). When petitioner acquired those
drawings, he did not intend to sell them. Drawings of the type
that petitioner purchased had often been used by their respective
artists as models for their own paintings, sculptures, and/or
frescos.
Petitioner conducted research throughout the 1970's and into
the 1980's on the drawings that he had acquired during the
1970's.4 As a result of that research, petitioner concluded that
certain drawings of the type that he had purchased either were
not attributed to particular artists or were attributed, as was
subsequently determined was the case with the drawing in ques-
4
For example, petitioner asked certain experts at the National
Gallery of Art in Washington, D.C. (National Gallery) to ascer-
tain whether the drawings that he had acquired were structurally
sound, that is to say, whether they were on acid-producing paper,
which would eventually deteriorate. There are inconsistencies in
the record as to when petitioner undertook such research.
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tion, to the wrong artists and that art museum curators knowl-
edgeable about both museum and privately-owned art collections
were qualified to determine the artists of such drawings.
Around the early 1980's, based on a visual comparison of the
drawing in question with drawings properly attributed to Anselmi,
petitioner became convinced that Anselmi had not sketched that
drawing; the curator of Italian drawings at the National Gallery
(curator of Italian drawings) became interested in the drawing in
question; that curator advised petitioner that she was fairly
certain that the drawing in question was attributable to a
follower of Correggio, who worked, as did Correggio, in Parma,
Italy, during the 16th century; petitioner lent that drawing to
the National Gallery; and the curator of Italian drawings con-
ducted research on it and attributed it to a follower of
Correggio named Franco Parmagianino (Parmagianino).
For some undisclosed period of time after the drawing in
question was attributed to Parmagianino, the curator of Italian
drawings caused the drawing in question to receive international
exposure by having it displayed in art exhibits at the National
Gallery and in Parma, Italy. During that period, that drawing
also received international exposure through newspaper articles
about it in the United States and Italy and photographs of it in
museum art catalogues.
During 1988 or 1989, Christie's Auction House in New York
City (Christie's) advised petitioner that the drawing in question
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could be sold at auction for approximately $100,000 and expressed
an interest in auctioning it on his behalf.5 At or about the
same time, the curator of Italian drawings informed petitioner
that the National Gallery was interested in purchasing that
drawing. Petitioner advised her that Christie's could sell the
drawing in question at auction for $100,000 and that he would be
willing to sell it to the National Gallery for an amount exceed-
ing $100,000. Thereafter, petitioner received a letter from the
National Gallery offering to purchase the drawing in question for
$115,000. In January 1989, petitioner sold it to that museum for
that amount.
During all relevant periods, petitioner did not own or
acquire any drawings, other than the drawing in question, that
were either unattributed or misattributed and for which proper
attribution was obtained. During the 1970's, petitioner did not
attempt to sell any of the drawings that he had acquired during
those years. During the period 1985 through 1994, petitioner did
not sell any artwork or collectible, other than the drawing in
question. After the sale of the drawing in question, petitioner
did not use the proceeds from its sale to purchase other drawings
for purposes of attribution and sale.
Petitioner's Simplified Employee Pension
During 1989, petitioner informed his tax preparer, Thomas A.
5
At some time prior to 1982, petitioner attempted to sell the
drawing in question through Christie's. However, upon being
advised by Christie's that that drawing had a value of $500,
petitioner decided not to auction it at that time.
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McVeigh, Jr. (Mr. McVeigh), about the sale of the drawing in
question and inquired about establishing some type of retirement
plan. Mr. McVeigh advised petitioner to consult with Earl
Schoenborn about establishing a retirement plan. The three of
them met and discussed the amount of the contribution that
petitioner could make to a retirement plan for 1989 after taking
into account the approximate amount of petitioner's income and
expenses during 1989 from various sources, including the New Life
Center and the sale of the drawing in question.
Sometime thereafter, petitioner chose to consult with
another individual about establishing a retirement plan. Peti-
tioner established a simplified employee pension (SEP) for 1989
to which he contributed $20,000. Petitioner's contributions to
the SEP for 1990 and 1991 were $30,000 and $26,000, respectively.
Petitioner's Horse Activity and Cattle Activity
Petitioner's Horse Activity
During the early 1970's, petitioner, who has at all relevant
times enjoyed equestrian activities, owned a horse, took riding
lessons, and learned how to train a horse (1) to perform at an
unspecified level in dressage and (2) to do low-level jumps,
provided that the horse had received some training in jumping.
In July 1988, petitioner, who did not have any formal
training as a horse breeder or a horse trainer, purchased for
approximately $8,000 a five-year old thoroughbred gelding named
Moonshadow (Moonshadow) that had received some training in riding
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and jumping as a result of having been used in fox hunting and
that had been exhibited in certain horse shows. When he acquired
Moonshadow, petitioner believed that it was a willing jumper. He
planned to train Moonshadow in dressage, jumping, and/or cross-
country riding, although he was aware that such activities would
expose that (as well as any other) horse to a significant risk of
injury. Although petitioner expected to spend around two years
in training a horse such as Moonshadow, he was aware that the
training period could vary depending, inter alia, on the level of
training that it had received prior to the time he purchased it
and the type of training that he chose to provide to it. Peti-
tioner hoped to be able to sell Moonshadow after it was trained.
During the period 1988 through sometime in 1990, petitioner
spent about two-and-a-half to three hours a day, or about 15 to
18 hours a week in riding, exercising, and caring for Moonshadow.
Petitioner spent that time during the mornings when he was not
providing services as a psychologist.
At no time did petitioner investigate or project the price
at which he would have to sell Moonshadow in order to realize a
profit from such a sale. Nor did he contemplate or inquire about
the risks associated with owning a gelding such as Moonshadow if
it were to become lame (i.e., not only could it not continue its
training in, or be used for, any of the activities that peti-
tioner had in mind when he acquired Moonshadow, it also could not
be used for breeding). In fact, petitioner did not become aware
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of those risks until Moonshadow became lame sometime during 1990,
approximately 18 months after petitioner had acquired it.
Petitioner had physical examinations, x-rays, and blood work
performed on Moonshadow. However, the cause of Moonshadow's
lameness was not determined. Although petitioner provided
Moonshadow with bed rest and took certain measures to alleviate
the horse's pain, he was unable to rehabilitate it. Around 1995,
petitioner donated Moonshadow to the Virginia Polytechnic Insti-
tute (VPI).
Although petitioner became aware of the risks associated
with owning a gelding after his experience with Moonshadow during
1990, he nonetheless decided to purchase another gelding because
geldings were considered to be the most valuable show horses.
Consequently, sometime during 1990, after Moonshadow became lame,
petitioner purchased for approximately $8,000 another gelding, a
five-year old named Gator (Gator) that already had had some
minimal training. Sometime during or after the spring of 1994,
petitioner retained the services of a horse trainer who worked
with Gator on suppling exercises on the flat, lead changes, and
consistency in the show ring. At unspecified times after the
purchase of Gator, petitioner entered it in certain horse shows
not for the nominal prize money, but for the recognition that it
might gain that would make it attractive to potential buyers.
Gator, however, exhibited certain difficulties that will prevent
it from ever becoming a show horse of great value.
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After his experience with Moonshadow during 1990, petitioner
concluded that if he were to purchase either a mare or a stallion
and that horse were to become lame or otherwise to lack athletic
ability, it could still be used for breeding purposes. Sometime
during 1990, after Moonshadow became lame, petitioner purchased
for approximately $3,500 to $4,000 a proven broodmare, a four-
year old thoroughbred named Jill (Jill) that had had no training
except for training in accepting a rider. Thereafter, around
1990, petitioner rode Jill, concluded that it did not possess the
characteristics necessary for a show horse or a competitive
horse, which he did not realize when he purchased Jill, and
decided to use it only for breeding purposes.6
Around 1990, petitioner bred Jill to an internationally
acclaimed dressage Trakehner stallion, even though he knew that a
crossbreeding of a thoroughbred and a Trakehner would probably
require that any male offspring be gelded. During 1991, the
crossbreeding of Jill produced a colt named Zack (Zack) that was
gelded within nine months thereafter.
Around 1992, when Zack was a year old, it was trained to
accept a lightweight rider. Around 1995, when Zack was a three-
year old, it was trained to accept a rider of normal weight and
6
Any horse that petitioner acquired through the breeding of a
mare such as Jill (1) would not be ready for serious training
until the age of two at which time it could support a rider;
(2) could not perform and compete as a show horse until the age
of three; and (3) could not become a show horse of great value
until at least the age of six.
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was trained to jump by a professional trainer that petitioner
hired. Sometime thereafter, Zack developed pedalostitis, a foot
disease that prevented it from performing athletic activities.
Around 1995, petitioner donated Zack to VPI.
During 1992, petitioner met Sue Attisani Lyman (Ms. Lyman),
a horse trainer and breeder since 1979, and bred Jill to Ms.
Lyman's stallion for a stud fee of approximately $1,000. That
breeding produced a filly named Lily (Lily) around 1993. During
1995, when petitioner started to provide Lily with some undis-
closed type of training, he discovered that it had fractured its
shoulder and hip and could not be trained as an athlete at that
time, and he therefore abandoned any attempt to train Lily at
that time. As of the time of the trial herein, petitioner
planned to breed Lily in the spring of 1996 and to sell it as a
broodmare.
Around 1993, petitioner again bred Jill to Ms. Lyman's
stallion for a stud fee of between $1,000 and $1,900. That
breeding produced a filly named Bunny (Bunny) during 1994.
Petitioner entered Bunny (1) in a horse show as a six-week old
with its dam Jill where it performed favorably; (2) in a horse
show as a yearling where it was the winner in a particular class;
and (3) in an international horse show for young prospective show
horses where it was the champion for yearling fillies. At some
undisclosed time during 1995, petitioner entered into a contract
to sell Bunny for $8,500 that was conditioned on the purchaser's
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ability to raise the necessary funds. Because of the purchaser's
inability to do so, the sale was not consummated. Although
during the fall of 1995 petitioner saddled Bunny and allowed it
to be ridden, he did not intend to provide other training for it
until it was three years old.
In December 1994, petitioner purchased another broodmare
that had a filly in the spring of 1995.
In the spring of 1995, petitioner and Ms. Lyman jointly
(1) purchased a three-year old untrained gelding named Ziggy
(Ziggy) for $10,000, a price that was substantially below its
fair market value; (2) sold it about a month later for $30,000;
and (3) split a substantial profit after accounting for their
minimal expenses (e.g., boarding, training, and veterinarian
fees) of between $500 and $1,000.
Prior to 1993 or 1994, petitioner boarded his horses at
facilities owned by others and incurred total average expenses
for each such horse of about $500 a month. Around 1993 or 1994,
petitioner began boarding the horses that he then owned in the
barn and paddocks located on real property (NLC land) that he had
acquired near Middleburg, Virginia, and that the New Life Center
was using as a residential facility for patients.
At some unspecified time during the period 1992 through
1995, petitioner asked Ms. Lyman to give him riding lessons and
to advise him on how to market his young horses. Starting in the
spring of 1994, petitioner asked Ms. Lyman from time to time to
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train some of his horses, including Gator.
At no time did petitioner retain the services of anyone to
appraise the fair market value of his horses. Petitioner did not
project during the years at issue, or at any other time, the
future income, expenses, or profits that he expected would be
generated by his horse activity.
Petitioner’s Cattle Activity
Sometime during 1990, petitioner, who did not have any
formal training as a cattle breeder, purchased for $3,000 a herd
of cattle consisting of a bull and four cows (cows) with calf.
During 1990 or 1991, and each year thereafter, the cows produced
calves. Petitioner kept the bull, cows, and calves (cattle) on
the NLC land. During the winter months, the cattle consumed
approximately five bales of hay that cost about $35 to $50 a
bale, and, during the remainder of the year, they consumed the
grass on the NLC land.
Petitioner kept the calves produced by his cows for six to
seven months until they weighed around 250 pounds, at which time
he sold them for approximately $250 each.
Petitioner did not project during 1990, or at any other
time, the future income, expenses, or profits that he expected
would be generated by his cattle activity.
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Petitioner’s Books and Records
Relating to His Horse Activity
and His Cattle Activity
During the years at issue, petitioner did not maintain a
separate bank account for either his horse activity or his cattle
activity. During those years, petitioner retained invoices,
receipts, and canceled checks relating to the expenses that were
incurred in those activities.7 However, he did not maintain
books or records such as ledgers and registers to memorialize the
various transactions relating to those activities or to maintain
a historical record of those activities (e.g., the dates on which
horses were purchased, foals and calves were born, and calves
were sold; the specific nature of any training that the horses
that he owned received; and the specific periods during which any
such training was provided).
Petitioner's Tax Returns
For the years 1988 through 1991, petitioner, who has a
limited knowledge of the Federal income tax laws and who has not
had any formal training in accounting or tax matters, retained
the services of Mr. McVeigh, a tax return preparer since about
1982, to prepare his individual Federal income tax returns
(returns).
Petitioner relied on Mr. McVeigh to prepare requests to
extend the time within which to file his returns for 1989 and
7
Those invoices, receipts, and canceled checks are not part of
the record in this case.
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1990. Mr. McVeigh completed and filed on petitioner's behalf
Forms 4868 (Application for Automatic Extension of Time to File
U.S. Individual Income Tax Return (application for automatic
extension)) for those years that were dated April 11, 1990, and
April 5, 1991, respectively, signed by petitioner, and requested
a four-month extension of time until August 15, 1990, and August
15, 1991, respectively, within which to file his returns for
those years. Line 1 of each of those applications required
petitioner to make a reasonable estimate, based on the informa-
tion available, of his tax liability for the year for which he
was seeking an extension. In arriving at the respective esti-
mated tax liabilities for 1989 and 1990 that Mr. McVeigh showed
on line 1 of petitioner's applications for automatic extension
for those years, Mr. McVeigh believed it reasonable, and so
advised petitioner, that, given petitioner's situation, those
estimates be based on the tax liability shown in petitioner's
return for the year immediately preceding the year for which each
such application was being filed, provided that petitioner paid
each of those estimated tax liabilities by the time he filed each
such application. Since the tax liabilities shown in peti-
tioner's 1988 and 1989 returns were $9,041 and $9,043, respec-
tively, Mr. McVeigh entered on line 1 of petitioner's applica-
tions for automatic extension for 1989 and 1990 estimated tax
liabilities of $9,100 and $9,043, respectively. Those respective
applications also indicated that for 1989 estimated tax payments
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of $9,100 were made by petitioner and that for 1990 $4,908 of tax
was withheld from petitioner and $4,135 of tax was paid with his
1990 application for automatic extension.
Petitioner filed returns for 1989 and 1990 that were dated
August 14, 1990, and October 25, 1991, respectively, were re-
ceived by the Internal Revenue Service (Service) on August 23,
1990, and November 1, 1991, respectively, and showed total tax
liabilities of $9,043 and $15,716, respectively.8
Petitioner took account of the following items to arrive at
the adjusted gross income of $61,892, $95,024, and $152,576 shown
in his respective returns for 1989, 1990, and 1991:
1989 1990 1991
Wages, salaries, etc. $14,923 $49,000 $86,500
Taxable interest 1,956 982 441
Dividends 55 947 1,720
Tax refunds -- 1,315 --
Schedules C
Net profit from
art sales 99,0009 -- --
Loss from commodities
and other investments 2,925 -- --
1989 1990 1991
Loss for 1989 and net
profit for 1990 from
the New Life Center 44,375 32,718 --
8
All dollar amounts are rounded to the nearest dollar.
9
In Schedule C of his 1989 return relating to art sales, peti-
tioner reported $100,000 as "Gross receipts or sales", $1,000 as
"Cost of goods sold and/or operations", and $99,000 as "Net
profit" with respect to the sale of the drawing in question.
Petitioner concedes that he sold that drawing for $115,000,
purchased it for $1,300, and realized a gain of $113,700 from its
sale.
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Net profit from
Psychological
Testing Services 7,372 34,930 104,371
Schedule D capital gain 18,339 -- 1,373
Schedule E loss for 1989
and income for 1991 2,200 -- 4,317
Schedule F loss 10,253 7,780 19,588
Deduction for one-half of
self-employment tax -- 176 558
Deduction for SEP
contribution 20,000 16,912 26,00010
With respect to the $99,000 net profit that petitioner
reported in Schedule C of his 1989 return relating to art sales,
petitioner informed Mr. McVeigh that he sold the drawing in
question during 1989 at a gain. Mr. McVeigh advised petitioner
that an important factor in characterizing that gain as self-
employment income was whether petitioner continued to purchase
and sell drawings in the future. Petitioner informed Mr. McVeigh
that he intended to do so. Based on the information that peti-
tioner provided to Mr. McVeigh, Mr. McVeigh concluded that the
gain from the sale of the drawing in question constituted self-
employment income, and not long-term capital gain, and that it
should be reported in a Schedule C of petitioner's 1989 return
relating to art sales.
With respect to the automobile expense deductions claimed in
Schedules C of petitioner’s returns for the years at issue
relating to Psychological Testing Services, petitioner gave Mr.
10
Although petitioner's 1991 return erroneously showed that
deduction as a deduction for "self-employed health insurance",
the parties agree that that deduction was for petitioner's 1991
SEP contribution.
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McVeigh information about the expenses relating to the business
use of his automobile (e.g., the type of vehicle that he used for
business purposes, the percentage of business use of that vehi-
cle, and the miles traveled with that vehicle for business
purposes). Mr. McVeigh advised petitioner that he could claim as
an expense for the business use of his automobile either (1) a
standard mileage deduction or (2) a deduction for depreciation
and certain actual expenses (e.g., gasoline). However, in
preparing Schedules C of petitioner's returns for the years at
issue relating to Psychological Testing Services, Mr. McVeigh
erroneously claimed both a standard mileage deduction and a
deduction for depreciation and certain actual automobile ex-
penses, as follows:
Depreciation Standard Other
Year Expense Mileage11 Expenses12
1989 $2,167 $956 --
1990 2,600 875 $1,530
1991 2,550 1,856 634
Respondent determined in the notice of deficiency (notice),
and petitioner concedes, that petitioner is not entitled to
reduce his income from Psychological Testing Services for the
11
The standard mileage deductions claimed in Schedules C of
petitioner's returns for 1989, 1990, and 1991 relating to Psycho-
logical Testing Services were shown as deductions for "Car and
truck expenses".
12
The deductions for certain other automobile expenses that
were claimed in Schedules C of petitioner's returns for 1990 and
1991 relating to Psychological Testing Services were shown as
deductions for insurance and interest expenses.
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years at issue by the following automobile expenses (disallowed
automobile expenses) claimed in Schedules C of his returns for
those years: (1) All claimed depreciation expenses for those
years and (2) other expenses of $293 claimed for 1990. Peti-
tioner was not aware of the errors relating to the disallowed
automobile expenses that appeared in his returns for the years at
issue and could not have detected them by reviewing those re-
turns.
Based on what petitioner told Mr. McVeigh about his horse
activity and his cattle activity, including that he intended to
buy, train, and sell horses and that he had incurred certain
expenses for various stables and training centers that Mr.
McVeigh believed to be reputable, Mr. McVeigh concurred in
petitioner's conclusion, and he and petitioner jointly decided,
that the gross income, expenses, and loss from petitioner's horse
activity during 1989 and the aggregate income, expenses, and
losses from his horse activity and cattle activity during 1990
and 1991 should be reported in Schedules F of petitioner's
returns for those years and that any loss from those activities
could be used to reduce petitioner's income from other sources
that was reported in those returns.
Schedule F of petitioner's return for each of the years 1988
and 1989, during which petitioner was engaged only in his horse
activity, and not his cattle activity, reflected the following
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income, expenses, and loss from that horse activity:
Year Income Expenses Loss
1988 -- $3,648 $3,648
1989 -- 10,253 10,253
Schedule F of petitioner's return for each of the years 1990
through 1994, during which he was involved in both his horse
activity and his cattle activity, did not show separately the
income and expenses attributable to each such activity. Instead,
those schedules reflected the following aggregate income, ex-
penses, and losses from both of those activities:
Aggregate Aggregate Aggregate
Year Income Expenses Losses
1990 -- $7,780 $7,780
1991 $1,024 20,612 19,588
1992 1,017 29,708 28,691
1993 61,27513 72,32814 11,053
1994 1,083 38,561 37,478
All of the income that petitioner reported in Schedules F of
his 1991, 1992, and 1994 returns and $1,275 of the income that he
reported in Schedule F of his 1993 return were attributable to
his cattle activity and represented income that he received
during each of those years from the sale of calves. During 1991,
petitioner incurred expenses of $1,024 in connection with his
13
The aggregate income reported in Schedule F of petitioner's
1993 return included an unexplained income item of $60,000 that
petitioner reported as "Other income".
14
The aggregate expenses reported in Schedule F of petitioner's
1993 return included an unexplained interest expense of $29,202.
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cattle activity.15
With respect to the $20,000 contribution that petitioner
made to the SEP for 1989, petitioner informed Mr. McVeigh in
April 1990 that he had established a retirement plan to which he
timely contributed $20,000 and related the conversations that he
had had with the individual who had assisted him in establishing
that plan. Mr. McVeigh advised petitioner that the deductible
amount of that contribution was limited to a percentage not to
exceed 25 percent of petitioner's self-employment income and that
that percentage varied depending on the nature of the retirement
plan. Based on the information that petitioner gave Mr. McVeigh
about, inter alia, the retirement plan that he had established
and the sale of the drawing in question, Mr. McVeigh advised
petitioner that he was entitled to deduct for 1989 his $20,000
contribution to that plan to the extent of 25 percent of his
self-employment income for that year.16 Mr. McVeigh further
advised petitioner that, in calculating his self-employment
income for 1989 for purposes of determining the deductible
portion of his $20,000 retirement plan contribution, he should
take into account only the Schedules C of his 1989 return that
15
The record does not disclose the expenses that petitioner
incurred during the years 1990, 1992, 1993, and 1994 in connec-
tion with his cattle activity.
16
At trial, the parties agreed that any deduction to which
petitioner may be entitled for each of the years 1989, 1990, and
1991 for contributions that he made to the SEP for each of those
years is limited by sec. 404(h)(1)(C) to 15 percent, and not 25
percent, of his self-employment income for each such year.
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showed net profits (viz., $99,000 net profit from art sales and
$7,372 net profit from Psychological Testing Services), and not
the Schedules C that showed losses (viz., $2,925 loss from
commodities and other investments and $44,375 loss from New Life
Center). Consequently, petitioner deducted in his 1989 return
the entire $20,000 that he contributed to the SEP. That deduc-
tion exceeded (by $5,075) 25 percent of the aggregate amount
(viz., $59,702) of the results shown in the various Schedules C
of that return that petitioner reported as his "Business income"
(business income) on page 1, line 12 of that return.
With respect to the $30,000 contribution that petitioner
made to the SEP for 1990, petitioner deducted $16,912 in his
return for that year. That deduction equaled 25 percent of the
aggregate amount (viz., $67,648) of the results shown in the
various Schedules C of that return that petitioner reported as
his business income for 1990. With respect to the $26,000
contribution that petitioner made to the SEP for 1991, petitioner
deducted that entire amount in his return for that year. That
deduction equaled 24.91 percent of the amount (viz., $104,371)
shown in Schedule C of that return that petitioner reported as
his business income for 1991.
At the time that Mr. McVeigh prepared petitioner's returns
for the years at issue, Mr. McVeigh did not know of any adverse
tax consequences that might result if petitioner's retirement
plan contribution for each such year exceeded the amount allow-
- 23 -
able as a deduction (excess contribution). Mr. McVeigh advised
petitioner that he could make excess contributions, with the only
consequence being that he could not deduct them.
After Mr. McVeigh prepared petitioner's return for each of
the years at issue, he provided petitioner with a copy of each
such return and pointed out to him the amount of tax that each
such return showed as due. Petitioner did not review any of
those returns and was merely interested in knowing the amount of
tax due so that he could write a check for that amount.
OPINION
Petitioner bears the burden of proving that respondent's
determinations in the notice are erroneous. Rule 142(a); Welch
v. Helvering, 290 U.S. 111, 115 (1933).
Petitioner attempted to satisfy his burden of proof in this
case through his own testimony and that of Mr. McVeigh and Ms.
Lyman. We found the testimony of Mr. McVeigh and Ms. Lyman to be
credible. We found petitioner's testimony to be general, vague,
conclusory, and/or questionable in certain material respects.
Under the circumstances presented here, we are not required to,
and we generally do not, rely on petitioner's testimony to
sustain his burden of establishing error in respondent's determi-
nations. See Lerch v. Commissioner, 877 F.2d 624, 631-632 (7th
Cir. 1989), affg. T.C. Memo. 1987-295; Geiger v. Commissioner,
440 F.2d 688, 689-690 (9th Cir. 1971), affg. per curiam T.C.
Memo. 1969-159; Tokarski v. Commissioner, 87 T.C. 74, 77 (1986).
- 24 -
Gain from the Sale of
the Drawing in Question
The parties agree that petitioner purchased the drawing in
question during the 1970's for $1,300, sold it during 1989 for
$115,000, and realized a gain of $113,700 from that sale. The
dispute here is whether that gain should be characterized as
ordinary income, as petitioner contends, or as long-term capital
gain, as respondent contends. The parties agree that if the
Court were to determine that that gain is long-term capital gain,
petitioner would not be entitled to deduct any amount for his
contribution to the SEP for 1989 and that he would be liable for
the excise tax imposed by section 4972(a) as determined by
respondent.17 The parties further agree that the resolution of
the dispute over the character of the gain from the sale of the
drawing in question depends on whether that drawing is "property
held by * * * [petitioner] primarily for sale to customers in the
ordinary course of his trade or business" within the meaning of
section 1221(1). If it is, the gain at issue is ordinary income,
and not capital gain.
The purpose of section 1221(1) is to "differentiate between
the 'profits and losses arising from the everyday operation of a
business' * * * and 'the realization of appreciation in value
17
Petitioner does not dispute that if the Court were to
determine that that gain is ordinary income, he would nonetheless
be liable for the excise tax imposed by sec. 4972(a), but in a
lesser amount than that determined by respondent. See supra note
16.
- 25 -
accrued over a substantial period of time'". Malat v. Riddell,
383 U.S. 569, 572 (1966) (quoting Corn Prods. Refining Co. v.
Commissioner, 350 U.S. 46, 52 (1955), and Commissioner v.
Gillette Motor Transp., Inc., 364 U.S. 130, 134 (1960)).
As used in section 1221(1), the word "primarily" means "of
first importance" or "principally." Malat v. Riddell, supra at
572. The question whether property is property described in
section 1221(1) is a factual inquiry. Pasqualini v. Commis-
sioner, 103 T.C. 1, 6 (1994). In resolving that question, the
courts have examined various factors, including the following:
(1) The purpose for which the property was acquired; (2) the
purpose for which it was held; (3) the frequency, continuity, and
substantiality of sales; (4) the duration of ownership; (5) the
use of the proceeds from the sale of the property; (6) the
business of the taxpayer; and (7) the time and effort that the
taxpayer devoted to sales activities relating to the asset in
question by developing or improving that asset, soliciting
customers, or advertising. See Graves v. Commissioner, 867 F.2d
199, 202 (4th Cir. 1989), affg. an Oral Opinion of this Court;
United States v. Winthrop, 417 F.2d 905, 910 (5th Cir. 1969);
Huey v. United States, 205 Ct. Cl. 551, 504 F.2d 1388, 1392
(1974); Maddux Constr. Co. v. Commissioner, 54 T.C. 1278, 1284
(1970); Hoover v. Commissioner, 32 T.C. 618, 627 (1959). No
single factor, or combination thereof, is necessarily control-
ling. Graves v. Commissioner, supra at 202. The foregoing
- 26 -
factors have varying degrees of relevancy depending on the facts
of a particular case, and all factors may not be relevant in a
particular case. S & H, Inc. v. Commissioner, 78 T.C. 234, 243-
244 (1982). Objective factors carry more weight than the tax-
payer's subjective statement of his or her intent. Guardian
Indus. Corp. v. Commissioner, 97 T.C. 308, 316 (1991), affd.
without published opinion 21 F.3d 427 (6th Cir. 1994).
Based on our review of the entire record before us, and in
particular the following facts, we find that petitioner has
failed to establish that he held the drawing in question primar-
ily for sale to customers in the ordinary course of his trade or
business within the meaning of section 1221(1): (1) When peti-
tioner acquired the drawing in question during the early 1970's,
he did not intend to sell it; (2) petitioner conducted research
throughout the 1970's and into the 1980's on the drawings that he
had acquired during the 1970's; (3) during the 1970's, petitioner
did not attempt to sell any of the drawings that he had acquired
during those years; (4) petitioner did not sell any artwork or
collectible, other than the drawing in question, during the
period 1985 through 1994;18 (5) petitioner purchased the drawing
18
Petitioner relies on Stockton Harbor Indus. Co. v. Commis-
sioner, 216 F.2d 638 (9th Cir. 1954), to support his contention
that, notwithstanding the absence of any sales of drawings by
petitioner other than the drawing in question, he held the
drawing in question primarily for sale to customers in the
ordinary course of his trade or business. We find that case to
be distinguishable and petitioner's reliance on it to be mis-
placed. In the Stockton Harbor Indus. Co. case, the Court of
(continued...)
- 27 -
in question during the early 1970's and had it attributed to the
correct artist around the early 1980's, but did not sell it until
January 1989; (6) petitioner did not use the proceeds from the
sale of the drawing in question to purchase other drawings for
purposes of attribution and sale; and (7) petitioner engaged in a
psychology practice during all relevant periods, the income from
which provided his support during those periods.
To support his position under section 1221(1), petitioner
contends that (1) during the 1970's, his research on the drawings
that he had acquired and his attempts to attribute them to the
correct artists were sporadic; (2) during 1979 or 1980, he
changed his intention with respect to certain drawings that he
had acquired during the 1970's, including the drawing in ques-
tion, and decided to have those drawings attributed to the
correct artists and sold at a profit; (3) during the 1980's, his
research on those drawings and his attempts to enlist the inter-
est of curators for purposes of attributing those drawings to the
correct artists became systematic; (4) during 1989, after the
18
(...continued)
Appeals for the Ninth Circuit found that the taxpayer held
certain condemned real estate primarily for sale to customers in
the ordinary course of its trade or business. Id. at 651-656.
In contrast to the instant case, the record in the Stockton
Harbor Indus. Co. case established, inter alia, that (1) the
taxpayer was a corporation organized for the purpose of dealing
in real estate; (2) it acquired the real estate in question for
the purpose of developing it as an industrial site; (3) it
advertised and attempted to sell that real estate; and (4) it
sold various parcels of that real estate prior to its condemna-
tion. Id. at 652-655.
- 28 -
sale of the drawing in question, he abandoned his art activities
because (a) there was a serious crash in the art market as a
result of an economic recession during that year and (b) he was
having difficulty in enlisting the interest of curators for
purposes of attributing certain of his drawings to the correct
artists.19 At trial, petitioner presented only his own testimony
to support the foregoing allegations. We are unwilling to rely
on that testimony to establish those contentions.20 For example,
it strains credulity that, as soon as petitioner sold in January
1989 the drawing in question, which was the only drawing, art-
work, or collectible that the record shows he ever sold, the art
market coincidentally and suddenly crashed, thereby materially
19
Petitioner further contends that his position that the
drawing in question is property described in sec. 1221(1) is
supported by the following facts: Certain experts checked the
physical stability of the drawing in question; it was determined
that Anselmi had not sketched that drawing; the curator of
Italian drawings attributed that drawing to Parmagianino; and the
drawing in question received international exposure through art
exhibits, newspapers, and art catalogues. We are not persuaded
by the foregoing facts on which petitioner relies and the other
facts that we have found relating to the sale of the drawing in
question that that drawing is property described in sec. 1221(1),
and not a capital asset.
20
We note that even if we had found certain of those conten-
tions as facts, they would not necessarily persuade us that the
drawing in question was property described in sec. 1221(1). For
example, assuming arguendo that, during 1979 or 1980, petitioner
had changed his intention with respect to certain drawings that
he had acquired during the 1970's, including the drawing in
question, and decided to have those drawings attributed to the
correct artists and sold at a profit, that would not necessarily
indicate that he held those drawings primarily for sale to
customers in the ordinary course of his trade or business, and
not for investment. See Howell v. Commissioner, 57 T.C. 546, 555
(1972).
- 29 -
contributing to petitioner's decision to abandon his alleged
business activities involving the sale of artwork.
On the instant record, we sustain respondent's determination
that the gain that petitioner realized from the sale of the
drawing in question is long-term capital gain.
Petitioner's Horse Activity and Cattle Activity
Section 183--In General
Section 183(a) generally limits the amount of expenses that
a taxpayer may deduct with respect to an activity "not engaged in
for profit" to the deductions provided in section 183(b).
Section 183(b)(1) provides that deductions that would be allow-
able without regard to whether such activity is engaged in for
profit are to be allowed. Section 183(b)(2) further provides
that deductions which would be allowable only if such activity is
engaged in for profit are to be allowed, but only to the extent
that the gross income derived from such activity for the taxable
year exceeds the deductions allowable under section 183(b)(1).
An activity is "not engaged in for profit" if it is an activity
other than one with respect to which deductions are allowable for
the taxable year under section 162 or section 212(1) or (2).
Sec. 183(c).
In determining whether an activity is engaged in for profit,
the taxpayer must show that he or she engaged in the activity
with an actual and honest objective of making a profit. E.g.,
Hulter v. Commissioner, 91 T.C. 371, 392 (1988); Dreicer v.
- 30 -
Commissioner, 78 T.C. 642, 645 (1982), affd. without opinion
702 F.2d 1205 (D.C. Cir. 1983). Although the taxpayer's expecta-
tion of a profit need not be reasonable, he or she must have a
good faith objective of making a profit. E.g., Dreicer v.
Commissioner, supra at 645; Dunn v. Commissioner, 70 T.C. 715,
720 (1978), affd. on another issue 615 F.2d 578 (2d Cir. 1980);
sec. 1.183-2(a), Income Tax Regs. Petitioners bear the burden of
proving the requisite intent. E.g., Golanty v. Commissioner, 72
T.C. 411, 426 (1979), affd. without published opinion 647 F.2d
170 (9th Cir. 1981); Johnson v. Commissioner, 59 T.C. 791, 813
(1973), affd. 495 F.2d 1079 (6th Cir. 1974). Whether a taxpayer
is engaged in an activity with the requisite profit objective is
determined from all the facts and circumstances. E.g., Hulter
v. Commissioner, supra at 393; Taube v. Commissioner, 88 T.C.
464, 480 (1987); Golanty v. Commissioner, supra at 426; sec.
1.183-2(a) and (b), Income Tax Regs. More weight is given to
objective facts than to the taxpayer's mere statement of his or
her intent. E.g., Dreicer v. Commissioner, supra at 645; sec.
1.183-2(a), Income Tax Regs.
The regulations promulgated under section 183 list the
following nine factors that should normally be taken into account
in determining whether an activity is engaged in for profit:
(1) The manner in which the taxpayer carried 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,
- 31 -
(4) the expectation that assets used in the activity may appreci-
ate in value, (5) the success of the taxpayer in carrying on
other similar or dissimilar activities, (6) the taxpayer's
history of income or loss with respect to the activity, (7) the
amount of occasional profits, if any, which are earned, (8) the
financial status of the taxpayer, and (9) the extent to which
elements of personal pleasure or recreation are involved. Sec.
1.183-2(b), Income Tax Regs. The list of factors in the regula-
tions is not exclusive, and other factors may be considered in
determining whether an activity is engaged in for profit. No
single factor is dispositive. E.g., Golanty v. Commissioner,
supra at 426; sec. 1.183-2(b), Income Tax Regs. The determina-
tion of a profit objective does not depend on counting the number
of factors that support each party's position. E.g., Dunn v.
Commissioner, supra at 720; sec. 1.183-2(b), Income Tax Regs.
Petitioner contends that (1) during 1989, 1990, and 1991, he
was engaged in his horse activity for profit within the meaning
of section 183; (2) during 1990 and 1991, he was engaged in his
cattle activity for profit within the meaning of section 183; and
(3) during 1990 and 1991, his horse activity and his cattle
activity constituted one activity for purposes of that section.
Respondent disagrees with each of petitioner's contentions.
We turn first to whether, during 1990 and 1991, petitioner's
horse activity and cattle activity constituted one activity or
two separate activities for purposes of section 183. Section
- 32 -
1.183-1(d), Income Tax Regs., provides that, in determining
whether several undertakings of a taxpayer constitute one activ-
ity or two or more separate activities for purposes of section
183, we must consider all of the facts and circumstances, includ-
ing: (1) The degree of organizational and economic interrela-
tionship of the undertakings, (2) the business purpose, if any,
that is served by carrying on the undertakings separately or
together, and (3) the similarity of the two undertakings.
Petitioner argues that, during 1990 and 1991, his horse
activity and his cattle activity constituted a single activity
for purposes of section 183 because he planned to expand his herd
of cattle and to use that cattle to help manage the pasture for
his horses. On the record before us, we reject petitioner's
argument. Except for petitioner's self-serving testimony on
which we are unwilling to rely, there is no evidence in the
record to support petitioner's assertion that, during 1990 or
1991, he planned to expand his herd of cattle and use them for
pasture management or that he thereafter took any measures to
implement that alleged plan. In fact, petitioner did not even
keep the cattle and the horses on the same land during 1990 and
1991; they were not kept on the same land until sometime around
1993 or 1994.
On the record before us, we find that petitioner has failed
to establish that, during 1990 and 1991, his horse activity and
his cattle activity constituted one activity for purposes of
- 33 -
section 183.21 We shall therefore treat each such activity as a
separate activity for those purposes.
Petitioner's Horse Activity
At all relevant times, petitioner has enjoyed equestrian
activities. During the early 1970's, he owned a horse, took
riding lessons, and learned how to train a horse (1) to perform
at an unspecified level in dressage and (2) to do low-level
jumps, provided that the horse had received some training in
jumping. During 1988, petitioner, who did not have any formal
training as a horse trainer or horse breeder, acquired Moon-
shadow, a horse that had had some training in riding and jumping.
He planned to train Moonshadow in dressage, jumping, and/or
cross-country riding--activities that petitioner knew would
expose that (and any other) horse to a significant risk of
injury. Petitioner hoped to be able to sell Moonshadow after it
was trained. However, the record does not establish that during
the years at issue petitioner had or attempted to acquire the
expertise that he needed to carry out the training that he
testified he envisioned for Moonshadow (and the other horses that
he acquired) or that he consulted with others who had such
21
Even assuming arguendo that we had found that, during 1990
and 1991, petitioner's horse activity and his cattle activity
constituted one activity for purposes of sec. 183, on the record
before us, we would nonetheless find that petitioner has failed
to establish that he was engaged in that activity during those
years with the requisite profit motive within the meaning of sec.
183.
- 34 -
expertise.22
Petitioner spent time in riding, exercising, and/or caring
for Moonshadow from July 1988 when he acquired it until sometime
during 1990 when it became lame. During that period, petitioner
spent about 15 to 18 hours a week in riding, exercising, and
caring for Moonshadow during the mornings when he was not provid-
ing services as a psychologist.23 Although the record estab-
lishes that during 1990 petitioner purchased Jill24 and Gator25
and rode Jill and that around 1991 Jill had a colt named Zack, it
22
Petitioner claims that during the years at issue he hired
experts to train his horses. However, the record does not
identify such experts, their qualifications, or the specific
training that they allegedly provided to petitioner's horses
during those years. What the record does show is that it was not
until 1994, after the years at issue, that petitioner asked Ms.
Lyman from time to time to train some of his horses and that it
was at some undisclosed time during the period 1992 through 1995
that petitioner asked her to advise him how to market them.
23
Petitioner suggested in his testimony that, during the period
from July 1988 until Moonshadow became lame in 1990, he worked
with Moonshadow in the ring in an effort to teach it to move
laterally and backwards. We found petitioner's testimony in this
regard to be general and vague. For example, he did not specify
the extent of, or the time he spent on, any such exercises for
Moonshadow.
24
When petitioner acquired Jill sometime during 1990 after
Moonshadow became lame, he did not realize that it did not
possess the characteristics necessary for a show horse or a
competitive horse, from which we infer that he may not have
properly investigated the potential of that horse before he
purchased it.
25
Petitioner purchased Gator, a five-year old gelding, during
1990. However, Ms. Lyman did not begin to train any of peti-
tioner's horses until the spring of 1994. Although Ms. Lyman
provided some training to Gator, it is not clear from the record
whether that training occurred in the spring of 1994 or thereaf-
ter.
- 35 -
shows nothing else about what, if anything, petitioner did with
or for (1) Jill and Gator during 1990 and (2) Moonshadow, Jill,
Gator, and Zack during 1991.
Petitioner did not during the years at issue (or at any
other time) project the future income, expenses, or profits that
he expected would be generated by his horse activity. Nor did he
contemplate or inquire about the risks associated with owning
Moonshadow if it were to become lame (i.e., not only could it not
continue its training in, or be used for, any of the activities
that petitioner had in mind when he acquired Moonshadow, it also
could not be used for breeding since it was a gelding).
During the years at issue, although petitioner retained
invoices, receipts, and canceled checks relating to the expenses
that were incurred in his horse activity, he did not maintain a
separate bank account for that activity or books or records, such
as ledgers and registers, to memorialize the various transactions
relating thereto or to maintain a historical record of that
activity (e.g., the dates on which horses were purchased and
foals were born, the specific nature of any training that the
horses that he owned received, and the specific periods during
which any such training was provided). In short, petitioner
failed to show that during the years at issue he maintained
complete and accurate books and records that were consistent with
a profit motive or that he carried on his horse activity in a
businesslike manner.
- 36 -
In Schedules F of his returns for 1988 and 1989, petitioner
reported no income and losses of $3,648 and $10,253, respec-
tively, from his horse activity. In Schedules F of his returns
for 1990 and 1991, petitioner reported aggregate income of $0 and
$1,024, respectively, from both his horse and cattle activities
and aggregate losses of $7,780 and $19,588, respectively, from
both of those activities.26 The aggregate losses that petitioner
reported in Schedules F of his returns for 1992 and 1994 from
those activities were $28,691 and $37,478, respectively. The
aggregate loss from those activities that he reported in Schedule
F of his 1993 return decreased from the prior year to $11,053,
presumably because of an unexplained $60,000 income item and an
unexplained $29,202 interest expense item for that year.
Petitioner had sufficient income during the years at issue
from various sources so as to enable him to maintain a comfort-
able standard of living, notwithstanding the losses from his
horse activity that he was able to use to reduce his tax liabil-
26
Although petitioner did not show separately the respective
income, expenses, and losses associated with his horse activity
and his cattle activity for 1990 through 1994, the record herein
otherwise establishes (1) that the income reflected in Schedules
F of petitioner's returns for 1991 through 1994 was solely from
his cattle activity except for an unexplained $60,000 income item
for 1993 and (2) that petitioner had expenses relating to his
cattle activity during 1991 in the amount of $1,024. Moreover,
based on the characterization of certain expenses that petitioner
claimed in Schedules F of his 1990, 1992, 1993, and 1994 returns,
it appears that at least $1,428, $17,623, $18,561, and $17,845,
respectively, of the aggregate expenses claimed therein related
to his horse activity.
- 37 -
ity for those years.27
Petitioner claims that he expected the horses that he
acquired to appreciate in value after he trained them. In
support of that claim, petitioner points to the fact that during
1995 petitioner and Ms. Lyman sold Ziggy for $30,000 one month
after they acquired it for $10,000. We do not take issue with
the proposition that a particular horse, depending on its breed,
training, and other facts and circumstances, may appreciate in
value.28 However, the record contains no reliable evidence of
the appreciation, if any, in the value of the horses that peti-
tioner acquired during the years at issue or thereafter. Peti-
tioner did not at any time retain the services of anyone to
appraise the fair market value of his horses. The only evidence
in the record relating to the value of petitioner's horses is
petitioner's own testimony as to the value of Zack and Bunny and
Ms. Lyman's testimony as to the value of Gator and Bunny.29 With
27
In his returns for 1989, 1990, and 1991, petitioner reported
taxable income, excluding the losses from his horse activity and
his cattle activity, of $92,145, $119,892, and $198,722, respec-
tively, and the parties agree that taxable income for those
years, excluding such losses, should be increased by $49,376,
$17,882, and $7,733, respectively.
28
On the record before us, we find that Ziggy did not materi-
ally appreciate in value, if it appreciated at all, during the
period in which petitioner and Ms. Lyman owned that horse until
they sold it one month later. That is because, when they pur-
chased Ziggy, they paid a price (i.e., $10,000) that was substan-
tially below its fair market value.
29
Ms. Lyman testified that, as of the time of the trial, Gator
had a value of about $25,000 and Bunny was expected to have a
(continued...)
- 38 -
respect to petitioner's testimony, although, as the owner of the
horses, he was qualified to testify as to their value, we are not
required to, and we do not, accept his self-serving testimony on
that point. See Harmon v. Commissioner, 13 T.C. 373, 383 (1949).
With respect to Ms. Lyman's testimony about the value of peti-
tioner's horses, Ms. Lyman was not qualified as an expert witness
in this case and thus was not qualified to opine on the value of
petitioner's horses.
Even assuming arguendo that petitioner did, in fact, expect
the horses that he acquired to appreciate in value, he failed to
establish that he intended in good faith that any expected
appreciation in the value of those horses when realized, would
together with any other income from his horse activity, exceed
the expenses from that activity.
Petitioner further claims that the losses that he sustained
during the years 1988 through 1994 are attributable to Moon-
shadow's becoming lame during 1990 and Lily's sustaining injuries
and Zack's developing a foot disease around 1995. Losses sus-
tained because of unforeseen or fortuitous circumstances beyond
the control of the taxpayer are generally not to be considered as
29
(...continued)
value of about $15,000 to $20,000 in the spring of 1996 and about
$25,000 in 1997. Petitioner disagreed with Ms. Lyman's testimony
about the value of Bunny in 1997 when he testified that, as of
the time of the trial, he expected Bunny to have a value of
between $30,000 and $50,000 in 1997. Petitioner also testified
that, as of the trial, Zack, a young horse with minimal training,
had a value of between $8,500 and $10,000.
- 39 -
a factor indicating that the activity was not engaged in for
profit. Faulconer v. Commissioner, 748 F.2d 890, 900-901 (4th
Cir. 1984); sec. 1.183-2(b)(6), Income Tax Regs.
We note initially that, when petitioner decided to acquire
Moonshadow in 1988, he was aware that the activities of dressage,
jumping, and/or cross-country riding would expose that (and any
other) horse to a significant risk of injury. Thus, any losses
sustained as a result of injuries to his horses should not have
been unforeseen by petitioner.
As for petitioner's contention that Moonshadow's lameness
during 1990 was responsible for the losses that he reported for
the years at issue and thereafter, petitioner claims that he was
about to offer Moonshadow for sale at the time it became lame and
that it had a value of about $25,000 at that time. The record
does not contain any reliable evidence showing (1) the value of
Moonshadow at the time it became lame, (2) the attempts, if any,
that petitioner made, or planned to make, to sell Moonshadow, or
(3) the profit that would have been generated from such a sale
taking into account the price that petitioner paid for Moonshadow
in 1988 and the expenses that he incurred from then until 1990
when Moonshadow became lame.30
With respect to petitioner's claims about the injuries to
Lilly and Zack's foot disease that occurred around 1995, we fail
30
It is also noteworthy that although Moonshadow became lame in
1990, petitioner kept that horse and continued to incur expenses
with respect to it until he donated it to VPI around 1995.
- 40 -
to see how those physical problems affected the profitability of
petitioner's horse activity for any of the preceding years,
including the years at issue.
We have considered and reject all of petitioner's other
claims and contentions with respect to his horse activity.
Based on our review of the entire record before us, we find
that petitioner has failed to establish that during the years at
issue his horse activity was an activity engaged in for profit
within the meaning of section 183. Accordingly, we sustain
respondent's determinations that the deductions that petitioner
claimed for 1989, 1990, and 1991 relating to his horse activity
are limited by section 183(a) and (b).
Petitioner's Cattle Activity
During 1990, petitioner, who did not have any formal train-
ing as a cattle breeder, purchased for $3,000 a herd of cattle
consisting of a bull and four cows with calf. The cows produced
calves during 1990 or 1991 and each year thereafter. Petitioner
kept his cattle on the NLC land. During the winter months, they
consumed approximately five bales of hay that cost about $35 to
$50 a bale, and, during the remainder of the year, they consumed
the grass on the NLC land.
Petitioner kept the calves produced by his cows for six to
seven months until they weighed around 250 pounds, at which time
he sold them for approximately $250 each.
During 1991, petitioner received $1,024 from the sale of the
- 41 -
calves and incurred expenses in that same amount in connection
with his cattle activity. During 1992, 1993, and 1994, peti-
tioner received $1,017, $1,275, and $1,083, respectively, from
the sale of the calves, but the record does not disclose the
expenses that he incurred during those years in connection with
his cattle activity.31
Petitioner did not project during 1990, or at any other
time, the future income, expenses, or profits that he expected
would be generated by his cattle activity. Although during 1990
and 1991 petitioner retained invoices, receipts, and canceled
checks relating to the expenses incurred in his cattle activity,
he did not maintain a separate bank account for that activity or
books or records, such as ledgers and registers, to memorialize
the various transactions relating thereto or to maintain a
historical record of that activity (e.g., the dates on which
calves were born and sold).
To support his contention that he was engaged in his cattle
activity during 1990 and 1991 with a profit motive, petitioner
relies on his receipt of income from the sale of calves during
1991 through 1994 in amounts ranging from $1,017 to $1,275.32
Receipt of income is not necessarily indicative of a profit
31
Petitioner testified that he incurred virtually no expenses
in connection with his cattle activity, other than annual ex-
penses of approximately $175 to $250 for winter feed for the
cattle. We are unwilling to rely on that testimony. It is
inconsistent with his oral stipulation at trial that during 1991
he incurred expenses relating to his cattle activity of $1,024.
32
Petitioner concedes that he did not expect his cattle to
appreciate in value.
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motive. In contrast, realizing a profit would be indicative of
such a motive. However, on the record before us, we find that
petitioner did not realize a profit from his cattle activity for
1990 or 1991. On that record, we are unable to determine whether
he realized a profit from that activity for 1992, 1993, and 1994.
Based on our review of the entire record before us, we find
that petitioner has failed to establish that during 1990 and 1991
his cattle activity was an activity engaged in for profit within
the meaning of section 183. Accordingly, we sustain respondent's
determinations that the deductions that petitioner claimed for
1990 and 1991 relating to his cattle activity are limited by
section 183(a) and (b).
Additions to Tax and Accuracy-Related Penalties
Section 6651(a)(1)
Respondent determined that petitioner is liable for each of
the years 1989 and 1990 for the addition to tax under section
6651(a)(1) because he failed to file timely his return for each
such year. For purposes of section 6651(a)(1), the determination
of the prescribed date for filing a return must be made by
reference to any extension of the time for filing the return.
The addition to tax under section 6651(a)(1) does not apply if it
is shown that the failure to file was due to reasonable cause,
and not willful neglect. In order to prove reasonable cause, the
taxpayer must show that, despite the exercise of ordinary busi-
ness care and prudence, he or she was nevertheless unable to file
the return within the prescribed time. United States v. Boyle,
- 43 -
469 U.S. 241, 246 (1985); sec. 301.6651-1(c)(1), Proced. & Admin.
Regs.
For 1989 and 1990, petitioner filed applications for auto-
matic extension that were dated April 11, 1990, and April 5,
1991, respectively, and that requested a four-month extension of
time until August 15, 1990, and August 15, 1991, respectively,
within which to file his returns for those years. The parties
agree that petitioner also filed a second request (application
for additional extension of time) that was dated August 8, 1991,
in order to extend the period within which to file his 1990
return to October 15, 1991.
Petitioner contends that the addition to tax under section
6651(a)(1) should not be imposed for either 1989 or 1990 because
he relied on Mr. McVeigh to prepare the applications for auto-
matic extension for those years. Respondent disagrees.
We have found as facts that petitioner relied on Mr. McVeigh
to prepare requests to extend the time within which to file his
returns for 1989 and 1990. Line 1 of each of those requests
required petitioner to make a reasonable estimate, based on the
information available, of his tax liability for the year for
which he was seeking an extension. In arriving at the respective
estimated tax liabilities for 1989 and 1990 that Mr. McVeigh
showed on line 1 of petitioner's applications for automatic
extension for those years, Mr. McVeigh believed it reasonable,
and so advised petitioner, that, given petitioner's situation,
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those estimates be based on the tax liability shown in peti-
tioner's return for the year immediately preceding the year for
which each such application was being filed, provided that
petitioner paid each of those estimated tax liabilities by the
time he filed each such application. Since the tax liabilities
shown in petitioner's 1988 and 1989 returns were $9,041 and
$9,043, respectively, Mr. McVeigh entered on line 1 of peti-
tioner's applications for automatic extension for 1989 and 1990
estimated tax liabilities of $9,100 and $9,043, respectively.
Those respective applications also indicated that for 1989
estimated tax payments of $9,100 were made by petitioner and that
for 1990 $4,908 of tax was withheld from petitioner and $4,135 of
tax was paid with his 1990 application for automatic extension.
When an accountant advises a taxpayer on a matter of tax law
in circumstances such as these, it is reasonable for the taxpayer
to rely on that advice. See United States v. Boyle, supra at
251. On the record before us, we find that petitioner's reliance
on Mr. McVeigh's advice with respect to the preparation of his
applications for automatic extension of time for 1989 and 1990
was reasonable and in good faith and constituted reasonable cause
within the meaning of section 6651(a)(1). Accordingly, we reject
respondent's determinations under section 6651(a)(1) for 1989
and, with one exception, for 1990. That exception for 1990
relates to the facts that petitioner's return for that year was
dated October 25, 1991, and was received by the Service on
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November 1, 1991. Yet, the parties agree that the application
for additional extension of time was filed in order to extend the
time within which to file his 1990 return to October 15, 1991.
On the record before us, we sustain respondent's determination
under section 6651(a)(1) for 1990 only to the extent that peti-
tioner filed his 1990 return after October 15, 1991.
Section 6662(a)
Respondent determined that petitioner is liable for the
years at issue for the accuracy-related penalty under section
6662(a) because a portion of the underpayment of tax for each of
those years was due to negligence, disregard of rules and regula-
tions, or a substantial understatement of income tax.
Section 6662(a) imposes an addition to tax equal to 20
percent of the underpayment of tax attributable to, inter alia,
(1) negligence or disregard of rules or regulations and (2) any
substantial understatement of income tax. Sec. 6662(b)(1) and
(2). For purposes of section 6662(a), the term "negligence"
includes any failure to make a reasonable attempt to comply with
the Code, and "disregard" includes any careless, reckless, or
intentional disregard. Sec. 6662(c). Negligence has also been
defined as a lack of due care or failure to do what a reasonable
person would do under the circumstances. Leuhsler v. Commis-
sioner, 963 F.2d 907, 910 (6th Cir. 1992), affg. T.C. Memo.
1991-179; Antonides v. Commissioner, 91 T.C. 686, 699 (1988),
affd. 893 F.2d 656 (4th Cir. 1990). With respect to individuals,
- 46 -
an understatement of tax is substantial if it exceeds the greater
of 10 percent of the tax required to be shown in the return or
$5,000. Sec. 6662(d)(1)(A). An understatement of tax is equal
to the amount of tax required to be shown in the return less the
amount shown therein. Sec. 6662(d)(2)(A).
The accuracy-related penalty under section 6662(a) does not
apply to any portion of an underpayment if it is shown that there
was reasonable cause for such portion and that the taxpayer acted
in good faith. Sec. 6664(c)(1). The determination of whether a
taxpayer acted with reasonable cause and in good faith depends
upon the pertinent facts and circumstances, including the tax-
payer's efforts to assess his or her proper tax liability, the
knowledge and experience of the taxpayer, and reliance on the
advice of a professional, such as an accountant. Sec.
1.6664-4(b)(1), Income Tax Regs.
Petitioner contends that he is not liable for any of the
years at issue for the accuracy-related penalty under section
6662(a) because he relied on the advice of his accountant, Mr.
McVeigh, for the preparation of his returns for those years.33
Respondent disagrees.
A taxpayer generally cannot avoid the duty of filing an
accurate return by placing that responsibility on an agent.
33
Petitioner does not rely on sec. 6662(d)(2)(B) in order to
reduce the underpayment for each of the years at issue that
respondent determined is attributable to a substantial
understatement of income tax.
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Pritchett v. Commissioner, 63 T.C. 149, 174 (1974). A taxpayer
bears the responsibility for any negligent errors of his or her
accountant. American Properties, Inc. v. Commissioner, 28 T.C.
1100, 1116-1117 (1957), affd. per curiam 262 F.2d 150 (9th Cir.
1958). However, a taxpayer may avoid the accuracy-related penalty
under section 6662(a) for negligence or substantial understate-
ment by showing that his reliance on the advice of a profes-
sional, such as an accountant, was reasonable and in good faith.
Sec. 1.6664-4(b)(1), Income Tax Regs. In the case of claimed
reliance on the accountant who prepared the taxpayer's return,
the taxpayer must establish that correct information was provided
to the accountant and that the item incorrectly claimed or
reported in the return was the result of the accountant's error.
See Ma-Tran Corp. v. Commissioner, 70 T.C. 158, 173 (1978). A
taxpayer's reliance on the advice of an accountant is not reason-
able or in good faith where a cursory review of a taxpayer's
return would reveal an omission from income. Metra Chem Corp. v.
Commissioner, 88 T.C. 654, 662 (1987).
We note initially that with respect to the items that
respondent contends were due to negligence, disregard of the
rules or regulations, or a substantial understatement of income
tax, the record contains evidence only as to the items specifi-
cally identified and discussed below. The record does not
contain any evidence as to the remainder of those items (remain-
ing items) on all of which petitioner bears the burden of proof;
- 48 -
nor does it show what information petitioner may have provided to
Mr. McVeigh, or what advice Mr. McVeigh may have given peti-
tioner, regarding those remaining items. Accordingly, we find
that petitioner has failed to establish that any reliance by him
on Mr. McVeigh with respect to the remaining items was reasonable
and in good faith. Consequently, we sustain respondent's de-
terminations imposing on petitioner the accuracy-related penalty
on the portion of the underpayment for each of the years at issue
that is attributable to those items.
Negligence or Disregard of
the Rules or Regulations
Petitioner's Underreporting of the Gain
from the Sale of the Drawing in Question
In Schedule C of his 1989 return relating to art sales,
petitioner reported a gain of $99,000 from the sale of the
drawing in question. The parties agree that petitioner realized
a gain of $113,700 from the sale of that drawing. Although not
determined in the notice, respondent contends on brief that
petitioner's underreporting of the gain from the sale of the
drawing in question was due to negligence or disregard of rules
and regulations. This issue constitutes a new matter on which
respondent bears the burden of proof. Rule 142(a); Foster v.
Commissioner, 80 T.C. 34, 197 (1983), affd. in part and vacated
in part 756 F.2d 1430 (9th Cir. 1985).
The record does not establish what petitioner told Mr.
McVeigh about the sales price of the drawing in question, the
- 49 -
purchase price of that drawing, and the gain realized from its
sale. However, assuming arguendo (1) that petitioner had told
Mr. McVeigh that he sold the drawing in question for $115,000,
that he had purchased it for $1,300, and that he realized a gain
of $113,700 from its sale and (2) that Mr. McVeigh erroneously
reported gross receipts of $100,000 from the sale of the drawing
in question, a cost of goods sold of $1,000 for that drawing, and
a gain of $99,000 from its sale, petitioner was nonetheless
negligent in underreporting the gain from that sale in his 1989
return. Petitioner had an obligation to review that return
before filing it. See Metra Chem Corp. v. Commissioner, supra at
662. Petitioner, however, did not review it; he was merely
interested in knowing the amount of tax due so that he could
write a check for that amount. If petitioner had reviewed
Schedule C of his 1989 return relating to art sales, he would
have known that the gain from the sale of the drawing in question
was underreported. See id. at 662.
On the record before us, we find that any reliance by
petitioner on Mr. McVeigh was not reasonable or in good faith
insofar as it relates to the underreporting of the gain from the
sale of the drawing in question (viz., $99,000, instead of
$113,700). Consequently, we find that petitioner is liable for
the accuracy-related penalty on the portion of the underpayment
for 1989 that is attributable to that underreported gain.
Petitioner's Claimed Disallowed
Automobile Expenses
- 50 -
We have found that petitioner was not aware of the errors
relating to the disallowed automobile expenses that Mr. McVeigh
made in Schedules C of petitioner's 1989, 1990, and 1991 returns
relating to Psychological Testing Services and that he could not
have detected them by reviewing those returns.
On the record before us, we find that petitioner's reliance
on Mr. McVeigh with respect to the claimed disallowed automobile
expenses in petitioner's returns for the years at issue was
reasonable and in good faith. Consequently, we reject respon-
dent's determinations imposing the accuracy-related penalty on
the portion of the underpayment for each such year that is
attributable to those disallowed expenses.
Substantial Understatement of Income Tax
Petitioner's Claimed Deductions of Losses
From His Horse Activity and His Cattle Activity
We have found that, based on what petitioner told Mr.
McVeigh about his horse activity and his cattle activity, includ-
ing that he intended to buy, train, and sell horses34 and that he
had incurred certain expenses for various stables and training
centers that Mr. McVeigh believed to be reputable, Mr. McVeigh
concurred in petitioner's conclusion, and he and petitioner
jointly decided, that the gross income, expenses, and loss from
34
We note that this finding is based on Mr. McVeigh's testimony
as to what petitioner told him about his intention with respect
to his horse activity.
- 51 -
petitioner's horse activity during 1989 and the aggregate income,
expenses, and losses from his horse activity and cattle activity
during 1990 and 1991 should be reported in Schedules F of peti-
tioner's returns for those years and that any loss from those
activities could be used to reduce petitioner's income from other
sources that was reported in each such return. With respect to
petitioner's horse activity, the record does not establish
whether petitioner fully disclosed to Mr. McVeigh when he pre-
pared petitioner's returns for the years at issue all the perti-
nent facts that would bear on the question whether petitioner
carried on that activity with the requisite profit motive within
the meaning of section 183 (e.g., facts relating to (1) the
manner in which petitioner carried on those activities, (2) the
extent of time or effort that he devoted to those activities,
(3) whether he had the expertise necessary to train his horses,
(4) whether he consulted with experts about training his horses,
and (5) whether he expected his horses to appreciate in value).
With respect to petitioner's cattle activity, the record does not
establish whether petitioner informed Mr. McVeigh of any of the
pertinent facts relating to that activity.
On the record before us, we find that petitioner has failed
to establish that any reliance by him on Mr. McVeigh with respect
to the claimed deductions in petitioner's returns for the years
at issue of the losses from his horse activity and cattle activ-
ity was reasonable or in good faith. Consequently, we sustain
- 52 -
respondent's determinations imposing the accuracy-related penalty
on the portion of the underpayment for each such year that is
attributable to such deductions.
Petitioner's Claimed Deductions
of SEP Contributions
For each of the years 1989 and 1991, petitioner underpaid
his income tax as a result of the deductions that he claimed
(viz., $20,000 and $7,977, respectively) and that respondent
disallowed with respect to his SEP contribution for each such
year.35 For 1989, the underpayment of income tax attributable to
petitioner's disallowed SEP deduction resulted from the following
errors: (1) Including the gain from the sale of the drawing in
question in Schedule C of petitioner's return and thus including
that gain in petitioner's self-employment income;36 (2) calculat-
ing petitioner's self-employment income by aggregating the
results of only those Schedules C of petitioner's return that
showed net profits, and not those that showed losses; and
(3) claiming a deduction for petitioner's contribution to the SEP
35
We note that, because respondent made determinations in the
notice that increased petitioner's self-employment income for
1990, respondent determined that petitioner is entitled to a SEP
deduction for that year in an amount in excess of the SEP de-
duction claimed in petitioner's 1990 return.
36
If the $99,000 net profit from the sale of the drawing in
question had not been reported in Schedule C of petitioner's 1989
return relating to art sales, that return would have reflected an
aggregate loss of $39,928 from petitioner's various Schedules C,
and, based on that return, petitioner would not have been enti-
tled to a deduction for any portion of the $20,000 contribution
that he made to the SEP for that year.
- 53 -
equal to 25 percent (25-percent limit), rather than 15 percent
(15-percent limit), of his self-employment income.37 For 1991,
the underpayment of income tax attributable to petitioner's
disallowed SEP deduction resulted from erroneously using the 25-
percent limit, rather than the 15-percent limit.
Erroneous Inclusion of the Gain From the
Sale of the Drawing in Question in
Petitioner's Self-employment Income for 1989
Based on the information that petitioner provided to Mr.
McVeigh, Mr. McVeigh concluded that the gain from the sale of the
drawing in question constituted self-employment income, and not
long-term capital gain, and that it should be reported in Sched-
ule C of petitioner's 1989 return relating to art sales. We have
found that petitioner informed Mr. McVeigh that he sold the
drawing in question during 1989 at a gain and that he intended to
continue to purchase and sell drawings in the future.38 We do
not know what else petitioner told Mr. McVeigh about the sale of
that drawing. We have found that petitioner did not sell any
drawings, artwork, or collectibles after he sold the drawing in
question in January 1989, and petitioner testified that, after
that sale, he had no intention of continuing to sell drawings.
37
See supra note 16.
38
Petitioner contradicted Mr. McVeigh's testimony when he
testified that, after the sale of the drawing in question, he did
not tell Mr. McVeigh that he intended to continue to sell draw-
ings. We believe and accept Mr. McVeigh's testimony on this
point, and not petitioner's.
- 54 -
On the record before us, we find that petitioner has failed
to establish that any reliance on Mr. McVeigh with respect to the
erroneous treatment of the gain from the sale of the drawing in
question as self-employment income was reasonable or in good
faith. Consequently, we sustain respondent's determination
imposing the accuracy-related penalty on the portion of the
underpayment for 1989 that is attributable to that treatment.
Erroneous Calculation of Petitioner's
Self-employment Income for 1989
The parties agree that if the Court were to sustain
respondent's determination that the gain from the sale of the
drawing in question constitutes long-term capital gain, that gain
should not have been included in petitioner's self-employment
income for 1989 for purposes of calculating the deductible
portion, if any, of petitioner's 1989 SEP contribution. However,
even assuming arguendo (1) that, contrary to our finding, the
gain from the sale of the drawing in question were ordinary
income, and not capital gain, and (2) that, contrary to the
agreement of the parties, the use of the 25-percent limit were
proper, the amount of the deduction that petitioner claimed in
his 1989 return for the SEP contribution nonetheless exceeded 25
percent of his self-employment income for that year. That is
because, in calculating petitioner's self-employment for 1989,
Mr. McVeigh failed to aggregate the results shown in all Sched-
ules C of his 1989 return and instead aggregated the results of
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only those Schedules C showing net profits.
On the record before us, we find that petitioner's reliance
on Mr. McVeigh with respect to the erroneous calculation of
petitioner's self-employment income for 1989 (i.e., not
aggregating all Schedules C of petitioner's 1989 return) was
reasonable and in good faith. Consequently, we reject respon-
dent's determination imposing the accuracy-related penalty on the
portion of the underpayment for that year that is attributable to
that error.39
Erroneous Use of the 25-Percent
Limit for 1989 and 1991
We have found that Mr. McVeigh advised petitioner to use the
25-percent limit, rather than the 15-percent limit. Except for
petitioner's (1) informing Mr. McVeigh in April 1990 that he had
established a retirement plan to which he timely contributed
$20,000 and (2) relating to him the conversations that he had had
with the individual who had assisted him in establishing that
plan, the record does not show what petitioner told Mr. McVeigh
about the contributions that he made to a retirement plan for
1989 and 1991. Specifically, we do not know whether petitioner
advised Mr. McVeigh that the retirement plan that he had estab-
lished was a simplified employee pension.
On the record before us, we find that petitioner has failed
39
Mr. McVeigh's error resulted in petitioner's claiming a
deduction that exceeded by $5,075 25 percent of the aggregate
results shown in the Schedules C of his 1989 return.
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to show that any reliance on Mr. McVeigh with respect to the
erroneous use of the 25-percent limit, rather than the 15-percent
limit, in computing the deductions relating to his SEP contribu-
tions for 1989 and 1991 was reasonable or in good faith. Conse-
quently, we sustain respondent's determinations imposing the
accuracy-related penalty on the portion of the underpayment for
each such year that is attributable to that error.
Petitioner's Failure to Pay Excise
Tax on Excess Contributions to the SEP
Respondent determined that petitioner is liable for each of
the years at issue for the accuracy-related penalty under section
6662(a) on the underpayment of excise tax attributable to peti-
tioner's excess contribution to the SEP for each such year on the
ground that each such underpayment is attributable to a substan-
tial understatement of income tax within the meaning of section
6662(d). Respondent's determinations are wrong. The under-
payment of excise tax for each of the years at issue is not
attributable to a substantial understatement of income tax for
each such year within the meaning of section 6662(b)(2) and (d).
See sec. 6662(b)(4), (d)(1)(A); secs. 1.6662-4(a), 1.6664-2(b),
Income Tax Regs. Consequently, we reject respondent's determina-
tions imposing the accuracy-related penalty on the underpayments
of excise tax for the years at issue.
To reflect the foregoing and the concessions of the parties,
Decision will be entered
- 57 -
under Rule 155.