Surridge v. Commissioner

T.C. Memo. 1998-304

UNITED STATES TAX COURT

JACK F. AND VIRGINIA SURRIDGE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

JACK F. SURRIDGE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 10495-97, 10496-97. Filed August 20, 1998.

Virginia Surridge, pro se.

Julie L. Payne, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

LARO, Judge: Jack F. and Virginia Surridge (petitioners)1

petitioned the Court to redetermine respondent's determination of

the following deficiencies and additions to tax:

1
The Surridges were copetitioners in docket No. 10495-97.
Mr. Surridge was the sole petitioner in docket No. 10496-97. For
clarity, we refer to the Surridges as petitioners for all years.
 - 2 -

Additions to Tax
Year Deficiency Sec. 6651(a)(1) Sec. 6654
1990 $9,672 $2,418 --
1991 4,615 1,154 $263
1992 11,216 2,804 492
1993 1,354 339 55
1994 2,486 622 80

Respondent reflected the determinations for 1990 in a notice of

deficiency issued to petitioners on February 20, 1997.

Respondent reflected the other determinations in a notice of

deficiency issued to Mr. Surridge on the same date.

We must decide:

1. Whether petitioners' Arabian horse racing, breeding, and

sales activity was an activity "not engaged in for profit" within

the meaning of section 183. We hold it was.

2. Whether petitioners are liable for the additions to tax

determined by respondent under section 6651(a)(1). We hold they

are.

3. Whether petitioners are liable for the additions to tax

determined by respondent under section 6654. We hold they are.

Unless otherwise stated, 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.

Dollar amounts are rounded to the nearest dollar.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

The stipulations of fact and the exhibits submitted therewith are

incorporated herein by this reference. Petitioners are husband
 - 3 -

and wife, and they filed joint Federal income tax returns for all

years in issue. They resided in Maple Valley, Washington, when

they petitioned the Court. Ms. Surridge is a full-time insurance

agent who works as a sole proprietor. Mr. Surridge is a retired,

career serviceman who is involved full-time on the family farm.

Ms. Surridge purchased her first horse in 1959 or 1960. She

began raising Arabian horses approximately 10 years later with

the intent to show them. She abandoned this intent

by the early 1970's, opting to breed and raise Arabian horses

with an intent to race them. She raced two Arabian horses in or

about 1974, and she did not race any more horses until

approximately 1984. Mr. Surridge began participating in Ms.

Surridge's horse-related activities in 1976. Neither he nor she

is a State certified or licensed horse trainer.

From 1990 through 1994, petitioners maintained a stable of

approximately 25 horses, four of which were capable of racing.

The remaining horses were broodmares, stallions, geldings, and

horses too young or physically unable to race. During the

subject years, the number of races in which the four horses

participated, and the amount of prize money that each horse won,

are as follows:

Horse Number of Races Prize Money Awarded
Bey El Shaw 4 $100
Sir Latigo 6 500
Parkwood Barbaado 15 2,237
Mystic Moods 6 uncertain
 - 4 -

In 1991, petitioners bred two of their broodmares, "Kamla" and

"Meczewza", with stallions owned by other breeders.

Petitioners are members of various Arabian horse

associations, registries, and clubs. They subscribe to various

magazines and newsletters, and they attend various classes and

seminars pertaining to horse raising and care.

Petitioners have never used in vitro fertilization

techniques as part of their horse breeding activities, and they

have never commissioned a study of Arabian horses' bloodlines to

determine those horses that are most likely to sire foals of

racing potential. They do not maintain a bank account for their

activity separate from their personal accounts, and they do not

maintain journals, ledgers, or organized records of income and

expenses for their activity. They have never prepared income

statements, balance sheets, income projections, or any other

financial guidelines for their activity. They have never

reported a profit from their activity, or from any other

horse-related activity, on any Federal income tax return.

During the years in issue, petitioners collected insurance

proceeds totaling $15,000 for injuries or death suffered by their

horses, and they had life insurance policies on many of their

horses. In 1993, they sold one horse for $1,500.

With respect to the subject years, petitioners reported on

their joint tax returns the following amounts of pension income,

self-employment income, capital gain income, farm income (loss),
 - 5 -

total income (loss), taxable income (loss), and Federal tax

liability:

1990 1991 1992 1993 1994
Pension income $20,511 $22,314 $22,504 $23,584 $25,114
Self-employment income 24,937 22,450 21,092 13,317 6,819
Capital gain income none none none 38,500 none
Farm income (loss) (46,475) (60,224) (32,203) (39,302) (50,786)
Total income (loss) (919) (13,628) 11,394 41,808 (18,489)
Taxable income (loss) (11,769) (23,088) (605) 29,508 (32,739)
Federal tax liability none none none 4,429 none

OPINION

I. Profit Motive

This is another case of taxpayers claiming that they may

deduct losses from a horse activity because they allegedly

entered into the activity for profit. Section 183(a) generally

limits the amount of expenses that may be deducted with respect

to an activity "not engaged in for profit". Whether an

individual conducts an activity for profit rests on whether he or

she engages in the activity with the primary purpose of reaping a

profit. Wolf v. Commissioner, 4 F.3d 709, 713 (9th Cir. 1993),

affg. T.C. Memo. 1991-212; see also Warden v. Commissioner, T.C.

Memo. 1995-176, affd. without published opinion 111 F.3d 139 (9th

Cir. 1997). Whether petitioners engaged in their horse activity

with the requisite profit objective must be determined from the

facts and circumstances of the case. Golanty v. Commissioner,

72 T.C. 411, 426 (1979), affd. without published opinion 647 F.2d

170 (9th Cir. 1981); sec. 1.183-2(a) and (b), Income Tax Regs.

Petitioners bear the burden of proof, Rule 142(a); Welch v.

Helvering, 290 U.S. 111, 115 (1933), and more weight is given to
 - 6 -

objective facts than to their subjective statements, Holbrook v.

Commissioner, T.C. Memo. 1993-383; sec. 1.183-2(a), Income Tax

Regs.

The following factors, which are nonexclusive, aid in

determining whether an activity is engaged in for profit: (1)

The manner in which the taxpayer carries on the activity; (2) the

expertise of the taxpayer or his advisers; (3) the time and

effort expended by the taxpayer in carrying on the activity;

(4) the expectation that assets used in the activity may

appreciate in value; (5) the success of the taxpayer in carrying

on other similar or dissimilar activities; (6) the taxpayer's

history of income or losses with respect to the activity;

(7) the amount of occasional profits, if any, which are earned;

(8) the financial status of the taxpayer; and (9) elements of

personal pleasure or recreation. Sec. 1.183-2(b), Income Tax

Regs. No single factor is dispositive, Golanty v. Commissioner,

supra at 426; sec. 1.183-2(b), Income Tax Regs., and a profit

objective does not hinge on the number of factors satisfied, sec.

1.183-2(b), Income Tax Regs. We proceed to analyze these

factors.

1. Manner in Which Petitioners Carried On Their Activity

One indicator of an activity engaged in for profit is a

taxpayer's businesslike conduct of the activity. Sec.

1.183-2(b)(1), Income Tax Regs. This includes the keeping of

complete and accurate books and records. Id.
 - 7 -

Petitioners did not conduct their activity in a businesslike

manner. They did not keep journals, ledgers, or organized

records of income and expense. They did not prepare income

statements, income projections, or other financial guidelines.

They did not retain organized files of invoices, receipts,

canceled checks, or bank statements. They did not maintain a

separate bank account or prepare a budget.2 They did not gauge

the activity's profitability. They made little effort to

advertise their horses to stud or to sell their horses outright.

Another indication of an activity engaged in for profit is a

change of operating methods, adoption of new techniques or

abandonment of unprofitable methods in a manner consistent with

an intent to improve profitability. Sec. 1.183-2(b)(1), Income

Tax Regs. In this regard, we do not believe that petitioners

were concerned with making their activity profitable. For a

period of almost two decades, during which the activity generated

a loss in every year, petitioners never attempted to change their

method of operation or take any other action that would reduce

the losses. Although petitioners did buy a new farm in 1993,

they have never utilized this farm in their activity.

This factor favors respondent.

2. Expertise of Petitioners

Preparation for an activity by extensive study or by

consultation with experts may indicate that a taxpayer has a

2
In contrast, Ms. Surridge kept extensive records and a
separate bank account for her insurance business.
 - 8 -

profit motive where the taxpayer follows such advice. Sec.

1.183-2(b)(2), Income Tax Regs. In preparing for an activity, a

taxpayer need not make a formal market study, but ordinarily

should undertake a basic investigation of the factors that will

affect the activity's profitability. Underwood v. Commissioner,

T.C. Memo. 1989-625; Holbrook v. Commissioner, supra.

We do not believe that either petitioner knows the business

or economic aspects of a horse racing, breeding, and sales

activity, including, specifically, the way in which such an

activity must be operated in order to return a profit.

Petitioners never studied their activity's market, and they never

conducted a basic investigation of the factors that would affect

the activity's profitability. Nor can we find that petitioners

knew the activity's accepted business and economic practices.

Although petitioners did employ three certified horse trainers in

their activity, and consulted a veterinarian, the trainers worked

for petitioners for no longer than 8 months, and the veterinarian

never advised petitioners on horse breeding or training. We are

unpersuaded that these individuals were utilized to assist

petitioners in running a profitable business. The same is true

with respect to an accountant whom petitioners retained to

represent them during an IRS audit in 1991. The record contains

no evidence that the accountant was retained to assist

petitioners with a business plan for the activity or to establish

any other methodology for producing a profit.
 - 9 -

This factor favors respondent.

3. Time and Effort Expended by Petitioners

We consider the time and effort spent by petitioners in

their horse activity. Sec. 1.183-2(b)(3), Income Tax Regs.

The fact that a taxpayer devotes much time to an activity may

indicate a profit intent.

Ms. Surridge spent little time in petitioner's activity; she

works long hours in her insurance business. Although Mr.

Surridge is involved full-time in the activity, we believe, as

discussed below, that his principal motive for his dedication to

this activity is pleasure or recreation, rather than profit.

This factor does not favor either party; it is neutral.

4. Petitioners' Expectation of Asset Appreciation

Another factor to consider is a taxpayer's expectation that

assets used in the activity may appreciate in value. Sec.

1.183-2(b)(4), Income Tax Regs. The term "profit" includes the

appreciation in the value of assets used in an activity. Id.

Although petitioners allege that they raised some of their

horses for sale, presumably at a profit, the record shows that

petitioners sold only one horse during the subject years. We are

unable to find that petitioners ever tried to keep track of the

value of their farm or their horses. In fact, Ms. Surridge

testified that she did not know the market value of her horses.

This factor favors respondent.
 - 10 -

5. Petitioners' Success in Similar or Dissimilar Activities

We consider petitioners' success in similar or dissimilar

activities. Sec. 1.183-2(b)(5), Income Tax Regs. Although an

activity is unprofitable, we take into account whether the

taxpayer previously converted similar activities from

unprofitable to profitable enterprises. Id.

Ms. Surridge was a successful insurance agent operating her

own business. Whereas an individual's success in a dissimilar

activity would ordinarily tilt this factor toward him or her,

such is not the case here because Ms. Surridge spent little time

in petitioner's horse activity.

This factor does not favor either party; it is neutral.

6. Activity's History of Income and Losses

We consider petitioners' history of income and/or losses

with respect to their horse activity. Sec. 1.183-2(b)(6), Income

Tax Regs. Losses continuing beyond the period customarily

required to make an activity profitable, if not explainable, may

indicate that the activity is not engaged in for profit.

Although a series of losses at the beginning of an activity does

not necessarily mean that the activity was not entered into for

profit, a continuing string of losses may weigh against a profit

intent absent unforeseen or fortuitous circumstances beyond the

taxpayer's control (e.g., fire, disease, theft). Id.
 - 11 -

Ms. Surridge began breeding and racing horses during the

early 1970's. Petitioners' activity never reported a profit.

Exclusive of the $1,500 insurance payment, petitioners received

less than $3,000 in race winnings during the subject years, while

claiming total losses of $228,988. Petitioners have not

established that any of these losses were due to unforeseen or

fortuitous circumstances beyond their control. Furthermore, they

offered no evidence at trial, other than their self-serving

testimony, to support their assertions that they expected their

pattern of losses to change.

This factor favors respondent.

7. Amount of Occasional Profits From the Activity

We consider the amount of occasional profits, if any, from

the subject activity. Sec. 1.183-2(b)(7), Income Tax Regs. An

occasional small profit from an activity generating large losses,

or from an activity in which the taxpayer has made a large

investment, would not generally be determinative that the

activity is engaged in for profit. However, substantial profit,

though only occasional, would generally be indicative that an

activity is engaged in for profit, where the investment or losses

are comparatively small. Id.

Petitioners barely recouped approximately 1 percent of their

expenses in the form of race winnings. Petitioners provided no

evidence that they ever made a profit from putting a horse out to
 - 12 -

stud or that they had developed an organized plan to reap a

profit from breeding or racing horses in the future.

This factor favors respondent.

8. Petitioners' Financial Status

We consider petitioners' financial status. Sec.

1.183-2(b)(8), Income Tax Regs. Substantial income from sources

other than the activity, particularly if the activity's losses

generated substantial tax benefits, may indicate that the

activity is not engaged in for profit. This is especially true

where there are personal or recreational elements involved. Id.

Petitioners received income mainly from Ms. Surridge's

insurance business and from Mr. Surridge's pension. For 1990

through 1994, petitioners' taxable income, if they had not

claimed the losses on their horse activity, would have equaled

$34,706, $37,136, $31,598, $68,610, and $18,047, respectively.

Petitioners' ability to earn income from sources other than their

horse activity enabled them to finance the activity and to use

its losses to shelter their other income from Federal income tax.

The claimed losses for the activity also allowed petitioners to

shelter Ms. Surridge's self-employment income from Federal

self-employment tax.

This factor favors respondent.

9. Elements of Personal Pleasure

We consider the personal pleasure derived by petitioners in

conducting their activity. Sec. 1.183-2(b)(9), Income Tax Regs.
 - 13 -

Although the mere fact that a taxpayer derives personal pleasure

from a particular activity does not negate a profit intent with

respect thereto, the presence of personal motives may indicate

that the activity is not engaged in for profit. This is

especially true where there are recreational or other personal

elements involved. Id.

We believe that petitioners had personal reasons for

participating in their horse activities. We believe that

petitioners operated their stable out of pleasure for the

activity itself. We recognize that caring for horses and

maintaining a horse farm is hard work. However, the fact that

running the horse farm was hard work does not negate the pleasure

petitioners received from engaging in the horse activity.

This factor favors respondent.

10. Conclusion

We have reviewed the record and evaluated the nine factors

above. Petitioners' lack of expertise, their history of

significant losses, their lack of concern in taking actions to

make their activity profitable, their ability to use the

activity's losses to avoid paying income and self-employment

taxes in 4 of the 5 years in issue, the unlikelihood of asset

appreciation, the fact that petitioners operated the activity in

a nonbusinesslike manner, and the personal pleasure enjoyed by

petitioners in conducting their activity lead us to conclude that

petitioners lacked the requisite profit objective in each of the
 - 14 -

subject years. We sustain respondent's determination on this

issue.

II. Section 6651(a)

Respondent determined that petitioners are liable for

additions to tax under section 6651(a)(1). Section 6651(a)(1)

imposes an addition to tax for failure to file a return timely

unless the taxpayer shows that the failure was due to reasonable

cause and not willful neglect. See Kotmair v. Commissioner,

86 T.C. 1253, 1263 (1986). A failure to file timely is due to

reasonable cause if the taxpayer exercised ordinary business

care 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 is a conscious,

intentional failure or reckless indifference. United States v.

Boyle, 469 U.S. 241, 245 (1985).

Petitioners argue that they did not prepare timely tax

returns for taxable years after 1990 because it had not been

determined whether their horse activity was subject to section

183, and they did not want to prepare returns twice. Their

unwillingness to file timely a return in these circumstances does

not constitute reasonable cause under section 6651. See Rakoski

v. Commissioner, T.C. Memo. 1993-68, affd. without published

opinion 46 F.3d 1144 (9th Cir. 1995). We sustain respondent's

determination on this issue.
 - 15 -

III. Section 6654

Respondent determined that petitioners underpaid their

estimated income tax and are liable for additions to tax under

section 6654. Where payments of tax, either through withholding

or by making estimated tax payments, do not equal the percentage

of the total liability required under the statute, imposition of

the addition to tax under section 6654 is automatic, absent a

showing that the taxpayer has met one of the exceptions contained

therein. Recklitis v. Commissioner, 91 T.C. 874, 913 (1988);

Tillman v. Commissioner, T.C. Memo. 1996-8. Petitioners have not

shown that any of the exceptions apply. We sustain respondent's

determination on this issue.

We have considered all of petitioners' arguments in this

case, and, to the extent not discussed above, find them to be

irrelevant or without merit. To reflect the foregoing,

Decisions will be entered

under Rule 155.