Wheeler v. Commissioner

T.C. Memo. 1999-56

UNITED STATES TAX COURT

FRANK K.B. WHEELER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 8269-97. Filed February 26, 1999.

During 1993, 1994, and 1995, P conducted a videotape
activity. P bought significant amounts of equipment,
claimed large deductions (primarily depreciation), and
generated little receipts during the years in issue.

1. Held: On the facts, P’s activity was not engaged
in for profit; deductions in excess of income from the
activity were properly disallowed. Sec. 183, I.R.C. 1986.

2. Held, further, P is liable for negligence
additions to tax. Sec. 6662, I.R.C. 1986.

Barbara Morlan DeCaro, for petitioner.

Steven L. Walker, for respondent.
 -2-

MEMORANDUM FINDINGS OF FACT AND OPINION

CHABOT, Judge: Respondent determined deficiencies in

Federal individual income tax and additions to tax under section

6662(a)1 (accuracy-related) against petitioner as follows:

Additions to tax
Year Deficiency Sec. 6662(a)

1993 $5,471 $1,094
1994 6,969 1,394
1995 8,341 1,668

After concessions,2 the issues for decision are as follows:

1. Whether petitioner’s Schedule C activity of making

and selling videotapes (hereinafter sometimes referred to as

petitioner’s videotape activity) was “not engaged in for

profit” within the meaning of section 183 for 1993 through

1995; and

2. Whether petitioner is liable for negligence

additions to tax under section 6662(a) for 1993 through

1995.

1
Unless indicated otherwise, all section and chapter
references are to sections and chapters of the Internal Revenue
Code of 1986 as in effect for the years in issue.
2
The parties have stipulated that (1) petitioner paid or
incurred all the expenses reported on his Schedule C for each of
the years in issue, (2) these expenses are not “start-up
expenditures” within the meaning of sec. 195, and (3) if the
Court holds that petitioner’s videotape activity constituted a
trade or business, then all these expenses are deductible.
 -3-

FINDINGS OF FACT

Some of the facts have been stipulated; the stipulations and

the stipulated exhibits are incorporated herein by this

reference.

When the petition was filed in the instant case, petitioner

resided in Los Altos Hills, California.

Petitioner’s Background

Petitioner is a retired captain from the U.S. Navy, where he

served for 29 years from 1931 to 1960. He is a 1935 graduate of

the U.S. Naval Academy, where he received bachelor’s degrees in

both electrical and mechanical engineering. After his service on

the U.S.S. Jouett and before his service on the U.S.S. Kearny

(see infra), petitioner took a postgraduate course in “Radio

Engineering” (now known as Electronics Engineering), earning a

degree which he believes to be the equivalent of a Ph.D. This

course was taught at the U.S. Naval Academy. Because of World

War II, this 3-year course was compressed into roughly 2 years.

Also, petitioner earned a master’s degree in the National Economy

and took business courses through Harvard University, receiving a

master’s degree in business.

After petitioner was graduated from the U.S. Naval Academy,

he served aboard the U.S.S. Minneapolis from 1935 through 1937.

From 1937 through 1938, petitioner was on a Fleet Staff called

“Commander Cruisers Scouting Force Staff”. Petitioner was on the
 -4-

U.S.S. Jouett from 1938 through 1942. He commanded a destroyer,

the U.S.S. Kearny, during World War II from 1944 until the end of

the war. From 1946 to 1948, petitioner was the Fleet Electronics

Officer for the entire Pacific Fleet and shore activity.

From 1948 to 1951, petitioner was the Electronics Officer

for all U.S. Navy ships in the Office of the Chief of Naval

Operations in Washington, D.C. From 1951 to 1953, petitioner was

the Electronics Officer for Mare Island Naval Shipyard and the

Industrial Manager for the 12th Naval District. He was

responsible for all new electronics facilities in the Pacific

Ocean area, building four major communication facilities and

providing air navigation facilities for the entire Pacific. From

1953 to 1955, petitioner was again the Pacific Fleet Electronics

Officer and was responsible for all joint military and Navy work

in the Pacific. From 1955 to 1958, petitioner was head of Ships

Electronics with the Bureau of Ships for the entire Navy,

including the Merchant Marine and the Coast Guard. From 1958 to

1960, petitioner was the Planning Officer for Pearl Harbor Naval

Shipyard.

After retiring from the U.S. Navy in 1960, petitioner worked

for Hewlett-Packard in California until about 1970. After

leaving Hewlett-Packard, petitioner worked for Fairchild

Electronics for 2 years and then began working full time for

Wheeler and Associates, his own engineering consulting firm,
 -5-

which he had started in 1960. The firm included about 16

consultants. In the early days of the firm, petitioner

concentrated on the technical/consulting end of the business, and

Kensington Management Consultants, Inc., handled the firm’s

administration.

Since 1961, petitioner has been a registered civil and

professional engineer in California. He has kept his license

current. Petitioner is also a member of the following

professional societies: (1) American Association for the

Advancement of Science, (2) U.S. Naval Institute, (3) American

Society of Naval Engineers, (4) American Institute of Electrical

Engineers, (5) U.S. Naval Academy Alumni Association, (6)

National Geographic Society, (7) Commonwealth Club, and (8) the

Institute of Electrical and Electronics Engineering.

Videotape Activity

Around 1985, when petitioner was 72 years old, he began

focusing primarily on making videos. He has conducted his

videotape activity in his home of 25 years. Petitioner has been

transferring home slides, movies, and prints onto videocassettes

and also creating his own videos.

Petitioner kept a log of his video sales showing (1) date of

sale, (2) number of videos sold, (3) buyer’s name, (4) name of

video sold, and (5) sale price for each video. The log
 -6-

constitutes all of petitioner’s books from his videotape

activity.3

Petitioner has devoted one room in his home to his videotape

activity. Petitioner’s reference items in that room include:

(1) Reference books such as The Technique of Film Editing, and

The Technique of the Film Cutting Room, (2) instruction manuals

for the video and audio equipment, and (3) numerous other

magazines and publications.

Petitioner has at least 30 video projects, for a total of at

least 75 tapes, covering the topics described in tables 1 through

4, infra.

Travel Videos

Petitioner and his wife (she died in 1991) vacationed

throughout the world. Petitioner videotaped and sold copies of

the videotapes of these vacations primarily to people who

petitioner and his wife either met on their excursions or

traveled with. Table 1 summarizes these videotapes.

Table 1

1. Golden Odyssey Cruise - This two-tape set covers a
cruise to the Mediterranean on The Royal Cruise
Line. Petitioner sold six copies of the video for
a total of $240.

3
So stipulated. Evidently petitioner’s expenses are not
recorded in the form of books but presumably are in the form of
records, which are sufficiently complete and accurate so as to
enable the parties to stipulate the correctness of all the
expense amounts reported on petitioner’s Schedule C for each year
in issue. Supra note 2.
 -7-

2. Cruise Around the World - This six-tape set covers
a cruise around the world on The Royal Cruise
Line. The cruise took about 6-8 weeks.
Petitioner sold six copies of the video for a
total of $270.

3. Cruise East Coast of South America - This two-tape
set covers a 3-week cruise along the east coast of
South America. Petitioner sold five copies of the
video for a total of $200.

4. Trip to Spain and Portugal - This video covers a
trip to Spain and Portugal. Petitioner sold seven
copies of the video for a total of $140.

5. Norway Cruise - This two-tape set covers a cruise
down the coast of Norway, from Russia to Bergen,
Norway. Petitioner sold six copies of the video
for a total of $240.

6. Cruise Around New Zealand, Australia, and Tasmania
- This two-tape set covers a cruise around New
Zealand (both islands), Australia, and Tasmania.
Petitioner sold five copies of the video for a
total of $200.

7. Kenya Trip - This two-tape set covers a trip to
Kenya, Africa. Petitioner sold six copies of the
video for a total of $240.

8. Eastern Europe Trip - This two-tape set covers a
trip to Eastern Europe. Petitioner sold six
copies of the video for a total of $240.

9. Cruising Mother Russia - This three-tape set
covers a cruise that petitioner took with his
grandson from St. Petersburg to Moscow.
Petitioner sold four copies of the video for a
total of $240.

10. Amazon Cruise - This two-tape set covers a cruise
down the Amazon. Petitioner sold four copies of
the video for a total of $160.
 -8-

Navy Videos

Petitioner has remained involved with the U.S. Navy since he

retired in 1960. He regularly attends Navy reunions and has

stayed in touch with U.S. Naval Academy classmates and with

shipmates. Petitioner is an active member of the U.S. Naval

Academy Alumni Association. As a result of his lifelong personal

interest in the Navy, petitioner has made videotapes about the

Navy and his experiences. For example, he made a videotape about

his 1935 graduating class of the U.S. Naval Academy and a

videotape about the U.S.S. Minneapolis, which he showed at a

reunion of the personnel of the U.S.S. Minneapolis. Petitioner

has given some of his Navy videotapes to such places as the

Department of the Navy, the U.S. Naval Academy, and the Hoover

Institution. Table 2 summarizes these videotapes.

Table 2

1. Captain K.G. Schacht Video - This video covers
Captain K.G. Schacht’s experiences in a Japanese
prisoner-of-war camp during World War II. Captain
Schacht was one of petitioner’s classmates at the
Naval Academy. As of the trial date, petitioner
had not yet completed the video and had not sold
any copies.

2. Shakedown Cruise U.S.S. Minneapolis - This video
covers the U.S.S. Minneapolis’ maiden voyage in
1934. Petitioner was on this ship from 1935-1937,
after having been graduated from the Naval Academy
in 1935. Petitioner sold four copies for a total
of $80. Petitioner received inquiries about the
video after it was mentioned in an alumni
newsletter for the U.S.S. Minneapolis.
 -9-

3. U.S.S. Minneapolis - This two-tape set covers the
U.S.S. Minneapolis and petitioner’s experiences
aboard the ship from 1935-1937. Petitioner sold
six copies for a total of $240.

4. Nobel Prize Award - Petitioner made this two-tape
set in the early 1980’s for a former shipmate who
won the Nobel Prize in Economics [James Tobin].
The video covers the award ceremony and the pre-
award dinner with the King and Queen. Petitioner
sold one copy for $40 and gave the video to the
shipmate’s family.

5. Memorial of Captain Paul Ryan - This video covers
the burial at Arlington National Cemetery of a
close friend of petitioner who was a Naval
officer. Petitioner thinks he sold one copy for
$20, and he gave a video to the family.

6. Memorial of Captain Joe Lyle - This video covers
the burial at Arlington National Cemetery of one
of petitioner’s classmates from the Naval Academy.
Petitioner sold two copies for a total of $40.

7. U.S.S. Kearny Story - This video covers the U.S.S.
Kearny, a destroyer that petitioner commanded
during World War II. Petitioner sold 68 copies
for a total of $1,360.

8. Class of 1935 Naval Academy - This video covers
petitioner’s 4 years at the Naval Academy from
1931-1935. Petitioner sold 65 copies for a total
of $1,318. Petitioner has copyrighted this video.

9. Naval Academy Class of 1936 - This video covers
the 1936 graduating class of the Naval Academy.
Petitioner sold 11 copies for a total of $220.

10. Anchors Aweigh - This six-part set covers events
in the 1930's. It includes historic newsreels,
movies clips, pictures, and sound bites from radio
shows. Petitioner has not completed the video
series and plans to extend it to the 1960’s.
Petitioner has given copies to such places as the
National Archives, the Naval History Museum in
Washington, D.C., and the Naval Academy.
Petitioner believes that he sold between three and
five copies at $120 each.
 -10-

11. Captain Austin - This two-tape set covers family
pictures of one of petitioner’s close friends and
classmates from the Naval Academy. Petitioner
sold four copies to the family for a total of
$160.

12. General Muehleison - This set covers family
pictures of General Muehleison, petitioner’s
acquaintance. Petitioner sold three copies to the
family for a total of $60.

Wedding and Family Videos

Petitioner also made family and wedding videotapes for

friends and acquaintances. Table 3 summarizes these videotapes.

Table 3

1. Jane and Joe Shea’s Wedding - This video covers
the wedding of Jane and Joe Shea, who were
petitioner’s close friends. Petitioner gave the
video to the family and did not sell any.

2. Rhonda and Lou’s Wedding - This video covers the
wedding of Rhonda and Lou, who are friends of
petitioner’s son. Petitioner sold two videos for
a total of $40.

3. Bill and Louise Kaiser’s Wedding Anniversary -
This video covers the 50th wedding anniversary of
petitioner’s close friend from kindergarten.

4. Poppy and DeLanney Clagett - This video covers
family pictures of a close friend and classmate
from the Naval Academy. Petitioner gave the video
to the family and did not sell any because, as of
the trial date, it was not yet completed.

5. Our Son Harold - This video is about Harold Hahn
when he was an infant. He was a child of Mrs.
Hahn, who was petitioner’s secretary. As of the
trial date, petitioner had not yet completed the
video series but had been paid $200 for his work
from 1993 through 1995.
 -11-

6. John and Priscilla Buchan - This three-tape set
covers family pictures of the Buchans. John
Buchan worked for petitioner at Wheeler and
Associates. Petitioner sold two copies for a
total of $120.

Miscellaneous Videos

Table 4 summarizes miscellaneous videotapes that petitioner

made and sold.

Table 4

1. Dancer’s Way - This is a promotion video for
Delores Gay, a dancer who worked with Bob Hope.
Petitioner sold about eight copies for a total of
$308.

2. Marketing Resource Group - This business paid
petitioner to videotape its business meeting.
Petitioner sold the video for $300.

Video Sales 1993-1995

From 1993 through 1995, petitioner had videotape sales as

shown in table 5.

Table 5

Year Sales

1993 $238
1994 20
1995 180

Total 438

Petitioner did not sell any of the videotapes listed in

table 1 during 1993 through 1995.

In 1993, petitioner sold $238 of videotapes. This consisted

of $38 for one copy of the videotape listed as item 8 in table 2
 -12-

and the $200 petitioner received for his work on the videotape

listed as item 5 in table 3. These are all of the videotapes

that petitioner sold in 1993.

In 1994, petitioner sold only one video for $20. This video

is item 1 in table 4.

In 1995, petitioner sold $180 of videos. As of the trial

date he had not yet collected the money from these sales. These

videos are not listed in tables 1 through 4, and the videos were

for a project that petitioner was working on.

Operation of Petitioner’s Activity

Petitioner did not formulate any written business plan or

make any substantive financial projections before starting his

videotape activity. He did not have any written business plan in

existence from 1993 through 1995, forecasting his videotape

activity’s income, expenses, or net profit or loss. Petitioner

did not maintain separate bank accounts for his personal funds

and the funds from his videotape activity.

Petitioner had incurred $155,553 of costs for videotape

equipment by the end of 1995, of which $74,977 was incurred from

1993 through 1995. Petitioner concedes that this equipment will

not appreciate in value.

Petitioner did not spend any money on advertising from 1993

through 1995. He relied solely on “word-of-mouth” to generate

sales of his videos from 1993 through 1995. Petitioner did not
 -13-

advertise because he already had as much business as he could

handle himself; he did not want his videotape activity to become

“a big company.”

Petitioner reported the income and expenses from his

videotape activity on Schedule C from at least 1985 through 1995.

His videotape activity has generated losses every year since

inception. Petitioner used the losses to offset his income.

That income has included his Navy pension, dividend income,

interest income, capital gains, and Social Security benefits.

Table 6 shows petitioner’s adjusted gross income (before the

Schedule C loss), Schedule C gross receipts, Schedule C gross

income, Schedule C expenses, the Schedule C losses that he used

to offset his income, and adjusted gross income after Schedule C

loss.
 Table 6

AGI before
Schedule C Schedule C Schedule C Schedule C Schedule C Adjusted
Year loss gross receipts gross income expenses1 loss1 gross income

1985 $48,679 $890 ($937) $3,506 ($4,443) $44,236
1986 45,271 1,675 (213) 3,016 (3,229) 42,042
1987 58,255 333 (1,987) 4,757 (6,745) 51,510
1988 165,311 1,592 1,123 6,900 (5,778) 159,533
1989 80,365 409 (1,793) 6,805 (8,598) 71,767
2
1990 -- -- -- -- -- --
1991 69,055 698 375 12,138 (11,876) 57,179
1992 66,534 883 690 15,638 (15,039) 51,495
1993 70,768 238 (306) 18,171 (18,570) 52,198
1994 72,191 20 15 23,862 (23,942) 48,249
1995 77,196 -0- -0- 28,302 (28,401) 48,795
3
1996 77,937 60 60 27,332 (27,272) 77,937

1
For 1991 through 1995, the amounts stipulated by the parties as petitioner’s Schedule C
expenses do not include expenses for business use of petitioner’s home, but the amounts
stipulated by the parties as petitioner’s Schedule C losses do take account of expenses
for business use of petitioner’s home. The expenses for business use of the home for 1991
through 1995 range from a high of $113.46 (1991) to a low of $91.53 (1992).
2
The parties were unable to obtain information regarding 1990. However, they stipulated
that petitioner’s videotape activity generated a loss for this year.
3
Although petitioner reported the $27,272 loss on Schedule C for 1996, he did not carry
this loss over to his Form 1040.
 -15-

Petitioner owned an avocado farm. Table 7 shows the gross

income and total expenses that petitioner reported on his

Schedules F and the amount of farm income or (loss) that

petitioner reported on the first page of his Forms 1040.

Table 7

Schedule F
Year Gross income Total expenses Form 1040

1985 -0- $3,749.19 -0-
1986 -0- 1,532.54 -0-
1987 -0- 914.81 ($914.81)
1988 $113.00 1,638.28 (1,525.28)
1989 -0- 5,796.57 -0-
1991 -0- 2,108.88 -0-
1992 -0- 4,002.43 -0-
1993 -0- 956.89 -0-
1994 -0- 3,577.59 -0-
1995 -0- 4,438.50 -0-
1996 N/A N/A -0-

Petitioner prepared his own tax returns for each of the

years in issue and for the prior years. Petitioner’s 1996

tax return was prepared by a paid tax return preparer.

_____________________________________

Petitioner did not engage in his videotape activity for

profit.

Petitioner was negligent with respect to his tax

treatment of his videotape activity; the entire deficiency

for each year in issue was due to this negligence.
 -16-

OPINION

I. Sec. 183--Activity Not Engaged In For Profit

Both parties base their cases on their respective analyses

of a list of factors often considered in so-called “hobby loss”

cases. Each party concludes that substantially all the factors

point to a conclusion favoring that side.

In general we agree with respondent’s analyses; we also

agree with respondent’s conclusion.
 -17-

In the context of the instant case, the effect of section

1834 is that petitioner’s disputed deductions are allowable but

4
Sec. 183 provides, in pertinent part, as follows:

SEC. 183. ACTIVITIES NOT ENGAGED IN FOR PROFIT.

(a) General Rule.--In the case of an activity engaged in by
an individual * * *, if such activity is not engaged in for
profit, no deduction attributable to such activity shall be
allowed under this chapter [i.e., chapter 1, relating to normal
taxes and surtaxes] except as provided in this section.

(b) Deductions Allowable.--In the case of an activity not
engaged in for profit to which subsection (a) applies, there
shall be allowed--

(1) the deductions which would be allowable under this
chapter for the taxable year without regard to whether or
not such activity is engaged in for profit, and

(2) a deduction equal to the amount of the deductions
which would be allowable under this chapter for the taxable
year only if such activity were engaged in for profit, but
only to the extent that the gross income derived from such
activity for the taxable year exceeds the deductions
allowable by reason of paragraph (1).

(c) Activity Not Engaged in for Profit Defined.--For
purposes of this section, the term "activity not engaged in for
profit" means any activity other than one with respect to which
deductions are allowable for the taxable year under section 162
or under paragraph (1) or (2) of section 212.

Sec. 162 provides, in pertinent part, as follows:

SEC. 162. TRADE OR BUSINESS EXPENSES.

(a) In General.--There shall be allowed as a deduction all
the ordinary and necessary expenses paid or incurred during the
taxable year in carrying on any trade or business * * *

Sec. 212 provides, in pertinent part, as follows:

(continued...)
 -18-

only if his videotape activity was engaged in for profit.

Whether an activity is engaged in for profit is determined

under section 162 and section 212 (except insofar as section

183(d) creates a presumption that the activity is engaged in for

profit). See sec. 183(c). Whether an activity is engaged in for

profit turns on whether the taxpayer has an actual and honest

objective of making a profit. Dreicer v. Commissioner, 78 T.C.

642, 645 (1982), affd. without opinion 702 F.2d 1205 (D.C. Cir.

1983); Engdahl v. Commissioner, 72 T.C. 659, 666 (1979); Golanty

v. Commissioner, 72 T.C. 411, 425-426 (1979), affd. without

published opinion 647 F.2d 170 (9th Cir. 1981). Petitioner’s

objective is a question of fact to be determined from all the

facts and circumstances. Polakof v. Commissioner, 820 F.2d 321,

324 (9th Cir. 1987), affg. T.C. Memo. 1985-197; Allen v.

Commissioner, 72 T.C. 28, 34 (1979); Dunn v. Commissioner, 70

T.C. 715, 720 (1978), affd. without published opinion 607 F.2d

995 (2d Cir. 1979), affd. on another issue 615 F.2d 578 (2d Cir.

1980). Mere statements of intent are not determinative.

4
(...continued)
SEC. 212. EXPENSES FOR PRODUCTION OF INCOME.

In the case of an individual, there shall be allowed as a
deduction all the ordinary and necessary expenses paid or
incurred during the taxable year--

(1) for the production or collection of income;
(2) for the management, conservation, or maintenance
of property held for the production of income * * *
 -19-

Independent Elec. Supply, Inc. v. Commissioner, 781 F.2d 724, 726

(9th Cir. 1986), affg. Lahr v. Commissioner, T.C. Memo. 1984-472;

Engdahl v. Commissioner, 72 T.C. at 666; Churchman v.

Commissioner, 68 T.C. 696, 701 (1977). The burden of proof is on

petitioner. Rule 142(a); Independent Elec. Supply, Inc. v.

Commissioner, 781 F.2d at 727; Golanty v. Commissioner, 72 T.C.

at 426; Boyer v. Commissioner, 69 T.C. 521, 537 (1977).

In general, for these purposes the “profit” that must be

sought is taxable income, Independent Elec. Supply, Inc. v.

Commissioner, 781 F.2d at 726; Brannen v. Commissioner, 78 T.C.

471, 501 (1982), affd. 722 F.2d 695 (11th Cir. 1984), or economic

profit independent of tax savings. Antonides v. Commissioner, 91

T.C. 686, 694 (1988), affd. 893 F.2d 656, 659 (4th Cir. 1990).

Section 1.183-2(b)(1) through (9), Income Tax Regs., sets

out the following factors (principally derived from case law, see

Benz v. Commissioner, 63 T.C. 375, 382-383 (1974)), to be taken

into account in determining a profit objective, or lack of one:

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

the expertise of the taxpayer or the taxpayer’s advisers; (3) the

time and effort spent 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 loss with respect to the
 -20-

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. No one factor is

conclusive, and we do not reach our decision herein by merely

counting how many of the nine enumerated factors support each

party’s position. Carter v. Commissioner, 645 F.2d 784, 787 (9th

Cir. 1981), affg. T.C. Memo. 1978-202; Dunn v. Commissioner, 70

T.C. at 720. We consider these factors seriatim.

(1) Manner of Carrying on the Activity

The parties have stipulated the accuracy of petitioner’s

Schedule C for each year in issue. Supra note 2. Also,

respondent did not determine, and does not assert, that

petitioner omitted to report any receipts from his videotape

activity. From the foregoing, we conclude that petitioner’s

books and records, though sparse and relatively informal, were

adequate for a trade or business.

By the end of 1992, petitioner was faced with a record of

fluctuating gross receipts which were trending somewhat downward,

and losses which were more-or-less consistently increasing.

Supra table 6. He had spent about $80,000 on equipment. His

reported losses from his videotape activity, including straight-

line depreciation, aggregated about $55,000, plus whatever he

reported on his 1990 tax return. Supra table 6, note 2. His

reaction to this state of affairs was to buy another $75,000 of
 -21-

equipment and spend most of the next 3 years learning how to use

the new equipment. His gross receipts plummeted; his losses

increased even more. Supra tables 5 and 6.

The parties have stipulated that petitioner did not have a

written business plan, forecasting income, expenses, and net

profit or loss, during the years in issue, and had not prepared

any such written business plan before starting his videotape

activity. When asked about this at trial, petitioner responded

as follows:

Q [Ms. DeCaro] Why did you not prepare a business
plan?

A [Petitioner] Well, I have my business plan in my head
and that’s one of my businesses that I was doing when I was
actually consulting was preparing business plans, and it
seemed like a silly waste of paper to put it down in black
and white.

Petitioner did not present us with an oral description of the

business plan that was in his head.

Petitioner noted at trial that his father had continued to

operate his own business until dying at age 92. When questioned

on cross-examination, petitioner did not give any indication as

to how long he thought it would take for him to earn enough

income from his videotape activity to recoup the $155,000 or so

that he had spent on equipment.

The parties have stipulated that petitioner did not spend

any money on advertising from 1993 through 1995; he relied solely

on “word-of-mouth”. Petitioner’s Schedules C also show that he
 -22-

did not spend any money on advertising from 1985 through 1989,

1991, 1992, and 1996. (The record does not include the

information for 1990.) We understand that many a successful

small business relies on word-of-mouth to increase its patronage

or maintain patronage at a satisfactory level. However, as supra

tables 2 through 6 show, petitioner’s patronage remained at

meager and unprofitable levels throughout the period for which we

have evidence in the record. Petitioner did not advertise or, so

far as we can tell from the record, take any other steps to try

to move his videotape activity into the profit column. Indeed,

petitioner testified that he already had as much work as he could

handle. The only facet of his activities that showed significant

changes are the fairly steady increases in expenses and losses.

Supra table 6.

On the whole, although petitioner’s books and records were

sufficient, the rest of his videotape activity does not appear to

have been carried on in a businesslike manner.

(2) Expertise of Taxpayer or Advisers

Petitioner’s background in electronics and communications is

impressive. Petitioner also has a master’s degree in business.

Petitioner consulted reference books such as The Technique of

Film Editing and The Technique of The Film Cutting Room,

instruction manuals for the video and audio equipment, and

numerous other magazines and publications. Petitioner has had
 -23-

extensive managerial experience covering numerous positions

including running his own engineering consulting firm and

commanding a destroyer during World War II.

This factor favors petitioner.

(3) Time and Effort Spent in the Activity

Petitioner testified that, on average, he spent about 50 to

60 hours per week on his videotape activities. On brief,

petitioner claims only about 30 hours per week. In either event,

it is evident that petitioner spent substantial time and effort

on his videotape activities, making this a factor pointing toward

a profit objective.

(4) Expectation That Assets May Appreciate in Value

A taxpayer’s “bona fide expectation” that assets used in a

questioned activity will appreciate in value is a factor pointing

toward a conclusion that the taxpayer engaged in the questioned

activity for profit. Engdahl v. Commissioner, 72 T.C. at 668-

669; Allen v. Commissioner, 72 T.C. at 36.

The parties have stipulated that “petitioner had incurred

$155,553 of costs for video equipment by the end of 1995, of

which $74,977 was incurred from 1993-1995.” On brief petitioner

concedes that this equipment “will not increase in value”.

This factor favors respondent.
 -24-

(5) Taxpayer’s Success in Other Activities

Petitioner had a long and successful military career.

Petitioner then worked for large electronics companies. He then

worked for an engineering consulting firm which he had founded.

The record does not indicate how successful petitioner was in his

civilian jobs. We cannot tell from the record that any of

petitioner’s jobs were sufficiently similar to his videotape

activity so that his degree of success in those jobs would be

helpful in predicting success in his videotape activity.

(6) History of Income or Losses From the Activity

Petitioner’s videotape activity produced a loss for every

year since the activity’s inception. As supra table 6 shows, the

losses trended upward with only minor fluctuations. By the end

of the last year in issue, petitioner was already past 80 years

old, with no indication that he would give up his videotape

activity and no indication that he would make any major change in

the way he conducted his videotape activity.

A series of losses during the initial or startup stage of an

activity may not necessarily be an indication that the activity

is not engaged in for profit. However, by the time of the years

in issue, petitioner’s videotape activity was no longer in its

initial or startup stage. Although the parties’ stipulation

“that the expenses on petitioner’s Schedule C for 1993 to 1995 do

not represent startup cost” was evidently directed primarily to
 -25-

respondent’s alternative contention (since abandoned) under

section 195, we are entitled to take it into account in

evaluating petitioner’s history of losses from his videotape

activity.

Nowhere in the record do we find a coherent explanation of

any plan by petitioner to produce a profit from his videotape

activity in either the short run or the long run.

This factor favors respondent.

(7) Amount of Occasional Profits Earned

There were not any occasional profits from petitioner’s

videotape activity. Indeed, as supra table 6 shows, as often as

not there was not even gross income from petitioner’s videotape

activity. The fluctuations in gross income were minor, compared

to the steady progression of increasing Schedule C expenses.

This factor favors respondent.

(8) Taxpayer’s Financial Status

Before petitioner’s wife’s death, petitioner’s videotape

activity losses were generally around 10 percent of his adjusted

gross income before the losses. After petitioner’s wife’s death,

the loss percentages increased, but a new pattern emerged--the

losses from petitioner’s videotape activities left him with about

$50,000 adjusted gross income each year. If petitioner would

have deducted his 1996 Schedule C loss, that would have produced

a 1996 adjusted gross income of $50,665. Supra table 6.
 -26-

On brief, petitioner contends that “the mere fact that a

taxpayer has a substantial income from other sources does not

foreclose a profit motive.” We agree. This is but an

illustration of the proposition that no one factor is conclusive.

The record does not show that petitioner needed profits, or

even gross income, from his videotape activity. His other income

apparently was substantial enough, even after the videotape

losses, to maintain his life style. The record does not include

any indication that petitioner feared that any of his major

income sources was going to “dry up” and that he thought it

prudent to engage in his videotape activity to develop a

replacement source of income. Compare the instant case with

Nickerson v. Commissioner, 700 F.2d 402, 403, 406 (7th Cir.

1983), revg. T.C. Memo. 1981-321.

This factor favors respondent.

(9) Elements of Personal Pleasure

Petitioner took great pains to provide high quality

videotapes. His methods were not slapdash. He preserved his,

his family’s, his classmates’, his shipmates’, and his friends’

memories. He preserved history. He enjoyed what he did. As we

have noted, “a business will not be turned into a hobby merely

because the owner finds it pleasurable”. Jackson v.

Commissioner, 59 T.C. 312, 317 (1972). Thus, petitioner’s

enjoyment of his work should not be a factor in respondent’s
 -27-

favor. By the same token, it is not a factor in petitioner’s

favor.

Conclusions

From 1985 through the end of 1992, just before the years in

issue, (1) petitioner had incurred about $80,000 of costs for

video equipment, (2) petitioner had lost increasing amounts of

money for each of the 8 years since he embarked on his videotape

activity, and (3) petitioner was approaching age 80. During the

3 years in issue, (1) petitioner incurred about $75,000 more of

costs for video equipment, (2) petitioner’s videotape sales

totaled $438, of which he had collected only $258 by the time of

the trial, and (3) petitioner lost another $70,000 on his

videotape activity. Petitioner's age ordinarily would not be

relevant to our determination. However, petitioner's substantial

capital investment at that age makes it more important that

petitioner be able to show that he really intended to earn enough

to (1) recoup his capital investment and also (2) earn a profit

on that capital investment.

Petitioner seemed to be unable to articulate any plan, or

even any moderately clear vision, for profitability of his

videotape activity.

We conclude, and we have found, on the basis of the

preponderance of the evidence, that petitioner did not engage in

his videotape activity for profit.
 -28-

We hold for respondent on this issue.

II. Section 6662--Negligence

Respondent determined that petitioner is liable for a 20-

percent negligence addition to tax on the entire underpayment for

each year in issue.

Respondent contends that petitioner “failed to act

reasonably in claiming increasingly larger expenses and losses on

Schedule C from 1993-1995.” Respondent relies on Sacks v.

Commissioner, T.C. Memo. 1994-217, affd. 82 F.3d 918 (9th Cir.

1996).

Petitioner maintains that he had reasonable cause for his

actions--in particular that he was following advice from one of

respondent’s employees and from respondent’s Schedule C

instructions. Petitioner also maintains that he acted in good

faith, as is shown by the disclosures on his tax returns.

Petitioner relies on Osteen v. Commissioner, 62 F.3d 356 (11th

Cir. 1995), affg. in part and revg. in part T.C. Memo. 1993-519.

Neither side suggests, even by way of a fallback position,

that one part of the underpayment may be due to negligence and

the other part not due to negligence.

We agree with respondent’s conclusion.
 -29-

Section 66625 imposes an accuracy-related penalty of 20

percent of any portion of an underpayment that is attributable to

the taxpayer’s negligence. Subsecs. (a) and (b)(1) of sec. 6662.

5
Sec. 6662 provides, in pertinent part, as follows:

SEC. 6662. IMPOSITION OF ACCURACY-RELATED PENALTY.

(a) Imposition of Penalty.--If this section applies to any
portion of an underpayment of tax required to be shown on a
return, there shall be added to the tax an amount equal to 20
percent of the portion of the underpayment to which this section
applies.

(b) Portion of Underpayment to Which Section Applies.--This
section shall apply to the portion of any underpayment which is
attributable to 1 or more of the following:

(1) Negligence or disregard of rules or regulations.

* * * * * * *

(c) Negligence.--For purposes of this section, the term
“negligence” includes any failure to make a reasonable attempt to
comply with the provisions of this title, [title 26, the Internal
Revenue Code] and the term “disregard” includes any careless,
reckless, or intentional disregard.

Sec. 6664 provides, in pertinent part, as follows:

SEC. 6664. DEFINITIONS AND SPECIAL RULES.

* * * * * * *

(c) Reasonable Cause Exception.--

(1) In general.--No penalty shall be imposed under
this part with respect to any portion of an underpayment if
it is shown that there was a reasonable cause for such
portion and that the taxpayer acted in good faith with
respect to such portion.
 -30-

For purposes of the instant case, “underpayment” is the same as

“deficiency”. Compare sec. 6664(a) with sec. 6211(a).

Broadly speaking, for purposes of this provision, negligence

is lack of due care or failure to do what a reasonable and

ordinarily prudent person would do under the circumstances to

determine that person’s income tax liability. ASAT, Inc. v.

Commissioner, 108 T.C. 147, 175 (1997); Cluck v. Commissioner,

105 T.C. 324, 339 (1995). Reasonable and good faith reliance by

a taxpayer on an accountant or attorney may be sufficient to

avoid the addition to tax for negligence. See United States v.

Boyle, 469 U.S. 241, 251 (1985). Petitioner has the burden of

proving error in respondent’s determination that these additions

to tax should be imposed against him. Little v. Commissioner,

106 F.3d 1445, 1449-1450 (9th Cir. 1997), affg. T.C. Memo. 1993-

281; Korshin v. Commissioner, 91 F.3d 670, 671 (4th Cir. 1996),

affg. T.C. Memo. 1995-46; ASAT, Inc. v. Commissioner, 108 T.C. at

175.

Petitioner was in the witness box for about 2½ hours. On

the basis of our observation, as well as the record in the

instant case, we conclude that petitioner is an articulate and

able man of integrity. He makes up his mind on the basis of the

information he has. If he feels the need for additional

information, or advice, or instruction, then he seeks it. If he

feels that no further information, advice, or instruction is
 -31-

needed, then he does not seek it. He does what he believes to be

appropriate and does not do what he believes to be superfluous,

regardless of the views of others.

Thus, petitioner does not bother with written business

plans. This would make less difference if petitioner had

business plans in his head. But petitioner was unable to

articulate any plans that he had as to how his videotape activity

was going to--or that he hoped would--produce a profit.

Petitioner did not offer any explanation of why he treated

his avocado-raising losses, shown on the Schedule F for each tax

return, differently from the way he treated his Schedule C

videotape activity, deducting the latter losses but ordinarily

not deducting the former losses. Supra table 7.

It appears that, at some undetermined time in the early

1980’s, some unidentified IRS employee suggested that petitioner

use Schedule C in connection with some activity that may have

been a precursor of petitioner’s videotape activity.

Petitioner’s reliance on the advice assertedly given to him

by an IRS employee a decade or so earlier is not exculpatory

because the record does not show what information petitioner gave

to the IRS employee and exactly what advice the IRS employee gave

to petitioner. Compare, e.g., Howard v. Commissioner, 931 F.2d

578, 582 (9th Cir. 1991), affg. T.C. Memo. 1988-531, with Weis v.

Commissioner, 94 T.C. 473, 486-488 (1990). From the sparse
 -32-

information in the record, we conclude that, regardless of what

an IRS employee may have mentioned to petitioner in the early

1980’s, by the time of the years in issue petitioner should have

sought advice from experts who could evaluate the implications of

a decade of increasing losses in petitioner’s videotape activity.

In light of the increasing magnitude of petitioner’s loss

deductions, a reasonable and ordinarily prudent person would have

sought such advice. Petitioner failed to make a reasonable

attempt to comply with the provisions of sections 183, 162, and

212, and the decade-old advice by the IRS employee is not

reasonable cause for petitioner’s failure.

Petitioner’s reliance on Osteen v. Commissioner, 62 F.3d 356

(11th Cir. 1995), is misplaced. Osteen dealt with whether the

taxpayers therein had “substantial authority” for their tax

treatment of an item, within the meaning of former section

6661(b)(2)(B)(i). Osteen v. Commissioner, 62 F.3d at 359. That

provision appears now as section 6662(d)(2)(B)(i), a

qualification in the application of the substantial

understatement addition to tax under section 6662. The

substantial authority language does not appear in section 6662(c)

(relating to the definition of “negligence”), nor does it appear

in section 6664(c)(1) (relating to the reasonable cause

exception). For an example of the differences between a

negligence analysis and a substantial-understatement analysis see
 -33-

Little v. Commissioner, 106 F.3d at 1449-1451, 1451-1453. Osteen

does not affect our analysis in the instant case.

For completeness, we note that respondent’s reliance on

Sacks v. Commissioner, T.C. Memo. 1994-217, also is misplaced.

In Sacks, the taxpayers invested in a tax shelter, the prospectus

for which projected that in the first 3 years of the investment

the taxpayers would be able to deduct 350 percent of their cash

outlay. The prospectus prominently displayed the fact that the

investment had significant tax risks and could well be challenged

by the Internal Revenue Service. We held the taxpayers were

liable for the negligence additions to tax, and the Court of

Appeals affirmed. Sacks v. Commissioner, 82 F.3d 918 (9th Cir.

1996), affg. T.C. Memo. 1994-217. There is no indication in the

record in the instant case that petitioner’s deductions exceeded

his actual cash outlays or that petitioner engaged in his

videotape activity for any substantial tax reduction purpose.

We have held, supra, that petitioner did not engage in his

videotape activity for profit.

By the time of the years in issue, a reasonable and

ordinarily prudent person would have sought competent advice on

the deductibility of the expenses of this videotape activity.

Petitioner failed to make a reasonable attempt to do so. We

conclude, and we have found, on the basis of the preponderance of

the evidence, that petitioner was negligent and that the entire
 -34-

deficiency for each of the years in issue was due to this

negligence.

We hold for respondent on this issue.

Decision will be entered

for respondent.