T.C. Memo. 1999-93
UNITED STATES TAX COURT
MELISSA S. SPRANGER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 8485-97. Filed March 25, 1999.
Melissa S. Spranger, pro se.
Eric R. Skinner, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
CARLUZZO, Special Trial Judge: This case was heard pursuant
to the provisions of section 7443A(b)(3) of the Internal Revenue
Code of 1986, as amended and in effect at the time the petition
was filed, and Rules 180, 181, and 182 of the Tax Court Rules of
Practice and Procedure. Unless otherwise indicated, subsequent
section references are to the Internal Revenue Code in effect for
1993.
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Respondent determined a deficiency in petitioner's 1993
Federal income tax in the amount of $6,426. The issue for
decision is whether petitioner is entitled to various deductions
claimed on a Schedule C included with her 1993 Federal income tax
return. The resolution of this issue depends upon whether,
during 1993, petitioner's dog breeding activity constituted a
trade or business within the meaning of section 162.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
Petitioner filed a timely 1993 Federal income tax return. On
that return, petitioner computed her taxable income and Federal
income tax liability in accordance with the cash receipts and
disbursements method of accounting. At the time that the
petition was filed, she resided in Omaha, Nebraska.
During 1993 petitioner was employed as a building
official/inspector by the City of Gross Pointe Woods, Michigan.
Her work schedule was somewhat irregular; however, she routinely
worked between 40 and 60 hours per week. She received and
properly reported wage income in the amount of $40,306 from this
employment.
As of the date of trial, petitioner had been involved in
breeding and showing Pomeranian dogs for over 30 years. Her
interest in Pomeranian dogs arose when she was only 10 years old.
For Federal income tax purposes, in 1989 she and her former
husband began reporting income earned and expenses paid in
connection with this activity on Schedules C included with their
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Federal income tax returns. Petitioner and her former husband
separated in 1993 and were divorced in 1994.
From 1989 through the date of trial, petitioner never
realized or reported on a Federal income tax return a net profit
from the activity. The income and expenses with respect to the
activity reported on petitioner's Federal income tax returns from
1993 through 1996, inclusive, are summarized in the following
table:
Year Income Expenses Net Loss
1993 $ 525 $29,142 $28,617
1994 375 19,111 18,736
1995 350 14,670 14,320
1996 250 7,104 6,854
On her 1993 Schedule C petitioner reported the following
items:
Income $525
Expenses
Advertising $ 891
Depreciation 7,903
Insurance 1,932
Interest 4,196
Repairs 2,431
Supplies 3,616
Tax 254
Travel, etc 5,071
Other 2,848 29,142
Net loss 28,617
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During 1993 petitioner owned 28 dogs. Some of the above
expenses related to the maintenance (including feeding, grooming,
and veterinarian services) of those dogs. The dogs were kept in
an addition to petitioner's residence that was constructed for
that purpose.
The $525 of income petitioner reported on the Schedule C
consists of a single stud fee ($150) and the sale of one puppy
($375). Stud fees and puppy sales are the only ways in which
petitioner expected to generate income from her dog breeding
activity.
Dog breeders gain recognition for themselves and their dogs
by entering their dogs in shows sanctioned by the American Kennel
Club and sponsored by various organizations. Dogs that have
successfully competed in shows attract customers interested in
obtaining stud services or purchasing puppies from dogs owned by
the breeders.
During 1993 petitioner entered only five of her dogs in
various shows. The shows were held at various locations in
different states. Some shows were scheduled in clusters over a
three or four-day period. Typically petitioner was required to
pay a fee to enter her dogs in a show. The shows did not award
cash prizes to the winners. As explained above, the financial
reward for winning came in the form of enhancing the winner's
reputation for breeding purposes, which in turn resulted in more
demand and higher fees for the breeding services of the winner.
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Petitioner traveled to the dog shows with an associate in
petitioner's 1989 Fleetwood motor home. Petitioner purchased the
motor home in 1989 for $36,897. On the Schedule C included with
her 1993 return, petitioner indicated that the motor home was
used exclusively in her dog breeding business.
Petitioner also owned a 1993 Ford Bronco that was purchased
in 1992 for $36,998. On the Schedule C included with her 1993
return, she indicated that 83 percent of the usage of the Bronco
was attributable to her dog breeding activity. Petitioner used
the Bronco to commute to her job with Gross Pointe Woods, a
distance of over 30 miles from her residence.
Petitioner did not keep a separate set of books and records
for her dog breeding activity. Some of the expenses relating to
the activity were paid from a personal joint checking account
that petitioner maintained with her former husband. She also
kept copies of receipts for some of the expenses related to her
dog breeding activity. Because of complications related to her
divorce, petitioner cannot locate the relevant check registers or
any receipts.
Since 1989, only five of petitioner's dogs generated any
income. Petitioner did not maintain any records that tracked
income and expenses attributable to a particular dog. She did
not develop a business plan for the year in issue, or for any
other year. Petitioner never consulted with any professionals in
order to develop a strategy that would allow her to profit from
her dog breeding activity, nor did she alter her practices from
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one year to the next in order to increase the likelihood for
profit. Petitioner never had her dogs appraised, and she did not
insure them.
Relevant for our purposes, in the notice of deficiency,
respondent disallowed the net loss reported on the Schedule C.
Respondent explained the disallowance as follows: "It is
determined that the Schedule C loss pertaining to your dog
operations was not incurred in transactions entered into for
profit. Therefore, the loss of $28,617.00 shown on your return
is not allowable."
OPINION
Deductions are a matter of legislative grace. A taxpayer
who claims a deduction must identify the specific statute that
allows for the type of deduction claimed and demonstrate that all
of the requirements of the statute have been satisfied.
INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New
Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).
Although not expressly referred to by petitioner, it is clear
that in this case petitioner relies upon section 162(a) in
support of the deductions here in dispute.
In general, section 162(a) allows a deduction for all
ordinary and necessary expenses paid or incurred during the
taxable year in carrying on a trade or business. The term "trade
or business" is not precisely defined in the Internal Revenue
Code or the regulations promulgated thereunder; however, it is
well established that in order for an activity to be considered a
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taxpayer's trade or business for purposes of section 162, the
activity must be conducted "with continuity and regularity" and
"the taxpayer's primary purpose for engaging in the activity must
be for income or profit." Commissioner v. Groetzinger, 480 U.S.
23, 35 (1987).
Consistent with the manner in which petitioner reported the
income and expenses attributable to petitioner's dog breeding
activity on her 1993 Federal income tax return, she argues that
she engaged in that activity during 1993 with the intent to make
a profit, and therefore the activity constitutes a trade or
business. She further points out that her return for taxable
year 1989 was examined and respondent allowed her to treat the
dog breeding activity as a trade or business.
Respondent argues that petitioner's dog breeding activity
did not constitute a trade or business during 1993 because
petitioner did not engage in that activity with the requisite
intent to profit. Consequently, according to respondent,
petitioner is only entitled to deduct the expenses related to
petitioner's dog breeding activity as allowable under section
183.
The test of whether a taxpayer conducted an activity for
profit is whether he or she entered into, or continued, the
activity with an actual or honest objective of making a profit.
Keanini v. Commissioner, 94 T.C. 41, 46 (1990); Dreicer v.
Commissioner, 78 T.C. 642, 644-645 (1982), affd. without opinion
702 F.2d 1205 (D.C. Cir. 1983); sec. 1.183-2(a), Income Tax Regs.
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Although a reasonable expectation of profit on taxpayer's part is
not required, the profit objective must be bona fide, as
determined from a consideration of the surrounding facts and
circumstances. Keanini v. Commissioner, supra at 46; Dreicer v.
Commissioner, supra at 645; Golanty v. Commissioner, 72 T.C. 411,
426 (1979), affd. without published opinion 647 F.2d 170 (9th
Cir. 1981); Bessenyey v. Commissioner, 45 T.C. 261, 274 (1965),
affd. 379 F.2d 252 (2d Cir. 1967).
Whether petitioner engaged in her dog breeding activity with
an actual and honest objective of realizing a profit must be
redetermined year-to-year, taking into account all of the
relevant facts and circumstances. 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 petitioner's statement of her
intent. Engdahl v. Commissioner, 72 T.C. 659, 666 (1979); sec.
1.183-2(a), Income Tax Regs. Respondent's determinations with
respect to other years, if any, may be taken into account but are
not conclusive.
The following factors, which are nonexclusive, should be
considered in the determination of 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 or her
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;
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(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 one factor is determinative in and of itself, and our
conclusion with respect to petitioner's profit motive does not
depend upon merely counting up those factors that suggest the
presence of a profit motive and comparing the number to those
factors that indicate the opposite. Sec. 1.183-2(b), Income Tax
Regs.
Taking into account the above factors and considering the
facts and circumstances relating to petitioner's dog breeding
activity, as discussed more fully below, we are not persuaded
that during 1993 petitioner engaged in that activity with the
intent to profit that is necessary to consider the activity a
trade or business for purposes of section 162. The activity did
generate gross income; however, not all income producing
activities constitute trades or businesses within the meaning of
section 162(a). Cf. Commissioner v. Groetzinger, supra at 35.
For the year in issue, the great majority of expense
deductions attributable to petitioner's dog breeding activity
were related to the Fleetwood motor home and Bronco that
petitioner owned. Deductions for the fixed costs of the those
vehicles, including depreciation, interest and insurance, totaled
$14,020. Deductions for the marginal costs attributable to those
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vehicles, including repairs, maintenance and actual travel
expenses, totaled $7,402. The marginal costs alone exceeded the
income from the activity by a factor of 12.
We are particularly influenced by petitioner's failure to
consider the extent of stud fees and puppy sales necessary to
cover not only the costs of operating the motor home and truck,
but the other expenses related to the activity as well. She did
not develop a business plan, or prepare a break-even analysis.
Nor did she record the particular income earning history of any
of her dogs, so that the profit potential of the activity could
be better evaluated. The following portion of petitioner's cross
examination demonstrates the complete lack of the type of
planning that is indicative of an activity engaged in for profit:
Q. Prior to the time when you began deducting losses
for your dog activity, did you ever prepare a business
plan?
A. No, sir.
Q. Between 1989 and -- well, until now, have you ever
prepared any profit or loss statements other than a
final tallying for your tax returns?
A. No, sir.
Q. Did you ever prepare a break-even analysis or any
projections of what you might have to earn to make a
profit?
A. No.
Q. Did you prepare any budgets for the activity?
A. No, sir.
Q. Okay. Just based upon your history of losses in
the activity, how much would you have to earn this year
to make a profit on the activity as a whole?
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A. With the prior years and losses?
Q. Yeah.
A. I would have no idea off the top of my head.
* * *
Q. During 1989 and subsequent years for the business,
did you keep any records that would show the
expenditures made with respect to any individual dog?
A. No, sir.
Q. Okay. Did you make any attempt, since 1989 and
subsequent years, to apportion the expenses to
determine how much each animal was costing you?
A. No, sir.
Since 1989 only five of petitioner's dogs generated any
income, although she owned 28 dogs during 1993, and deducted the
costs of maintaining all of those dogs. Petitioner has an
obvious interest in owning, raising, and showing Pomeranian dogs;
however, we find that during the year in issue, her interest,
which developed when she was a child, was personal in nature and
not based upon the necessary profit motive that would allow for
the activity to be considered a trade or business within the
meaning of section 162(a). Of course, deriving personal
satisfaction out of an activity does not necessarily indicate the
absence of an intent to profit; however, "where the possibility
for profit is small (given all the other factors) and the
possibility for gratification is substantial, it is clear that
the latter possibility constitutes the primary motivation for the
activity." Smith v. Commissioner, T.C. Memo. 1997-503 (citing
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Burger v. Commissioner, T.C. Memo. 1985-523); Sec. 1.183-2(b)(9),
Income Tax Regs. Weighing the personal pleasures derived from
petitioner's involvement with her dogs against the profit
potential that could result from her breeding activity, we are
satisfied that the breeding activity was conducted more for the
purpose of subsidizing the costs of maintaining and showing her
dogs than for profit.
Our conclusion on the point is further supported by the
history of losses incurred by petitioner since she began treating
the activity as a trade or business for Federal income tax
purposes. "[W]here losses continue to be sustained beyond the
period which customarily is necessary to bring the operation to
profitable status such continued losses, if not explainable,
* * * may be indicative that the activity is not being engaged in
for profit." Sec. 1.183-2(b)(6), Income Tax Regs. During 1993,
petitioner deducted a $28,617 loss attributable to her dog
breeding activity. Since 1989, when petitioner began reporting
the income and expenses attributable to her dog breeding
activity, she has never realized a profit. Over a 4-year period
starting in 1993, expenses exceeded income by almost $60,000.
During that period annual income ranged from a low of $250 to a
high of $575. The magnitude of annual and cumulative losses
compared to the low levels of income generated strongly indicates
that petitioner did not conduct the activity for profit. Smith
v. Commissioner, supra; Burger v. Commissioner, supra.
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Because petitioner's dog breeding activity was not an
activity engaged in for profit, the activity cannot be considered
a trade or business for purposes of section 162(a). Therefore,
she is only entitled to deduct the expenses incurred in that
activity in accordance with section 183. It follows, and we
hold, that respondent's determination in this regard is
sustained.
To reflect the foregoing,
Decision will be
entered for respondent.