Hastings v. Commissioner

T.C. Memo. 1999-167

UNITED STATES TAX COURT

JOYCE E. HASTINGS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 2032-97. Filed May 18, 1999.

Joyce E. Hastings, pro se.

Linas N. Udrys, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

GERBER, Judge: Respondent determined income tax

deficiencies and additions to tax for petitioner’s 1986 and 1988

through 1992 taxable years as follows:
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Addition to Tax
Year Deficiency Sec. 6651(a)(1)
1986 $2,096 $525
1988 351 88
1989 3,188 797
1990 10,816 2,704
1991 11,961 2,909
1992 5,801 1,448

After concessions by respondent,1 the issues remaining for our

consideration are: (1) Whether petitioner had unreported gross

receipts for her 1986, 1990, and 1991 tax years; (2) whether

petitioner’s horse breeding activity was an activity not engaged

in for profit within the meaning of section 183;2 and (3) whether

petitioner is liable for additions to tax under section

6651(a)(1) for the 1986, 1989, 1990, 1991, and 1992 taxable

years.

FINDINGS OF FACT3

Petitioner Joyce E. Hastings had her legal residence in

Huntington Beach, California, at the time her petition was filed

in this proceeding. After attending Western State College of

1
Respondent conceded the disallowed Schedule C law practice
expenses for 1988, 1989, and 1990. Respondent also conceded
$7,400 of the $15,499 unreported gross receipts adjustment for
1990 and $5,080 of the $22,410 gross receipts adjustment for
1991.
2
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the periods under
consideration. Rule references are to this Court’s Rules of
Practice and Procedure.
3
The parties’ stipulation of facts and exhibits are
incorporated by this reference.
 - 3 -

Law, petitioner began practicing law in 1972, and she continued

to practice during the years under consideration. She

specialized in family law, including the handling of divorces,

separations, and child custody matters.

Petitioner, who is a diabetic, began experiencing additional

health problems, including some lapses of memory, and in the mid-

1980’s she decided to curtail her legal practice and change to a

different source of income. From the time petitioner was 5 years

old, she has been involved in and become familiar with training,

breeding, and showing horses. As a young woman, petitioner was

successful in showing her family’s horses. After having little

involvement with horses throughout college, law school, and

during her practice of law, petitioner, in 1985, began to join

saddlebred horse associations and to become more involved in

horse-related activity.

During 1989, petitioner began her horse activity. She

visited farriers and horse farms during the period 1986 through

1989 to determine the ways to generate income from horse

activity. After considering the advice received, petitioner

decided to purchase and/or breed a stud horse that would generate

revenue. She concluded that an approach involving the breeding

of stallions would require the least amount of annual overhead

and would generate income from stud fees. Petitioner intended to

show the stallions and any other horses of the same bloodline as
 - 4 -

a means of advertisement and to enhance the worth of the stud

service. Although petitioner thought that some income could be

generated from showing horses, she thought more could be earned

from selling a stallion’s stud services.

Petitioner decided to purchase a chestnut show horse with

white markings to be bred with a palomino. The particular type

of show horses sought by petitioner were ones that show well in

harness and also those shown as “park horses”, which are saddled

with a rider. Petitioner sought out a horse from a bloodline of

Will Shriver, who was one of the top two or three horses in his

category. Petitioner believed that the horse activity would be

suitable for her because it required less memory skills and more

physical involvement.

Before purchasing the first horse, petitioner consulted

Saddle and Bridle magazine to determine how much money had been

won by the progeny of the horses under consideration. In July of

1989, she hired Bobby Morrison (Morrison), a well-qualified

Kentucky horse expert, who, on petitioner’s behalf, acquired

Casablanca Chestnut Charm (Misty),4 a yearling saddlebred, for a

total cost to petitioner of $4,400. Morrison was paid a 10-

percent commission ($400) for his services. Misty was shipped

from Kentucky to California and was trained by Susan Haight of

4
The shortened names do not necessarily coincide with the
formal names and are used by the owner as “stable names”.
 - 5 -

Victory Lane Stables. During 1990, Susan Haight showed Misty at

six different shows, and Misty received the “Best of Breed Fine

Harness Two Year Old” award from Saddle & Bridle magazine.

Although Misty was a fine looking harness horse, upon

reaching her third year she was not mature enough to become a

saddle horse, and petitioner decided that it would be too

expensive to show her as such because she did not have a good

chance of winning a purse. Petitioner hired a trainer to train

Misty as a saddle horse, and after that failed, to train her with

an antique carriage, and that also failed. Attempts at breeding

Misty were, for the most part, unsuccessful.

During 1991, petitioner purchased, for $4,500, Casablanca

Sky King (Rey), a registered palomino, who at the time was 4

months old. Rey was trained by Dow and Debbie Blumberg and

showed well and won ribbons as a yearling and 2-year old until he

developed a leg problem and irregularity in his gait during 1992.

Unable to show Rey, petitioner decided to develop him for stud

service, which could begin during his fourth or fifth year.

Although he would have been more valuable in that role if he

could have been shown, his bloodlines were still good, and it was

hoped that he would be successful in the breeding activity. Rey

did prove to be a successful stud with five offspring, two of

which are of good quality. Petitioner’s goal was to show

successfully Rey’s progeny to promote his bloodline and improve
 - 6 -

petitioner’s potential for income. As of the time of trial

(1998), petitioner was selling Rey’s stud service for a low price

($900) as a loss leader to generate more interest in the horse.

A stud may be capable of breeding for more than 20 years.

During 1993, petitioner purchased Jolly Berry, a mare, for

$8,000. Jolly Berry’s former owner was unsuccessful in

attempting to show her. Ultimately, Jolly Berry produced two

foals, Princess during 1994 and Skylark during 1995, and

petitioner continues to own all three horses. Princess was sired

by a horse not owned by petitioner, and she was shown in a 1994

show. Princess has good conformation and bloodlines, but little

talent, and petitioner decided to use her as a replacement brood

mare for Princess’ mother, Jolly Berry. Skylark was sired by

Rey. As of 1998, petitioner was preparing Skylark for sale in

the $3,500 to $4,500 price range. After two successful foals,

Jolly Berry lost a foal and then incurred liver problems,

resulting in petitioner’s inability to recoup her $8,000

investment.

During 1993, petitioner purchased, for $3,800, the mare

Fairy Dust, which produced a foal by Rey, called Bandit. Fairy

Dust was from an excellent bloodline, and she was obtained for a

very favorable price at a distress-type sale. Also in 1993,

petitioner purchased the mare Trigger Happy for $2,200 and a
 - 7 -

gelding named Defy for $1,100. The stated purpose for purchasing

Defy was for resale.

Petitioner believed that Bandit, a 3-year old during 1998,

had the potential to be a very successful stud horse. He had won

the title of Reserve Champion of the California Futurity, a

Statewide ranking. Petitioner intends to exploit Bandit first as

a show horse and then to earn income from his stud service.

Petitioner began with a single horse in 1989, and by 1998

she had 10 horses and 1 that she expected to be a profitable

champion. Petitioner set annual goals that were not achieved,

but she would analyze her situation when resetting goals.

Although capable of personally doing so, petitioner always

hired professionals to show her horses to achieve the best

results and maximum exposure for her animals. Petitioner made

efforts to advertise her animals at shows, in magazines, and

within various associations. Petitioner did not prepare any

profit projections prior to commencing the horse activity.

Petitioner does not keep all of her horses on her property, and

some are kept on an acquaintance’s property near Julian,

California. Petitioner maintains a trailer on the Julian

property to reside in when she is tending the horses there.

For the years 1989 through 1995, petitioner reported income

and expenses and claimed losses from her horse activity as

follows:
 - 8 -

Year Expenses Income Losses
1989 $7,025 -0- $7,025
1990 12,838 $305 12,533
1991 12,994 -0- 12,994
1992 19,667 447 19,220
1
1993 21,531 -0- 21,531
1994 26,876 -0- 26,876
1995 31,322 -0- 31,322
Totals $132,253 $752 $131,501
1
On her tax return, petitioner reported $21,531 of expenses
and income of $10,402 for a net of $11,129. The parties,
however, stipulated that petitioner had no gross receipts from
the horse activity in 1993. Accordingly, for purposes of our
analysis, we assume that petitioner’s claimed expenses and losses
are the same.

Petitioner did not maintain a separate bank account for her

horse activity, but she did keep separate records for each horse.

In order to distinguish expenditures for her horse activity from

others, she marked an “H” on those checks written for the

activity. In addition, horse activity invoices or bills

underlying each check expenditure were kept separately for each

horse and accumulated and maintained on a monthly basis.

The annual specific records for each horse contained

information regarding pedigree, pictures and information about

the sire and dam, medical history, pictures of the specific

horse, breeding information, medical information, insurance

information, and training records. Petitioner also maintained

numerous specific-topic horse activity files containing such

information and documents as: Forms, horses for sale, health

tips, boarding and training information, equipment information,
 - 9 -

horse-related articles, association membership, etc. During the

period 1988 through 1996, petitioner belonged to 11 different

organizations related to her horse activity, and she maintained a

relatively large library of books and video tapes concerning

training and breeding of horses and related subjects. Petitioner

also maintains at least 27 catalogs and 11 directories for

various horse organizations and activities.

Petitioner usually sought an extension to file her Federal

income tax return and submitted a remittance with her application

to extend. Petitioner’s tax returns were filed after the

extended deadline in each of the taxable years in issue. During

1991-92, petitioner’s mother, who had Alzheimer’s and Parkinson’s

disease, lived with petitioner. Petitioner, to a great extent,

shouldered the physical responsibility of caring for her mother,

and the time devoted to her mother put pressure on her ability to

service her legal clients, manage her horse activity, and attend

to her personal life. During the time her mother resided with

petitioner, petitioner’s life was complicated, and her personal

matters were in a state of disarray. Petitioner’s mother died

during 1993.

Petitioner failed to timely file her 1986 and 1988 through

1992 Federal income tax returns. The following schedule reflects

the chronology of her tax return filings, including the extended

dates for filing:
 - 10 -

Time to File
Year Date Filed Extended Until
1986 Jan. 18, 1994 Aug. 15, 1987
1988 June 22, 1994 Aug. 15, 1989
1989 Mar. 1, 1994 Aug. 15, 1990
1990 July 25, 1994 Aug. 15, 1991
1991 Nov. 19, 1993 Aug. 15, 1992
1992 Sept. 10, 1993 Aug. 15, 1993

For her taxable years 1986, 1990, and 1991, respondent

determined that petitioner had unreported income from her law

practice in the amounts of $6,872, $15,499, and $22,410,

respectively. Respondent conceded $7,400 of the $15,499

unreported gross receipts adjustment for 1990 and $5,080 of the

$22,410 unreported gross receipts adjustment for 1991.

Respondent’s determination of unreported income was based on a

bank deposits analysis of petitioner’s bank accounts. During the

audit examination, petitioner told respondent’s agent that

petitioner did not have any cash on hand as of the year 1986.

Petitioner maintained the following types of bank accounts:

Personal, general business (for law practice), trust (ostensibly

for client’s funds), and payroll (for law practice).

Petitioner’s total deposits to each of the four accounts were as

follows:

General
Year Personal Business Trust Payroll
1986 $17,183.51 $60,351.00 $1,043 $12,457.17
1990 3,740.30 89,175.13 100,318 8,474.44
1991 1,759.04 96,366.00 60 7,236.70
 - 11 -

Petitioner had unreported income in the amounts of $6,872,

$8,099, and $17,330 for the taxable years 1986, 1990, and 1991,

respectively.

For the years 1986 and 1988 through 1995, petitioner

reported net profit or (net loss) from her practice of law,

without considering the unreported amounts decided above, as

follows:

Year Net Profit or (Loss)
1986 $15,914
1988 24,131
1989 35,562
1990 11,594
1991 22,160
1992 31,247
1993 12,444
1994 6,262
1995 (38,571)

OPINION

The three issues remaining for our consideration are:

Whether petitioner’s horse activity was not for profit in any of

the taxable years before the Court; whether petitioner’s income

from her law practice was understated for 3 taxable years; and

whether petitioner is liable for an addition to tax for late

filing in any of the taxable years before the Court. We address

each issue separately.

Horse activity--for profit? Section 183(a) provides that

individual taxpayers will not be allowed deductions that are

attributable to an “activity * * * not engaged in for profit”.
 - 12 -

This terminology is defined in section 183(c) as “any activity

other than one with respect to which deductions are allowable for

the taxable year under section 162 [trade or business] or under

paragraph (1) or (2) of section 212 [expenses incurred for the

production of income].” Section 183(b) permits deductions that

would be allowable only if the activity were engaged in for

profit, but such deductions may be taken only to the extent that

any gross income generated from the activity exceeds deductions

that are not dependent upon a profit objective (e.g., State and

local taxes under section 164).

Although a reasonable expectation of profit is not required,

the facts and circumstances must indicate that the taxpayer

entered into the activity or continued the activity with the

actual and honest objective of making a profit. See Keanini v.

Commissioner, 94 T.C. 41, 46 (1990); Dreicer v. Commissioner, 78

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

Cir. 1983); sec. 1.183-2(a), Income Tax Regs. In making this

determination, more weight is accorded to objective facts than to

the taxpayer’s statement of intent. See Engdahl v. Commissioner,

72 T.C. 659, 666 (1979); sec. 1.183-2(a), Income Tax Regs.

Petitioner bears the burden of proving that she possessed the

required profit objective. See Rule 142(a); Dreicer v.

Commissioner, supra; Golanty v. Commissioner, 72 T.C. 411, 426
 - 13 -

(1979), affd. without published opinion 647 F.2d 170 (9th Cir.

1981).

In determining whether an activity is engaged in for profit,

reference is made to objective standards, taking into account all

of the facts and circumstances of each case. See sec. 1.183-

2(a), Income Tax Regs. The regulations set forth nine criteria

normally considered for this purpose. The factors are: (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, that are earned; (8) the

financial status of the taxpayer; and (9) the presence of

elements of personal pleasure or recreation. See sec. 1.183-

2(b), Income Tax Regs. None of these factors is determinative,

nor is the decision to be made by comparing the number of factors

that weigh in the taxpayer’s favor with the number that support

the Commissioner. See id.

Petitioner contends that she had the requisite profit

objective with respect to her horse-breeding and showing

activity. Conversely, respondent contends that the activity was
 - 14 -

not engaged in for profit. We agree with respondent.

Petitioner, who from early childhood was involved with horses,

decided that her ability to practice law was diminishing and that

it was necessary to find some other source of income. Because

she was beginning to experience memory loss, petitioner decided

that the horse-related activity would be more apropos. Beginning

about 1986, she investigated the potential to earn income from

horse-related activity. Petitioner visited horse farms, read

magazines and reference materials, and consulted farriers

concerning the operation of horse activities. After completing

her research, in 1989 petitioner commenced her horse activity.

Based on her research, she set the goal of acquiring a

champion stallion for the purpose of selling its stud services.

Her goal was to be accomplished by either purchasing or breeding

champion stallions. After acquiring stallions, they were to be

shown and publicized to build a high quality reputation. She

projected that once the stallion attained some recognition, the

stud service fees would provide a stream of income. She stated

that a champion stallion could produce from $100,000 to $300,000

in stud fees and that merely showing horses would not provide

sufficient income to recoup the costs of acquiring, maintaining,

showing, and training horses. Petitioner chose a particular type

and breed of horse and sought out a particular bloodline for

acquisition. Petitioner, who possessed a considerable background
 - 15 -

in and experience with horses, hired others with expertise for

buying, training, and showing her animals. She knew that in

order to be successful, she would have to acquire and/or breed

championship quality stock.

Her first acquisition of mares and attempts at quality

offspring did not work out due to circumstances beyond

petitioner’s control. She continued to make new acquisitions of

breeding stock and had others train and show her horses.

Petitioner, however, also purchased horses that did not comport

with her goal of producing a champion stallion during the period

under consideration. In fact, at the time of trial she had about

10 horses, only a few of which had the potential to be or to

produce a champion stallion. Petitioner did not attempt to cut

her overhead or losses by either ridding herself of unproductive

horses or limiting her acquisitions to horses that would assist

in a profit-oriented goal.

Petitioner testified that her overall approach was directed

toward the achievement of an income stream; however, she

experienced practically no income during the 9-year period from

1989 through 1998 and did little to cut her expenses/losses.

Even though petitioner believed that one of her young stallions

had the potential to recoup more than the $131,000 in incurred

expenses/losses, no independent or reliable evidence was supplied

to show that her stallion's potential or any stallion's potential
 - 16 -

would result in a sufficient amount of profit to overcome

petitioner's losses. We note that petitioner, at the time of

trial, was offering one of her stallion's stud service for $900,

but she made no showing of an existing or potential income flow

or means to achieve a profit.

Petitioner did not maintain a separate checking account or

prepare financial statements for her horse activity, but she did

maintain detailed records of the breeding, maintenance, and

health status of each horse. In addition, each check issued for

horse-related activity was marked or referenced for that purpose

and maintained and segregated on a monthly basis. Petitioner was

able to substantiate her horse activity expenditures, and the

only question before the Court is whether petitioner’s horse

activity was a for-profit activity.

Although we can accept the precept that horse breeding

necessarily includes a startup period, petitioner provided no

explanation as to why she was not able to earn some income or cut

losses for such an extended period of time. Petitioner generally

worked toward the goal of someday making a profit, but based on

the record she did not attempt in earnest to achieve that goal

prior to or during the years in issue. From 1989 through the

time when petitioner believed she had produced a stallion with

championship potential (1995), petitioner had claimed $132,253 in
 - 17 -

expenses and reported $7525 in income, for a net loss from all

operations of $131,501. She has not shown that her projections

for income were reasonable in relation to her investment.

In the setting of this case, petitioner's actions did not

reflect a profit-seeking objective. Instead, petitioner offset

or sheltered her law practice income by her losses from the horse

activity. It may have been petitioner's intent to pursue her

horse activity in a businesslike manner when her law practice

ceased or declined, but that had not yet occurred as of or during

the years in issue.

Finally, it is obvious that petitioner sought involvement in

horse activity because of her affinity for and background

involving horses. We hold that, for the 1989 through 1992

taxable years, petitioner did not enter into and\or continue the

horse activity with an actual and honest objective of making a

profit.

Petitioner’s income from her law practice--was it

understated? Respondent, based on a bank deposit analysis,

determined that petitioner had unreported income from her law

practice in the amounts of $6,872, $15,499, and $22,410 for 1986,

5
Petitioner had amended her 1994 income tax return to
reflect $20,000 in income from her horse activity. At trial,
however, it was unclear whether petitioner had actually received
the $20,000 in connection with her horse activity. In either
event, petitioner’s comparative figures are similar.
 - 18 -

1990, and 1991, respectively. Subsequently, respondent conceded

$7,400 of the $15,499 unreported gross receipts adjustment for

1990 and $5,080 of the $22,410 unreported gross receipts

adjustment for 1991.

It is well established that respondent may utilize indirect

methods of reconstructing a taxpayer’s income. Where a taxpayer

fails to provide adequate records, an indirect method may be used

to reconstruct income. See Holland v. United States, 348 U.S.

121 (1954). Respondent used the bank deposits method to

reconstruct petitioner’s income. The bank deposits method has

been approved as an indirect method with which to reconstruct

income. See United States v. Carter, 721 F.2d 1514, 1538 (11th

Cir. 1984) (citing United States v. Boulet, 577 F.2d 1165 (5th

Cir. 1978)); Holland v. United States, supra. Petitioner must

show by a preponderance of the evidence that respondent’s

determination is erroneous. See Rule 142(a); Welch v. Helvering,

290 U.S. 111 (1933); Webb v. Commissioner, 394 F.2d 366, 372 (5th

Cir. 1968), affg. T.C. Memo. 1966-81.

Petitioner did not offer records of her law practice or a

methodology that would more clearly reflect income than the bank

deposits reconstruction used by respondent. In addition,

petitioner does not question respondent’s approach or methodology

in reconstructing her income by means of the bank deposits

method. Instead, she contends that some of the deposits that
 - 19 -

respondent determined were sourced in receipts or income from her

law practice were from a nontaxable source. Petitioner testified

that in 1977 she received $60,000 as proceeds of a life insurance

policy in connection with her husband’s October 1976 death. She

further testified that she kept the $60,000 in a safe and used it

during 1986, 1990, and/or 1991 by making the deposits that

respondent considers unexplained and determined to be sourced in

petitioner’s law practice.

Respondent emphasizes that petitioner told respondent’s

examiner that there was no cash on hand as of the beginning of

1986. In the same vein, although petitioner contends that

insurance proceeds represented a cash hoard that could explain a

nontaxable source for the deposits, she testified as follows:

Oh, yes. I wanted to mention about my husband dying in
<76. I was flabbergasted when I discovered that,
purportedly, there was income that I had not reported.

And the only thing I can say is that somehow I
spent $60,000 between about 1977 and <87.

In addition, petitioner, in showing that she was not offsetting

her losses from her horse activity against her legal income,

explained that she had to borrow money to buy horses and pay

expenses of her horse activity. Petitioner’s borrowing at a time

when she purportedly possessed $60,000 in cash does not support

her claim that the alleged cash hoard existed 10 or more years

after she received it.
 - 20 -

We hold that petitioner’s explanation of a cash hoard

(nontaxable source) is not credible and is insufficient to show

that respondent’s determination of unreported income is in error.

Accordingly, respondent’s determination, after concessions, is

sustained.

Is petitioner liable for additions to tax for filing

delinquent returns (section 6651(a)(1)) for the 1986, 1989, 1990,

1991, and 1992 taxable years? Respondent determined that

petitioner is liable for the additions to tax under section

6651(a)(1) for her failure to timely file Federal income tax

returns. Section 6651(a)(1) provides for an addition to tax of 5

percent of the tax required to be shown on the return for each

month or fraction thereof for which there is a failure to file,

not to exceed 25 percent. The addition to tax for failure to

file a timely return is imposed unless the taxpayer shows that

the delay was due to reasonable cause and not willful neglect.

See sec. 6651(a)(1); United States v. Boyle, 469 U.S. 241, 245

(1985). A failure to file is due to “reasonable cause” if the

taxpayer exercised ordinary business care and prudence and was,

nevertheless, unable to file the return within the time

prescribed by law. See United States v. Boyle, supra at 246.

Petitioner contends that the difficulties in her life,

including her mother’s illness and her obligations as a solo

practitioner of law, caused turmoil in her life and constitute a
 - 21 -

reasonable cause for failing timely to file. In each instance,

petitioner filed for an extension to file, but failed to file

before the extended time. Petitioner was aware of her filing

obligations, and, as a lawyer, it would be difficult for her to

claim otherwise. In spite of her personal difficulties, she was

able to conduct her law practice and horse activity. Although we

can agree that petitioner experienced hardships and had much

responsibility, we are unable to find that she had reasonable

cause for failing to timely file. In similar situations of

deaths in the family, e.g., Radde v. Commissioner, T.C. Memo.

1997-490, and the press of work of a solo practitioner/doctor,

Polsby v. Commissioner, T.C. Memo. 1998-459, we have held that

the delinquency addition or penalty can apply. Petitioner here

is no different. Petitioner’s failure-to-file pattern was

lengthy and consistent and preceded and continued after the

difficulties presented by petitioner’s mother’s condition and

death. Accordingly, we sustain respondent’s determination that

petitioner is liable for the additions to tax under section

6651(a)(1) for the years determined.

To reflect the foregoing,

Decision will be entered under

Rule 155.