MCCARTHY v. COMMISSIONER

T.C. Memo. 2000-135

UNITED STATES TAX COURT

ANTHONY J. MCCARTHY, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 16929-96. Filed April 12, 2000.

Toni Robinson, Raj J. Mahale, Susan L. Moon, and Erin M.

O'Hanlon, for petitioner.

Robert E. Marum, for respondent.

SUPPLEMENTAL MEMORANDUM OPINION

DINAN, Special Trial Judge: This case is before the Court

on remand from the Court of Appeals for the Second Circuit. The

Court of Appeals vacated our decision in McCarthy v.

Commissioner, T.C. Memo. 1997-436 (McCarthy I), in which we held

that petitioner was not entitled to a business loss deduction for
 - 2 -

amounts paid in connection with his son's motocross racing

activity because the activity was not entered into for profit

during the year in issue. The Court of Appeals stated: "The

principal error in the Tax Court's decision is that it gave

dispositive weight to the fact that McCarthy's son was an amateur

in the tax year in question, and, therefore, '[t]here was no

possibility that petitioner could have realized a profit from his

management activity' in that year. * * * The inability to make

a profit in a particular year is not, however, by itself

dispositive." The Court of Appeals stated:

It may be that, on remand, the Tax Court will
conclude that the evidence relied on by McCarthy is
insufficient to establish that he had the requisite
profit motive. However, such a determination must be
based on all the facts and circumstances, not merely on
one or two facts that favor the Commissioner's
position. See Ranciato, 52 F. 3d at 26. On remand,
the Tax Court should explicitly weigh factors that may
favor the taxpayer such as the manner in which McCarthy
carried on his management activities, his expertise in
the motocross business, his foregoing advancement as a
construction worker, and his financial situation.

We have reconsidered the facts in this case on remand as

instructed by the Court of Appeals, McCarthy v. Commissioner, 164

F.3d 618 (1998), and remain firmly convinced that petitioner did

not engage in managing and promoting his son's amateur motocross

racing activity during 1993 with the requisite intent to profit.

We therefore adhere to our holding in McCarthy I.

We incorporate herein by this reference the facts found in

McCarthy I.
 - 3 -

Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the taxable year in

issue. All Rule references are to the Tax Court Rules of

Practice and Procedure.

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 defined with particularity in the Internal

Revenue Code or the regulations promulgated thereunder for

purposes of section 162. However, it is well established that to

be involved in a trade or business within the meaning of section

162, "the taxpayer must be involved in the activity 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).

The test of whether a taxpayer conducted an activity for

profit is whether he or she engaged in the activity with an

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

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

T.C. 642, 644-645 (1982), affd. without published opinion 702

F.2d 1205 (D.C. Cir. 1983); sec. 1.183-2(a), Income Tax Regs.

Although a reasonable expectation of profit is not required, the

taxpayer's profit objective must be bona fide, as determined from

a consideration of all the facts and circumstances. See Keanini
 - 4 -

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 managing and promoting his

son's (Benjamin) motocross racing activity with an actual and

honest objective of earning a profit must be determined by

considering all the facts and circumstances. See 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 his intent. See Engdahl v.

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

Tax Regs.

In deciding whether petitioner engaged in managing

Benjamin's motocross racing activity for profit, we apply the

nine factors listed in section 1.183-2(b), Income Tax Regs. The

factors are: (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 the 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
 - 5 -

respect to the activity; (7) the amount of occasional profits, if

any, which are earned; (8) the financial status of the taxpayer;

and (9) whether elements of personal pleasure are involved. No

single factor controls. See Osteen v. Commissioner, 62 F.3d 356,

358 (11th Cir. 1995), affg. in part and revg. on other issues

T.C. Memo. 1993-519; Brannen v. Commissioner, 722 F.2d 695, 704

(11th Cir. 1984), affg. 78 T.C. 471 (1982); sec. 1.183-2(b),

Income Tax Regs. Petitioner has the burden of proof on this

issue. See Golanty v. Commissioner, supra at 426.

Application of the Factors

1. Manner in Which the Taxpayer Conducts the Activity.

Petitioner, himself, engaged in motocross racing as an

amateur for approximately 2 years during 1976 and 1977, and, we

assume, was well aware of the rules and regulations applicable to

amateur motocross racing. He knew that an amateur in motocross

racing was not permitted to earn a profit from that activity, and

that his son, Benjamin, who was 13 years of age during the year

in issue (1993) was not eligible to turn pro until he reached the

age of 16 in 1996. When this case was tried in May 1997,

Benjamin had still not turned pro.

Benjamin was 12 years of age when petitioner first discussed

with him the alleged agreement between them about Benjamin's

racing future. No agreement between petitioner and his 12-year

old son was memorialized in writing. Petitioner and his 12-year
 - 6 -

old son allegedly entered into an oral agreement as to Benjamin's

racing future. Petitioner did maintain receipts for the expenses

he paid during 1993 in support of Benjamin's motocross racing

activity. Petitioner also kept records showing that Benjamin,

who was not eligible to win cash prizes, won $2,525 in

contingency certificates in 1993, redeemable in racing equipment

and other merchandise. Petitioner also reported on his 1993

Federal income tax return $2,250 worth of the above-mentioned

certificates as a "management fee" from Benjamin.

Petitioner had no written plan or any financial analysis of

the profit potential of his activity. His skeletal records serve

only to substantiate the expenses claimed by him on his 1993

return. Otherwise, his records do not serve to establish a

business activity with a potential for profit.

This factor favors respondent.

2. The Expertise of the Taxpayer or His Advisers.

Petitioner performed repairs and maintenance on the

motorcycles used by his son, helped train his son, and decided

which races his son would enter and what size motorcycle his son

would ride. Although these facts may seem to favor finding that

petitioner had expertise in racing (or managing a racer), a

distinction must be drawn between expertise in conducting an

activity and expertise in the economic and business aspects of an

activity: the former is consistent with a hobby interest, while
 - 7 -

the latter indicates the likelihood of a profit motive. See

Golanty v. Commissioner, 72 T.C. 411, 432 (1979); Burger v.

Commissioner, 809 F.2d 355, 359 (7th Cir. 1987), affg. T.C. Memo.

1985-523; sec. 1.183-2(b)(2), Income Tax Regs.

Petitioner was clearly an expert in racing in the amateur

context, but we find that the record does not establish that he

was an expert in conducting the activity for profit, or that he

actively sought such expertise elsewhere. Despite the fact that

petitioner personally engaged in motocross racing as an amateur

for 2 years, there is no evidence that he was so engaged on a

businesslike basis or that he sought to earn a profit from that

activity. There is also no evidence in the record that

petitioner managed any motocross racer other than his son.

Although petitioner investigated sponsorship opportunities and

other methods by which his son could potentially earn future

income, there is nothing in the record which establishes that

petitioner studied business and economic practices or consulted

with an accountant to advise him financially about the racing

activity prior to engaging in the activity. Furthermore, there

is no evidence indicating petitioner analyzed the overall cost or

necessary capital investment relative to potential revenue. See,

e.g., Nichols v. Commissioner, T.C. Memo. 1990-546.

This factor favors respondent.
 - 8 -

3. Taxpayer's Time and Effort.

The fact that a taxpayer spends much time and effort in

conducting an activity may indicate that he or she has a profit

objective, particularly if the activity does not have substantial

personal or recreational aspects. See sec. 1.183-2(b)(3), Income

Tax Regs. In McCarthy I, T.C. Memo. 1997-436, we found that

petitioner “devoted most of his spare time” to Benjamin's racing

and that he “has extended his time and effort well beyond the

degree that parents ordinarily devote to their children's

‘extracurricular’ interests.” In this case, however, there can

be no doubt that petitioner, who himself was an amateur motocross

racer for 2 years, experienced personal joy in observing his son

participate in motocross racing and in helping his son pursue the

activity. Although elements of personal satisfaction do not

necessarily negate a profit motive, see, e.g., Ranciato v.

Commissioner, 52 F.3d 23, 26 n.4 (2d Cir. 1995), vacating T.C.

Memo. 1993-536, we find in this case that the father-son

relationship involved and the considerable amount of personal

satisfaction and recreation derived by both taxpayer and his son

outweigh the significant time and effort invested.

A taxpayer’s withdrawal from another occupation to devote

most of his energies to the activity may also be evidence that

the activity is engaged in for profit. See sec. 1.183-2(b)(3),

Income Tax Regs. The record shows that, at all pertinent times,
 - 9 -

petitioner continued to work a 40-hour work week in concrete

construction. Petitioner briefly mentioned in his testimony that

he forwent supervisory positions in order to continue his

involvement in his son’s activities. The only evidence presented

to support this contention was petitioner’s own testimony:

For somebody with my skills, [the average earnings per
year are] anywhere from 40 to 50 thousand dollars and
upwards. Actually, the situation for me is that I – I
probably – I shouldn’t say probably – I know that I could
have been in supervisory positions from ‘93 on.
Before ‘93, I was in supervisory positions. At that
point, once I decided to manage Benjamin’s career, it was
impossible for me to work a lot of hours. I couldn’t work
the weekends. I had to take weeks off for national events.

Even without a supervisory position, petitioner earned

substantial income, $44,709, in the construction business during

1993. No evidence was presented indicating what amount of income

petitioner may have forgone by managing his son and participating

in the motocross activities. We do not find from petitioner’s

uncorroborated, self-serving, and irresolute testimony that

petitioner withdrew in any significant sense from his

construction job in order to pursue motocross.

This factor favors respondent.

4. Expectation That Property Used in the Activity Would

Appreciate in Value.

Petitioner did not invest in any property that would

appreciate in value.

This factor is neutral.
 - 10 -

5. Taxpayer's Success in Other Activities.

The evidence does not show that petitioner engaged in any

other activity that relates to his management of Benjamin's

motocross racing activity.

This factor favors respondent.

6. & 7. Taxpayer's History of Income or Losses and the

Amount of Occasional Profit, If Any.

The record shows that Benjamin did not earn a profit in any

prior year, and that Benjamin’s motocross racing activities could

not have produced a profit during 1993, the year in issue,

because as an amateur he was not eligible to win any cash prizes.

This would also have been true for at least the 3 years

succeeding 1993, until 1996, when upon reaching the age of 16

Benjamin could have turned pro. Even then, however, the record

shows that petitioner decided that Benjamin should not turn pro

because of his slight size and because he wanted Benjamin to

continue riding a motorbike which was not as big as the smallest

bike ridden in professional competition. We also note that for

the year in issue, petitioner reduced his total income of $44,709

earned in the concrete construction business by $13,217 expended

in connection with Benjamin's motocross racing activity.

A series of losses during the startup stage of an activity

is not necessarily an indication that the activity was not

engaged in for profit. See sec. 1.183-2(b)(6), Income Tax Regs.
 - 11 -

Petitioner admitted that he and his son began the racing

activities without an intent to profit. The profit motive

allegedly arose some time later, but at a time which was at least

several years prior to petitioner’s son becoming eligible to win

cash prizes. No evidence was presented which supports a finding

that the losses were customary or usual for this type of

activity. See id. The losses were in no way unforeseen or due

to circumstances beyond the petitioner’s control; rather,

petitioner knew with certainty that profits could not be made.

See id. Based on these facts, and because the expenses were

incurred after the activity was already being engaged in, at a

time when the earning of income was impossible, and in connection

with an activity which was inherently familial and recreational,

we find that the expenses were not startup expenses consistent

with an intent to make future profits.

These factors favor respondent.

8. Financial Status of the Taxpayer.

Substantial income from sources other than the activity, in

particular if the losses result in substantial tax benefits, may

indicate that the taxpayer is not conducting the activity for

profit, especially if there are personal or recreational elements

involved. See sec. 1.183-2(b)(8), Income Tax Regs. The record

clearly shows that petitioner earned substantial income from his

full-time employment in 1993 in the amount of $44,709, and that
 - 12 -

this income was reduced by the $13,217 which he spent in support

of Benjamin's amateur motocross racing activity. Furthermore, as

more fully discussed, infra, at factor 9, the activity was both

personal and recreational with respect to petitioner and his son:

petitioner’s actions were as consistent, if not more consistent,

with one who wishes to participate in an activity with his son as

with one who wishes to supplement his already substantial income.

This factor favors respondent.

9. Elements of Personal Pleasure or Recreation.

The presence of personal motives in carrying on an activity,

especially where there are recreational or personal elements

involved, may indicate that the activity is not engaged in for

profit. See sec. 1.183-2(b)(9), Income Tax Regs. Profit need

not be the only objective, however, and personal motives may

coexist with an actual and honest intent to derive a profit. See

id.

Benjamin was unable to earn any potential profit for several

years after the year in issue. Furthermore, any potential profit

was dependent upon many unknown variables involved with beginning

a professional career–-such as Benjamin’s future size, abilities,

and even desire to continue pursuing the activity into his late

teen and early adult years. Finally, the motocross racing

activity was inherently recreational and was conducted as an

activity to be shared by father and son. Considering these
 - 13 -

facts, we find that the prospect for profit in this case was too

remote and inconsequential to outweigh the immediate personal

nature of the activity. Thus, the primary motivation of

petitioner in participating in the motocross racing with his son

was personal, not for profit.

This factor favors respondent.

Having fully considered the above-enumerated factors and

taking into account all of the relevant facts and circumstances,

we reaffirm our previous holding in McCarthy I that petitioner in

1993 did not engage in managing Benjamin's motocross racing with

the intent to make a profit which is necessary to establish the

management activity as a trade or business within the intendment

of section 162(a). Cf. Commissioner v. Groetzinger, 480 U.S. 23,

35 (1987).

Additional Considerations

In its mandate remanding this case to the Court for further

consideration, the Court of Appeals instructed us, as follows:

In addition, the Tax Court should consider the
relevance to this matter, if any, of the "pre-opening
expense" doctrine. The "pre-opening expense" doctrine
requires that expenses incurred before a taxpayer
begins business operations be capitalized rather than
deducted in the year at issue. See, e.g., Sorrell v.
Commissioner, 882 F.2d 484, 486 (11th Cir. 1989);
Richmond Television Corp. v. United States, 345 F.2d
901, 905-07 (4th Cir.), vacated on other grounds, 382
U.S. 68 (1965) (per curiam). We ask for consideration
of this doctrine, or a determination that it is
irrelevant, because it was mentioned in the
Commissioner's brief on this appeal. See Appellee's
Br. at 26 n.7.
 - 14 -

The preopening expense doctrine requires expenses incurred

prior to the commencement of a trade or business, or prior to the

start of an income producing activity, to be capitalized rather

than deducted under section 162(a) or 212. See Hardy v.

Commissioner, 93 T.C. 684 (1989). If otherwise eligible,

preopening expenses may be amortized under section 195 after a

trade or business begins.

The preopening expense doctrine is inapplicable in this

case. The doctrine is a limitation on the deductibility of

certain expenses under sections 162(a) and 212. Petitioner,

however, did not have a profit motive and consequently the

expenses he incurred do not pass the threshold requirements of

these sections. See sec. 212; Commissioner v. Groetzinger, supra

at 35 ("to be engaged in a trade or business [within the meaning

of section 162(a)] * * * the taxpayer's primary purpose for

engaging in the activity must be for income or profit"). Because

neither section 162(a) nor section 212 applies to petitioner, the

preopening expense doctrine does not operate to require

petitioner to capitalize, rather than deduct, any expenses.

On careful reconsideration pursuant to the mandate of the

Court of Appeals,

Decision will be entered

for respondent.