T.C. Summary Opinion 2001-87
UNITED STATES TAX COURT
TOD McMULLEN AND ROBBIN EVERSON, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12373-99S. Filed June 13, 2001.
Tod McMullen and Robbin Everson, pro sese.
G. Michelle Ferreira, for respondent.
CARLUZZO, Special Trial Judge: This case was heard pursuant
to the provisions of section 7463 of the Internal Revenue Code in
effect at the time the petition was filed. Unless otherwise
indicated, subsequent section references are to the Internal
Revenue Code in effect for the year in issue. The decision to be
entered is not reviewable by any other court, and this opinion
should not be cited as authority.
- 2 -
Respondent determined a deficiency of $5,920 in petitioners’
1995 Federal income tax. The issue for decision is whether
petitioners are entitled to various deductions claimed on a
Schedule C, Profit or Loss From Business, included with their
1995 Federal income tax return.
Background
Some of the facts have been stipulated and are so found.
Petitioners are husband and wife. They filed a timely 1995 joint
Federal income tax return. At the time the petition was filed,
petitioners resided in Alameda, California. References to
petitioner are to Tod McMullen.
On June 25, 1984, petitioner applied for a United States
patent for an auxiliary or secondary oil filtration system for
automobile internal combustion engines (the system). His
application was approved and he was issued a patent on December
31, 1985. During 1985, petitioner consulted with a professional
income tax return preparer and was advised in a letter dated
August 9, 1985, how expenditures made in connection with the
patent process could be treated for Federal income tax purposes.
Petitioner unsuccessfully attempted to license the patent to
the Amway Corporation in 1986. Sometime thereafter, petitioner
decided to manufacture and market the system. The amount of time
and effort petitioner devoted to this pursuit over the years is
- 3 -
not entirely clear. It appears that petitioner’s marketing
efforts consisted primarily of promoting the system through “word
of mouth” advertising. Petitioner tested the system by
installing it in his vehicles. It appears that there were
relatively few sales from the date of the patent through the year
in issue.
After the patent was issued in 1985, petitioner made some
changes to the system. Prior to 1995, petitioner adapted the
system for use in automobile hydraulic power steering systems and
automobile automatic transmissions. In 1992, or thereabouts,
petitioner began to develop what he described as “curious motor
oils” or “teflon particle saturated oils” for use with the
system. According to petitioner, if a motorist used the system
and one of the motor oils that he claims to have developed, oil
changes would be virtually eliminated.
Robbin Everson was a salesperson for Mary Kay Cosmetics,
Inc. during the year in issue. In 1993, as a salesperson for
that company, she was provided with a new, 1993 Pontiac Grand Am,
leased for a 2-year period on her behalf by the company, at the
company’s expense. Upon the expiration of the lease in 1995,
petitioners were entitled to purchase the car, which they did
for $7,836. During 1995, petitioners also purchased a computer
- 4 -
printer for $287 and a 1972 Dodge van1.
Petitioners’ 1995 joint Federal income tax return was timely
filed. Petitioners did not elect to itemize deductions for
1995. Included with that return is a Schedule C for petitioner’s
business, identified as Micron Systems. The primary business
of Micron Systems is described on the Schedule C as
“developing/improving patentable products”. The following
items are reported on the Schedule C:
Income
Gross receipts $492
Returns/allowances 330
Cost of goods sold 3,502
Gross income (3,340)
Deductions
Advertising $320
Car and truck 1,264
Depreciation/sec. 179
expense deduction 10,312
Insurance 533
Office 1,565
Rent/lease 3,240
Supplies 1,008
Taxes/licenses 60
Meals/entertainment 641
Utilities 181
Other 1,020
Total expenses 20,144
Net Loss 23,484
1
According to the Form 4562, Depreciation and Amortization,
included with petitioners’ 1995 joint Federal income tax return,
the cost of the van was $2,189. According to the parties’
stipulation, the cost of the van was $952.
- 5 -
The deduction for advertising relates to expenditures for 35mm
film, film processing, and photocopying. The deduction for car
and truck expenses relates to mileage driven on a 1993 Mazda MPV,
the cost of which was deducted in a prior year under section 179.
The depreciation and section 179 deduction includes the costs of
the 1993 Pontiac Grand Am, the 1972 Dodge Van, and the computer
printer. The deduction for insurance relates to automobile
insurance on petitioners’ automobiles. The deduction for office
expense includes expenditures for magazine and newspaper
subscriptions. The deductions for rent and utilities relate to
home office expenses. The deduction for taxes and licenses
relates to registration fees for petitioners’ automobiles. The
deduction for other expenses relate to the cost of driving the
Mazda MPV on a trip described by petitioner as follows:
It was a scenic trip, San Diego [where petitioners
lived at the time], customer in Bakersfield, customer
in - - no, that was it, the guy was in Bakersfield.
The guy that had been a diesel engine rebuild mechanic
who gave us a great reference. He was in –- he was
moving to Iowa, so I outfitted him, and that was in
part of the gross sales –- no, wait, I –- he didn’t
have any money, so I sold it to him on credit and never
collected, come to think of it.
The net loss claimed on the Schedule C offset other income
reported on petitioners’ return.
In the notice of deficiency, respondent disallowed the
deduction for the net loss.
- 6 -
Discussion
Petitioners claim they are entitled to a deduction for the
net loss reported on the Schedule C under the authority of either
section 162 or section 174. In general, a taxpayer is entitled
to deductions for “all the ordinary and necessary expenses paid
or incurred during the taxable year in carrying on any trade or
business”. Sec. 162(a). Furthermore, a taxpayer is generally
entitled to deductions for research and experimental expenditures
paid or incurred during the taxable year “in connection with” the
taxpayer’s trade or business. Sec. 174(a). A taxpayer who
claims a deduction under either section must be engaged in a
trade or business. See Commissioner v. Groetzinger, 480 U.S. 23,
35 (1987); Green v. Commissioner, 83 T.C. 667, 686-687 (1984).
Respondent argues that petitioner was not engaged in a trade or
business during 1995. For the following reasons, we agree with
respondent.
Although the term “trade or business” is not specifically
defined in the Internal Revenue Code, “to be engaged in a trade
or business, 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, supra at 35. A sporadic activity
does not qualify as a trade or business. See id.; see also Green
v. Commissioner, supra at 686-687. We assume, without finding,
- 7 -
that petitioner intended to profit from the development and
subsequent sales of the system and related products. See, e.g.,
Snow v. Commissioner, 416 U.S. 500 (1974); Louw v. Commissioner,
T.C. Memo. 1971-326. Nevertheless, petitioners failed to
establish that, with respect to Micron Systems, petitioner
engaged in any activity with regularity and continuity during
1995 so as to consider the activity a trade or business for
purposes of section 162 or 174 for that year.
The operation of petitioners’ vehicles in which the system
had been installed, in and of itself, does not support the
deductions here in dispute. Otherwise, petitioners provided
little detail of what petitioner was doing on a day-by-day basis
during the year in issue. We cannot determine whether he was
actively involved in any research and development or
manufacturing and marketing during that year. Petitioner
explained that prior to 1995 he decided to manufacture and market
the system himself after unsuccessfully attempting to license it,
but there is no evidence that petitioner manufactured anything
during 1995, and, other than his generalized testimony on the
point, there is no evidence that he was otherwise researching or
developing any products for sale or patents during that year.
Based upon the negligible gross receipts for the year in issue,
it also appears that petitioner made very little attempt to sell
- 8 -
anything.2 See Bendetovitch v. Commissioner, T.C. Memo. 1993-
443.
As evidence of his sales efforts, petitioner provided
numerous testimonial type letters to petitioner regarding Micron
Systems. However, none relate to the year 1995.3
Furthermore, focusing on each deduction provides no
meaningful insight into the nature of petitioner’s activities
during 1995. At trial, petitioners conceded that they were not
entitled to some of the deductions. Some of the deductions not
conceded could not be explained; others relate to expenses that
would have otherwise been incurred regardless of the activity.
We understand that 10 years prior to the year in issue,
petitioner obtained a patent on the auxiliary oil filtration
system for internal combustion engines. We think it likely that
petitioner intended to make a profit from it someday. However,
petitioners failed to explain, and we cannot devine, what
petitioner was doing in 1995 that would entitle them to the
2
We cannot determine the source of the gross receipts
reported on the Schedule C.
3
One letter dated March 31, 1999, addressed to petitioner
at his home address is prepared on letterhead of Compuware,
Oakland, California, and signed by Robbin Everson, one of the
petitioners in this case. The subject of this letter is
petitioners’ 1993 Pontiac Grand Am. Another letter was written
by a service manager of SuperShuttle in 1991. Petitioner
discontinued his relationship with SuperShuttle in 1994.
- 9 -
deductions claimed on the Schedule C. See Karara v.
Commissioner, T.C. Memo. 1999-253, affd. without published
opinion 214 F.3d 1358 (11th Cir. 2000). It follows that
respondent’s disallowance of the loss that results from those
deductions is sustained, and we so hold.
Reviewed and adopted as the report of the Small Tax Case
Division.
Based on the foregoing,
Decision will be
entered for respondent.