REIMER v. COMMISSIONER

T.C. Summary Opinion 2002-26

UNITED STATES TAX COURT

J. MICHAEL AND SUSAN L. REIMER, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 10638-99S. Filed March 28, 2002.

John J. Morrison, for petitioners.

Jennifer L. Nuding, for respondent.

GOLDBERG, 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. The decision to be

entered is not reviewable by any other court, and this opinion

should not be cited as authority. Unless otherwise indicated,

subsequent section references are to the Internal Revenue Code in

effect for the years in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure.
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Respondent determined the following deficiencies, additions

to tax, and penalties with respect to petitioners’ Federal income

taxes:

Addition to Tax Penalty
Year Deficiency Section 6651(a) Section 6662(a)

1993 $3,937 $237 $787
1994 6,917 287 1,383
1995 6,330 568 1,266

After concessions by respondent,1 the issues for decision are:

(1) Whether petitioners’ horse breeding operation was an activity

engaged in for profit within the meaning of section 183(a); (2)

whether petitioners’ water and air filtration operation was an

activity engaged in for profit within the meaning of section

183(a); (3) whether petitioners are liable for additions to tax

for failure to timely file returns under section 6651(a) for the

taxable years 1994 and 1995; and (4) whether petitioners are

liable for accuracy-related penalties pursuant to section 6662(a)

for the years in issue.

Some of the facts have been stipulated and are so found.

The stipulation of facts and the attached exhibits are

incorporated herein by this reference. At the time the petition

was filed, petitioners resided in Montgomery, Illinois.

1
Respondent concedes that there is no addition to tax
under sec. 6651(a) due from petitioners for 1993. Respondent
further concedes $252 of the sec. 6651(a) addition to tax for
1995 due to respondent’s failure to credit petitioners with
$5,035 of withheld income taxes.
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A. Petitioners’ Background

Petitioners are husband and wife. Susan L. Reimer (Mrs.

Reimer) has had a lifelong passion for horses. Her parents have

owned horses since her early childhood, and she had a pony at the

age of 3. During high school, Mrs. Reimer entered her first

horse show competition through participation in a 4-H program.

Mrs. Reimer has continued to ride horses on her own since her

early adulthood. At the time of petitioners’ marriage,

approximately 32 years ago, Mrs. Reimer owned her own horse.

Mrs. Reimer was a preschool teacher during the years in issue.

J. Michael Reimer (Mr. Reimer) holds a bachelor’s degree in

business administration. He also completed some postgraduate

courses, although he does not hold a graduate degree. During

college, he completed approximately 16 hours of accounting

courses. In 1989, Mr. Reimer began working for Recticel Foam

Corporation as vice president of sales and marketing. When the

corporation was bought in 1990, his position was terminated. Mr.

Reimer, while seeking new employment, learned of a company called

National Safety Associates (NSA), which privately marketed air

and water filters. This activity will be described in detail

below. In order to earn more income, Mr. Reimer looked for full-

time employment. In the fall of 1991, Mr. Reimer was hired as an

automobile salesman for Borg Pontiac. He worked for Borg Pontiac

until September 1993 when he again changed employment to Village
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Pontiac. At Village Pontiac Mr. Reimer started as a salesperson,

but quickly advanced to finance manager.

B. NSA Air and Water Filtration Activity

As stated above, in 1990 Mr. Reimer became involved with NSA

after he lost his job with Recticel Foam Corporation. Mr. Reimer

attended a local NSA seminar that he became aware of through a

newspaper advertisement. NSA marketed air and water filtration

devices, and later educational goods, through a direct marketing

distributorship similar to the Amway business model. At first,

Mr. Reimer was a distributor for NSA but rose to the next level

of sales coordinator. As a sales coordinator, Mr. Reimer had

other distributors below him. Mr. Reimer conducted local

seminars to sell products and recruit new sales coordinators, and

also attended regional and national conferences.

Mr. Reimer recorded all NSA related business income and

expenses in an outdated computer system which used 5-1/4-inch

floppy disks. Petitioners upgraded their computers in 1995 and

as a result Mr. Reimer no longer has access to his business

records pertaining to NSA on the floppy disks. Mr. Reimer

reported income and business expenses from the NSA activity on

Schedule C, Profit or Loss From Business. Beginning in late

1991, Mr. Reimer decided that he would seek new full-time

employment because he wanted to earn more money but would

continue the NSA activity on a part-time basis. He obtained
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full-time employment with Borg Pontiac, an automobile dealer, and

then at Village Pontiac, another automobile dealer. In 1993, Mr.

Reimer testified that he made a conscious decision to end his

involvement with NSA. Mr. Reimer terminated the NSA activity

either in 1993 or early in 1994, at the latest, by writing a

letter of termination and returning all remaining inventory to

NSA.

Mr. Reimer’s NSA activity was reported on Schedules C for

the tax years 1991 through 1994, as a secondary activity separate

from petitioners’ horse breeding activity.

C. Horse Breeding Activity

Petitioners’ horse breeding operation first began around

1976. This activity was originally named J-Mar Arabians.

Petitioners changed the name to Summer’s End Farm upon their move

from Ohio to Oswego, Illinois, in 1989.

In 1971, petitioners purchased their first purebred Arabian

foal, J-Mar Elbravado. They thought J-Mar Elbravado would become

a stallion and could be bred. About 3 years after the purchase

of J-Mar Elbravado, petitioners learned that the stallion had a

cryptorchidism (recessed testicle) which rendered him useless for

breeding. Petitioners had J-Mar Elbravado gelded in 1974, but

they still continued to show him in Arabian horse shows. He was

sold in either 1977 or 1978 for an undisclosed amount.
 - 6 -

Petitioners decided to change the direction of their

operation by going into mare breeding. In 1976, the year that

petitioners began their breeding activity and completed a

Schedule F, Profit or Loss From Farming, for their horse breeding

endeavor, they purchased a second Arabian horse, Emkay Asmara

(Asmara), a yearling filly. This horse was petitioners’ first

breeding mare. Asmara was bred first with Amerigo and a foal was

born in 1977, which died several hours later. Asmara was then

bred to Bak, owned by Paramont Arabians (Paramont). Paramont

became interested in Asmara, and, as a result, petitioners worked

out a trade arrangement, whereby Paramont would keep Asmara in

foal and petitioners would obtain a higher quality filly than

Asmara. When petitioners had the veterinarian examine the

Paramont filly on their premises, it was determined that the

filly had a major breeding fault. The filly was returned and

petitioners received back Asmara in foal. The foal was born in

1978 but only lived for 10 days. Petitioners brought Asmara back

to Paramont for breeding.

Paramont was interested in Asmara because they had a

potential buyer for her. Petitioners sold Asmara to Paramont and

acquired Ms. Bak in 1979, a mare born in 1976. On September 1,

1981, petitioners entered into a mare lease agreement with Keg

Arabian. The Keg Arabian stallion named Pattrone was bred to Ms.

Bak for the purpose of obtaining a marketable foal. The first
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foal born in 1983 was Parable. Keg Arabian exercised the option

under the lease agreement to keep the filly and petitioners had

an option on the next foal. Ms. Bak was bred to Pattrone again.

In 1984 a filly was born, and she was named Tender Moment.

Petitioners exercised their option and kept Tender Moment. A

third foal was born in May 1986 from breeding Ms. Bak to

Pattrone. This filly was named Autumn Eve. Petitioners sold

Autumn Eve in 1987 for $7,500.

On January 1, 1987, petitioners entered into a horse

breeding agreement with Grenier Training Center, whereby they

bred Ms. Bak to their stallion, Azare. A foal was born but was

killed when hit by an automobile. Petitioners were not able to

successfully breed Tender Moment.

On March 7, 1988, petitioners entered into a horse breeding

agreement with Robert and Elizabeth Pasquesi to breed Ms. Bak

with their stallion named Kamin. The record is not clear whether

any foal was born.

In the meanwhile, sometime in 1981, petitioners purchased a

mare named Sassafras Street (Sassafras) for $5,700. In 1985,

Sassafras was bred with Pattrone, and in 1986 a foal was born

named J.W. Venture. In 1988, Sassafras was bred with Kamin, and

in 1989 a foal named Kamin’s Dark Star was born. In 1989,

Sassafras was bred with Kamin, and in 1990 a foal, Jessica’s

Melody, was born.
 - 8 -

J.W. Venture was sold in 1986 and subsequently gelded in

1997. Jessica’s Melody was sold in 1994 for $2,500.

Petitioners, on December 15, 1994, entered into a lease

agreement with Jim and Jackie Gully to breed Ms. Bak and

Sassafras with two stallions of Mr. and Mrs. Gully’s choice. No

foals were born.

In 1993 petitioners’ “herd” consisted of four mares: Ms.

Bak, Sassafras, Tender Moment, and Jessica’s Melody. The ages of

these mares were 16, 13, 9, and 3 years, respectively. Jessica’s

Melody was sold in 1994 for $2,500. By the end of 1994,

petitioners only had three mares.

D. Petitioners’ Business Plans

In petitioners’ first business plan entitled “J-Mar Arabians

Est. 1971" (1971 business plan), petitioners stated their

objective as “long term profit ‘optimization’ through careful,

practical, well-planned program of investment in a quality stock

for breeding and sale, and to breed the perfect Arabian horse -

athletic elegance.”

Attached to their 1971 business plan was a 5-year plan

financial spreadsheet and summary for the period 1971 to 1976.

According to this plan, petitioners would yield an annual

positive cashflow starting in 1975, or year 5; however,

petitioners’ plan stated an overall net loss through 1976 of

$8,500. In 1976, the plan projected total assets worth $11,000.
 - 9 -

Petitioners’ second plan, entitled “J-Mar Arabians 5 Year

Plan - Revised: 1975-1980" (revised 5-year plan), carried forward

the overall net loss of $8,500 from the 1971 business plan, and

continued to make projections through 1980. At the end of 1980,

petitioners projected assets worth $19,450 and an overall net

loss of $18,650.

Petitioners’ third business plan, entitled “J-Mar Arabians 5

Year Plan - Revision II: 1980-1985" (second revised 5-year plan),

also carried forward the projected net loss of $18,650 in 1980

(from the revised 5-year plan) as the starting point for the 1980

to 19892 projections. According to the second revised 5-year

plan, petitioners would yield an overall net profit of $23,850 in

1988, or year 18.

In 1985, petitioners drafted a proposed limited partnership

agreement for the purchase of a one-third interest in Sassafras

and Tender Moment by a third party. Included in the proposal are

the following documents: An estimated 5-year cashflow, estimated

fair market value of the horses (Sassafras valued at $200,000 and

Tender Moment valued at $300,000), payment terms, and cash

reconciliation with depreciation. This partnership was never

formed.

2
Petitioners’ financial projections were for the time
period 1980 through 1989, even though their business plan was for
the period 1980 through 1985.
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Petitioners’ next business plan is entitled “Summer’ [sic]

End Farm 10 Year Plan Financials” (1990 business plan). The 1990

business plan did not carry over the prior period’s “net

cumulative” amount, thus starting from scratch. Based upon the

1990 business plan, petitioners projected a net profit in 1992.

Petitioners testified that the business plans were written

within a year or two from the beginning of the time period

covered in each plan. Petitioners did not conduct an income or

expense summary based on actual amounts incurred or expended for

any given time period. Petitioners stipulated that they did not

revise any of the above business plans or financial projections

after the plans were written.

Each plan also included an attached narrative summary of

what occurred in the prior period.

Petitioners printed business cards and brochures to promote

the horse breeding activity. Petitioners also maintained a

separate checking account for the horse breeding activity.

Petitioners were members of various Arabian horse

associations during the years in issue, including the

International Arabian Horse Association (IAHA) and American Horse

Shows Association.

E. Petitioners’ Time and Effort

Petitioners divided the work responsibilities for their

horses. Mrs. Reimer handled most of the labor and the horses’
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physical needs, e.g., taking the horses out to pasture, grooming,

feeding, and cleaning out stalls daily, while Mr. Reimer handled

all of the administrative duties, e.g., maintaining farm records,

paying bills, and preparing all tax returns.

During the years in issue, both petitioners worked full-time

outside of their horse breeding activity. Mrs. Reimer worked

with the horses before and after returning from teaching

preschool on weekdays. In a typical week, Mrs. Reimer spent 2 to

4 hours a day maintaining the horses, e.g., cleaning out the

stalls, feeding, grooming, and exercising the horses. During

weekends, Mrs. Reimer would complete all of the barn chores,

spending from 3 to 6 hours on Saturday and Sunday. Mrs. Reimer

testified that she tracked each horse’s “heat cycle” on a

calendar for breeding purposes; however, the calendar was not

provided at trial.

Mrs. Reimer is primarily responsible for training, grooming,

and preparing the horses for show. She rode the horses every day

as part of their exercise and condition training for shows. Mr.

Reimer assisted, on occasion, in preparing the horses for show,

which included warming up or riding the horses, although Mrs.

Reimer exclusively rode the horses during a show. Mr. Reimer

typically assisted Mrs. Reimer about 1 hour per day in the more

labor intensive aspect of horse breeding in addition to the

approximately 10 hours per week of administrative duties.
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Although petitioners have four children, the children have

no interest in the horses and do not ride them.

F. Arabian Horse Shows

Petitioners regularly showed their horses in IAHA sanctioned

shows and non-IAHA shows. Only horses that showed and placed in

IAHA sanctioned shows received points toward various rankings.

Ms. Bak was awarded the Supreme Legion of Merit in 1985,3 Tender

Moment was awarded the Legion for Supreme Honor, and Sassafras

was awarded the Legion of Merit in 1997.

Their horses were trained primarily by Mrs. Reimer, as she

does not trust her horses to most trainers,4 and have

accumulated an impressive record. During 1994, Tender Moment

placed in 12 separate Arabian horse shows, Sassafras placed in 4

separate Arabian horse shows, and Jessica’s Melody placed in 1

Arabian horse show. The “herd” was not shown often in 1993.

Through participation in the horse shows Mrs. Reimer was

able to associate with the “inner circle of trainers” who worked

for wealthy horse owners. At horse shows, Mrs. Reimer

intentionally warmed up her horses at the same time as trainers

with more “political power” and knew many of them on a first name

basis.

3
Ms. Bak was the 110th Arabian horse to reach the level
of Supreme Legion of Merit.
4
However, Mrs. Reimer hired a professional trainer
during 1995 to train Tender Moment.
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G. Appreciation of Property

The assets of petitioners’ horse breeding activity consist

of the horses. Ms. Bak was purchased in 1979 for $15,000. In

1981, Ms. Bak was insured for $40,000. In petitioners’ proposed

1985 partnership offering, drafted by petitioners, Sassafras and

Tender Moment were valued at $200,000 and $300,000, respectively.

At trial, Mr. Reimer estimated the collective value of Ms. Bak,

Tender Moment, and Sassafras in 1993 to range between $30,000 and

$50,000. No expert testimony was given at trial to support Mr.

Reimer’s valuations, the insurance record valuation, or the 1985

partnership offering valuation. Furthermore, no estimated value

was given for Jessica’s Melody which was sold in 1994 for $2,500.

H. Petitioners’ Advisers

Petitioners consulted an accountant in 1976 “when we set up

the business”. Petitioners showed the accountant their books and

records and were purportedly told by the accountant that they

could handle the record keeping themselves, and that “it would be

a waste of money” to hire the accountant. According to Mr.

Reimer they did not discuss what amounts were deductible because

Mr. Reimer “knew I could” take the deductions. Mr. Reimer read

the regulations and the Internal Revenue Code and filed their

returns based upon his research. At times Mr. Reimer consulted

with the Internal Revenue Service (IRS). Prior to the audit of

this case, petitioners were never audited by the IRS.
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I. Petitioners’ Income And Expenses

Petitioners do not recall whether their horse breeding

activity ever resulted in any net income. The following is a

summary of petitioners’ gross receipts, expenses, and net losses

from their NSA activity and horse breeding activity, as reported

on petitioners’ Schedules F for the years 1992-1998:

Year NSA Activity Horse Activity Combined Operations

Gross Expenses Gross Expenses Gross Expenses Net Gain
Receipts Receipts Receipts (Loss)
1 2
1992 $406 $202 $240 $37,813 $646 $38,015 ($37,369)
3 2
1993 0 1,072 80 22,665 80 23,737 (23,657)
4 5
1994 4,465 1,365 4,430 38,738 8,895 40,103 (31,208)

1995 N/A N/A 0 25,162 0 25,162 (25,162)
6
1996 N/A N/A 28,292 30,903 28,292 30,903 (2,611)
7
1997 N/A N/A 20,303 25,223 20,303 25,223 (4,920)
8
1998 N/A N/A 32,130 36,852 32,130 36,852 (4,722)

Total $4,871 $2,639 $85,475 $217,356 $90,346 $219,995 ($129,649)

1
Petitioners also claimed cost of goods sold of $1,774.
2
This amount represents “other income, including Federal and State gasoline or fuel tax
credit or refund.”
3
Petitioners also claimed cost of goods sold of $920.
4
Petitioners also claimed cost of goods sold of $4,931.
5
$1,930 of this amount is from “other income”.
6
This amount represents sale of livestock of $12,700, custom hire income of $11,082, and
“other income” of $4,510.
7
This amount represents sale of livestock of $3,000, custom hire income of $13,593, and
“other income” of $3,710.
8
This amount represents sale of livestock of $15,200 and custom hire income of $16,930.

Horse breeding activity income received during years 1996

through 1998 includes sale of livestock, custom hire income, and

other income, including Federal and State gasoline or fuel tax

credits or refunds.

The following is a table of petitioners’ W-2 income, and

Federal income taxes withheld for 1992-1998:
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Federal Income
Year W-2 Income Taxes Withheld
1992 $70,015 $98.96
1993 70,621 48.63
1994 84,555 2,702.03
1995 94,697 5,034.71
1996 92,865 5,920.28
1997 70,054 3,502.74
1998 87,380 4,369.16
Total $570,187 $21,676.51

In 1993, Mr. Reimer claimed 26 exemptions on Form W-4,

Employee’s Withholding Allowance Certificate. In 1995, Mr.

Reimer also requested his employer, Village Pontiac, to apply a

flat 10-percent Federal and flat 2-percent Illinois income tax

rate for payroll purposes. In 1996, Mr. Reimer requested his

employer, Village Pontiac, to apply a flat 5-percent Federal and

flat 1-percent Illinois income tax rate for payroll purposes.

J. Petitioners’ Federal Income Tax Returns and Notice of

Deficiency

Petitioners timely filed their 1993 Federal income tax

return. Petitioners filed and were granted automatic extensions

of time to file their 1994 and 1995 Federal income tax returns.

Their 1994 and 1995 returns were received by respondent on August

21, 1995, and August 23, 1996, respectively. The postmark on the

envelope containing the 1994 return was stamped August 15, 1995.
 - 16 -

The record does not contain a copy of the envelope in which

petitioners mailed their 1995 return.

On petitioners’ Federal income tax returns for 1993, 1994,

and 1995, petitioners deducted Schedule F expenses of $22,665,

$38,738, and $25,162, respectively. Petitioners also deducted

Schedule C expenses of $1,072 and $1,365 for tax years 1993 and

1994, respectively.

In a notice of deficiency for the 1993, 1994, and 1995

taxable years, respondent determined that petitioners did not

engage in their horse breeding activity or their NSA water and

air filtration activity with an actual and honest objective of

making a profit, and that the expenses incurred in connection

with each respective activity were therefore deductible only to

the extent of income earned from that activity. Respondent

further determined that petitioners are liable for accuracy-

related penalties for all years in issue, and additions to tax

for failure to timely file their 1994 and 1995 returns.

K. Discussion

Section 162 allows deductions for ordinary and necessary

expenses paid or incurred in carrying on a trade or business. 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, 480 U.S. 23,
 - 17 -

35 (1987). If an individual engages in an activity without the

objective for profit, section 183 generally limits allowable

deductions attributable to the activity to the extent of gross

income generated by such activity. Sec. 183(b).

Although “it is sufficient if the taxpayer has a bona fide

expectation of realizing a profit, regardless of the

reasonableness of such expectation”, whether or not a taxpayer is

engaged in the activity for profit depends on all the surrounding

facts and circumstances of the case. Golanty v. Commissioner, 72

T.C. 411, 425-26 (1979), affd. without published opinion 647 F.2d

170 (9th Cir. 1981). Greater weight is given to objective facts

than to a taxpayer’s mere statement of intent. Dreicer v.

Commissioner, 78 T.C. 642, 645 (1982), affd. without opinion 702

F.2d 1205 (D.C. Cir. 1983).

The regulations set forth the following nonexclusive factors

to consider in determining whether an activity is engaged in for

profit. These factors are: (1) The manner in which the taxpayer

carried 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 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 losses with

respect to the activity; (7) the amount of occasional profits, if
 - 18 -

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 conclusive. Keanini v. Commsisioner, 94

T.C. 41, 47 (1990). We do not reach a decision by merely

counting factors supporting each party’s position. Dunn v.

Commissioner, 70 T.C. 715, 720 (1978), affd. on another issue 615

F.2d 578 (2d Cir. 1980). Petitioners bear the burden of proving

that they possessed the required profit objective.5 Rule 142(a);

Golanty v. Commissioner, supra at 426; Smith v. Commissioner,

T.C. Memo. 1997-503, affd. without published opinion 182 F.3d 927

(9th Cir. 1999).

Respondent does not contest that the claimed deductions were

incurred with respect to petitioners’ horse breeding activity and

NSA activity but argues that petitioners did not engage in either

activity during the years in issue with an intent to make a

profit. We agree. Because the parties argued their respective

cases by addressing each of the nine criteria enumerated in the

regulations, we follow the same approach in our discussion.

(1) Manner in Which The Taxpayer Carries on The Activity.

In this respect relevant factors include whether petitioners

maintained complete and accurate books and records, and whether

5
We note that sec. 7491 is inapplicable in this case
because petitioners’ examination commenced prior to July 22,
1998.
 - 19 -

changes were attempted in order to improve profitability. Sec.

1.183-2(b)(1), Income Tax Regs.

Petitioners maintained a record of the income and expenses

related to their horse breeding activity, but they did not

provide evidence of a breakdown or break-even analysis of their

overall horse breeding activity. Although petitioners created a

business plan for their horse breeding activity, it appears that

they did not make decisions in accordance with the business

plans, projections, or analyses of the costs required to carry on

the activity in a profitable manner. It seems unhelpful for

petitioners to create and rely on a “revised” business plan based

on earlier projections rather than actual expenses. Such

reliance on projections that have no semblance to reality or to

historical income and expense information is foolish. Although

there is some indication that petitioners carried on the horse

breeding activity as a separate business, we do not think that

petitioners carried on their activity in a businesslike manner.

Petitioners’ NSA records were unretrievable due to a change

and upgrade of software. As such, we are not able to review

these purported records.

This factor favors respondent’s position.

(2) The Expertise of The Taxpayer or Their Advisers.

A taxpayer’s expertise, research, and study of an activity,

as well as his or her consultation with experts, may be
 - 20 -

indicative of a profit objective. Sec. 1.183-2(b)(2), Income Tax

Regs.

The fact that Mrs. Reimer had experience in raising or

maintaining horses prior to entering into the horse breeding

activity does not alone show that the horse activity was engaged

in with a profit objective. See Glenn v. Commissioner, T.C. Memo

1995-399, affd. without published opinion 103 F.3d 129 (6th Cir.

1996). At the time they started the activity, petitioners owned

J-Mar Elbravado, which introduced them to the business of Arabian

horse breeding. Petitioners also sought general advice from

other breeders, trainers, and an accountant. However, there is

no evidence that they reviewed the records of other breeding

operations or sought specific advice as to how to make their

operation profitable. Similar to the taxpayers in Burger v.

Commissioner, T.C. Memo. 1985-523, affd. 809 F.2d 355, 359 (7th

Cir. 1987), petitioners could not point to any evidence that

demonstrated how they planned to reduce their losses. (“The

taxpayers’ failure to consult economic experts or develop an

economic expertise themselves is another fact that indicates a

lack of profit motive”.) Nor could petitioners show how they

monitored expenses or losses to enable them to make informed

business decisions as to how to make their activity profitable.

This factor favors respondent’s position.
 - 21 -

(3) The Time And Effort Expended by The Taxpayer in

Carrying on The Activity.

The devotion of a great deal of personal time and effort by

the taxpayer in carrying on an activity may indicate that it is

engaged in for profit, particularly if there are no substantial

personal or recreational elements associated with such activity.

Sec. 1.183-2(b)(3), Income Tax Regs.

Mr. Reimer was employed full-time during 1994 and 1995.

Mrs. Reimer was also employed full-time as a preschool teacher

during the years in issue. Mrs. Reimer worked on the horse

breeding activity before and after school during the week and for

3 to 6 hours on Saturday and Sunday. Mr. Reimer worked on the

administrative aspects of the horse breeding activity about 10 to

15 hours each week.

Although the time and effort expended by petitioners on

their horse breeding activity support a contention of profit

objective, we discern that petitioners derived substantial

recreational benefit from the time they spent with their horses

and with the community of “horse people”.

This factor is neutral.

(4) Expectation That Assets Used in The Activity May

Appreciate in Value.

An expectation that the appreciation in the value of the

assets used in the activity will produce a profit when netted
 - 22 -

against the losses from the operation of the activity may

indicate a profit objective. Sec. 1.183-2(b)(4), Income Tax

Regs.

Petitioners testified that they expected their horses to

increase in value. They further testified that during the years

in issue, their “herd” could have sold for $30,000 to $50,000.

However, they did not provide any evidence besides their own

belief of the value of their horses. Petitioners argue that the

insurance coverage on Ms. Bak of $40,000 is “third party”

evidence of the value of the horses. We note that the insurance

coverage was for Ms. Bak in 1981, 12 years prior to the earliest

year in issue, and petitioners failed to provide the actual

policy showing the basis of this valuation. Even assuming their

figure was the true market value of their herd, this would

compensate them for only about one-quarter of $179,543, their

total losses incurred from 1992 through 1998.

To be profitable, the horse breeding activity would need to

produce future net earnings and appreciation in an amount greater

than $179,543. Petitioners failed to produce any evidence to

show that their activity had a reasonable chance of recovering

their reported losses. See Bessenyey v. Commissioner, 45 T.C.

261, 274 (1965), affd. 379 F.2d 252 (2d Cir. 1967).

This factor favors respondent’s position.
 - 23 -

(5) The Success of The Taxpayer in Carrying on Other

Similar or Dissimilar Activities.

The fact that a taxpayer has engaged in similar activities

in the past and converted them from unprofitable to profitable

enterprises may indicate that he is engaged in the present

activity for profit, even though the activity is presently

unprofitable. Sec. 1.183-2(b)(5), Income Tax Regs.

Mr. Reimer is a well-educated and smart businessman. Upon

entering the automobile sales industry, he advanced quickly from

a salesperson to a financial manager. He also used his skills to

participate in the administration of various horse breeding

shows, including writing scripts for the shows. However, despite

his ability to make contacts with others in the horse breeding

industry, petitioners have consistently failed to make this

activity profitable. Mr. Reimer’s efforts in the water and air

filtration activity also failed to be profitable.

Even with Mr. Reimer’s business experience and ability, we

do not find that he applied such experience to their horse

breeding activity to make it profitable.

This factor favors respondent’s position.

(6) The Taxpayer’s History of Income or Losses With Respect

to The Activity.

A history of income, losses, and occasional profits from an

activity may indicate a profit objective. Allen v. Commissioner,
 - 24 -

72 T.C. 28, 34 (1979). Startup losses and losses that result

from unforeseen circumstances do not necessarily show that a

profit objective was lacking. Engdahl v. Commissioner, 72 T.C.

659, 669 (1979).

Petitioners argue that their horse breeding activity did not

begin until 1976, just prior to the purchase of Emkay Asmara.6

Mr. Reimer testified that he could not recall whether the horse

breeding activity generated any net profit prior to 1992, and the

record shows that they failed to make a profit from 1992 through

1998. It appears that any minimal income generated from 1992

through 1995 came from “other income” including fuel tax credits

or refunds. From 1996 through 1998, petitioners generated sale

of livestock income of $30,900, about one-third of the losses

claimed in the time period, “custom hire” income of $41,605, and

“other income” of $8,220. The magnitude of the losses in

comparison with the revenues is an indication that petitioners

did not have a profit objective. See Burger v. Commissioner,

T.C. Memo. 1985-523.

At trial, Mr. Reimer testified that he would not have

entered the NAS activity if he did not intend to make a profit.

He further testified that he made many sales, “enough to keep us

alive"; however, the returns from 1992 through 1994, the year

6
For the purpose of this opinion, it is not necessary to
decide whether the activity began in 1971 or 1976 because the
years in issue are well beyond the seventh year in the activity.
See sec. 183(d).
 - 25 -

petitioners ended the activity, show that only losses were

carried.

This factor favors respondent’s position.

(7) The Amount of Occasional Profits, if Any, Which Are

Earned.

An occasional small profit from an activity that generates

otherwise consistently large losses may not be determinative that

the activity is conducted for profit, although an occasional

substantial profit may indicate a profit objective. Sec. 1.183-

2(b)(7), Income Tax Regs. From 1976 through 1998, at least 22

years of operation, petitioners’ horse breeding activity has

never produced a profit. See McKeever v. Commissioner, T.C.

Memo. 2000-288.

Petitioners failed to prove that they earned a profit from

the NAS activity from 1990 through 1994, the year they terminated

the activity. However, in reviewing petitioners’ returns in the

record, 1992 through 1994, we note that petitioners deducted

gross receipts of $4,871, costs of good sold of $7,625, and

expenses of $2,639, thus yielding a net loss of $5,393.

This factor favors respondent’s position.

(8) The Financial Status of The Taxpayer.

The lack of substantial income from other sources may

indicate a profit objective. Sec. 1.183-2(b)(8), Income Tax

Regs. Conversely, substantial income from other activities may
 - 26 -

indicate the lack of a profit objective, especially where the

losses from the activity produce a tax benefit. Id.

Petitioners reported Form W-2 income in the respective

amounts of $70,621, $84,555, and $94,697 for 1993, 1994, and

1995. Petitioners claimed net losses from the horse breeding and

NAS activities of $23,657, $31,208, and $25,162 for 1993, 1994,

and 1995, respectively. Thus, petitioners reduced their taxable

income by approximately 34 percent in 1993, 37 percent in 1994,

and 27 percent in 1995, and accordingly their tax liability was

reduced.

This factor favors respondent’s position.

(9) Elements of Personal Pleasure or Recreation.

The existence of personal pleasure or recreation relating to

the activity may indicate the absence of a profit objection.

Sec. 1.183-2(b)(9), Income Tax Regs.

While neither petitioner rides the horses purely for

pleasure, petitioners acknowledge that they both derived personal

pleasure in working with horses and horse breeding. Mrs. Reimer

trained the horses for show and derived much pleasure and pride

in seeing her hard work result in IAHA sponsored awards. She

also enjoyed being in the “inner circle” of horse breeders and

trainers with highly “political” connections.

The Court has recognized that “unquestionably, an enterprise

is no less a ‘business’ because the entrepreneur gets
 - 27 -

satisfaction from his work; 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.”

Burger v. Commissioner, supra.

Because petitioners derived substantial personal pleasure

from their horse breeding activity, including showing their

horses, this factor favors respondent.

L. Conclusion

Considering all the facts and circumstances, we find that

petitioners’ horse breeding activity was not engaged in for

profit within the meaning of section 183(c). In reaching our

decision, we have considered the factors listed in section 1.183-

2(b), Income Tax Regs., all arguments presented by the parties,

and the unique facts of this case.

Petitioners engaged in their horse breeding activity for at

least 22 years, with a net loss of at least $217,356 during 1992

through 1998. Petitioners did not generate a profit or even come

close to doing so during any of the years in issue. We do not

question petitioners’ dedication to their horses. But, based

upon the totality of the circumstances and the objective facts,

petitioners’ arguments are unsupportable that their horse

activity was engaged in for profit. Petitioners did not prepare

for the economic realities of the horse breeding business as
 - 28 -

reflected in their inability to realize a profit in a meaningful

time period. Although they followed some business formalities,

they failed to plan and project a reasonable method of turning

their activity into a profitable enterprise. The facts and

evidence in this case lead us to conclude that during the years

in issue petitioners were unreasonably willing to sustain massive

losses in spite of their improbability of profits.

We further find that petitioners failed to prove that their

NAS activity was engaged in for profit. Petitioners offered very

little evidence to support their contention that the NAS activity

was maintained in a business like manner, that profits were ever

sustained, or that they had a plan to make this venture

profitable.

We hold that respondent’s disallowance of petitioners’

losses is sustained.

M. Section 6651(a)(1) Addition to Tax

Respondent determined additions to tax as a result of

petitioners’ failure to timely file their respective tax returns

for tax years 1994 and 1995. Section 6651(a)(1) imposes an

addition to tax for failure to timely file a tax return. The

addition to tax is equal to 5 percent of the amount of the tax

required to be shown on the return if the failure to file is not

for more than 1 month. Sec. 6651(a)(1). An additional 5 percent

is imposed for each month or fraction thereof in which the
 - 29 -

failure to file continues, to a maximum of 25 percent of the tax.

Id.

The additions are applicable unless petitioners establish

that their failure to timely file the returns was due to

reasonable cause and not willful neglect. Id. If petitioners

exercised ordinary business care and prudence and were

nonetheless unable to file their returns within the date

prescribed by law, then reasonable cause exists. Sec. 301.6651-

1(c)(1), Proced. & Admin. Regs. “Willful neglect” means a

“conscious, intentional failure or reckless indifference.”

United States v. Boyle, 469 U.S. 241, 245 (1985).

Petitioners timely filed and were granted automatic

extensions to file their respective 1994 and 1995 Federal income

tax returns on August 15, 1995, and August 15, 1996,

respectively. Petitioners’ returns were filed with the Kansas

City, Missouri, field office on August 21, 1995, and August 23,

1996, respectively.

The postmark on the envelope attached to their 1995 return

shows a date of August 15, 1995. We find that petitioners timely

filed their 1994 Federal income tax return. Sec. 7502.

Accordingly, petitioners are not liable for the addition to tax

under section 6651(a) for 1994.

Petitioners’ 1996 envelope in which their 1995 return was

mailed was not available in the record. Mr. Reimer testified
 - 30 -

that he mailed their 1996 return on August 15, 1996. The burden

is on petitioners to prove that their return was filed on time or

that the failure is due to reasonable cause and not willful

neglect. Coltman v. Commissioner, 980 F.2d 1134 (7th Cir. 1992),

affg. T.C. Memo. 1991-127. Petitioners’ self-serving testimony

that they mailed the return on August 15, 1996, without more, is

insufficient to overcome this burden. Accordingly, petitioners

are liable for the addition to tax under section 6651(a)(1) for

the tax year 1996.

N. Section 6662(a) Accuracy-Related Penalty

Section 6662(a) imposes an accuracy-related penalty of 20

percent of the portion of the underpayment which is attributable

to negligence or disregard of rules or regulations. Sec.

6662(b)(1). Negligence is the lack of due care or failure to do

what a reasonable and ordinarily prudent person would do under

the circumstances. Neely v. Commissioner, 85 T.C. 934, 947

(1985). The term “disregard” includes any careless, reckless, or

intentional disregard. Sec. 6662(c). No penalty shall be

imposed if it is shown that there was reasonable cause for the

underpayment and the taxpayer acted in good faith with respect to

the underpayment. Sec. 6664(c).

Respondent argues that petitioners’ treatment of the horse

activity and NAS activity expenditures as business expenditures

was negligent or an intentional disregard of rules or
 - 31 -

regulations. Petitioners sought the advice of one accountant

sometime in the 1970s as they were entering the horse breeding

activity. Mr. Reimer also intentionally altered his Federal

income tax withholding in full anticipation of the massive losses

they were claiming in each respective year. We hold that

petitioners are liable for the accuracy-related penalty under

section 6662(a) for each year in issue.

We have considered all arguments by the parties, and, to the

extent not discussed above, conclude that they are irrelevant or

without merit.

Reviewed and adopted as the report of the Small Tax Case

Division.

Decision will be entered

under Rule 155.