T.C. Memo. 2002-76
UNITED STATES TAX COURT
JOHN G. PARKER AND JANICE E. PARKER, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 9781-98. Filed March 27, 2002.
Jerome L. Blut and Elliot S. Blut, for petitioners.
Rollin G. Thorley, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
SWIFT, Judge: Respondent determined deficiencies and
accuracy-related penalties against petitioners for 1994, 1995,
and 1996 as follows:
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Accuracy-Related Penalty
Year Deficiency Sec. 6662(a)
1994 $21,603 $4,321
1995 20,881 4,176
1996 18,608 3,722
Unless otherwise indicated, all 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.
References to petitioner in the singular are to John G.
Parker.
The primary issue for decision is whether significant
expenses that petitioner incurred in purchasing, building,
improving, and flying airplanes were incurred by petitioner in an
activity engaged in for profit.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
At the time the petition was filed, petitioners resided in
Reno, Nevada.
Since the age of 16, petitioner has been a licensed airplane
pilot. While in the U.S. Air Force, petitioner earned a degree
in aeronautical engineering from the Air Force Institute of
Technology. Upon leaving the Air Force in 1965, petitioner
became a full-time pilot for American Airlines (American) where
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he worked for the next 33 years. Petitioner also became a
licensed airplane mechanic.
Beginning in 1967, petitioner also became engaged in an
activity that, over the course of the next 34 years, involved the
building, improving, and flying of four small airplanes that
petitioner owned (airplane activity), three of which petitioner
built from kits. When not flying for American, petitioner
personally would spend many hours each week working on his
airplanes, seeking to improve their mechanical operation and
flight speed.
Over the years, including 1994, 1995, and 1996, petitioner
entered his airplanes in a number of air shows and air races.
Flight logs relating to petitioner’s airplanes for 1994, 1995,
and 1996 reflect that petitioner won either first or second place
in five air races. In 1977, petitioner won a national
championship race for the class relating to one of his airplanes.
Only petitioner flew his airplanes in the above air shows and air
races.
In 1994, petitioner installed in one of his airplanes a
direct ignition system that he had developed. Petitioner hoped
that his direct ignition system could replace standard magnetos
typically used in airplanes. Petitioner thought that such a
direct ignition system might improve the speed of airplanes.
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During 1995 and 1996, petitioner sold six or seven of his
direct ignition systems for use in experimental aircraft for
approximately $1,900 to $3,000 each.
In December of 1996, petitioner obtained from the City of
Reno, Nevada, a general business license relating to his airplane
activity.
Also in 1996, petitioner leased property in Reno, Nevada, on
which petitioner constructed a 7,000-square foot hangar to be
used as a place to build and work on his airplanes.
In 1998, petitioner retired from American.
On a Schedule C, Profit or Loss From Business, filed with
petitioners’ joint Federal income tax returns for 1989 through
1999 that were prepared by an accountant, petitioners reported
gross income, ordinary business expenses, and net losses relating
to petitioner’s airplane activity, and unrelated wage and taxable
pension and annuity income as follows:
Unrelated
Airplane Activity Wages,
Pensions,
Year Gross Income Expenses Net (Loss) & Annuities
1989 $ 3,048 $ 83,216 ($ 80,168) $ 169,433
1990 7,119 45,000 (37,881) 166,643
1991 4,944 49,930 (44,986) 186,683
1992 1,596 78,367 (76,771) 180,683
1993 9,942 112,549 (102,607) 188,829
1994 2,002 80,899 (78,897) 182,590
1995 3,810 76,826 (73,016) 183,415
1996 10,390 76,277 (65,887) 185,770
1997 22,545 82,673 (60,128) 206,506
1998 23,773 103,889 (80,116) 110,844
1999 5,402 88,713 (83,311) 202,559
TOTAL $94,571 $878,339 ($783,768) $1,963,955
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As a result of an audit examination, on May 6, 1998,
respondent issued a notice of deficiency to petitioners in which
respondent determined that, for 1994, 1995, and 1996,
petitioner’s airplane activity was not engaged in for profit
under section 183, and respondent disallowed the claimed losses
for each of those years. Also, respondent determined accuracy-
related penalties under section 6662.
Respondent has conceded that the claimed expenses relating
to petitioner’s airplane activity have been substantiated for the
years at issue and that during the years 1986 through 2001
petitioner spent approximately $1 million of his own funds on his
airplane activity.
During a prior audit of petitioners’ 1989, 1990, and 1991
Federal income tax returns, respondent did not raise an issue as
to petitioner’s profit objective relating to petitioner’s
airplane activity.
OPINION
Activity not Engaged in for Profit
Generally, under section 183, if an activity is not engaged
in for profit, deductions for expenses relating to such activity
are allowable only to the extent of gross income derived from the
activity.
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An activity is not regarded as engaged in for profit unless
it is conducted by the taxpayer with an actual and honest
expectation of making a profit. Dreicer v. Commissioner, 78 T.C.
642, 645 (1982), affd. without published opinion 702 F.2d 1205
(D.C. Cir. 1983); Golanty v. Commissioner, 72 T.C. 411, 425-426
(1979), affd. without published opinion 647 F.2d 170 (9th Cir.
1981). An expectation of profit need not be reasonable. Id.
Petitioners have the burden of proof on this issue.1 Rule
142(a); Golanty v. Commissioner, supra at 426.
In considering whether a taxpayer engaged in an activity for
profit, greater weight is given to objective factors, taking into
account all of the facts and circumstances, than to a taxpayer’s
mere statement of intent. Beck v. Commissioner, 85 T.C. 557, 570
(1985); sec. 1.183-2(a), Income Tax Regs.
In section 1.183-2(b), Income Tax Regs., a nonexclusive list
of factors is provided for use in analyzing whether an activity
is engaged in for profit. Such factors include: (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
1
Because the examination in this case commenced before
July 23, 1998, sec. 7491, which places the burden of proof with
respect to any fact issue on respondent where the taxpayer
maintains adequate records, satisfied applicable substantiation
requirements, cooperated with respondent, and produced credible
evidence with regard to the fact issue, does not apply. See
Internal Revenue Service Restructuring and Reform Act of 1998,
P.L. 105-206, sec. 3001, 112 Stat. 685, 726.
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by the taxpayer in carrying on the activity; (4) the expectation
by the taxpayer 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 earned by the taxpayer, if any;
(8) the financial status of the taxpayer; and (9) elements of
recreation or personal pleasure in the taxpayer’s carrying on the
activity.
Although no single factor is conclusive, a record of
substantial losses over many years and the unlikelihood of
achieving a profit are important factors bearing on whether the
taxpayer had a profit objective in carrying on the activity.
Golanty v. Commissioner, supra at 426; sec. 1.183-2(b)(6), Income
Tax Regs. Generally, the profit-objective test looks for a
profit on the entire activity, including profits to recoup losses
from prior years. Golanty v. Commissioner, supra at 427 (citing
Bessenyey v. Commissioner, 45 T.C. 261, 274 (1965), affd.
379 F.2d 252 (2d Cir. 1967)).
Substantial income from sources other than the activity,
particularly where the activity generates large losses that
result in substantial tax benefits, may indicate that the
activity is not engaged in for profit, especially if the activity
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has personal or recreational elements. Sec. 1.183-2(b)(8),
Income Tax Regs.
Petitioner contends that he engaged in the airplane activity
for profit. We disagree.
The evidence does not establish that petitioner carried on
his airplane activity in a businesslike manner.
Petitioner has consistently reported substantial net losses
from his airplane activity and used the losses to offset
significant wages that petitioner earned from American and
taxable pensions and annuity income. The uninterrupted,
substantial losses realized in petitioner’s airplane activity
over many years are highly indicative of a lack of profit
objective. See Golanty v. Commissioner, supra at 426.
Petitioner testified that a business plan for his airplane
activity was developed in 1996 (namely, to build from kits and to
sell airplanes for a substantial profit). Petitioner, however,
did not offer into evidence written documentation of this
business plan. Petitioner acknowledged that prior to 1996 his
airplane activity was “a pencil and paper operation”.
Other than income tax returns, flight logs, and a business
license (issued to petitioner during the last month of the last
year at issue herein), petitioner did not offer into evidence any
written documentation of his business plans or projections,
payroll or other employee records, sales contracts, or any other
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business records regarding petitioner’s airplane activity from
1967 to the time of trial in 2001.
Petitioner’s testimony that during the late 1970s and early
1980s his airplane activity realized some profits was not
corroborated.
Petitioner testified that at the time of trial he employed
three people in his airplane activity and that he had contracts
to build from kits two Glasair airplanes and one Thunder Mustang
airplane for an expected profit of approximately $462,000.
Petitioner, however, did not offer into evidence written
documentation of the above contracts or any employee records to
corroborate petitioner’s testimony.
Petitioner is a highly educated, trained, and experienced
pilot who loves airplanes and who has devoted much of his time
and money to his airplane activity.
We conclude, for the years in issue, that petitioner’s
airplane activity constitutes a hobby and is not to be regarded
as an activity engaged in for profit under section 183.
Accordingly, we sustain respondent’s disallowance of the losses
relating to petitioner’s airplane activity.
Accuracy-Related Penalties
Under section 6662, a 20-percent accuracy-related penalty is
imposed on the portion of any underpayment of tax attributable
to, among other things, negligence or disregard of Federal tax
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rules and regulations, or a substantial understatement of tax.
An understatement of tax is substantial if it exceeds either 10
percent of the tax required to be shown on the return, or $5,000.
Sec. 6662(d)(1)(A).
The above accuracy-related penalty, however, is not imposed
with respect to any portion of a taxpayer’s understatement of tax
for which the taxpayer acted with reasonable cause and in good
faith. Sec. 6664(c)(1).
In our discretion, and based on the facts before us, we
conclude that petitioners had reasonable cause in treating
petitioner’s airplane activity as a for profit activity.
Petitioners are not liable for the accuracy-related penalties
determined by respondent under section 6662 with respect to the
deficiencies at issue herein.
To reflect the foregoing,
Decision will be entered
under Rule 155.