MATTHEWS v. COMMISSIONER

T.C. Summary Opinion 2004-89

UNITED STATES TAX COURT

ALBERT R. MATTHEWS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 17869-02S. Filed July 1, 2004.

Albert R. Matthews, pro se.

Donald E. Edwards, for respondent.

WOLFE, Special Trial Judge: This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect when the petition was filed. Unless otherwise indicated,

all subsequent section references are to the Internal Revenue

Code in effect at relevant times, and all Rule references are to

the Tax Court Rules of Practice and Procedure. The decision to

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

should not be cited as authority.
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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. When he filed his

petition, petitioner resided in Muskogee, Oklahoma.

Respondent determined deficiencies in petitioner’s Federal

income taxes, additions to tax under section 6651(a)(1), and

accuracy-related penalties under section 6662(a) as follows:

Additions to Tax Penalties
Year Deficiency Sec. 6651(a)(1) Sec. 6662(a)
1997 $26,097 $6,524.26 $5,146.20
1998 19,113 4,778.25 3,341.80
1999 18,173 1,750.95 3,329.80

The issues for decision are: (1) Whether petitioner engaged

in his rodeo and horse-training activity during 1997-99 with the

objective of making a profit within the meaning of section 183,

(2) whether petitioner is liable for additions to tax under

section 6651(a)(1) for filing his tax returns after the due

dates, and (3) whether petitioner is liable for accuracy-related

penalties under section 6662(a).

Background

Petitioner is an attorney and partner with the Bonds

Matthews Law Firm in Muskogee, Oklahoma. Petitioner’s law

practice is concentrated primarily in litigation and plaintiff

personal injury law. In 1997, 1998, and 1999, petitioner’s
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taxable income from his law practice was $214,736, $164,008, and

$161,332, respectively.1

In addition to practicing law, petitioner also is engaged in

rodeo and horse-training activities (horse activity) that are the

subject of this case. Petitioner raises and trains horses on his

ranch in Muskogee, Oklahoma, where he also resides. For the

years 1991 and 1993 through 1999 (data is not available for

1992), petitioner reported income and expenses and claimed losses

from his horse activity as follows:

Rodeo & Horse Rodeo & Horse Rodeo & Horse
Year Gross Income Expenses Losses

1991 $17,763 $92,116 ($74,353)
1992 Data not available
1993 6,264 66,211 (59,947)
1994 3,130 58,983 (55,853)
1995 15,195 53,622 (38,427)
1996 4,625 45,736 (41,111)
1997 1,016 60,837 (59,821)
1998 8,212 52,477 (44,265)
1999 4,616 47,377 (42,761)
Total 60,821 477,359 (416,538)

As shown above by the table, petitioner claimed horse

activity losses of $59,821, $44,265, and $42,761 on Schedule C,

1
The parties stipulated that these amounts were earned
from practicing law. However, a review of Schedules E,
Supplemental Income and Loss, for the years in issue shows that,
while most of petitioner’s income consisted of partnership
distributions from the Bonds Matthews Law Firm, petitioner also
received Schedule E income in the form of royalties from TEPPCO
Crude Oil, LLC, and GM Oil Prop, Inc., partnership income or loss
from the Matthews, Bonds Jr., & Hayes Building Partnership, and
income or loss from an S corporation called Hopes & Dreams Ltd.
 - 4 -

Profit or Loss from Business, in 1997, 1998, and 1999,

respectively.2

Petitioner’s income tax returns for the years in issue were

received by the Internal Revenue Service on the following dates:

(1) Petitioner’s 1997 tax return was received on July 7, 1999,

(2) petitioner’s 1998 tax return was received on August 23, 2000,

and (3) petitioner’s 1999 tax return was received on December 26,

2000.

By notice of deficiency dated August 30, 2002, respondent

determined that petitioner’s horse activity was not engaged in

for profit, and the corresponding deductions for the Schedule C

losses from this activity were disallowed.

Discussion

I. Deductibility of Losses

In general, a taxpayer bears the burden of proving his

entitlement to business expense deductions. Rule 142(a); Welch

v. Helvering, 290 U.S. 111, 115 (1933); Burrus v. Commissioner,

T.C. Memo. 2003-285. Section 7491(a) does not apply in this case

to shift the burden of proof to respondent. Petitioner has

neither alleged that section 7491 applies nor established his

compliance with the requirements of section 7491(a)(2)(A) and (B)

2
The total amounts of losses deducted on petitioner’s tax
returns for 1997, 1998, and 1999 actually were $56,733, $44,265,
and $30,910, respectively. Petitioner’s Schedule C losses from
his horse activity were offset by Schedule C income from his law
practice in the amounts of $3,088 in 1997 and $11,851 in 1999.
 - 5 -

to substantiate items, maintain required records, and cooperate

fully with respondent’s reasonable requests. In addition,

petitioner is not entitled to a presumption that his horse

activity is engaged in for profit under section 183(d) because

petitioner’s gross income from his horse activity has not

exceeded deductions for any 2 years in the period of 7

consecutive taxable years ending with the first of the years in

issue. Sec. 183(d). Thus, petitioner has the burden of proving

that respondent’s determination is incorrect and that he is

entitled to the claimed losses from his horse activity.

The deductibility of a taxpayer’s expenses attributable to

an income-producing activity depends upon whether that activity

was engaged in for profit. See secs. 162, 183, 212. Section 162

provides that a taxpayer who is carrying on a trade or business

may deduct ordinary and necessary expenses incurred in connection

with the operation of the business. Section 212 provides a

deduction for expenses paid or incurred in connection with an

activity engaged in for the production or collection of income,

or for the management, conservation, or maintenance of property

held for the production of income. Section 183 specifically

precludes deductions for activities “not engaged in for profit”

except to the extent of the gross income derived from such

activities. Secs. 183(a) and (b)(2). For example, deductions
 - 6 -

are not allowable for activities a taxpayer engaged in as a sport

or hobby or for recreation. Sec. 1.183-2(a), Income Tax Regs.

For a taxpayer’s expenses in an activity to be deductible

under section 162 or section 212, and not subject to the

limitations of section 183, the taxpayer must show that he

engaged in the activity with an actual and honest objective of

making a profit. Hulter v. Commissioner, 91 T.C. 371, 392

(1988); Dreicer v. Commissioner, 78 T.C. 642, 645 (1982), affd.

without opinion 702 F.2d 1205 (D.C. Cir. 1983); Hastings v.

Commissioner, T.C. Memo. 2002-310. Although a reasonable

expectation of a profit is not required, the taxpayer’s profit

objective must be “actual and honest”. Dreicer v. Commissioner,

supra at 645; sec. 1.183-2(a), Income Tax Regs. Whether a

taxpayer has an actual and honest profit objective is a question

of fact to be resolved from all the relevant facts and

circumstances. Hulter v. Commissioner, supra at 393; Hastings v.

Commissioner, supra; sec. 1.183-2(a), Income Tax Regs. Greater

weight is given to objective facts than to a taxpayer’s statement

of intent. Dreicer v. Commissioner, supra at 645; sec. 1.183-

2(a), Income Tax Regs. As stated earlier, the taxpayer bears the

burden of establishing the requisite profit objective. Rule

142(a); Keanini v. Commissioner, 94 T.C. 41, 46 (1990); Hastings

v. Commissioner, supra.
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Regulations promulgated under section 183 provide the

following nonexclusive list of factors which normally should be

considered in determining whether an activity was engaged in for

profit: (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 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 single factor, nor the existence of even a

majority of the factors, is controlling, but rather it is an

evaluation of all the facts and circumstances in the case, taken

as a whole, that is determinative. Golanty v. Commissioner, 72

T.C. 411, 426-427 (1979), affd. without published opinion 647

F.2d 170 (9th Cir. 1981); sec. 1.183-2(b), Income Tax Regs.

Petitioner claims that he engaged in his horse activity with

a profit objective, but he has not introduced any records or

documentation to substantiate his claims. A taxpayer is required

to maintain records sufficient to substantiate deductions that he

claims on his tax return. Sec. 6001; sec. 1.6001-1(a), Income
 - 8 -

Tax Regs. The fact that a taxpayer reports a deduction on his

income tax return is not sufficient to substantiate the deduction

claimed on the return. Wilkinson v. Commissioner, 71 T.C. 633,

639 (1979); Roberts v. Commissioner, 62 T.C. 834, 837 (1974).

Despite petitioner’s training and experience as an attorney, he

did not have his books and records stipulated into evidence and

did not bring any supporting documentation with him to trial.

The stipulation of facts agreed upon by the parties did not

include necessary objective facts relevant to the issue of

whether petitioner operated his horse activity with a profit

motive.

Instead of introducing objective evidence that he engaged in

his horse activity for profit, petitioner stated that he “chose

to come [before the Court] and tell my story of what I have done

for the past 45 years.” Petitioner testified that he has been

involved in activities relating to cattle and horses for the past

40 or 50 years and has focused on raising and training horses for

about the past 25 years. He was raised on a farm, majored in

animal husbandry in college, and considers himself an expert in

raising and training horses. Consequently, petitioner explained

that he never felt the need to consult with outside experts. He

bought his ranch in Muskogee about 20 years ago and has made

numerous improvements over the years, including constructing both

indoor and outdoor training arenas, three barns, miles of
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fencing, and pipe corrals. He formed a futurity named Hopes and

Dreams Futurity in the early 1980s3 and remains active in

promoting his horses at various rodeos and horse shows throughout

the nation.

Petitioner specifically testified that he has always been in

the horse business for profit, and that during the years in

issue, he split his time equally between his law practice and his

horse activity. Petitioner did not maintain a separate bank

account for his horse activity and did not keep an inventory

accounting of each individual horse. Petitioner testified that

he kept inventory as he claims most ranchers do--by simply

keeping track of “how much money you take in and how much money

you spend”. Petitioner suggested that on the basis of these

cashflows, he expects to profit from the sale of each horse once

it is fully trained. Furthermore, petitioner testified that most

3
Petitioner explained the Hopes and Dreams Futurity as
follows:

Hopes and Dreams takes – enrolls stallions in their
program of $1000 stud fee or less.

And they put that money in a pot, and Hopes and Dreams
takes a small percentage of it. Then the foals – if
that entices a mare owner to breed to these stallions
that are enrolled in Hopes and Dreams, and when they
breed to them, their foals, which are the offspring of
the mare, are then eligible for the futurity that they
run at two years of age.

Now, after about three or four years, the pot got pretty
big, and you’d pay out for the winner of the Hopes and
Dreams * * *
 - 10 -

ranchers experience a history of operating losses as money is

spent improving their land but will make a profit when they

eventually sell their ranches. Petitioner stated that the value

of his ranch has appreciated significantly, and he estimated that

the value of his ranch has increased from $150 per acre to

approximately $1,000 to $1,500 per acre.

Without supporting documentation, petitioner’s testimony is

self-serving, and it is well established that this Court is not

bound to accept at face value such unverified testimony from a

taxpayer. See Shea v. Commissioner, 112 T.C. 183, 189 (1999);

Tokarski v. Commissioner, 87 T.C. 74, 77 (1986).

We apply the nine factors provided in the regulations, sec.

1.183-2(b), Income Tax Regs., to the limited evidence petitioner

introduced to prove that he was engaged in his horse activity for

profit.

In the complete absence of books and records, we can only

conclude that petitioner did not engage in his horse activity in

a businesslike manner. Although petitioner claims that he sent

receipts to his accountant twice a year for purposes of

maintaining books and records for his ranch, petitioner did not

introduce these books and records into evidence. In addition,

petitioner did not develop a budget or an informal business plan

to project whether the horse activity could be operated

profitably, did not have a separate bank account for his horse
 - 11 -

activity, and did not maintain an inventory accounting for each

of his horses.

His testimony indicates that petitioner’s primary

expectation for a profit comes from the anticipated appreciation

in the value of his assets, his ranch property and improvements

and his horses. Because of the absence of supporting

documentation, such as an outside appraisal, records from the

sale of comparable ranch property in the area, or receipts for

the cost of the improvements to his ranch, petitioner failed to

substantiate the value of his ranch. Furthermore, in response to

direct questioning from this Court, petitioner admitted that the

current value of his ranch is probably less than the cumulative

amount of losses he has claimed from his horse activity.

Petitioner speculated that his property will continue to

appreciate tremendously in the future, but he did not introduce

any objective evidence of projected increases in property values

in the area of his ranch for the Court to consider. As to the

values of his horses, petitioner’s 1997 return showed a sale of a

horse at a loss of $7,500, undermining his own unverified and

self-serving testimony that he expects to profit from the sale of

his horses. Petitioner failed to substantiate the value of his

assets or the likelihood of any appreciation in the value of

these assets. The record clearly shows that petitioner’s horse

activity has produced a history of losses. For each year since
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1991 for which his financial information was made available to

the Court, petitioner reported substantial losses from the horse

activity. Petitioner has not introduced evidence of even a

single profitable year, although he did offer uncorroborated

testimony that he previously sold a cattle ranch at a profit and

sold a portion of his current horse ranch in 2001 to a relative

at a profit.

In contrast to his history of losses from his horse

activity, the record shows that petitioner was a successful

attorney. For the years in question, petitioner was able to use

losses from his horse activity to offset income earned from the

practice of law. The magnitude of petitioner’s losses from his

horse activity and the substantial tax benefits petitioner

received by offsetting those losses against income from his law

practice support the view that petitioner did not engage in his

horse activity for profit.

Petitioner testified that he was an expert in raising and

training horses. He grew up on his father’s cattle and horse

farm, has a degree in animal husbandry, and has focused on

training horses for the past 25 years. Petitioner’s testimony

that he is an expert in raising and training horses and that he

had no need to consult with advisers about such matters is not

contradicted. Petitioner also testified that he spent

approximately one-half of his time on his horse activity.
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Although we cannot overlook the fact that petitioner had a

successful legal practice during the years in issue, it does

appear that petitioner spent a substantial amount of time with

his horse activity. However, these factors, particularly

standing alone, are not enough to show that petitioner engaged in

his horse activity for profit.

Finally, petitioner admitted that he received personal

pleasure and enjoyment from his horse activity but stated that he

was always in it to make money.

From this record, we conclude that petitioner did not have

an actual and honest objective of making a profit from his horse

activity. Rather, the record demonstrates that petitioner

conducted this activity as part of his way of life and at least

partly for pleasure, and he used expenses from this activity to

offset income from his law practice. Under section 183, his

horse activity was not engaged in for profit, and petitioner is

not permitted to deduct losses from his horse activity.

II. Additions to Tax

Section 6651(a)(1) imposes an addition to tax for a

taxpayer’s failure to file a required return on or before the

specified filing date, including extensions. The amount of the

liability is based upon a percentage of the tax required to be

shown on the return. Sec. 6651(a)(1). The addition to tax is

inapplicable, however, if the taxpayer’s failure to file the
 - 14 -

return was due to “reasonable cause and not due to willful

neglect”. Sec. 6651(a)(1).

Under section 7491(c), the Commissioner bears the burden of

production with regard to whether any penalty or addition to tax

is appropriate, but he does not bear the burden of proof with

regard to the “reasonable cause” exception of section 6651(a).

Higbee v. Commissioner, 116 T.C. 438, 447 (2001). Petitioner’s

tax returns for 1997, 1998, and 1999 are part of the record, and

the filing dates of the returns were stipulated. In the notice

of deficiency, respondent sets forth the following: (1) For

1997, petitioner’s return was due on August 15, 1998, and was

filed on July 7, 1999, approximately 11 months after its due

date; (2) for 1998, petitioner’s return was due on August 15,

1999, and was filed on August 23, 2000, approximately 12 months

after its due date; and (3) for 1999, petitioner’s return was due

on October 15, 2000, and was received on December 26, 2000,

approximately 2 months after its due date. The stipulation of

facts and the stipulated tax returns are consistent with these

statements in the notice of deficiency. On the basis of this

record, we conclude that respondent has satisfied the burden of

production in regard to whether the additions to tax under

section 6651(a)(1) are appropriate.

Because respondent met his burden of production, petitioner

is liable for the additions to tax unless he can show his failure
 - 15 -

to file was due to reasonable cause and not willful neglect. See

Higbee v. Commissioner, supra at 447. Petitioner did not argue

that his failure to file was due to reasonable cause, nor is

there any evidence in the record to suggest that petitioner’s

failure to file was due to reasonable cause. Accordingly, we

sustain the additions to tax under section 6651(a)(1).

III. Penalties for Underpayment of Tax

Section 6662 provides that a taxpayer may be liable for a

penalty of 20 percent of the portion of an underpayment of tax

(1) attributable to a substantial understatement of tax or (2)

due to negligence or disregard of rules or regulations. A

substantial understatement of tax occurs where the understatement

exceeds the greater of 10 percent of the tax required to be shown

or $5,000. Sec. 6662(d)(1)(A). “Negligence” is defined as any

failure to make a reasonable attempt to comply with the

provisions of the Internal Revenue Code and includes any failure

by the taxpayer to keep adequate books and records or to

substantiate items properly. Sec. 6662(c); sec. 1.6662-3(b)(1),

Income Tax Regs. “Disregard” includes any careless, reckless, or

intentional disregard. Sec. 6662(c).

A taxpayer may avoid the accuracy-related penalty with

respect to any portion of an underpayment of tax if the taxpayer

acted with reasonable cause and good faith under section

6664(c). The determination of whether the taxpayer acted with
 - 16 -

reasonable cause and good faith depends upon all the pertinent

facts and circumstances. See sec. 1.6664-4(b)(1), Income Tax

Regs. Relevant factors include the taxpayer’s efforts to assess

his proper tax liability, including the taxpayer’s reasonable and

good faith reliance on the advice of a professional such as an

accountant. See id. Further, an honest misunderstanding of fact

or law that is reasonable in light of the experience, knowledge,

and education of the taxpayer may indicate reasonable cause and

good faith. See Remy v. Commissioner, T.C. Memo. 1997-72; sec.

1.6664-4(b)(1) Income Tax Regs.

As discussed above, section 7491(c) imposes upon the

Commissioner the burden of production with regard to any penalty

or addition to tax, including the section 6662(a) penalty. Once

the Commissioner comes forward with sufficient evidence to

indicate that it is appropriate to impose the section 6662(a)

penalty, the taxpayer has the burden of proof in regard to

whether the taxpayer acted with reasonable cause and in good

faith under section 6664(c)(1). Higbee v. Commissioner, supra at

447; Emerson v. Commissioner, T.C. Memo. 2003-82.

In the notice of deficiency, respondent summarized his

calculations of petitioner’s underpayments of tax as follows:

(1) In 1997, respondent calculated an understatement of $25,731

on a tax liability of $71,354, or a 36-percent understatement,

(2) in 1998, respondent calculated an understatement of $16,709
 - 17 -

on a tax liability of $56,423, or a 29.6-percent understatement,

and (3) for 1999, respondent calculated an understatement of

$16,649 on a tax liability of $62,381, or a 26.7-percent

understatement. Therefore, from the notice of deficiency, it is

clear that petitioner’s understatement of tax for each year is a

substantial understatement under section 6662(d)(1)(A), and

respondent has satisfied his burden of production. These

computations are consistent with our disallowance of petitioner’s

claimed deductions for losses in excess of his revenue from his

horse activity.

Petitioner did not present convincing evidence that his

underpayments of tax resulted in spite of his acting with

reasonable cause and good faith. He argued only that he had been

claiming the disallowed deductions for many years without adverse

results. Under these circumstances, we sustain respondent’s

determination of accuracy-related penalties under section

6662(a).

Reviewed and adopted as the report of the Small Tax Case

Division.

To reflect the foregoing,

Decision will be entered

for respondent.