T.C. Memo. 2004-252
UNITED STATES TAX COURT
BRAD AND TERI MONTAGNE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 11648-02. Filed November 8, 2004.
Brad Montagne, pro se.
James Brian Urie, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
VASQUEZ, Judge: Respondent determined the following
deficiencies in, addition to, and accuracy-related penalties on
petitioners’ Federal income taxes:
Addition to Tax Penalty
Year Deficiency Sec. 6651(a)(1) Sec. 6662(a)
1997 $17,091 $3,956 $3,418
1998 17,867 -- 3,573
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After concessions,1 the issues for decision are: (1)
Whether petitioners’ horse training and breeding activity was an
activity not engaged in for profit; (2) whether petitioners are
liable for self-employment tax; (3) whether petitioners are
liable for an accuracy-related penalty pursuant to section
6662(a);2 and (4) whether petitioners are liable for an addition
to tax for failure to file a timely return.
FINDINGS OF FACT
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. Petitioners resided in
Sturgeon Lake, Minnesota, at the time they filed their petition.
Chiropractic Practice
Brad Montagne (petitioner) has been a chiropractor for 14
years. He operated his chiropractic practice as a sole
proprietorship in 1997 and 1998. Petitioner typically works as a
chiropractor 5 days a week for 40 hours.
1
Petitioners conceded every issue raised in the statutory
notice of deficiency, except the addition to tax and penalty and
whether petitioners are subject to self-employment tax.
Accordingly, petitioners conceded that they had additional
interest income of $2,056 and $1,861 in 1997 and 1998,
respectively. Petitioners also conceded that they had additional
“net schedule C income” of $61,960 and $65,719 in 1997 and 1998,
respectively.
2
Unless otherwise stated, all section references are to
the Internal Revenue Code, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
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Horse Training and Breeding Activity
Petitioners purchased a 115-acre farm in 1994. Starting in
1994, petitioner decided to breed, train, and sell horses.
Before this, petitioner was not involved in horse training or
breeding. Petitioner’s previous experience with horses consisted
of riding them as a child. Petitioner derived personal pleasure
and enjoyment from riding horses.
In 1997 and 1998, petitioners owned 14 horses. Petitioner
and his children rode the horses. Petitioners’ children fed,
groomed, and cared for the horses and performed “groundwork” on
the farm. The children also rode the horses in 4-H Club
competitions in 1998.
Petitioner sold three horses in 1997 and two horses in 1998.
Petitioner purchased two of the horses sold in 1997 for $2,500,
and the third was foaled on the farm. Petitioner received $4,000
for the three horses sold in 1997. Petitioner purchased the two
horses sold in 1998 for $1,650. Petitioner received $1,850 for
the two horses sold in 1998.
Petitioner maintained inadequate records of the horse
activity. Petitioner did not prepare, nor did he have a
qualified professional prepare, financial projections or a
business plan for the horse training and breeding activity.
Petitioner did not keep business invoices for the sales of
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horses. Petitioner did not maintain a separate bank account for
the horse activity.
Petitioners’ Returns and Respondent’s Determinations
Respondent determined from petitioners’ original tax returns
deficiencies of $17,091 and $17,867 for 1997 and 1998,
respectively. Petitioners claimed losses from the horse activity
of $21,823 and $16,891 on amended returns for 1997 and 1998,
respectively. Respondent did not process the amended returns for
1997 and 1998.
OPINION
I. Petitioners’ Horse Activity
Section 183(a) provides generally that, if an activity is
not engaged in for profit, no deduction attributable to such
activity shall be allowed except as provided in section 183(b).
Section 183(c) defines an “activity not engaged in for profit” as
“any activity other than one with respect to which deductions are
allowable for the taxable year under section 162 or under
paragraph (1) or (2) of section 212.”
For a deduction to be allowed under section 162 or 212(1) or
(2), a taxpayer must establish that he or she engaged in the
activity with an actual and honest objective of making an
economic profit independent of tax savings. Evans v.
Commissioner, 908 F.2d 369 (8th Cir. 1990), revg. T.C. Memo.
1988-468; Antonides v. Commissioner, 91 T.C. 686, 693-694 (1988),
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affd. 893 F.2d 656 (4th Cir. 1990); Dreicer v. Commissioner, 78
T.C. 642, 644-645 (1982), affd. without opinion 702 F.2d 1205
(D.C. Cir. 1983). The expectation of profit need not have been
reasonable; however, the taxpayer must have entered into the
activity, or continued it, with the objective of making a profit.
Hulter v. Commissioner, 91 T.C. 371, 393 (1988); sec. 1.183-2(a),
Income Tax Regs.
Whether the requisite profit objective exists is determined
by examining all of the surrounding facts and circumstances.
Keanini v. Commissioner, 94 T.C. 41, 46 (1990); sec. 1.183-2(b),
Income Tax Regs. Greater weight is given to objective facts than
to a taxpayer’s mere statement of intent. Thomas v.
Commissioner, 84 T.C. 1244, 1269 (1985), affd. 792 F.2d 1256 (4th
Cir. 1986); sec. 1.183-2(a), Income Tax Regs.
Although section 7491(a) places the burden of proof on the
Commissioner with regard to certain factual issues involving
examinations commenced after July 22, 1998, petitioners do not
assert that section 7491(a) shifts the burden to respondent, nor
have petitioners complied with the substantiation and record-
keeping requirements of section 7491(a)(2). Therefore, the
burden of proof remains on petitioners.
Section 1.183-2(b), Income Tax Regs., provides a list of
factors to be considered in determining whether a taxpayer had a
profit objective: (1) The manner in which the taxpayer carried
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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 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, from
the activity; (8) the financial status of the taxpayer; and (9)
elements of personal pleasure or recreation. This list is
nonexclusive, and the number of factors for or against the
taxpayer is not necessarily determinative, but rather all facts
and circumstances must be taken into account, and more weight may
be given to some factors than to others. See id.; cf. Dunn v.
Commissioner, 70 T.C. 715, 720 (1978), affd. 615 F.2d 578 (2d
Cir. 1980).
Petitioners contend that the losses from the horse training
and breeding activity are properly deductible because the
activity was motivated by an actual and honest objective of
making a profit. Conversely, respondent asserts that the
activity was not engaged in for profit. For the reasons
discussed below, we agree with respondent.
A. Manner in Which the Activity Is Conducted
The fact that a taxpayer carries on the activity in a
businesslike manner and maintains complete and accurate books and
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records may indicate a profit objective. Sec. 1.183-2(b)(1),
Income Tax Regs.
Petitioner commingled the financial affairs of the horse
training and breeding activity with his personal finances. He
paid all the expenses of the horse activity from his personal
account, and the horse activity maintained no financial accounts
of its own. This commingling of funds is an indication that the
activity is a hobby rather than a business for profit. See
Ballich v. Commissioner, T.C. Memo. 1978-497. Petitioner also
did not generate or maintain business documents or records. We
conclude that petitioners did not conduct the horse training and
breeding activity in a businesslike manner, and this fact
indicates that the activity was not engaged in for profit.
B. Expertise of Petitioner
A taxpayer’s expertise, research, and study of an activity,
as well as his consultation with experts, may be indicative of a
profit objective. Sec. 1.183-2(b)(2), Income Tax Regs.
Petitioner testified that he consulted with experts, read books,
and attended seminars and conferences about the subjects of horse
training and breeding. Although petitioner testified that he
became knowledgeable about techniques of training and breeding
horses, he was not knowledgeable about the economics of the
activity. Significantly, petitioner did not seek professional
advice on the economic aspects of horse training and breeding.
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These facts do not persuade us that petitioners had a profit
motive.
C. Elements of Personal Pleasure
The absence of personal pleasure or recreation relating to
the activity in question may indicate the presence of a profit
objective. Sec. 1.183-2(b)(9), Income Tax Regs. Petitioner
conceded that he enjoyed riding horses and watching his children
compete by riding his horses in 4-H Club competitions. We find
that this factor weighs against petitioners.
D. Time and Effort Petitioner Expended
Where an activity has substantial personal or recreational
aspects, the time and effort spent may be due to a taxpayer’s
enjoyment of the activity rather than an intent to derive a
profit. White v. Commissioner, 23 T.C. 90, 94 (1954), affd. per
curiam 227 F.2d 779 (6th Cir. 1955). Although enjoying an
activity does not preclude a profit objective, the facts of this
case suggest that petitioner spent time on the activity because
of his children’s and his own fondness for horses rather than an
expectation of profit. Cf. Harrison v. Commissioner, T.C. Memo.
1996-509.
E. The Activity’s History of Income or Losses
A record of substantial losses over several years may be
indicative of the absence of a profit motive. Golanty v.
Commissioner, 72 T.C. 411, 426 (1979), affd. without published
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opinion 647 F.2d 170 (9th Cir. 1981). This Court has recognized
that the startup phase of a horse breeding activity is 5 to 10
years. Engdahl v. Commissioner, 72 T.C. 659, 669 (1979). The
1997 and 1998 losses were incurred within the recognized period
of the startup of a horse breeding activity. This factor
therefore does not weigh against petitioners’ having a profit
motive.
F. The Amount of Occasional Profits
The amount of occasional profits, if substantial in relation
to losses incurred or the taxpayer’s investment, may indicate a
profit objective. See sec. 1.183-2(b)(7), Income Tax Regs.
Petitioner testified that he earned a small profit from the horse
activity in 2000; however, he produced no evidence to support
this assertion. Petitioners incurred losses in 1997 and 1998 far
in excess of the small profit that petitioner claimed to have
realized in 2000. Therefore, the relatively small amount of
profit petitioners purportedly realized does not indicate a
profit motive.
G. Petitioners’ Financial Status
Substantial income from sources other than the activity in
question, particularly if the activity’s losses generated
substantial tax benefits, may indicate that the activity is not
engaged in for profit. Sec. 1.183-2(b)(8), Income Tax Regs.
Petitioner operated his chiropractic practice as a sole
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proprietorship and had net profits of $86,960 and $90,719 in 1997
and 1998, respectively. Therefore, petitioners could afford to
operate the horse training and breeding activity as a hobby, and
we conclude that they sought to reduce or eliminate their tax
liability by using the losses from the horse activity to offset
income from other sources.
H. Conclusion
After reviewing the entire record, we conclude that
petitioners did not engage in the horse breeding activity with an
actual and honest objective of making a profit within the meaning
of section 183.
II. Self-Employment Tax
Section 1401(a) imposes a tax upon the self-employment
income of every individual. Self-employment income consists of
gross income an individual derives from carrying on any trade or
business. Sec. 1402(a) and (b); Spiegelman v. Commissioner, 102
T.C. 394, 396 (1994). Petitioner operated his chiropractic
practice as a sole proprietorship and had net profits of $86,960
and $90,719 in 1997 and 1998, respectively. Petitioners deny
that they are liable for self-employment tax. On brief regarding
this issue, petitioners advanced arguments characteristic of tax
protester rhetoric that has been universally rejected by this and
other courts. See Wilcox v. Commissioner, 848 F.2d 1007 (9th
Cir. 1988), affg. T.C. Memo. 1987-225; Carter v. Commissioner,
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784 F.2d 1006, 1009 (9th Cir. 1986). We shall not painstakingly
address petitioners’ assertions “with somber reasoning and
copious citation of precedent; to do so might suggest that these
arguments have some colorable merit.” Crain v. Commissioner, 737
F.2d 1417, 1417 (5th Cir. 1984).
III. Penalty and Addition to Tax
Respondent has the burden of production under section
7491(c) for the addition to tax and the penalty and must come
forward with sufficient evidence showing that they are
appropriate. See Higbee v. Commissioner, 116 T.C. 438, 446-447
(2001). Once respondent has done so, the burden of proof is upon
petitioners to establish reasonable cause and good faith. Id. at
449.
A. Section 6662(a) Accuracy-Related Penalty
Pursuant to section 6662(a), a taxpayer may be liable for a
penalty of 20 percent on 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. Sec.
6662(b). The term “understatement” means the excess of the
amount of tax required to be shown on a return over the amount of
tax imposed which is shown on the return, reduced by any rebate
(within the meaning of section 6211(b)(2)). Sec. 6662(d)(2)(A).
An understatement is a “substantial understatement” when the
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understatement exceeds the greater of $5,000 or 10 percent of the
amount of tax required to be shown on a return. Sec.
6662(d)(1)(A).
Whether applied because of a substantial understatement of
tax or negligence or disregard of rules or regulations, the
accuracy-related penalty is not imposed with respect to any
portion of the underpayment as to which the taxpayer acted with
reasonable cause and in good faith. Sec. 6664(c)(1). The
decision as to whether the taxpayer acted with reasonable cause
and in good faith depends upon all the pertinent facts and
circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs.
Respondent determined tax deficiencies of $17,091 and
$17,867 for 1997 and 1998, respectively. Petitioners conceded at
trial that respondent’s adjustments to petitioners’ tax liability
in the notice of deficiency were correct, with the exception of
self-employment tax. We have found for respondent on the issues
of petitioners’ self-employment tax liability and the
deductibility of losses from their horse activity. Respondent
has met his burden of production. Petitioners did not present
any evidence indicating reasonable cause or substantial
authority. See secs. 6662, 6664. Accordingly, we sustain
respondent’s penalty determination.
B. Addition to Tax
Respondent determined that petitioners are liable for an
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addition to tax pursuant to section 6651(a)(1). Section
6651(a)(1) imposes an addition to tax for failure to file a
return on the date prescribed (determined with regard to any
extension of time for filing), unless such failure is due to
reasonable cause and not due to willful neglect.
Petitioners signed the 1997 return on April 14, 1999. We
conclude that respondent satisfied his burden of production
regarding this issue. Thus, petitioners must come forward with
evidence sufficient to persuade the Court that respondent’s
determination is incorrect or that an exception applies. See
Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933); see
Higbee v. Commissioner, supra at 447.
Petitioners presented no evidence that they timely filed a
return for 1997 or that their failure to file was due to
reasonable cause and not due to willful neglect. We hold that
petitioners are liable for the addition to tax pursuant to
section 6651(a)(1).
In reaching all of our holdings herein, we have considered
all arguments made by the parties, and, to the extent not
mentioned above, we find them to be irrelevant or without merit.
To reflect the foregoing,
Decision will be
entered for respondent.