T.C. Memo. 2005-265
UNITED STATES TAX COURT
MICHAEL PAUL REMLER AND PAULINE M. VELEZ, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 21868-03. Filed November 17, 2005.
Michael Paul Remler and Pauline M. Velez, pro sese.
Anthony J. Kim, Aaron Stonecash, and Paul R. Zamolo, for
respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
HAINES, Judge: Respondent determined deficiencies in
petitioners’ Federal income tax of $8,546 and $4,750 for 1999 and
2000, respectively. Respondent also determined a section 6662(a)
- 2 -
penalty for 2000.1 After concessions,2 the issues for decision
are: (1) Whether petitioners’ special education activity was
engaged in for profit during 1999 and 2000 (years in issue), and
(2) whether petitioners are liable for an accuracy-related
penalty under section 6662(a) for 2000.
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. At the time they filed
the petition, petitioners resided in Berkeley, California.
Michael Paul Remler (Dr. Remler) and Pauline M. Velez (Dr.
Velez) (collectively referred to as petitioners) are husband and
wife. During the years in issue, petitioners were employed full
time by the Department of Veterans Affairs. Dr. Remler is a
neurologist and previously served as the child neurologist for
1
Unless otherwise noted, all section references are to the
Internal Revenue Code, as amended, and all Rule references are to
the Tax Court Rules of Practice and Procedure.
2
Petitioners conceded they were liable for increases to
taxable income of: (1) $8,920 and $10,903 for 1999 and 2000,
respectively, resulting from disallowed deductions for real
estate losses; (2) $11,570 and $24,639 for 1999 and 2000,
respectively, resulting from disallowed deductions claimed in
connection with petitioner Velez’s Schedule C surgery activity;
(3) $1,118 for 1999 resulting from a disallowed Keogh deduction;
and (4) $3,249 for 2000 attributable to a State income tax
refund. The parties signed a Form 870, Waiver of Restrictions on
Assessment and Collection of Deficiency in Tax, regarding the
settled issues, and petitioners paid the additional tax liability
in full prior to trial.
- 3 -
the Autism Diagnostic and Teaching Program (TEACCH) at the
University of North Carolina. Dr. Velez is a surgeon, and during
the years in issue, she also ran a surgery practice.
Petitioners’ son, GJR3, was born on April 13, 1994. GJR was
diagnosed with autism in 1995, and his condition was classified
as moderately severe in 1997. From February 1997 to August 1998,
GJR was enrolled in a behavioral intervention program with the
Behavioral Intervention Associates (BIA). BIA provided
diagnostic and supervisory services to aid petitioners in
educating GJR at home. Petitioners also received training in
special education methods from the Autism Institute of America
(AIA).
From the spring of 1997 through November 2000, GJR was
enrolled in different special education programs in the Berkeley
Unified School District (BUSD). Petitioners became progressively
dissatisfied with the school-based programs. In coordination
with BUSD, petitioners developed an integrated afterschool
program to supplement the school-based programs.
By November 2000, petitioners decided that GJR’s needs could
no longer be met in the school-based programs. GJR was pulled
from all school-based programs and was educated at home in what
3
We shall refer to petitioners’ son using only his
initials.
- 4 -
petitioners call a “microschool”.4 BUSD agreed to reimburse
petitioners for GJR’s special education expenses up to $44,000
per year in exchange for petitioners’ releasing BUSD from any
liability for failing to provide GJR with a “free and appropriate
public education” (FAPE).
Petitioners did not spend much time teaching GJR in either
the afterschool program or the microschool. Instead, petitioners
hired several people who were interested in being teachers,
trained them using methods petitioners had developed or learned
through BIA and AIA, and had them teach GJR. Claudia Alexander
(Ms. Alexander) was one of GJR’s teachers from June 1998 through
the years in issue.
Petitioners had two sources of funding for the afterschool
program and the microschool, Regional Center and BUSD. Regional
Center, a California State organization that provides funding for
qualifying families for special education needs, paid petitioners
directly for a limited number of hours petitioners spent on GJR’s
education. From June 1998 through November 2000, petitioners
received indirect funding from BUSD channeled through Ms.
Alexander. BUSD paid Ms. Alexander, who would then sign her
paychecks over to petitioners. Petitioners would use the
paychecks and additional funds to pay Ms. Alexander and the other
4
For purposes of clarity, the Court will use petitioners’
terminology of afterschool program and microschool when referring
to petitioners’ home-schooling activities.
- 5 -
teachers at an agreed-upon hourly wage. Beginning in November
2000, petitioners received direct reimbursement from BUSD, as
described above. GJR’s education expenses exceeded funding for
both years in issue, and petitioners paid out-of-pocket for the
remainder.
GJR was the only student in petitioners’ afterschool program
and microschool. Petitioners did not advertise or otherwise seek
additional students. Petitioners did not apply for or receive
any grants during the years in issue. Petitioners did not
maintain a separate bank account for, or have any separate
business assets dedicated to, the afterschool program or the
microschool.
Petitioners timely filed joint Federal income tax returns
for the years in issue. Attached to each return was a Schedule
C, Profit or Loss From Business, for petitioners’ “special
education” activity. Petitioners deducted Schedule C losses with
respect to the special education activity of $24,417 and $12,351,
and reported adjusted gross income of $229,665 and $229,219 for
1999 and 2000, respectively.
On November 6, 2003, respondent sent petitioners a notice of
deficiency for the years in issue. Respondent determined that
petitioners’ special education activity was not a bona fide
business activity entered into for profit and disallowed the
claimed deductions. Respondent also determined that petitioners
- 6 -
were liable for an accuracy-related penalty of $42 under section
6662(a) for 2000 based on petitioners’ omission of a State income
tax refund from their return. In response to the notice of
deficiency, petitioners filed their petition with this Court on
December 24, 2003.
OPINION
A. Petitioners’ Special Education Activity
The first issue is whether petitioners’ special education
activity was an activity engaged in for profit during the years
in issue. Section 183(a) provides that if an individual engages
in an activity, and “if such activity is not engaged in for
profit, no deduction attributable to such activity shall be
allowed under this chapter except as provided in this section.”5
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.”
Section 162 allows the taxpayer to deduct expenses of
carrying on a taxpayer’s trade or business if those expenses are
5
Sec. 183(b)(1) provides that deductions which would be
allowable without regard to whether such activity is engaged in
for profit shall be allowed. Sec. 183(b)(2) provides that
deductions which would be allowable only if such activity is
engaged in for profit shall be allowed “but only to the extent
that the gross income derived from such activity for the taxable
year exceeds the deductions allowable by reason of paragraph
(1).” Neither subsection is at issue in the instant case.
- 7 -
ordinary and necessary to the conduct of the trade or business.
Paragraphs (1) and (2) of section 212 allow the taxpayer to
deduct expenses 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.
A taxpayer must show that he engaged in an activity with an
actual and honest objective of making a profit in order to deduct
expenses of the activity under either section 162 or 212.
Antonides v. Commissioner, 91 T.C. 686, 693 (1988), affd. 893
F.2d 656 (4th Cir. 1990); Beck v. Commissioner, 85 T.C. 557, 569
(1985); Dreicer v. Commissioner, 78 T.C. 642, 645 (1982), affd.
without opinion 702 F.2d 1205 (D.C. Cir. 1983); Golanty v.
Commissioner, 72 T.C. 411, 425 (1979), affd. without published
opinion 647 F.2d 170 (9th Cir. 1981). While the expectation of
making a profit need not be reasonable, the facts and
circumstances must indicate that the taxpayer entered into the
activity, or continued it, with the objective of making a profit.
Antonides v. Commissioner, supra at 694; Beck v. Commissioner,
supra, Dreicer v. Commissioner, supra; Golanty v. Commissioner,
supra at 425-426.
The question of whether a taxpayer engages in an activity
with the intention of making a profit is one of fact to be
resolved on the basis of all the surrounding facts and
- 8 -
circumstances. Antonides v. Commissioner, supra; Golanty v.
Commissioner, supra; Jasionowski v. Commissioner, 66 T.C. 312,
321 (1979). Greater weight is given to objective facts than to a
taxpayer’s mere statement of intent. Antonides v. Commissioner,
supra; Thomas v. Commissioner, 84 T.C. 1244, 1269 (1985), affd.
792 F.2d 1256 (4th Cir. 1986). Petitioners bear the burden of
proving the requisite intention. Rule 142(a). The parties do
not argue that the burden shifts to respondent under section
7491(a).
Section 1.183-2(b), Income Tax Regs., sets forth a
nonexclusive list of relevant factors which should normally be
considered in determining whether an activity is engaged in for
profit. The factors include: (1) The manner in which the
taxpayer carries 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 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) the elements of personal pleasure or recreation. Sec.
1.183-2(b), Income Tax Regs; Antonides v. Commissioner, supra at
694 n.4; Golanty v. Commissioner, supra at 426. No single factor
- 9 -
or group of factors is determinative. Sec. 1.183-2(b), Income
Tax Regs.; Golanty v. Commissioner, supra; Dunn v. Commissioner,
70 T.C. 715, 720 (1978), affd. 615 F.2d 578 (2d Cir. 1980).
Petitioners contend that they entered into the special
education activity with the expectation of making a profit.
Respondent contends that petitioners did not have the requisite
profit motive. To make our determination, we address the nine
factors found in section 1.183-2(b), Income Tax Regs.
1. Manner in Which Petitioners Carried On the Special
Education Activity
The fact that the taxpayer carries on the activity in a
businesslike manner and maintains complete and accurate books and
records may indicate that the activity is engaged in for profit.
Sec. 1.183-2(b)(1), Income Tax Regs.; Elliot v. Commissioner, 90
T.C. 960, 972 (1988); Engdahl v. Commissioner, 72 T.C. 659, 666
(1979). Petitioners introduced evidence of checks issued to
teachers and testified that they were required to provide expense
reports in order to receive funding from BUSD and Regional
Center. Respondent concedes that petitioners kept adequate
records.
When the taxpayer conducts the activity in a manner
substantially similar to other activities of the same nature
which are profitable, a profit motive may be indicated. Sec.
1.183-2(b)(1), Income Tax Regs.; Engdahl v. Commissioner, supra.
- 10 -
Relevant indicators include advertising, maintaining a separate
business bank account, the development of a written business
plan, and having a plausible strategy for earning a profit. See
Morley v. Commissioner, T.C. Memo. 1998-312; Butler v.
Commissioner, 1997-408; De Mendoza v. Commissioner, T.C. Memo.
1994-314; Ellis v. Commissioner, T.C. Memo. 1984-50.
GJR was the only student in petitioners’ afterschool program
and microschool. Petitioners did not advertise or otherwise seek
additional students. Petitioners did not maintain a separate
bank account and did not have a written business plan. In
addition, petitioners testified that they expected to make a
profit. However, BUSD reimbursed petitioners only for special
education expenses and Regional Center paid petitioners only for
a limited number of hours worked. Petitioners testified that
they could get additional funding through grants, but they did
not apply for or receive any grants during the years in issue.
Because their current funding was limited and petitioners did not
seek additional funding, we find that petitioners did not have a
plausible strategy for earning a profit.
The fact that petitioners did not advertise, maintain a
separate bank account, have a written business plan, or have a
plausible strategy for earning a profit, outweighs any positive
inference made from petitioners’ adequate records. We find that
petitioners did not operate the special education activity in a
- 11 -
businesslike manner. These facts weigh in favor of respondent.
2. Expertise of Petitioners or Their Advisers
Preparation for the activity by extensive study of its
accepted business, economic, and scientific practices, or
consultation with those who are expert therein, may indicate a
profit motive. Sec. 1.183-2(b)(2), Income Tax Regs.; Engdahl v.
Commissioner, supra at 668; Lundquist v. Commissioner, T.C. Memo.
1999-83, affd. 211 F.3d 600 (11th Cir. 2000). Efforts to gain
experience and a willingness to follow expert advice may indicate
a profit motive. Dworshak v. Commissioner, T.C. Memo. 2004-249;
Lundquist v. Commissioner, supra.
Dr. Remler served as the child neurologist for TEACCH at the
University of North Carolina. Petitioners also received guidance
and training in special education methods from BIA and AIA.
While petitioners had no experience running a school, we find
that Dr. Remler had expertise in dealing with child autism, and
petitioners made efforts to gain experience in special education.
These facts weigh in favor of petitioners.
3. Time and Effort Expended by Petitioners in Carrying
on the Activity
The fact that the taxpayer devotes much of his personal time
and effort to carrying on an activity may indicate an intention
to derive a profit, particularly if the activity does not have
substantial personal or recreational aspects. Sec. 1.183-
- 12 -
2(b)(3), Income Tax Regs.; Lundquist v. Commissioner, supra; De
Mendoza v. Commissioner, supra. Petitioners both worked full
time for the Department of Veterans Affairs. Dr. Velez also ran
a surgery practice. Petitioners testified that Dr. Velez spent 6
to 8 hours per week, and Dr. Remler spent only 1 to 2 hours per
week. In addition, the activity has a substantial personal
aspect--petitioners devoted this time to GJR, their son. We find
that petitioners did not devote a significant amount of time to
the special education activity. These facts weigh in favor of
respondent.
4. Expectation That Assets Used in Activity May Appreciate
in Value
The expectation that assets used in the activity will
appreciate in value sufficiently to lead to an overall profit
when netted against losses may indicate a profit motive. Sec.
1.183-2(b)(4), Income Tax Regs.; Engdahl v. Commissioner, supra
at 668-669; De Mendoza v. Commissioner, supra. Petitioners had
no assets devoted to the special education activity. This fact
is neutral.
5. Success of Petitioners in Carrying on Other Similar
or Dissimilar Activities
The fact that the taxpayer has engaged in similar activities
in the past and converted them to profitable enterprises may
indicate that he engaged in the present activity for profit.
- 13 -
Sec. 1.183-2(b)(5), Income Tax Regs.; Lundquist v. Commissioner,
supra; De Mendoza v. Commissioner, supra. Petitioners testified
that Dr. Remler has a history of receiving grants in medicine and
Dr. Velez runs a successful surgery practice. We find that
petitioners’ successes in the medical world do not necessarily
translate into successfully running their special education
activity. See Hastings v. Commissioner, T.C. Memo. 2002-310.
These facts are neutral.
6. Petitioners’ History of Income or Losses With Respect
to the Activity
A series of losses during the initial or startup stage of an
activity may not necessarily be an indication that the activity
is not engaged in for profit. Sec. 1.183-2(b)(6), Income Tax
Regs.; Engdahl v. Commissioner, 72 T.C. at 669; Dworshak v.
Commissioner, supra; De Mendoza v. Commissioner, supra.
Petitioners had losses from their special education activity
during the years in issue. However, these losses were during the
initial or startup stage of the activity. This fact is neutral.
7. The Amount of Occasional Profits, If Any, Which Are
Earned
The amount of profits in relation to the amount of losses
incurred may provide a useful criterion in evaluating whether the
taxpayer engaged in the activity for profit. Sec. 1.183-2(b)(7),
Income Tax Regs. Petitioners did not earn any profits during the
- 14 -
years in issue. This fact weighs in favor of respondent.
However, because petitioners’ special education activity was in
the startup stage, we do not give this factor much weight. See
Vitale v. Commissioner, T.C. Memo. 1999-131, affd. 217 F.3d 843
(4th Cir. 2000).
8. The Financial Status of Petitioners
Substantial income from sources other than the activity may
indicate that the taxpayer is not engaged in the activity for
profit, particularly if the losses generate substantial tax
benefits. Sec. 1.183-2(b)(8), Income Tax Regs.; Hastings v.
Commissioner, supra; Lundquist v. Commissioner, supra.
Petitioners reported adjusted gross income of $229,665 and
$229,219 in 1999 and 2000, respectively. Petitioners deducted
the losses at issue from their taxable income, thus generating
substantial tax benefits. These facts weigh in favor of
respondent.
9. Elements of Personal Pleasure or Recreation
The presence of personal or recreational motives in
conducting an activity may indicate that the taxpayer is not
conducting the activity for profit. Sec. 1.183-2(b)(9), Income
Tax Regs.; Hastings v. Commissioner, supra; Lundquist v.
Commissioner, supra. However, the fact that the taxpayer derives
personal pleasure from engaging in the activity does not show
that the taxpayer lacks a profit objective if the activity is, in
- 15 -
fact, conducted for profit as evidenced by other factors. Sec.
1.183-2(b)(9), Income Tax Regs.
While petitioners testified that they hoped to make a
profit, petitioners also testified that the purpose of their
special education activity was to provide GJR, their son, with an
education that met his needs as an autistic child. Taking into
consideration the factors discussed above, we find that
petitioners’ predominate motive for undertaking the special
education activity was personal. These facts weigh in favor of
respondent.
In summary, the only factor indicating a profit motive is
petitioners’ expertise in dissimilar activities. This factor is
heavily outweighed by the manner in which petitioners conducted
the activity, the time and effort they expended, the lack of
occasional profits, petitioners’ financial status, and their
personal motive. We hold that petitioners did not engage in the
special education activity for profit during the years in issue
within the meaning of section 183.
B. Section 6662(a) Accuracy-Related Penalty
The second issue is whether petitioners are liable for an
accuracy-related penalty. Respondent determined that petitioners
were liable for a penalty of $42 under section 6662(a) for 2000
based on petitioners’ omission of their State income tax refund
from their return for 2000.
- 16 -
Section 6662(a) imposes an accuracy-related penalty of 20
percent of the underpayment of tax attributable to negligence or
disregard of rules or regulations. Sec. 6662(a) and (b)(1).
Negligence is defined as “any failure to make a reasonable
attempt to comply with the provisions of this title”. Sec.
6662(c). However, no penalty will be imposed if the taxpayer had
reasonable cause for the underpayment of tax and the taxpayer
acted in good faith. Sec. 6664(c); sec. 1.6662-3(a), Income Tax
Regs.
The Commissioner bears the burden of production with respect
to penalties. Sec. 7491(c); Higbee v. Commissioner, 116 T.C.
438, 446-447 (2001). However, the taxpayer must show that he had
reasonable cause and acted in good faith. See Rule 142(a).
The parties stipulated that petitioners received, but did
not report, a State income tax refund of $3,249 in 2000. We find
that respondent has met his burden of production. Petitioners
have presented no evidence that their omission of the State
income tax refund from their 2000 return was the result of
reasonable cause. Accordingly, we hold that petitioners are
liable for the accuracy-related penalty pursuant to section
6662(a).
In reaching our holdings, we have considered all arguments
made, and, to the extent not mentioned, we conclude that they are
moot, irrelevant, or without merit.
- 17 -
To reflect the forgoing and the concessions of the parties,
Decision will be entered
under Rule 155.