CHOW v. COMMISSIONER

T.C. Summary Opinion 2006-116

UNITED STATES TAX COURT

PETER K. CHOW, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 19059-03S. Filed July 24, 2006.

Peter K. Chow, pro se.

Bradley C. Plovan, 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 year in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure.
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Respondent determined a deficiency in petitioner’s Federal

income tax of $25,964, an addition to tax of $5,562.22 pursuant

to section 6651(a)(1), an addition to tax of $3,090.12 pursuant

to section 6651(a)(2), and an addition to tax of $1,322.13

pursuant to section 6654(a) for the taxable year 2000.

After a concession1 by respondent, the issues for decision

are: (1) Whether petitioner was engaged in the trade or business

of trading securities; (2) whether petitioner may deduct for

taxable year 2000 a net operating loss (NOL) which purportedly

arose in taxable year 1999; (3) whether petitioner may exclude

any portion of his disability benefits from income for taxable

year 2000; and (4) whether petitioner is liable for additions to

tax pursuant to sections 6651(a)(1) and 6654(a) for taxable year

2000.

Background

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. On the date the petition

was filed in this case, petitioner resided in North Potomac,

Maryland.

1
In the notice of deficiency, as previously stated,
respondent determined petitioner was liable for an addition to
tax in the amount of $3,090.12 pursuant to sec. 6651(a)(2).
However, at trial, respondent conceded that petitioner was not
liable for the addition to tax under sec. 6651(a)(2).
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Until 1994, when he was placed on short-term disability, the

petitioner was employed as an insurance agent for Metropolitan

Life and Affiliated Companies, Inc. (Met Life). Petitioner--who

holds an M.B.A. degree--was previously employed by Met Life as a

systems analyst and a financial planner. Petitioner also has

been employed as an investment broker and is a registered

investment advisor.

Petitioner suffers from serious medical conditions and

physical impairments. Petitioner was placed on short-term

disability in 1994, whereupon he was periodically examined for 2

years before he was placed on long-term disability. He has

remained on long-term disability continuously since 1996.

Petitioner failed to file a tax return for 2000. Respondent

prepared a substitute return and determined petitioner’s income

tax liability and accordingly, an amount in deficiency, based on

income as reported by third-party payers. Petitioner did not

make any estimated income tax payments for 2000.

At a partial trial on June 1, 2004, petitioner appeared

before this Court, and--for the first time--delivered to

respondent a completed Federal income tax return for 2000. Upon

discovering that respondent had not reviewed the material

contained in petitioner’s return, this Court retained

jurisdiction, issuing an order for both parties to submit written

status reports. However, before petitioner offered his completed
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return, this Court heard testimony regarding the nature of the

disability benefits paid to petitioner by Met Life in 2000. In

sum, although he did not raise the issue in his underlying

petition, petitioner argued that because he paid one-sixth of the

premiums for his disability insurance policy from his after-tax

income, the amount attributable to his contribution should not be

included in his gross income.

Following the partial trial, and after reviewing

petitioner’s submitted return, respondent concluded that

petitioner had improperly deducted expenses arising from his

buying and selling of stock futures contracts. Respondent also

concluded that petitioner had improperly excluded from income

one-sixth of his disability benefits without a proper basis for

doing so and impermissibly carried over a net operating loss from

his 1999 taxable year.

Included among the stipulated exhibits for this case is a

copy of petitioner’s Form 1040, U.S. Individual Income Tax

Return, for the 2000 taxable year that petitioner supplied to

respondent on June 1, 2004. On the Form 1040, petitioner

reported $82,862 in wages, salaries, and tips; a business loss on

Schedule C, Profit or Loss From Business, of $13,627; a capital

loss on Schedule D, Capital Gains and Losses, of $3,000; pensions

and annuities totaling $3,696; and total Social Security benefits

(line 20a) of $15,810, with taxable Social Security benefits
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(line 20b) of $13,439. In addition, petitioner reported a loss

of $13,131 as an adjustment to long-term disability income. Of

the $82,862 reported in wages, salaries, and tips: Met Life

reported to respondent wage income totaling $78,950; pension

income was reported by the Social Security Administration as

$15,810; $9,195 was reported as income from interest and

dividends; and $216 was reported by Putnam Investments as an

early IRA distribution.

Further trial of this case was held on May 9, 2005.

Petitioner argued that he was engaged in the trade or business of

short-term trading of stock futures contracts during 2000.

Petitioner deducted both his business expenses from the gross

receipts of his investment transactions, and a capital loss

arising from these activities. Petitioner also claimed a carry

over of a net operating loss from 1999 to his 2000 taxable year.

Discussion

In general, the Commissioner’s determination set forth in a

notice of deficiency is presumed correct. Welch v. Helvering,

290 U.S. 111, 115 (1933). Moreover, deductions are a matter of

legislative grace and are allowed only as specifically provided

by statute. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84

(1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440

(1934). In pertinent part, Rule 142(a)(1) provides the general

rule that “The burden of proof shall be upon the petitioner”. In
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certain circumstances, however, if the taxpayer introduces

credible evidence with respect to any factual issue relevant to

ascertaining proper tax liability, section 7491 places the burden

of proof on the Commissioner. Sec. 7491(a)(1); Rule 142(a)(2).

Credible evidence is “‘the quality of evidence which, after

critical analysis, * * * [a] court would find sufficient * * * to

base a decision on the issue if no contrary evidence were

submitted’”.2 Baker v. Commissioner, 122 T.C. 143, 168 (2004)

(quoting Higbee v. Commissioner, 116 T.C. 438, 442 (2001)).

Section 7491(a)(1) applies only if the taxpayer complies with

substantiation requirements, maintains all required records, and

cooperates with reasonable requests by the Commissioner for

witnesses, information, documents, meetings, and interviews.

Sec. 7491(a)(2). Although neither party alleges the

applicability of section 7491(a), we conclude that the burden of

proof has not shifted to respondent with respect to the issue in

the present case.

1. Was Petitioner Engaged in a Trade or Business?

The term “trade or business” is not defined by the Internal

Revenue Code. Commissioner v. Groetzinger, 480 U.S. 23, 27

(1987); Estate of Yaeger v. Commissioner, 889 F.2d 29, 33 (2d

2
We interpret the quoted language as requiring the
taxpayer’s evidence pertaining to any factual issue to be
evidence the Court would find sufficient upon which to base a
decision on the issue in favor of the taxpayer. See Bernardo v.
Commissioner, T.C. Memo. 2004-199.
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Cir. 1989), affg. 92 T.C. 180 (1989). The determination of

whether petitioner’s securities activities during the year in

issue constituted a trade or business is a question of fact.

Higgins v. Commissioner, 312 U.S. 212, 217 (1941); Estate of

Yaeger v. Commissioner, supra at 33; Paoli v. Commissioner, T.C.

Memo. 1991-351.

“In determining whether a taxpayer in a securities activity

is engaged in a trade or business, courts have distinguished

between ‘traders’, who are in a trade or business, and

‘investors’, who are not.” Mayer v. Commissioner, T.C. Memo.

1994-209 (and the cases cited therein.) Managing security

investments, no matter what the extent or scope of such activity,

is seen as the work of a mere investor, “not the trade or

business of a trader.” Estate of Yaeger v. Commissioner, supra

at 34; see also Whipple v. Commissioner, 373 U.S. 193, 202

(1963); Higgins v. Commissioner, supra at 217; Paoli v.

Commissioner, supra; Beals v. Commissioner, T.C. Memo. 1987-171.

The outcome is the same notwithstanding the amount of time the

individual devotes to the activity. Even “full-time market

activity in managing and preserving one’s own estate is not

embraced within the phrase ‘carrying on a business’ and * * *

salaries and other expenses incident to the operation are not

deductible as having been paid or incurred in a trade or

business.” Commissioner v. Groetzinger, supra at 30. However,
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under certain circumstances, an investor’s expenses may be

deductible pursuant to section 212 if incurred in the production

of income. Sec. 212; Whipple v. Commissioner, supra at 200;

United States v. Gilmore, 372 U.S. 39, 45 (1963). Petitioner has

not argued this point in the alternative.

To determine whether a taxpayer who manages his own

investments is a trader, we consider the following nonexclusive

factors: (1) The taxpayer’s intent; (2) the nature of the income

to be derived from the activity; and (3) the frequency, extent,

and regularity of the taxpayer’s securities transactions. Moller

v. United States, 721 F.2d 810, 813 (Fed. Cir. 1983). Therefore,

as stated in Mayer v. Commissioner, T.C. Memo. 1994-209:

A taxpayer’s activities constitute the trade or business of
trading only where both of the following are true:

(1) The taxpayer’s trading is substantial. King
v. Commissioner, 89 T.C. 445, 458-459 (1987); Paoli v.
Commissioner, supra; Walker v. Commissioner, T.C. Memo.
1990-609. In this regard, sporadic trading will not
constitute a trade or business. Commissioner v.
Groetzinger, supra at 35; Paoli v. Commissioner, supra.

(2) The taxpayer seeks to catch the swings in the daily
market movements, and to profit from these short-term
changes, Moller v. United States, supra at 813; Purvis v.
Commissioner, 530 F.2d 1332, 1334 (9th Cir. 1976), affg.
T.C. Memo. 1974-164; Liang v. Commissioner, 23 T.C. 1040,
1043 (1955); Walker v. Commissioner, supra, rather than to
profit from the long-term holding of investments, Estate of
Yaeger v. Commissioner, supra at 33; Paoli v. Commissioner,
supra. In connection with this, courts look at whether the
taxpayer’s securities income is principally derived from the
frequent sale of securities rather than from dividends,
interest, or long-term appreciation. Moller v. United
States, supra at 813; Purvis v. Commissioner, supra at 1334;
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King v. Commissioner, supra at 458-459; Liang v.
Commissioner, supra at 1043.

Petitioner has offered into evidence trading records which

substantiate his purchasing and selling of 146 paired purchases

and sales of futures contracts during taxable year 2000. It is

clear from petitioner’s trading records that these activities

sought to profit from short-term market swings. However,

petitioner’s records show trading activities only during the

months of April, May, August, and December of 2000. In fact,

petitioner’s records indicate trading activities on only 20 days

during taxable year 2000.

Further, although petitioner testified that he handled his

securities investments in a businesslike manner, that fact is

irrelevant to our determination of whether he was a trader or a

mere investor. See Higgins v. Commissioner, supra at 213; Moller

v. United States, supra at 814. In Higgins v. Commissioner,

supra at 217, the taxpayer had substantial investments in real

estate, stocks, and bonds. He devoted a considerable amount of

time to oversight of his investments. Id. He maintained two

offices from which he conducted his investment activities. In

his New York office, the taxpayer employed an office manager, an

assistant, an accountant, and a stenographer/clerk. Higgins v.

Commissioner, 39 B.T.A. 1005, 1006 (1939), affd. 111 F.2d 795 (2d

Cir. 1940), affd. 312 U.S. 212 (1941). The taxpayer employed an

additional employee who worked in the Paris office. Id. Despite
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the taxpayer’s businesslike conduct of his investment activities,

the Supreme Court held that he was a mere investor, and his

activity did not constitute a trade or business. Higgins v.

Commissioner, 312 U.S. at 217.

On the basis of the facts and circumstances of the present

case, we find that petitioner’s trading activities were not

regular, continuous, and frequent enough for him to be considered

a trader during taxable year 2000. Therefore, petitioner was an

investor, not a trader. As such, he was not conducting a trade

or business. Commissioner v. Groetzinger, 480 U.S. at 30;

Whipple v. Commissioner, supra at 202; King v. Commissioner, 89

T.C. 445, 459 (1987); Paoli v. Commissioner, supra.

2. Net Operating Loss

Because petitioner is not in a trade or business of trading

securities, he is not entitled to any net operating loss of such

nonexistent business.

Furthermore, as of the time of trial, respondent had not

accepted petitioner’s 1999 Form 1040, U.S. Individual Income Tax

Return, as a valid return. Therefore, any carryover losses

claimed by petitioner, whether NOL losses or capital carryover

losses, have not been proven by petitioner. Thus, any such

losses cannot be deducted by petitioner for taxable year 2000.
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3. Disability Benefits

Included in the stipulated exhibits for this case is

literature from Met Life detailing petitioner’s long-term

disability insurance which provides an explanation of the taxable

consequences resulting from the payout of disability benefits.

At trial, petitioner testified that he had selected “Option 3”3

as his long-term disability plan, and asserted that because his

monthly contribution (an amount equal to one-sixth) for the

premium was deducted from his paycheck ‘after taxes’ that he

should accordingly be entitled to exclude from his gross income

that amount attributable to his contribution (one-sixth of the

approximately $78,000 paid as disability income by Met Life in

2000).

However, it is clear from the information provided in the

Met Life literature that petitioner is misguided in maintaining

this position. First, at LTD-2,4 the brochure describes the

taxability of the payouts, stating that “since [the employee]

paid for the cost of the LTD coverage on a before tax basis ...

the LTD benefits are taxable when you receive them.” Then, at

LTD-14, the brochure reads:

3
“Option 3” bases long-term disability benefits on 60
percent of the participant’s pre-disability income.
4
“LTD” refers to Met Life’s long-term disability policy
brochure.
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Under present law, disability benefit payments are
generally considered as part of gross taxable income
for federal income tax purposes. When you are
disabled, the Company will not automatically withhold
income taxes from your LTD benefits. However, you may
arrange with the Company’s claim unit to have federal
income taxes withheld.

Although petitioner testified that his portion of the

premium was paid with ‘after tax’ dollars, both the brochure

detailing the plan and the petitioner’s Pay Statement provide no

evidentiary corroboration for these claims. Petitioner has

failed to provide any evidence illustrating that tax was

otherwise withheld from his disability payments in 2000.

Accordingly, petitioner is not entitled to exclude from gross

income one-sixth of the total amount of disability benefits paid

to him in the year at issue.

4. Additions to Tax

a. Section 6651(a)

Respondent determined an addition to tax as a result of

petitioner’s failure to file timely his Federal income tax

return for the year at issue. Section 6651(a)(1) imposes an

addition to tax for failure to file a return on the date

prescribed for filing, unless petitioner proves that such failure

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

Sec. 6651(a)(1); Higbee v. Commissioner, 116 T.C. at 447.

Respondent must carry the burden of production with respect to
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the addition to tax under section 6651(a)(1). Sec. 7491(c);

Higbee v. Commissioner, supra at 446-447.

To satisfy respondent's burden of production, respondent

must come forward with "sufficient evidence indicating that it is

appropriate to impose" the addition to tax. Higbee v.

Commissioner, supra at 446. 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 failure to file continues, to a

maximum of 25 percent of the tax. Id. The addition to tax is

imposed on the net amount due. Sec. 6651(b).

The addition to tax is applicable unless a taxpayer

establishes that the failure to file was due to reasonable cause

and not willful neglect. Sec. 6651(a). If a taxpayer exercised

ordinary business care and prudence and was nonetheless unable to

file the return within the date prescribed by law, then

reasonable cause exists. Sec. 301.6651-1(c)(1), Proced. & Admin.

Regs. “[W]illful neglect” means a “conscious, intentional failure

or reckless indifference.” United States v. Boyle, 469 U.S. 241,

245 (1985).

At trial, petitioner testified that his 2000 income tax

return was not filed timely because of both his medical

afflictions and his belief that he was being erroneously targeted
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by respondent as a tax shelter marketer. Petitioner also

responded that he accepted full responsibility for his failure to

timely file his return. Petitioner also testified that although

he hired persons to trade stock futures for him, he did not hire

anyone to help prepare his taxes because ‘he didn’t really know

how much of an impact it would have.’

Petitioner’s delay in filing a timely tax return

is not due to reasonable cause. Petitioner failed to

exercise ordinary care and willfully neglected to file his 2000

Federal tax return timely. “As a general rule, taxpayers are

charged with knowledge of the law.” Niedringhaus v.

Commissioner, 99 T.C. 202, 222 (1992). A taxpayer need not be an

expert in tax law to know that tax returns have fixed filing

dates. United States v. Boyle, supra at 251.

Petitioner’s 2000 Federal income tax return was due on April

15, 2001. Petitioner filed his return on June 1, 2004, and

offered no rational explanation for his failure to file the

return timely. Petitioner failed to show that he exercised

ordinary care and prudence in this case. Accordingly, petitioner

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

Respondent is sustained on this issue.

b. Section 6654(a)

Respondent also determined that petitioner is liable for an

addition to tax for the underpayment of estimated tax pursuant to
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section 6654(a) for taxable year 2000. Section 6654(a) provides

that in the case of an underpayment of estimated tax by an

individual, there shall be added to the tax an amount determined

by applying the underpayment rate established under section 6621

to the amount of the underpayment for the period of the

underpayment. Unless the taxpayer demonstrates that one of the

statutory exceptions applies, imposition of the section 6654(a)

addition to tax is mandatory where prepayments of tax, either

through withholding or by making estimated quarterly tax payments

during the course of the taxable year, do not equal the

percentage of total liability required under the statute. See

sec. 6654(a); Niedringhaus v. Commissioner, supra at 222.

The amount of the addition to tax under section 6654(a)

stated in the notice of deficiency is based on the return

respondent prepared for petitioner before the issuance of the

notice of deficiency. Nothing in the record indicates petitioner

made the required amount of estimated tax payments for taxable

year 2000. Petitioner has not shown that he falls within any of

the exceptions to the section 6654(a) addition to tax. See sec.

6654(e); Grosshandler v. Commissioner, 75 T.C. 1, 20-21 (1980).

Accordingly, we conclude petitioner is liable for the addition to

tax pursuant to section 6654(a) for taxable year 2000.

Reviewed and adopted as the report of the Small Tax Case

Division.
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To reflect the foregoing and respondent’s concession,

Decision will be entered

for respondent, except as to

the addition to tax pursuant

to section 6651(a)(2).