T.C. Memo. 2008-191
UNITED STATES TAX COURT
WILLIAM G. HOLSINGER AND JOANN MICKLER, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 15563-06. Filed August 11, 2008.
V. Jean Owens and James S. Eggert, for petitioners.
Stephen R. Takeuchi, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
VASQUEZ, Judge: Respondent determined deficiencies of
$54,462 and $43,423 in petitioners’ 2001 and 2002 Federal income
taxes, respectively. Respondent amended his answer and increased
petitioners’ 2001 deficiency by $20,278, for a total 2001
deficiency of $74,740. After concessions by both parties, the
issues for decision are: (1) Whether losses from purchases and
- 2 -
sales of securities are deductible by petitioners as ordinary
losses or are instead subject to the limitations applicable to
capital losses; and (2) whether expenses attributable to those
purchases and sales are deductible by petitioners as business
expenses or are instead subject to the limitations applicable to
itemized deductions.
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 Florida.
William Holsinger (petitioner) retired in 1992, having
worked approximately 30 years for Eli Lilly & Co. In 1999
petitioners married. In 2000 petitioners began buying and
selling stocks, earning approximately $280,000 from that source
during 2000. Petitioner opened brokerage accounts in his name,
using his Social Security number. Petitioners reported their
trading1 income as capital gains in 2000.
On April 19, 2001, petitioners incorporated Alpha Trading
Co. of Sarasota, L.L.C. (Alpha) under the laws of Florida.
Petitioner owns 67 percent of Alpha, and petitioner Mickler owns
the remaining 33 percent. On or about May 17, 2001, Alpha made a
1
The use of the term “trading income” is not a conclusion
that petitioners or Alpha were engaged in a business of trading
in securities.
- 3 -
timely election pursuant to section 475(f) to use the mark-to-
market method of accounting.2
Petitioners maintained two trading accounts with E-Trade,
two with Options Xpress, and one with Ameritrade-Comdisco. From
April 19 until December 31, 2001, petitioners executed
approximately 289 trades on their various trading accounts. In
2002 petitioners executed approximately 372 trades.
In 2001 petitioners claimed an ordinary loss of $180,1743
from Alpha on their 2001 Schedule E, Supplemental Income and
Loss. The loss consists of trading losses of $178,870,
depreciation of $1,284, and interest of $40. The aggregate cost
or other basis of the securities sold in 2001 was $933,147. The
sale prices in 2001 collectively were $754,277. Also in 2001
petitioners claimed a net loss of $80,100 on their Schedule C,
Profit or Loss From Business. Respondent disallowed the $80,100
as business expenses but allowed itemized deductions for
investment interest of $7,620 and miscellaneous deductions of
2
Unless otherwise indicated, all section references are to
the Internal Revenue Code, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
3
The 2001 ordinary loss petitioners claimed on Schedule E
is $20 less than the total claimed of the trading losses,
depreciation, and interest. Both parties have stipulated the
amounts, and there appears to be no explanation for the $20
discrepancy. The $20 discrepancy has no effect as to the outcome
of the case.
- 4 -
$72,480. After adjustments for gross income limitations,
respondent allowed net itemized deductions of $69,153.
In 2002 petitioners claimed an ordinary loss of $45,521.
This loss comprises $11,227 in trading losses related to Alpha
and $34,294 in claimed business expenses related to Alpha.
Respondent disallowed the $34,294 as business expenses but
allowed a net itemized deduction of $26,181.
After petitioner incorporated Alpha, he did not switch the
name on his trading accounts. Petitioner’s Social Security
number also remained on the trading accounts. Petitioners
continued to trade stocks and options during 2001 and 2002 with
the accounts they had used before the incorporation of Alpha. In
December 2002 petitioners had one trading account in Alpha’s
name. During the years in issue petitioners used five accounts
to conduct trades.
Petitioners traded from a room in their house. The room
contained computers with Internet access in order for petitioners
to trade and do research. Additionally, petitioner had four
monitors connected to his computer because he wanted to be able
to trade and track different investments and potential
investments simultaneously. Petitioner purchased the computer
equipment around July 1, 2000, before incorporating Alpha. None
of the computer equipment was transferred to Alpha.
- 5 -
OPINION
I. Mark-to-Market Election
Respondent concedes that Alpha made a timely mark-to-market
election pursuant to section 475(f). Section 475(f) applies only
to those engaged in a trade or business as traders in securities.
Having made a timely election, if Alpha were a trader in
securities, it would be eligible to recognize gain or loss on any
security held in connection with such a trade or business at the
close of any taxable year as if the security were sold at its
fair market value on the last business day of the taxable year.
See sec. 475(f)(1)(A)(I). In general any gains or losses with
respect to the securities, whether deemed sold at yearend under
the mark-to-market method of accounting or actually sold during
the taxable year, shall be treated as ordinary income or loss.
Sec. 475(d)(3)(A)(I). If Alpha is considered an investor in
securities, the 2001 and 2002 net losses from the purchases and
sales of securities would be capital losses and only partially
deductible to petitioners.
II. Trade or Business
The Internal Revenue Code does not define the term “trade or
business” for purposes of section 162. Commissioner v.
Groetzinger, 480 U.S. 23, 27 (1987); Estate of Yaeger v.
Commissioner, 889 F.2d 29, 33 (2d Cir. 1989), affg. T.C. Memo.
1988-264. Whether activities constitute a trade or business is a
- 6 -
question of fact. See Higgins v. Commissioner, 312 U.S. 212, 217
(1941); Estate of Yaeger v. Commissioner, supra at 33; Mayer v.
Commissioner, T.C. Memo. 1994-209; Paoli v. Commissioner, T.C.
Memo. 1991-351. Petitioners have neither claimed nor shown that
they satisfied the requirements of section 7491(a) to shift the
burden of proof to respondent with regard to any factual issue.
Accordingly, petitioners bear the burden of proof. See Rule
142(a).
Petitioners argue that they were traders, trading as agents
of Alpha. With the incorporation of Alpha, petitioners argue
they became traders. In determining whether a taxpayer’s trading
activity constituted a trade or business, courts have
distinguished between “traders” and “investors”. Moller v.
United States, 721 F.2d 810, 813 (Fed. Cir. 1983); see also Levin
v. United States, 220 Ct. Cl. 197, 597 F.2d 760, 765 (1979).
In determining whether a taxpayer is a trader, nonexclusive
factors to consider are: (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, supra at 813. For a
taxpayer to be a trader the trading activity must be substantial,
which means “‘frequent, regular, and continuous enough to
constitute a trade or business’” as opposed to sporadic trading.
Ball v. Commissioner, T.C. Memo. 2000-245 (quoting Hart v.
- 7 -
Commissioner, T.C. Memo. 1997-11). A taxpayer’s activities
constitute a trade or business where both of the following
requirements are met: (1) The taxpayer’s trading is substantial,
and (2) the taxpayer seeks to catch the swings in the daily
market movements and to profit from these short-term
changes rather than to profit from the long-term holding of
investments. Mayer v. Commissioner, supra.
As to the first requirement, we find petitioners’ trading
was not substantial. Courts consider the number of executed
trades in a year and the amount of money involved in those trades
when evaluating whether a taxpayer’s trading activities were
substantial. See, e.g., Mayer v. Commissioner, supra; Paoli v.
Commissioner, supra. In Paoli, the Court held trading activities
were substantial when the taxpayers traded stocks or options
worth approximately $9 million. In Mayer, the Court considered
over 1,100 executed sales and purchases in each of the years at
issue therein to be substantial trading activity. Trading
activity was found to be insubstantial when a taxpayer executed
at most 83 purchases and 41 sales in one year and 76 purchases
and 30 sales in the second year. Moller v. United States, supra
at 813. In 2001 petitioners executed approximately 289 trades.
An analysis of petitioners’ trading activity reveals that in 2001
they traded on 63 days. This total represents less than 40
percent of the trading days from April 19, 2001, the day
- 8 -
petitioners incorporated Alpha, until December 31, 2001. In 2002
petitioners traded on 110 days and executed approximately 372
trades. This total represents less than 45 percent of the
trading days in 2002. We find it doubtful whether the trades
were conducted with the frequency, continuity, and regularity
indicative of a business.
As to the second requirement, petitioners have failed to
prove that they sought to catch the swings in the daily
market movements and to profit from these short-term changes
rather than to profit from the long-term holding of investments.
Petitioner testified that his goal in forming Alpha was to profit
from short-term swings in the market. Additionally, petitioner
testified that he usually closed his account at the end of the
day and tried to avoid holding stocks and options overnight. The
documentary evidence, however, paints a different picture. A
list of petitioners’ trades shows they rarely bought and sold on
the same day. Furthermore, a significant amount of petitioners’
holdings was held for more than 31 days. As a result, we find
that petitioners have not demonstrated that they sought to
capture the daily swings in the market. We find that they were
not traders, but investors. Petitioners’ trading pattern is
consistent with that of an investor, not of a trader.
- 9 -
III. Business Expenses
Deductions are a matter of legislative grace, and the
taxpayer has the burden of showing entitlement to any deduction
claimed. See Rule 142(a); INDOPCO, Inc. v. Commissioner, 503
U.S. 79, 84 (1992). Taxpayers must substantiate amounts claimed
as deductions by maintaining the records necessary to establish
such entitlement. Sec. 6001; sec. 1.6001-1(a), Income Tax Regs.;
see Hradesky v. Commissioner, 65 T.C. 87 (1975), affd. per curiam
540 F.2d 821 (5th Cir. 1976).
Petitioners claimed business deductions for 2001 and 2002.
Petitioners argue that their trading activity was on behalf of
Alpha, not for themselves as individuals. Petitioners claim they
were Alpha’s agents and therefore had the authority to conduct
trades on its behalf. Even if petitioners acted on Alpha’s
behalf, because their activity, as we have already found, did not
rise to the level of a business (the business of trading
securities), the expenses petitioners attributed to that
activity, even if incurred on Alpha’s behalf, are not deductible
as business expenses.
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.
- 10 -
To reflect the foregoing,
Decision will be entered
under Rule 155.