Rosenblatt v. Comm'r

T.C. Summary Opinion 2008-137

UNITED STATES TAX COURT

RONALD AND SUSAN ROSENBLATT, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 17002-06S. Filed October 30, 2008.

Elizabeth Opalka and Suzanne Meiners-Levy, for petitioners.

Jeffrey S. Luechtefeld, for respondent.

RUWE, Judge: This case was heard pursuant to the provisions

of section 7463 of the Internal Revenue Code in effect when the

petition was filed.1 Pursuant to section 7463(b), the decision

1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
 - 2 -

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

opinion shall not be treated as precedent for any other case.

Respondent determined deficiencies in petitioners’ Federal

income taxes of $33,583 and $20,684 and section 6662 accuracy-

related penalties of $6,716.60 and $4,136.80 for the taxable

years 2002 and 2003, respectively. The issues for decision are:2

(1) Whether petitioners’ aircraft activity during 2002 and 2003

was engaged in for profit within the meaning of section 183; (2)

whether petitioners are entitled to deductions for worthless

stock and bad debts incurred in 2002; and (3) whether petitioners

are liable for section 6662 accuracy-related penalties for 2002

and 2003.3

2
Before trial, petitioners’ counsel submitted to the Court
a document entitled “Petitioners’ Consolidated Pre-Trial Motion”,
which the Court treated as petitioners’ pretrial memorandum. At
trial, petitioners’ counsel requested that the Court treat part
of their pretrial memorandum as a motion for partial summary
judgment (motion). The Court obliged the request but denied the
motion and declined to rule on petitioners’ counsel’s request to
shift the burden of proof. Petitioners failed to pursue some of
the arguments made in their motion at trial or in their post-
trial briefs. Accordingly, we deem those arguments to have been
abandoned and will decide only the issues that petitioners’
counsel disputed in their posttrial briefs. See Nicklaus v.
Commissioner, 117 T.C. 117, 120 n.4 (2001).
3
Respondent also determined that petitioners’ itemized
deductions should be decreased by $2,534 in 2002 and $2,052 in
2003. These are computational adjustments that depend on our
disposition of the other issues in this case.
 - 3 -

Background

Some facts have been stipulated and are so found. The

stipulation of facts and the attached exhibits are incorporated

by this reference. At the time of filing the petition,

petitioners resided in Iowa.

Ronald Rosenblatt (petitioner) is a graduate of Columbia

University with a bachelor’s degree in art history, a minor in

economics, and a master’s of art. Petitioner also holds a Ph.D.

in economics from the University of Idaho. Petitioner worked as

a professor and taught economics for 7 years after he received

his Ph.D.

In 2002, petitioner was employed by Principal Residential

Mortgage, Inc. (PRM), a subsidiary of Principal Financial Group.

Petitioner directly managed six or seven people. Indirectly, he

managed approximately 500 people. Petitioner worked

approximately 50 hours per week in 2002, and he spent most of his

work week in the offices of PRM in downtown Des Moines. Most of

petitioner’s income in 2002 came from his position at PRM.

Between 2002 and 2003, PRM sold the division that petitioner

managed to American Home Mortgage (AHM). In 2003, petitioner was

employed by AHM as an executive vice president of sales support

and development. Petitioner’s work hours and responsibilities

did not change very much between 2002 and 2003. Petitioner Susan

Rosenblatt (Mrs. Rosenblatt) is an anchor reporter for the local
 - 4 -

FOX news network in Des Moines, Iowa. Petitioners reported wages

on their Federal income tax returns in excess of $593,000 for

2002 and $742,000 for 2003.

Petitioner always had an interest in flying. Petitioner had

been interested in being a pilot since his youth. In 1965, when

petitioner graduated from high school, he had an appointment to

the Air Force Academy, and he intended to become an Air Force

pilot. However, petitioner did not attend the Air Force Academy

because his eyesight did not meet the requirements for him to

train as a pilot.

Petitioners’ daughter Katie received flight instruction from

Executive One Aviation (EOA), beginning in 2001. In the fall of

2001, petitioner also began taking flight training lessons from

EOA. On June 6, 2002, petitioner formed KAR RRR Aviation

Leasing, LLC (KAR RRR). Mrs. Rosenblatt purchased a one-half

interest in KAR RRR on September 30, 2002. Before Mrs.

Rosenblatt became a member of KAR RRR, petitioner was the sole

member, and they were the only two members thereafter.4 Aside

from petitioners, KAR RRR had no employees.

4
Petitioners apparently accounted for the aircraft activity
as a sole proprietorship on a Schedule C, Profit or Loss From
Business, until Mrs. Rosenblatt became a member of KAR RRR in
2002. Thereafter, petitioners accounted for the aircraft
activity as a partnership on a Schedule E, Supplemental Income
and Loss.
 - 5 -

In June 2002, KAR RRR purchased a Cessna 172 R (N3529D)

aircraft (Cessna) from EOA. Petitioner has never been a licensed

pilot. Before the Cessna was purchased, petitioner had no

experience in the aviation industry other than being a “frequent

flyer”. Petitioner described his decision to purchase the Cessna

“as a way of having a good new plane upon which to learn, and as

a way of starting a new business with the plane.”

KAR RRR financed the Cessna with Cessna Finance Corp. (CFC).

Petitioners paid 10 percent of the purchase price for the Cessna

as a down payment, and KAR RRR financed $144,350, the balance of

the purchase price for the Cessna, through CFC. Petitioner

personally guaranteed the loan from CFC to KAR RRR. The Cessna

was hangared at Ankeny Regional Airport in Ankeny, Iowa.

On May 6, 2002, before petitioner purchased the Cessna, EOA

provided a written projection of net income to petitioners

related to a purchase and leaseback of a Cessna. EOA projected

that if the Cessna was rented out for 700 hours per year at $95

per Hobbs hour,5 it could potentially generate $66,500 in gross

receipts.6 After subtracting expenses for insurance, hangar,

fuel, maintenance, engine reserve, and management fees totaling

5
A Hobbs meter is a device used to measure the amount of
time an aircraft is in operation.
6
Petitioners had actual gross receipts from the aircraft
activity of $21,645 in 2002 and $31,865 in 2003.
 - 6 -

$44,725, EOA projected a net income of $21,775 on a leaseback by

EOA of the Cessna. Petitioner did not produce any other formal

business plan for KAR RRR.7

EOA’s projection did not include finance expenses,

commissions, legal and professional services expenses, or

depreciation. Reported expenses for petitioners’ 2002 and 2003

aircraft activity were as follows:

2002 Expenses

Deductions Schedule C Schedule E Total

Repairs and $1,210 $2,146 $3,356
maintenance
Interest 1,777 1,777 3,554
Depreciation 73,447 5,924 79,371
(and sec. 179)
Commissions 1,595 1,160 2,755
(and fees)
Fuel 3,513 2,385 5,898
Hangar 375 375 750
Insurance 2,495 2,709 5,204
Miscellaneous -- 39 39
Legal and professional 3,100 -- 3,100
services
Management fees 2,087 -- 2,087
Total 89,599 16,515 106,114

7
Petitioner testified that he “worked off * * * [a] pro
forma and * * * [his] own notes about marketing and so on” and
that those materials indicated that, “given a certain number of
hours per month of * * * lease that it would be profitable.”
Petitioner’s “pro forma” and marketing notes were not offered
into evidence.
 - 7 -

2003 Expenses

Deductions Schedule E

Repairs and maintenance $8,739
Interest 5,942
Depreciation (and 35,882
sec. 179)
Commissions (and fees) 4,282
Fuel 6,203
Hangar 1,500
Insurance 10,762
Miscellaneous 906
Legal and professional 1,500
services
Instruction 591
Total 76,307

On June 14, 2002, KAR RRR, CFC, and EOA entered into a

“Consent to Lease Agreement” (lease agreement), related to the

Cessna. CFC required the lease agreement as a condition

precedent to obtaining financing on the Cessna because the Cessna

would be rented out to the general public. Under the lease

agreement, KAR RRR was designated the “Lessor” and EOA was

designated the “Lessee”. The lease agreement stated in pertinent

part: “Neither Lessor [KAR RRR] nor Lessee [EOA] shall further

lease the * * * [Cessna] or assign the Lease without first

obtaining the prior written consent of CFC, which consent may be

withheld at the sole discretion of CFC.”

KAR RRR and EOA also entered into an “Aircraft Marketing

Agreement” (marketing agreement), drafted by Advocate Consulting,

which stated as follows:

AIRCRAFT MARKETING AGREEMENT
This agreement, made on this 14th day of June, 2002 by
and between KAR RRR Aviation Leasing, LLC., hereinafter
 - 8 -

referred to as the Owner, and * * * [EOA], hereinafter
referred to as the Agent.

WITNESSETH

WHEREAS, Owner is the owner of one (1) Cessna 172R,
Registration Number N3529D;

WHEREAS, Agent in the ordinary course of business
develops relationships with prospective customers for
owner seeking to rent aircraft;

WHEREAS, Agent is willing to serve as marketing and
compliance agent on a non-exclusive basis upon the
terms and conditions herein set forth.

NOW, THEREFORE, in consideration of the mutual
covenants and agreements herein contained, the parties
hereto do hereby agree as follows;

1) Aircraft: Owner hereby authorizes Agent to
serve as a nonexclusive marketer for the aircraft
outlined on Exhibit A.

2) Terms of Agreement: The term of this agreement
shall be for a period of seven (7) days commencing on
the date hereof, and automatically renew each seven (7)
days thereafter. This agreement shall be subject to
termination by either the Owner or Agent for any reason
whatsoever upon five (5) days advance written notice
given to the other party.

3) The aircraft will be based at the Ankeny
Airport, and the owner will assume all responsibility
for storage fees in the amount of $125.– per month for
heated, community hangar space.

4) Owner has had the aircraft inspected by * * *
[EOA], verifying that the aircraft meets the standards
required by the Federal Aviation Regulations and that a
valid Airworthiness Certificate exists in respect
thereto, and that all other requirements and paperwork
are in good order and effect.

5) The fees payable by Owner to Agent for the
rental of said aircraft shall be calculated at the rate
of 15% of the gross Hobbs rental charge. At the start
of this agreement, said hourly rate shall be $90.00,
 - 9 -

and may be adjusted with approval of both parties. The
rent shall be paid within ten days after the end of
each calendar month, based upon the hours rented during
each prior month. Agent agrees to waive charges for
the use of the aircraft by Owner. Owner agrees to
follow scheduling procedures established by Agent for
the reservations of aircraft and to return aircraft
with full fuel to the Agent.

6) Owner shall maintain the aircraft to
satisfactorily retain its airworthiness certificate
thereby meeting the requirements of the Federal
Aviation Administration.

7) Owner shall furnish at their own expense all
fuel, oil, lubricants and other materials necessary for
the operation of said aircraft. Fuel shall be priced
by Agent to Owner at the leaseback rate of twenty (20)
cents below the then current retail rate. In addition
all shop labor shall be priced at $5 per hour below
current list and parts shall be charged at 15% above
cost, plus freight or other added charges. All
required & routine maintenance may be performed by the
* * * [EOA] maintenance facility without prior notice
to Owner.

8) Renters shall be required at a minimum to have
12 hours total time plus a sign-off from an FAA
Approved Current Flight Instructor in order to solo
this aircraft. Other than for maintenance down time,
this aircraft shall be available for scheduled rent at
all times.

9) Owner shall provide and keep insurance in full
force and effect, at their own expense. Such insurance
shall be written by an underwriter satisfactory to all
parties and naming the Owner, Agent and Current
Lienholder as insured, and shall protect the interests
of the Owner, Agent and Current Lienholder. If the
risk is covered by the insurance policy of the Agent,
the Owner shall prepay Agent the amount of such
insurance at the first of each calendar month and Agent
shall provide Owner evidence of such Insurance coverage
in force and satisfactory to the Owner and Current Lien
holder. Agent shall be responsible for deductible if
the aircraft is damaged while hangared at * * * [EOA],
if such damage is caused by an * * * [EOA] employee or
by a customer renting the aircraft through * * * [EOA].
 - 10 -

10) The term of this agreement shall be 5 years,
commencing on the below mentioned execution date.
Owner may terminate this agreement for any reason upon
thirty (30) days written notice to Agent.

Petitioner provided documents (logs) indicating his

involvement with KAR RRR during 2002 and 2003. These logs show

that petitioner spent approximately 197.058 and 208.25 hours on

KAR RRR activities in 2002 and 2003, respectively.9 Petitioner

prepared these logs himself, though he admits they are

incomplete. Much of the time reflected in petitioner’s logs

represents time during which he participated in flight

instruction, ground school, and test flights.

Petitioners relied on the services of EOA for taking

reservations for the Cessna, providing storage for the Cessna,

and providing licensed flight instructors to fly the Cessna. The

customers who rented the Cessna did not enter into written lease

agreements, but they did sign a document ensuring that the people

who flew the Cessna were licensed pilots. These agreements were

maintained by EOA. The people who flew the Cessna included both

flight instruction students and private pilots. KAR RRR’s Cessna

8
The total time on petitioner’s log for 2002 is listed as
191.3 hours but actually adds up to 197.05 hours.
9
The logs separate petitioner’s “Business Time” and “Travel
Time” spent on KAR RRR. In 2002, petitioner’s log reflects 52.75
hours of travel time and 144.3 hours of business time. In 2003,
petitioner’s log reflects 41 hours of travel time and 167.25
hours of business time.
 - 11 -

was one of three or four aircraft available to rent at the Ankeny

Regional Airport in 2002 and 2003.

Benefit Technologies, Inc. (BTI), is a research and

development business specializing in full flexible benefit plans

for small to midsize companies. Andrew Hyman (Mr. Hyman) was the

founder of BTI and is still actively involved with BTI. BTI

filed for chapter 7 bankruptcy protection in February 2001,

shortly after BTI defaulted on a $250,000 interest payment to a

venture capital firm on January 15, 2001. Sometime after filing

for bankruptcy, BTI’s bankruptcy proceedings were converted from

chapter 7 to chapter 11.

Petitioner owned BTI stock, lent money to BTI, and served on

BTI’s board of directors, but petitioner was not an employee of

BTI. Petitioner was never actively involved in BTI, other than

having attended occasional board meetings. Petitioners claimed

losses of $432,346 in 2002 relating to the alleged worthlessness

of their BTI stock and loans that petitioner made to BTI.

Discussion

Generally, the Commissioner’s determinations in a notice of

deficiency are presumed correct, and the taxpayer bears the

burden of proving that the determinations are incorrect. Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
 - 12 -

I. Claimed Losses From Aircraft Activity

Pursuant to section 183(b), deductions with respect to an

activity “not engaged in for profit” generally are limited to the

amount of gross income derived from such activity. 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.”

Deductions are allowed under section 162 for the ordinary

and necessary expenses of carrying on an activity which

constitutes the taxpayer’s trade or business. Deductions are

allowed under section 212 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. With

respect to either section, however, the taxpayer must demonstrate

a profit objective for the activities in order to deduct

associated expenses. Dreicer v. Commissioner, 78 T.C. 642, 644-

645 (1982), affd. without published opinion 702 F.2d 1205 (D.C.

Cir. 1983); Warden v. Commissioner, T.C. Memo. 1995-176, affd.

without published opinion 111 F.3d 139 (9th Cir. 1997); sec.

1.183-2(a), Income Tax Regs. In order to meet the required

profit objective, “the taxpayer’s primary purpose for engaging in

the activity must be for income or profit.” Commissioner v.
 - 13 -

Groetzinger, 480 U.S. 23, 35 (1987); Bot v. Commissioner, 353

F.3d 595, 599 (8th Cir. 2003), affg. 118 T.C. 138 (2002); Am.

Acad. of Family Physicians v. United States, 91 F.3d 1155, 1157-

1158 (8th Cir. 1996).

Section 1.183-2(b), Income Tax Regs., provides factors to be

considered when determining whether an activity is engaged in for

profit as follows:

(b). Relevant factors.--In determining whether an
activity is engaged in for profit, all facts and
circumstances with respect to the activity are to be
taken into account. No one factor is determinative in
making this determination. In addition, it is not
intended that only the factors described in this
paragraph are to be taken into account in making the
determination, or that a determination is to be made on
the basis that the number of factors (whether or not
listed in this paragraph) indicating a lack of profit
objective exceeds the number of factors indicating a
profit objective, or vice versa. * * *

Nine nonexclusive factors are set forth in the regulations

which are to be considered when determining profit intent. Those

factors are: (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 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) whether
 - 14 -

elements of personal pleasure or recreation exist. Id. Not all

of the factors are applicable in every case, and no one factor is

controlling. See Abramson v. Commissioner, 86 T.C. 360, 371

(1986); sec. 1.183-2(b), Income Tax Regs. We begin by applying

each of these factors to the facts relating to petitioners’

aircraft activity.

The fact that a taxpayer carries on an activity in a

businesslike manner and maintains complete and accurate books and

records may indicate that the activity was engaged in for profit.

See Engdahl v. Commissioner, 72 T.C. 659, 666 (1979); sec. 1.183-

2(b)(1), Income Tax Regs. During the years at issue, petitioner

kept logs noting his involvement with KAR RRR, but he admitted

that those logs were incomplete. The logs were not made

contemporaneously with the activities petitioner noted therein.

Much of the time memorialized in the logs is attributable to

travel time and time that petitioner spent on his own flight

training activities and classes.

Petitioner failed to develop a formal business plan.

Although petitioner testified that he used a “pro forma”, it was

not produced at trial. EOA’s financial projections overestimated

the profitability of renting the Cessna, and the projected

expenses did not include finance expenses, sales tax, or

registration fees and did not take into account actual

depreciation of the Cessna.
 - 15 -

Petitioner testified that he was active in advertising the

Cessna throughout the community, but he failed to adequately

corroborate that testimony with evidence of such marketing

activities. Petitioner also did bookkeeping for KAR RRR,

including the establishment and maintenance of the company bank

account. However, petitioners relied on the services of EOA for

the day-to-day rental of the Cessna, including taking

reservations for the Cessna, providing storage for the Cessna,

and providing licensed flight instructors to fly the Cessna.

Moreover, the maintenance, rental of the aircraft, and collection

of rental receipts were performed by either EOA or the flight

instructors associated with the rental flights. Petitioner

explained at trial that student pilots and renters would pay EOA

directly for the use of the Cessna at the end of the rental

period. EOA would then credit the account of KAR RRR for the fee

generated. At the end of the month, EOA would deduct their

commission and other expenses, such as fuel and maintenance.

Petitioner was not qualified to perform the maintenance on the

Cessna necessary to keep it airworthy. Petitioner reviewed some

of these activities but did not perform them himself and

otherwise had limited involvement in the day-to-day activities

involving the Cessna. Consequently, consideration of the first

factor weighs against the finding of a profit objective.
 - 16 -

A taxpayer’s expertise or that of his advisers is a factor

in determining profitability. Sec. 1.183-2(b)(2), Income Tax

Regs. Before his purchase of the Cessna, petitioner had no

relevant experience in the aircraft industry. Petitioner spent

time “going on the FAA’s website” to understand what rules and

regulations governed private aviation. He also researched

Cessna’s advisories about his type of aircraft to determine

“whether there were recalls or anything like that.”

Petitioner sought advice in selecting the appropriate

aircraft for the activity, relying in part on the knowledge of

local flight instructors. Otherwise, petitioner relied on EOA,

the seller of the Cessna, and Advocate Consulting. Before the

purchase of the Cessna, petitioner was informed by EOA’s

president that the Cessna could be rapidly depreciated for tax

purposes. At the same time, employees of EOA informed petitioner

that Advocate Consulting could structure the purchase of the

Cessna in a tax-advantageous manner. Petitioner’s independent

research on Advocate Consulting entailed going online and trying

“to get a little background on the * * * company.” Petitioner

did not know anyone else who was referred to Advocate Consulting.

Petitioner testified that Advocate Consulting agreed to represent

petitioners before the IRS as part of their agreement with KAR

RRR.
 - 17 -

Petitioners retained the services of Advocate Consulting on

a yearly basis. Petitioners sought the advice of Advocate

Consulting because aircraft leasing “was a field that * * *

[petitioner] really didn’t know in terms of legal or tax issues.”

When asked at trial if he ever thought that the tax advice he

received was too good to be true, petitioner responded that if

he’s “paying for their advice and their counsel tells me that

this is the way it is, then * * * I believe them.”

As we have already noted, EOA provided a written projection

of net income that did not include finance expenses, commissions,

legal and professional services expenses, or tax depreciation

expenses related to the Cessna. Given petitioner’s educational

background in economics and his discussions with employees of EOA

and Advocate Consulting about structuring the purchase of the

Cessna in a tax-advantageous manner, it is reasonable to assume

that petitioner recognized the significant distortions these

omissions would create between the projected profits and the

profits or losses from the aircraft activity that petitioners

would report on their tax returns. In preparing for an activity,

a taxpayer need not make a formal market study, but might be

expected to undertake a basic investigation of the factors that

would affect profit. Westbrook v. Commissioner, T.C. Memo. 1993-

634, affd. 68 F.3d 868 (5th Cir. 1995). Yet petitioner failed to

seek an objective opinion about the profit potential of such an
 - 18 -

undertaking and relied heavily on parties with their own

subjective interest in the transaction. Under the circumstances,

petitioner’s independent research of profitability of the

aircraft activity was insufficient. Consequently, the second

factor weighs against a finding of a profit objective.

The fact that a taxpayer devotes much of his personal time

and effort to carrying on an activity, particularly if there are

no substantial personal or recreational elements, may indicate a

profit motive. Sec. 1.183-2(b)(3), Income Tax Regs. Much of the

time that petitioner spent on the aircraft activity involved his

own flying lessons. Petitioner and his daughter had decided to

learn how to fly, and petitioner purchased the Cessna as a way to

do that. Petitioner had long wanted to learn to fly airplanes,

having attempted to join the Air Force when he was younger.

Petitioner created logs documenting his activities related to the

Cessna. The logs, though incomplete, indicate that petitioner

spent approximately 197.05 and 208.25 hours on KAR RRR activities

in 2002 and 2003, respectively. Much of that time represents

petitioner’s own flying instruction. While the logs petitioner

kept indicate some activity that could be construed as business

related, it could also be construed as a genuine interest in a

recreational activity. Regardless, the relatively small amount

of time spent on this activity that was substantiated in the

record does not outweigh the evidence indicating that petitioner
 - 19 -

had a significant interest in the recreational elements of the

activity. Consequently, the third factor does not support a

finding of a profit objective.

An expectation that the assets used in the activity will

appreciate in value might indicate a profit objective. Sec.

1.183-2(b)(4), Income Tax Regs. It is unlikely that petitioner

expected the Cessna, the only asset owned by KAR RRR, to

appreciate in value. Additionally, absent extenuating

circumstances, none of which were established in this case, the

regular wear and tear on a Cessna would likely cause economic

depreciation. Accordingly, the fourth factor weighs against

finding a profit objective.

The fact that the taxpayer has engaged in similar activities

in the past and converted them from unprofitable to profitable

enterprises may indicate that he is engaged in the present

activity for profit, even though the activity is presently

unprofitable. Sec. 1.183-2(b)(5), Income Tax Regs. Petitioner

had no previous experience in the aircraft industry, and provided

no evidence that he had engaged in any similar activities for

profit. Consequently, the fifth factor is neutral.

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. However, where losses continue to be sustained beyond the
 - 20 -

period that customarily is necessary to bring the operation to

profitable status, such continued losses, if not explainable as

due to customary business risks or reverses, may be indicative

that the activity is not being engaged in for profit. Id.

Ultimately, a taxpayer must demonstrate an ability to make a

profit in the long term to offset any startup losses. See

Bessenyey v. Commissioner, 45 T.C. 261 (1965), affd. 379 F.2d 252

(2d Cir. 1967).

There was no prior history of either profits or losses from

petitioner’s aircraft activity because the years at issue were

the first 2 years in which petitioner’s aircraft activity

existed. In neither 2002 nor 2003 did the aircraft activity

generate a profit.10 Petitioner testified and submitted evidence

indicating that in the years following the years at issue,

several flight instructors who had used petitioner’s Cessna to

give lessons decided to start their own flight instruction

business using petitioner’s Cessna at Des Moines International

Airport. Petitioner explained that he became very involved in

the marketing and organization of this new business and had plans

to merge his aircraft activity with the flight instructors’

business. However, petitioner failed to submit evidence

regarding the profitability of the aircraft activity in the years

10
The aircraft activity generated losses of $84,469 for
2002 and $44,442 for 2003.
 - 21 -

after 2003. Without any proof of profitability in later years,

the sixth factor is neutral.

The amount of occasional profits earned in relation to the

amount of losses incurred may provide useful criteria in

determining the taxpayer’s intent. Sec. 1.183-2(b)(7), Income

Tax Regs. As we have established, there is no history of the

aircraft activity’s being profitable. Consequently, the seventh

factor is neutral.

Substantial income from sources other than the activity may

indicate that the activity is not engaged in for profit,

especially if there are personal or recreational elements

involved. Sec. 1.183-2(b)(8), Income Tax Regs. Petitioner

worked approximately 50 hours per week in 2002, and he spent most

of his work week in the offices of PRM in downtown Des Moines.

Most of petitioner’s income came from his position at PRM.

Petitioner’s hours and responsibilities did not change very much

between 2002 and 2003. Petitioners reported salaries in excess

of $593,000 in 2002 and $742,000 in 2003. The losses created by

the aircraft activity, if found to be deductible, would offset

some of petitioners’ substantial salaries and generate a

significant tax savings in the years at issue. Consequently, the

eighth factor weighs against a profit objective.

Finally, the presence of personal motives in carrying on an

activity may indicate that the activity is not engaged in for
 - 22 -

profit, especially where there are recreational or personal

elements involved. Sec. 1.183-2(b)(9), Income Tax Regs.

Petitioners’ daughter Katie received flight instruction from EOA

beginning in 2001. In the fall of 2001, petitioner also began

taking flight training lessons from EOA. Before taking flying

lessons, petitioner always had an interest in flying. Being a

pilot had been a long-term interest of petitioner since his

youth. Petitioner acknowledges the purchase of the Cessna as “a

way of having a good new plane upon which to learn”.

Consequently, the ninth factor weighs against a finding of a

profit objective.

When considering whether a taxpayer engaged in an activity

for profit, greater weight must be given to the objective facts

than to a taxpayer’s mere statement of intent. Beck v.

Commissioner, 85 T.C. 557, 570 (1985). While some of

petitioner’s efforts could support an argument in favor of a

profit objective, they could also be construed as a genuine

interest in and an effort to contribute to an activity that

provided personal pleasure in the form of a hobby. Regardless,

petitioner’s testimony and the evidence on record in favor of

petitioners’ argument are insufficient to overcome the weight of

the objective facts indicating that petitioners were not engaging
 - 23 -

in the activity primarily for profit.11 Accordingly, we will

sustain respondent’s determination with regard to the

disallowance of losses created by the aircraft activity.

II. Claimed Loss from Worthless Stock and Loans

On their 2002 Federal income tax return, petitioners claimed

losses of $432,346 relating to the alleged worthlessness of their

BTI stock and loans petitioner made to BTI. On petitioners’ 2002

Schedule D, Capital Gains and Losses, they reported a short-term

capital loss of $332,346 related to BTI, which contributed to a

total net short-term loss of $412,033 reported for that year.

Petitioners also reported a $100,000 long-term capital loss

related to BTI on their Schedule D for 2002, which contributed to

a total net long-term capital loss of $26,245. Petitioners were

limited by section 1211(b)(1) to a recognized capital loss of

$3,000 on their 2002 Federal income tax return. Petitioners

carried forward a short-term capital loss of $409,033 and a long-

term capital loss of $26,245 to 2003.

Respondent disallowed petitioners’ claimed capital losses

relating to BTI. However, respondent concedes that after

application of the section 1211(b)(1) capital loss limitation in

2002, petitioners’ Federal income tax return for 2002 reflected

11
Because we find that petitioners’ aircraft activity was
not engaged in with the required profit objective, we need not
decide whether petitioners’ losses were nondeductible passive
activity losses subject to the limitations imposed under sec.
469.
 - 24 -

the appropriate amount of capital losses (i.e., capital loss of

$3,000). Accordingly, the disallowance of the reported loss with

respect to BTI affects only petitioners’ taxable income for 2003.

Petitioners argue that the BTI stock became worthless and

that their loans to BTI became nonbusiness bad debt when BTI “ran

out of opportunities to sell the company” in 2002. Respondent

argues that neither the stock nor the loans became worthless in

2002.

In order for a taxpayer to claim a loss for worthless

securities in a taxable year, the security must become worthless

in that taxable year. Sec. 165(g)(1). A loss shall be treated

as sustained during the taxable year in which the loss occurs as

evidenced by closed and completed transactions and as fixed by

identifiable events occurring in such taxable year. Sec. 1.165-

1(d)(1), Income Tax Regs. Total worthlessness of the security is

required for the deduction. Sec. 1.165-4, Income Tax Regs. No

loss deduction is allowed for partial worthlessness or for mere

decline in value. Sec. 1.165-5, Income Tax Regs. Stock becomes

worthless and the loss is sustained only when the stock has no

liquidating value and there is no reasonable hope and expectation

that at some future point in time it will become valuable.

Duncan v. Commissioner, T.C. Memo. 1986-122. The burden is on

the taxpayer to establish the worthlessness of the stock and the

year in which it became worthless. Id. (citing Boehm v.
 - 25 -

Commissioner, 326 U.S. 287, 292 (1945)). The loss can be

established satisfactorily only by some “identifiable event” in

the corporation’s life which extinguishes all hope and

expectation of revitalization, such as bankruptcy, cessation of

business operations, liquidation of the corporation, or

appointment of a receiver for it. Morton v. Commissioner, 38

B.T.A. 1270, 1279 (1938), affd. 112 F.2d 320 (7th Cir. 1940).

In the case of a taxpayer other than a corporation, where

any nonbusiness debt becomes worthless within the taxable year,

the loss resulting therefrom shall be considered a loss from the

sale or exchange, during the taxable year, of a capital asset

held for not more than 1 year. Sec. 166(d)(1)(B). A loss on a

nonbusiness debt is treated as sustained only if and when the

debt has become totally worthless. Sec. 1.166-5(a)(2), Income

Tax Regs. The burden is on the taxpayer to establish the

worthlessness of the debt and the year in which it became

worthless. Crown v. Commissioner, 77 T.C. 582, 598 (1981). It

is generally accepted that the year of worthlessness is to be

fixed by identifiable events which form the basis of reasonable

grounds for abandoning hope of recovery. Id.

Whether petitioner’s loans made to BTI should be evaluated

for fitting the definition of worthless securities or nonbusiness

bad debt depends on whether the debt is evidenced by a security
 - 26 -

as defined in section 165(g)(2)(C).12 Sec. 166(e). However,

each of these alternatives requires petitioners to show that, at

the end of 2002, there was no reasonable prospect for recovery.

See Boulafendis v. Commissioner, T.C. Memo. 1984-321 (citing

Boehm v. Commissioner, supra at 291-292; Crown v. Commissioner,

supra at 598). Accordingly, we begin our analysis by addressing

this issue.

Mr. Hyman testified that BTI owned furniture, fixtures, and

a patent on the use of linear programming at the time it filed

for bankruptcy in 2001. He testified that BTI had substantial

value at that time. Almost immediately after the bankruptcy

filing, the venture capital firm on whose interest payment BTI

defaulted and another company submitted separate bids to purchase

the assets of BTI for $2 million. Mr. Hyman testified that if a

sale had occurred in 2001, BTI shareholders would have benefited.

However, Mr. Hyman believed that BTI could be sold for, and the

assets were worth, significantly more than $2 million. According

to Mr. Hyman, that is the reason that BTI’s bankruptcy trustee

turned down both of the $2 million offers.

Mr. Hyman testified that it was reasonable for petitioner to

believe that he could get something for his investment in BTI at

12
Sec. 165(g)(2)(C) defines a “security” as “a bond,
debenture, note, or certificate, or other evidence of
indebtedness, issued by a corporation or by a government or
political subdivision thereof, with interest coupons or in
registered form.”
 - 27 -

the end of 2001, even after it filed for bankruptcy. At that

time, Mr. Hyman was hopeful that a sale was going to occur. Mr.

Hyman testified that, when no sale occurred, the company was “put

into cold storage” with the goal of trying to raise money. BTI’s

bankruptcy proceeding was later converted from chapter 7 to

chapter 11. BTI is presently operating as a business in chapter

11, and Mr. Hyman testified that “there’s activity now starting

to try to raise capital within the chapter 11 environment to be

able to, to bring the company potentially out of chapter 11 and

operate * * * the company.”

The evidence presented at trial, combined with Mr. Hyman’s

testimony, indicates that BTI had value at all times in 2002 and

still has value. Petitioners have failed to carry their burden

of proof to show that there was no reasonable prospect of

recovery for their stock and loans in 2002. Accordingly, we hold

that petitioners are not entitled to deductions for worthless

securities or nonbusiness bad debt.

III. Accuracy-Related Penalty

With respect to the accuracy-related penalty under section

6662(a), the Commissioner has the burden of production. Sec.

7491(c). To prevail, the Commissioner must produce sufficient

evidence that it is appropriate to apply the penalty to the

taxpayer. Higbee v. Commissioner, 116 T.C. 438, 446 (2001).

Once the Commissioner meets his burden of production, the
 - 28 -

taxpayer bears the burden of supplying sufficient evidence to

persuade the Court that the Commissioner’s determination is

incorrect. Id. at 447.

Section 6662(a) and (b)(1) provides accuracy-related

penalties equal to 20 percent of the underpayment of tax required

to be shown on a return if the underpayment is due to negligence

or disregard of rules or regulations.13 For purposes of section

6662, the term “negligence” includes “any failure to make a

reasonable attempt to comply with the provisions of * * * [the

Code], and the term ‘disregard’ includes any careless, reckless,

or intentional disregard.” Sec. 6662(c). “Negligence” also

includes any failure by a taxpayer to keep adequate books and

records or to substantiate items properly. Sec. 1.6662-3(b)(1),

Income Tax Regs.

An 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); see

Higbee v. Commissioner, supra at 448. This determination is made

based on all the relevant facts and circumstances. Higbee v.

Commissioner, supra at 448; sec. 1.6664-4(b)(1), Income Tax Regs.

13
Sec. 6662 can also apply when there is a substantial
understatement of tax. See sec. 6662(b)(2). However, since the
only reason given in the notice of deficiency for imposing the
penalty was negligence or intentional disregard of rules and
regulations, and respondent did not raise sec. 6662(b)(2) until
after trial, we will only consider the issue raised in the notice
of deficiency.
 - 29 -

Relevant factors include the taxpayer’s efforts to assess his

proper tax liability.

While we have held that petitioners did not have profit as

their primary objective for entering into the aircraft activity,

we believe that they had both personal and profit objectives in

the sense that they actually hoped that their activity might

produce a profit. See Warden v. Commissioner, T.C. Memo. 1995-

176. Sometimes it is difficult to determine which of two motives

for engaging in an activity is primary. That is one of the basic

reasons for using objective facts to determine subjective intent.

But a finding that profit was not the primary motive does not

automatically result in a conclusion that petitioners were

negligent or intentionally disregarded the rules and regulations.

See Bernardo v. Commissioner, T.C. Memo. 2004-199; Sherman v.

Commissioner, T.C. Memo. 1989-269. On the basis of the

previously stated facts, we find that petitioners’ reporting of

their aircraft activity was not due to negligence and that they

are not liable for the penalties with respect to the portions of

the underpayments due to their aircraft activity. Likewise, we

find that petitioners are not liable for the penalty on the

portion of the 2003 underpayment due to their claimed losses from

worthless stock and loans. The determination of worthlessness in

the situation described in this case is not without some doubt,

and while we have found that petitioners have not proven
 - 30 -

worthlessness, we believe that they honestly believed that their

stock and loans were worthless in 2002.14 We therefore hold that

petitioners are not liable for the section 6662 penalties.

To reflect the foregoing,

Decision will be entered

for respondent as to the

deficiencies and for

petitioners as to the

accuracy-related penalties.

14
In petitioners’ posttrial brief, they requested the
following finding of fact:

62. Dr. Rosenblatt believes his investments in Benefit
Technologies became worthless in 2002 because during
that year the bankruptcy trustee ran out of
opportunities to the [sic] sell the company.

In his answering brief, respondent had no objection to this
proposed finding of fact.