Phemister v. Comm'r

T.C. Memo. 2009-201

UNITED STATES TAX COURT

THURMAN L. PHEMISTER AND DENISE M. ROSS, f.k.a. DENISE M. AIELLO
PHEMISTER, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 21419-06. Filed September 9, 2009.

Denise M. Ross, pro se.

James A. Kutten and Timothy J. Driscoll, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

MARVEL, Judge: Respondent determined the following

deficiencies, additions to tax, and penalties with respect to

petitioners’ Federal income taxes:1

1
Unless otherwise indicated, all section references are to
(continued...)
 - 2 -

Accuracy-related
Addition to tax penalty
Year Deficiency sec. 6651(a)(1) sec. 6662(a)

1999 $31,508 $9,208 $6,302
2000 37,642 10,500 7,528
2001 44,986 12,611 8,956
2002 43,360 6,216 8,672
2003 52,241 1,973 10,448
2004 38,706 -0- 7,741

After concessions,2 the issues for decision are:

1
(...continued)
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. Monetary amounts are rounded to the nearest dollar.
2
Respondent determined that petitioners are liable for an
additional tax under sec. 72(t) for an early withdrawal from an
individual retirement account (IRA). Petitioners did not contest
the additional tax in their petition or at trial. Petitioners’
liability for the additional tax under sec. 72(t) is deemed
conceded in accordance with Rule 34(b)(4).

Respondent also determined that petitioners received
unreported interest income and an unreported IRA distribution in
2001 and an unreported State income tax refund in 2004.
Respondent determined that Dr. Phemister received unreported
nonemployee compensation in 2003. Additionally, respondent
disallowed a portion of petitioners’ charitable contribution
deductions for 1999, 2000, 2001, 2003, and 2004 and petitioners’
special fuel tax credits for 2000 and 2001. In their petition,
petitioners contested respondent’s adjustments to their income,
charitable contribution deductions, and special fuel tax credits.
However, petitioners did not introduce any evidence at trial or
present any argument on brief with respect to respondent’s
determinations. We therefore deem petitioners to have conceded
the adjustments to their income, charitable contributions, and
special fuel tax credits. See Rules 142(a), 149(b); Rothstein v.
Commissioner, 90 T.C. 488, 497 (1988); Cerone v. Commissioner, 87
T.C. 1, 2 n.1 (1986). The only other adjustments that
petitioners dispute concern their personal exemptions and self-
employment tax, which we need not address because they are
computational.
 - 3 -

(1) Whether petitioners Thurman L. Phemister (Dr. Phemister)

and Denise M. Ross (Ms. Ross) substantiated the deductions they

claimed for 1999-2004 with respect to their horse activity and

whether their horse activity constituted an activity not engaged

in for profit within the meaning of section 183;

(2) whether petitioners substantiated deductions claimed for

1999-2004 on Schedules C, Profit or Loss From Business, with

respect to Dr. Phemister’s emergency room physician business (ER

physician business);

(3) whether petitioners substantiated Schedule C interest

expense and legal and professional services expense deductions

claimed for 2003 and 2004 with respect to a retail business, End

of the Trail (retail business);

(4) whether petitioners should have reported additional

income with respect to the retail business for 2003 and 2004;

(5) whether petitioners are liable for an addition to tax

under section 6651(a)(1) for each of the years 1999-2003;

(6) whether petitioners are liable for an accuracy-related

penalty under section 6662(a) for each year in issue; and

(7) to the extent we find petitioners liable for any tax

deficiencies, additions to tax, and/or penalties, whether Ms.

Ross is entitled to relief under section 6015.
 - 4 -

FINDINGS OF FACT

Ms. Ross and respondent have stipulated some of the facts,

which we incorporate in our findings by this reference.

Petitioners resided in Illinois when they petitioned this Court.

Dr. Phemister did not participate in the trial because he had

settled all of the issues with respondent before the trial.

Petitioners

Ms. Ross is a high school graduate. Although she took

several college-level courses, including courses in music,

foreign language, government, and marketing, she neither pursued

nor received a college degree. At some point Ms. Ross worked as

a medical assistant. In 1982 she married Dr. Phemister, with

whom she had three children. Petitioners separated in

approximately November 2005 and divorced in approximately August

2007.

For all relevant years, Dr. Phemister was a physician who

worked in various hospital emergency rooms. He received wages

and nonemployee compensation for his services as a physician.

During the same period Ms. Ross was not employed and received no

wages. She occupied her time by, among other things,

volunteering at local clubs and buying, training, and selling

horses.

Petitioners maintained a joint checking account into which

Dr. Phemister deposited his earnings and from which Ms. Ross paid
 - 5 -

household bills. Although Ms. Ross typically paid most of the

household bills, Dr. Phemister occasionally paid some of them.

During the years at issue petitioners lived on property they

owned in a rural area of southern Illinois. The property was

improved by a residence, an in-ground swimming pool, and a barn.

ER Physician Business

Dr. Phemister contracted with several hospitals for him to

perform services as an emergency room physician. He maintained

an office on the lower level of petitioners’ residence for his ER

physician business. At some point during the 1980s Ms. Ross

worked as a medical assistant in her husband’s ER physician

business, but she has had no substantive involvement with his

business since then.3

Dr. Phemister hired an accountant to keep the books and

records of his ER physician business and to prepare petitioners’

income tax returns. Dr. Phemister was responsible for supplying

information regarding his income and expenses to the accountant.

Ms. Ross was not involved in recording the expenses for Dr.

Phemister’s ER physician business or in determining what

deductions to claim regarding that business. Dr. Phemister paid

most of the bills attributable to his ER physician business.

3
Respondent contends that Ms. Ross paid some of the expenses
of Dr. Phemister’s ER physician business.
 - 6 -

Horse Activity

In 1999 Ms. Ross began attending horse auctions and

purchasing horses. Her experience with horses started when she

was 16 years old and consisted of riding and training horses for

pleasure. Ms. Ross became interested in purchasing, training,

and selling horses (horse activity) through friends, and she

viewed the horse activity as an activity she and her sons could

do together. The horse activity also provided her with something

to do while staying at home to be near one of her sons who had

health problems.

Ms. Ross spent between 20 and 40 hours each week on the

horse activity but did not maintain a regular schedule. Although

Ms. Ross opened a separate checking account for the horse

activity, she primarily used petitioners’ personal checking

account for the activity.

Before beginning the horse activity Ms. Ross did not have

any experience operating a business. She did not prepare a

business plan, and she did not consult with any experts on how to

keep records or make her horse activity profitable.

Petitioners shared responsibility for maintaining the horse-

activity records and making general purchases for the activity.

Petitioners did not keep detailed records with respect to each

horse. In fact, they maintained few records that were horse
 - 7 -

specific. In general, petitioners did not maintain accurate

contemporaneous records for their horse activity.

In a year that does not appear in the record petitioners

erected the barn on their property to stable their horses. The

barn contained a riding arena, a training area, several horse

stalls, and an office. When petitioners first began building the

barn, they discovered that a covenant had been placed upon their

property that prohibited stabling horses. With the assistance of

an attorney, they had the covenant removed and then constructed

their barn.

When Ms. Ross first began purchasing horses, she based her

purchasing decisions on advice she received from horse traders

who accompanied her to auctions.4 Initially Ms. Ross purchased

more expensive horses, but she discovered that they did not sell

well in the area where petitioners lived. She eventually began

making bulk purchases at auctions of lower quality, inexpensive

horses. Some of the more expensive horses were insured, but most

of petitioners’ horses were not. Occasionally, petitioners

registered a horse in the name of one of their children.

Petitioners did not post any signs on their property

advertising their horse activity. In early 2005 petitioners

discontinued their horse activity.

4
Dr. Phemister also bought and sold horses.
 - 8 -

End of the Trail

In approximately December 2003 Ms. Ross opened the retail

business, which specialized in western wear. Ms. Ross developed

a business plan, and she kept books and records for the business.

Dr. Phemister was not involved in the retail business’

operations. He did, however, help Ms. Ross obtain financing for

the retail business by cosigning a loan.

Petitioners’ Tax Reporting

Petitioners filed joint Forms 1040, U.S. Individual Income

Tax Return, for 1999-2004 on the following dates:5

Year Date filed

1999 Apr. 16, 2003
2000 Nov. 19, 2003
2001 May 12, 2004
2002 Aug. 24, 2004
2003 Dec. 15, 2005
2004 Jan. 30, 2006

On their returns petitioners reported wages from Dr. Phemister’s

employment as a physician and net income or loss from Dr.

Phemister’s ER physician business as follows:

ER physician
Year Wages business Total

1999 $29,728 $227,147 $256,875
2000 34,583 239,005 273,588
2001 17,500 282,118 299,618
2002 271,582 58,945 330,527
2003 413,635 (7,892) 405,743
2004 405,877 (1,700) 404,177

5
Petitioners generally provided their books and records to
an accountant who prepared their returns.
 - 9 -

Dr. Phemister reported income and expenses from his ER physician

business for 1999-2004 on Schedules C attached to the returns.

Petitioners also attached to their 1999-2004 returns

Schedules F, Profit or Loss From Farming, on which they reported

the income, expenses, and net losses from their horse activity,

and Schedules C, on which they reported the income, expenses, and

net losses from the retail business. The net losses were as

follows:

Retail
Year Horse activity business

1999 ($33,224) n/a1
2000 (59,571) n/a
2001 (80,939) n/a
2002 (116,733) n/a
2003 (129,273) ($11,099)
2004 (82,369) (27,396)
1
The retail business did not begin operations until 2003.

In approximately March 2004 respondent began to audit

petitioners’ returns. On July 24, 2006, respondent issued a

notice of deficiency for 1999-2004 that (1) disallowed all of the

deductions claimed with respect to Dr. Phemister’s ER physician
 - 10 -

business6 for 1999-2004; (2) disallowed the net losses claimed

with respect to petitioners’ horse activity for 1999-2004; (3)

disallowed some or all of the legal and professional services

expense deductions and the interest expense deductions claimed

with respect to the retail business for 2003-2004; and (4)

determined that the retail business Schedules C for 2003 and 2004

underreported gross receipts by $3,630 and $23,654,

respectively.7 In the notice of deficiency respondent also

determined that petitioners were liable for section 6651(a)(1)

additions to tax and section 6662 accuracy-related penalties.

Petitioners timely petitioned this Court. Shortly before

trial Ms. Ross asserted for the first time that she is entitled

to relief from any deficiencies for 1999-2004 under section

6015(b), (c), or (f). We treated the claim as timely raised and

6
Respondent disallowed the following expenses for the ER
physician business:

ER physician
business
Year expenses

1999 $36,646
2000 29,007
2001 31,679
2002 31,481
2003 31,928
2004 41,074
7
The notice of deficiency also adjusted other items on
petitioners’ 1999-2004 returns, but petitioners have conceded or
are deemed to have conceded those adjustments.
 - 11 -

as a proper issue for decision. A trial was held at which Ms.

Ross appeared but Dr. Phemister did not.8

OPINION

I. Respondent’s Determinations

The Commissioner’s determinations in the notice of

deficiency are presumed correct, and a taxpayer bears the burden

of proving error in the Commissioner’s determinations.9 Rule

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

Commissioner, 840 F.2d 1379, 1382 (7th Cir. 1988), affg. T.C.

Memo. 1986-78.

A. Schedule C Deductions

Respondent argues that petitioners are not entitled to

deduct the expenses claimed on the Schedules C for Dr.

Phemister’s ER physician business and the legal and professional

service and interest expenses for the retail business because

petitioners did not substantiate the expenses and because some of

the expenses were nondeductible personal expenditures.

8
At trial respondent confirmed that Dr. Phemister had
settled all issues with respondent. However, neither respondent
nor Dr. Phemister submitted any documentation of the settlement
to the Court before or during trial. At trial we determined that
Ms. Ross had not agreed to any settlement and that trial would
proceed with respect to Ms. Ross. Dr. Phemister, who did not
appear at trial, remains a party to this proceeding.
9
Ms. Ross does not argue that the burden of proof with
respect to respondent’s determinations shifts to respondent under
sec. 7491(a), and Ms. Ross did not introduce any evidence that
petitioners satisfied the requirements of sec. 7491(a)(2).
 - 12 -

Deductions are strictly a matter of legislative grace, and

the taxpayer bears the burden of proving entitlement to any

deduction claimed. INDOPCO, Inc. v. Commissioner, 503 U.S. 79,

84 (1992); Pfluger v. Commissioner, supra at 1386. The taxpayer

must maintain records sufficient to establish any deduction

claimed. Sec. 6001; sec. 1.6001-1(a), Income Tax Regs.

Section 162(a) authorizes a deduction for business expenses

if a taxpayer proves that the expenses (1) were paid or incurred

during the taxable year, (2) were incurred to carry on the

taxpayer’s trade or business, and (3) were ordinary and necessary

expenditures of the business. See Commissioner v. Lincoln Sav. &

Loan Association, 403 U.S. 345, 352 (1971). An expense is

ordinary if it is customary or usual within a particular trade,

business, or industry or relates to a transaction “of common or

frequent occurrence in the type of business involved.” Deputy v.

du Pont, 308 U.S. 488, 495 (1940). An expense is necessary if it

is appropriate and helpful for the development of the business.

See Commissioner v. Heininger, 320 U.S. 467, 471 (1943).

Personal, living, or family expenses, on the other hand,

generally are not deductible. See sec. 262(a).

1. ER Physician Business

The only evidence introduced at trial regarding the

disallowed deductions Dr. Phemister claimed with respect to his

ER physician business was Ms. Ross’ testimony. Ms. Ross
 - 13 -

testified that she had reviewed the deductions and she thought

they appeared correct. Ms. Ross’ testimony was general, vague,

unpersuasive, and uncorroborated by documentation showing the

dates, amounts, and business purpose of the expenses claimed.

Ms. Ross’ testimony was completely inadequate to substantiate the

disallowed deductions as required by sections 162 and 6001. See

Lerch v. Commissioner, 877 F.2d 624, 631-632 (7th Cir. 1989),

affg. T.C. Memo. 1987-295; Geiger v. Commissioner, 440 F.2d 688,

689-690 (9th Cir. 1971), affg. per curiam T.C. Memo. 1969-159;

Shea v. Commissioner, 112 T.C. 183, 189 (1999).

Because Ms. Ross failed to substantiate the disallowed

deductions or to prove that respondent’s determinations were

otherwise in error, we sustain respondent’s determinations.

2. Retail Business

Ms. Ross also failed to introduce credible evidence to

substantiate the disallowed deductions claimed for her retail

business. Although she testified that she kept records for the

retail business, she did not produce any documents to

substantiate the disallowed deductions. We sustain respondent’s

determination.

B. Unreported Income

Section 61(a) defines gross income for purposes of

calculating taxable income as “all income from whatever source
 - 14 -

derived”. Respondent argues that the gross receipts generated by

the retail business during 2003 and 2004 were underreported.

1. Burden of Production

When a case involves unreported income and that case is

appealable to the Court of Appeals for the Seventh Circuit, as

this case is absent a stipulation to the contrary, see sec.

7482(b)(2), the Commissioner’s determination of unreported income

is entitled to a presumption of correctness only if the

determination is supported by a minimal evidentiary foundation

linking the taxpayer to an income-producing activity, see Pittman

v. Commissioner, 100 F.3d 1308, 1317 (7th Cir. 1996), affg. T.C.

Memo. 1995-243; Gold Emporium, Inc. v. Commissioner, 910 F.2d

1374, 1378 (7th Cir. 1990), affg. Malicki v. Commissioner, T.C.

Memo. 1988-559; see also Golsen v. Commissioner, 54 T.C. 742, 756

(1970) (Tax Court is bound to apply the law of the circuit in

which the case is appealable), affd. 445 F.2d 985 (10th Cir.

1971). Once the Commissioner produces evidence linking the

taxpayer to an income-producing activity, the burden shifts to

the taxpayer to rebut the presumption by establishing that the

Commissioner’s determination is arbitrary or erroneous. See Gold

Emporium, Inc. v. Commissioner, supra at 1378; see also United

States v. Janis, 428 U.S. 433, 441-442 (1976).10

10
The Court of Appeals for the Seventh Circuit has indicated
that it is difficult for taxpayers to overcome the presumption of
(continued...)
 - 15 -

To satisfy his initial burden of production, respondent

introduced evidence linking Ms. Ross to the retail business. Ms.

Ross testified, and petitioners’ Schedules C reflect, that she

was the proprietor of the business. Further, respondent

introduced evidence that petitioners had cash receipts that were

not from horse sales. Many of the sales were for small items,

such as western wear and accessories, and some of the receipts

were deposited into the retail business’ checking account.

Respondent also introduced evidence that some of the retail

business’ sales were incorrectly reported on petitioners’ 2003

and 2004 Schedules F as income from the horse activity. On this

record we conclude that respondent has laid the requisite

foundation for the unreported income adjustments and that

respondent’s unreported income adjustments are entitled to the

presumption of correctness.

2. Burden of Proof

The taxpayer ordinarily has the burden of proving by a

preponderance of the evidence that the Commissioner’s adjustments

are erroneous or arbitrary. See Pittman v. Commissioner, supra

at 1314; Lundgren v. Commissioner, T.C. Memo. 2006-177. Although

10
(...continued)
correctness surrounding the notice of deficiency where they have
failed to supply adequate books and records from which their
income can be ascertained. Gold Emporium, Inc. v. Commissioner,
910 F.2d 1374, 1379 (7th Cir. 1990), affg. Malicki v.
Commissioner, T.C. Memo. 1988-559.
 - 16 -

Ms. Ross had the burden of proof on this issue, she failed to

carry it. We sustain respondent’s unreported income adjustments.

C. Horse-Activity Losses

Respondent asserts that petitioners are not entitled to

deduct the losses for their horse activity. According to

respondent, petitioners were not engaged in a trade or business

and they did not adequately substantiate their claimed Schedule F

deductions.

Taxpayers generally have the burden of proving that they

were engaged in a trade or business and that they are entitled to

the deductions claimed. Rule 142(a); INDOPCO, Inc. v.

Commissioner, 503 U.S. at 84; New Colonial Ice Co. v. Helvering,

292 U.S. 435, 440 (1934); Welch v. Helvering, 290 U.S. at 115.

Taxpayers must maintain adequate records to substantiate their

claimed deductions. Sec. 6001; Pfluger v. Commissioner, 840 F.2d

at 1386. If a taxpayer fails to show error in the Commissioner’s

determination that the taxpayer was not engaged in an activity

for profit, then section 183 limits the taxpayer’s deductions for

expenses attributable to the activity, as provided in section

183(b).

The Court of Appeals for the Seventh Circuit has applied the

dominant or primary objective standard to test whether an alleged

business activity is conducted for profit. Nickerson v.

Commissioner, 700 F.2d 402, 404 (7th Cir. 1983), revg. T.C. Memo.
 - 17 -

1981-321; see Peat Oil & Gas Associates v. Commissioner, 100 T.C.

271, 291 n.11 (1993) (Ruwe, J., concurring), affd. sub nom.

Ferguson v. Commissioner, 29 F.3d 98 (2d Cir. 1994); see also

Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987). Under that

standard a taxpayer must prove that he or she conducted an

activity with the dominant or primary objective of making a

profit in order to claim deductions under section 162 and a

resulting net loss if expenses exceed the activity’s gross

receipts.

In order to establish that they engaged in the horse

activity for profit, petitioners were required to show they

entertained an actual and honest profit objective, even if that

objective was unreasonable or unrealistic. Burger v.

Commissioner, 809 F.2d 355, 358 (7th Cir. 1987), affg. T.C. Memo.

1985-523; Surloff v. Commissioner, 81 T.C. 210, 233 (1983);

Dreicer v. Commissioner, 78 T.C. 642, 644-645 (1982), affd.

without opinion 702 F.2d 1205 (D.C. Cir. 1983); sec. 1.183-2(a),

Income Tax Regs. In determining whether the requisite intent to

make a profit exists, greater weight is given to the objective

facts than to the taxpayer’s self-serving characterization of his

intent. Dreicer v. Commissioner, supra at 645; sec. 1.183-2(a),

Income Tax Regs.

Section 1.183-2(b), Income Tax Regs., sets forth a

nonexclusive list of factors to be considered in determining
 - 18 -

whether the taxpayer has the requisite profit objective. The

factors are: (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 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 loss with respect to the

activity; (7) the amount of occasional profits, if any, that are

earned; (8) the financial status of the taxpayer; and (9)

elements of personal pleasure or recreation. No single factor is

determinative, and not all factors are applicable in every case.

Burger v. Commissioner, supra at 358 n.4; Allen v. Commissioner,

72 T.C. 28, 34 (1979). We review each of the factors below.

1. Manner of Conducting the Activity

The first factor considers the manner in which petitioners

conducted their horse activity. In analyzing this factor we

examine: Whether a taxpayer maintained complete and accurate

books and records; whether the taxpayer conducted the activity in

a manner substantially similar to other profitable activities of

the same nature; and whether the taxpayer made changes in

operating methods, adopted new techniques, or abandoned

unprofitable methods in a manner consistent with an intent to
 - 19 -

improve profitability. See Engdahl v. Commissioner, 72 T.C. 659,

666-667 (1979); sec. 1.183-2(b)(1), Income Tax Regs.

The maintenance of complete and accurate books and records

is an indication that a taxpayer may have engaged in an activity

for profit. Sec. 1.183-2(b)(1), Income Tax Regs. Ms. Ross

conceded that petitioners did not keep regular records of the

income and expenses for their horse activity. Ms. Ross also

admitted they did not have a business plan for their horse

activity.

Changing operating methods to improve profitability may

indicate an intent to make a profit. Although Ms. Ross testified

that petitioners decided to purchase inexpensive horses after

discovering that more expensive horses did not sell well in their

area, the record does not establish that the change had a

material impact on the horse activity’s profitability. See

Golanty v. Commissioner, 72 T.C. 411, 428 (1979) (changes must be

sufficient to alter materially the prospects of making a profit),

affd. without published opinion 647 F.2d 170 (9th Cir. 1981).

Losses from the horse activity did not decline after petitioners

changed their approach to buying horses. In fact, petitioners’

largest losses were generated during 2002 and 2003 when

petitioners allegedly purchased and sold inexpensive horses.

Finally, we note that Ms. Ross presented no evidence of

petitioners’ marketing and sales efforts, including whether these
 - 20 -

efforts, if any, changed after the inception of the activity.

Relatively little was spent on advertising. Cf. Burrow v.

Commissioner, T.C. Memo. 1990-621 (finding horse-breeding

activity had profit objective where taxpayers publicized business

and advertised extensively). Despite substantial losses and few

sales, petitioners did not increase their advertising efforts to

improve sales revenue.

We conclude that during the years at issue petitioners did

not conduct their horse activity in a businesslike manner. This

factor favors respondent’s position.

2. Expertise of Taxpayers and/or Their Advisers

The second factor considers the expertise of the taxpayers

or their advisers with respect to the activity. Preparation for

an activity by extensive study of its accepted business,

economic, and scientific practices or consultation with industry

experts may indicate a profit motive where the taxpayer carries

on the activity in accordance with such practices. See sec.

1.183-2(b)(2), Income Tax Regs. Taxpayers must either possess

expertise in an activity or “familiarize themselves with the

undertaking” and “consult or employ an expert” on how to operate

profitably. Burger v. Commissioner, 809 F.2d at 359.

Ms. Ross presented no evidence that petitioners had personal

expertise in operating a profitable horse breeding and trading

activity. Ms. Ross’ experience with horses was limited to
 - 21 -

riding, and she gained knowledge of the trading business by

accompanying traders to horse shows. Ms. Ross admitted

petitioners neither consulted experts for advice on operating

their horse activity profitably nor developed any personal

expertise as to how to make their activity profitable. This

factor favors respondent’s position.

3. Taxpayer Time and Effort

The third factor considers the time and effort a taxpayer

commits to an activity. The fact that a taxpayer devotes

personal time and effort to carry on an activity may indicate an

intent to derive a profit, particularly where there are no

substantial personal or recreational elements associated with the

activity. See Daley v. Commissioner, T.C. Memo. 1996-259; sec.

1.183-2(b)(3), Income Tax Regs. A taxpayer’s withdrawal from

another occupation to devote most of his energies to the activity

may be evidence that the activity was engaged in for profit. See

sec. 1.183-2(b)(3), Income Tax Regs.

Dr. Phemister was employed as a physician and maintained a

business as a physician during all relevant years. There is no

evidence in the record that he devoted any significant time to

the horse activity.11 The record reveals that Ms. Ross was not

employed when petitioners began the horse activity. She

11
The record reveals only that Dr. Phemister purchased and
sold horses.
 - 22 -

committed anywhere from 20 to 40 hours each week to the activity,

but she also derived personal pleasure from the activity. This

factor is neutral.

4. Potential for Asset Appreciation

The fourth factor examines a taxpayer’s expectation that the

assets used in an activity will appreciate in value. Petitioners

did not argue, nor did they provide any evidence, that they

expected the assets used in the horse activity to appreciate in

value. This factor favors respondent’s position.

5. Success With Similar Activities

The fifth factor considers a taxpayer’s past success with

similar activities. Ms. Ross admitted she had no prior

experience operating a business similar to the horse activity.

She did not submit any evidence that Dr. Phemister had any

relevant experience. This factor is neutral.

6. History of Profit or Loss

The sixth factor considers a taxpayer’s history of profit or

loss from the activity. A taxpayer’s history of profit or loss

with respect to any activity may indicate the presence or absence

of a profit objective. See Golanty v. Commissioner, supra at

426; sec. 1.183-2(b)(6), Income Tax Regs. Where losses continue

beyond the period which is customarily necessary to bring an

operation to profitable status, it may be an indication that the
 - 23 -

activity is not engaged in for profit. Sec. 1.183-2(b)(6),

Income Tax Regs.

Petitioners sustained losses for 6 consecutive years. Over

those 6 years, their total losses from the horse activity

exceeded $500,000. Ms. Ross does not argue that 6 years is an

inadequate period of time to evaluate the activity’s potential

for profit. This factor favors respondent’s position.

7. Amount of Profits

The seventh factor considers the profits a taxpayer earns

from the activity. The amount and frequency of occasional

profits earned from an activity may indicate a profit objective.

Sec. 1.183-2(b)(7), Income Tax Regs. Petitioners never made a

profit from their horse activity. They reported significant

losses for 6 years and discontinued the horse activity during the

seventh year. This factor favors respondent’s position.

8. Taxpayers’ Financial Status

The eighth factor deals with the taxpayers’ overall

financial status. Substantial income from sources other than the

activity (especially if the losses from the activity generate

substantial tax benefits) may indicate a lack of profit motive,

particularly where there are elements of personal pleasure or

recreation involved. See sec. 1.183-2(b)(8), Income Tax Regs.

During the years at issue petitioners reported over $1.9

million of income from Dr. Phemister’s wages and business income.
 - 24 -

In comparison, during those same years petitioners reported over

$500,000 of losses from their horse activity. Petitioners funded

their horse activity from Dr. Phemister’s substantial income,

while reaping significant tax benefits from the losses they

reported. This factor favors respondent’s position.

9. Personal Pleasure or Recreation

The final factor considers the personal pleasure or

recreation a taxpayer derives from the activity. The existence

of personal pleasure or recreation relating to the activity may

indicate the absence of a profit objective. See sec.

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

Ms. Ross does not argue that petitioners did not derive any

personal pleasure or recreation from their horse activity. In

addition, the record supports a finding that Ms. Ross derived

personal pleasure and recreation from the horse activity. This

factor favors respondent’s position.

10. Conclusion

All of the factors are either neutral or indicate that

petitioners did not engage in their horse activity with the

intent to make a profit. Therefore, petitioners have not carried

their burden of proving they were engaged in the horse activity

for profit. After considering the factors listed in section

1.183-2(b), Income Tax Regs., and the facts and circumstances of

this case, we conclude that petitioners were not engaged in their
 - 25 -

horse activity with a good-faith expectation of realizing a

profit. Accordingly, we hold that petitioners’ horse activity

during the years in issue was an activity not engaged in for

profit within the meaning of section 183. We sustain

respondent’s determinations with respect to petitioners’ horse

activity.12

D. Additions to Tax for Failure To Timely File Tax Returns

Respondent claims that for 1999-2003 petitioners are liable

for additions to tax under section 6651(a)(1) because they failed

to file timely returns or to show that they had reasonable cause

for that failure.

Section 6651(a)(1) imposes an addition to tax for failure to

file a return unless it is shown that such failure is due to

reasonable cause and not due to willful neglect. See United

States v. Boyle, 469 U.S. 241, 245 (1985). Failure to file a

timely Federal income tax return is due to reasonable cause if

the taxpayer exercised ordinary business care and prudence and

nevertheless was unable to file the return within the prescribed

time. See Crocker v. Commissioner, 92 T.C. 899, 913 (1989); sec.

301.6651-1(c)(1), Proced. & Admin. Regs. Willful neglect means a

conscious, intentional failure to file or reckless indifference.

See United States v. Boyle, supra at 245.

12
Our holding applies to all of respondent’s determinations
to disallow losses, deductions, and credits attributable to
petitioners’ horse activity.
 - 26 -

Section 7491(c) imposes on the Commissioner the burden of

production with respect to additions to tax. In order to meet

his burden of production, the Commissioner must come forward with

sufficient evidence that it is appropriate to impose the relevant

addition to tax or penalty. Higbee v. Commissioner, 116 T.C.

438, 446 (2001). However, the Commissioner is not required to

introduce evidence regarding reasonable cause, substantial

authority, or similar defenses. Id. Once the Commissioner meets

his initial burden of production, the taxpayer must come forward

with persuasive evidence that the Commissioner’s determination is

incorrect. Id. at 447.

Petitioners do not dispute that they failed to file their

1999-2003 returns timely and therefore respondent has satisfied

the initial burden of production with respect to the section

6651(a)(1) additions to tax.

Petitioners did not address this issue at trial.

Accordingly, petitioners have failed to satisfy their burden of

proving respondent’s determination is incorrect, and we sustain

respondent’s determination with respect to the section 6651(a)(1)

additions to tax. See Rules 142(a), 149(b); Petzoldt v.

Commissioner, 92 T.C. 661, 683 (1989); Money v. Commissioner, 89

T.C. 46, 48 (1987).
 - 27 -

E. Accuracy-Related Penalty Under Section 6662

Respondent contends that petitioners are liable for the

accuracy-related penalty under section 6662 for all years at

issue. Respondent asserts that petitioners are liable for the

section 6662 penalty on alternative grounds: (1) The

underpayment resulting from respondent’s determinations was

attributable to negligence or disregard of rules or regulations

within the meaning of section 6662(b)(1); or (2) there was a

substantial understatement of income tax within the meaning of

section 6662(b)(2).

Section 6662(a) and (b)(1) authorizes the Commissioner to

impose a penalty in an amount equal to 20 percent of the

underpayment attributable to negligence or disregard of rules or

regulations. Negligence is defined as any failure to make a

reasonable attempt to comply with the provisions of the Internal

Revenue Code. Sec. 6662(c); see also Neely v. Commissioner, 85

T.C. 934, 947 (1985) (negligence is lack of due care or failure

to do what a reasonably prudent person would do under the

circumstances).

Section 6662(a) and (b)(2) authorizes the Commissioner to

impose a 20-percent penalty if there is a substantial

understatement of income tax. A substantial understatement of

income tax with respect to individual taxpayers exists if the

amount of the understatement for the taxable year exceeds 10
 - 28 -

percent of the tax required to be shown on the return for the

taxable year, or $5,000, whichever is greater. Sec.

6662(d)(1)(A).

The Commissioner bears the initial burden of production with

respect to a taxpayer’s liability for the section 6662 penalty,

in that the Commissioner must first produce sufficient evidence

to establish that the imposition of the section 6662 penalty is

appropriate. Sec. 7491(c); Kikalos v. Commissioner, 434 F.3d

977, 986 (7th Cir. 2006), affg. T.C. Memo. 2004-82. If the

Commissioner satisfies his initial burden of production, the

burden of producing evidence to refute the Commissioner’s

evidence and to establish that the taxpayers are not liable for

the section 6662 penalty shifts to the taxpayers. See Higbee v.

Commissioner, supra at 447.

Respondent has satisfied his burden by showing that for each

year at issue the amount of understatement exceeds the greater of

$5,000 or 10 percent of the tax required to be shown on the

return. Respondent has also met his burden of production with

respect to negligence by establishing that petitioners did not

maintain required records or substantiate deductions as required

by the Code. See Kikalos v. Commissioner, supra at 986.

Petitioners did not address this issue at trial.

Accordingly, petitioners have failed to satisfy their burden of

proving respondent’s determination is incorrect, and we sustain
 - 29 -

respondent’s determination on the accuracy-related penalties.

See Rules 142(a), 149(b); Petzoldt v. Commissioner, supra at 683;

Money v. Commissioner, supra at 48.

II. Section 6015 Relief

In general, married taxpayers who file a joint Federal

income tax return for a taxable year are jointly and severally

liable for the full amount of that year’s tax liability. Sec.

6013(d)(3); Butler v. Commissioner, 114 T.C. 276, 282 (2000).

Under section 6015, however, a spouse may obtain relief from

joint and several liability if the spouse satisfies certain

requirements.13

Section 6015(a)(1) provides that a spouse who has made a

joint return may elect to seek relief from joint and several

liability under section 6015(b) (dealing with relief from

liability for an understatement of tax on a joint return).

Section 6015(a)(2) provides that a spouse who is eligible to do

so may elect to limit that spouse’s liability for any deficiency

with respect to a joint return under section 6015(c). If

complete relief is not available under section 6015(b) or (c), an

individual may seek equitable relief under section 6015(f).

13
Sec. 6015 applies to tax liabilities arising after July
22, 1998, and to tax liabilities arising on or before July 22,
1998, but remaining unpaid as of such date. Internal Revenue
Service Restructuring and Reform Act of 1998, Pub. L. 105-206,
sec. 3201(g), 112 Stat. 740.
 - 30 -

At trial Ms. Ross asserted a claim for relief under section

6015(b), (c), or (f)14 as an affirmative defense.15 We have

jurisdiction to review Ms. Ross’ affirmative defense that she is

entitled to section 6015 relief. See secs. 6212-6214; Charlton

v. Commissioner, 114 T.C. 333, 342 (2000); Butler v.

Commissioner, supra at 287-292.

A. Section 6015(b)

Section 6015(b)(1) authorizes respondent to grant relief

from joint and several liability if the taxpayer satisfies each

requirement of subparagraphs (A) through (E). Section 6015(b)(1)

provides:

SEC. 6015(b). Procedures For Relief From
Liability Applicable to All Joint Filers.--

(1) In general.--Under procedures prescribed
by the Secretary, if--

14
A spouse or former spouse who is not a party to a
deficiency proceeding in which a claim for relief under sec. 6015
is raised has the right to intervene in the proceeding. Van
Arsdalen v. Commissioner, 123 T.C. 135, 143 (2004); King v.
Commissioner, 115 T.C. 118, 122-123 (2000). Dr. Phemister is a
party and not an intervenor. Consequently, procedures related to
participation by an intervenor do not apply. See Rule 325. Dr.
Phemister had notice that Ms. Ross was asserting a claim for
relief under sec. 6015 as an affirmative defense in the
deficiency proceeding, and he did not appear at trial to
challenge Ms. Ross’ request for relief. We assume, therefore,
that Dr. Phemister does not oppose Ms. Ross’ request for sec.
6015 relief.
15
Although Ms. Ross did not raise her claim in her petition,
the issue was tried by the consent of the parties. Rules 39,
41(b)(1).
 - 31 -

(A) a joint return has been made for a
taxable year;

(B) on such return there is an
understatement of tax attributable to
erroneous items of 1 individual filing the
joint return;

(C) the other individual filing the
joint return establishes that in signing the
return he or she did not know, and had no
reason to know, that there was such
understatement;

(D) taking into account all of the facts
and circumstances, it is inequitable to hold
the other individual liable for the
deficiency in tax for such taxable year
attributable to such understatement; and

(E) the other individual elects (in such
form as the Secretary may prescribe) the
benefits of this subsection not later than
the date which is 2 years after the date the
Secretary has begun collection activities
with respect to the individual making the
election,

then the other individual shall be relieved of
liability for tax (including interest, penalties,
and other amounts) for such taxable year to the
extent such liability is attributable to such
understatement.

The requirements of section 6015(b)(1) are stated in the

conjunctive. Thus, if the requesting spouse fails to meet any

one of them, she does not qualify for relief. Alt v.

Commissioner, 119 T.C. 306, 313 (2002), affd. 101 Fed. Appx. 34

(6th Cir. 2004). Except as provided by section 6015,16 the

16
If a spouse requests relief under sec. 6015(c), the
Commissioner bears the burden of proving that assets have been
(continued...)
 - 32 -

requesting spouse bears the burden of proving that she satisfies

each requirement of section 6015(b)(1). See Rule 142(a).

In order to make relief from joint and several liability

more accessible, Congress repealed section 6013(e) and enacted

section 6015 in 1998. See Internal Revenue Service Restructuring

and Reform Act of 1998, Pub. L. 105-206, sec. 3201(a), (e)(1),

112 Stat. 734, 740; H. Conf. Rept. 105-599, at 249 (1998), 1998-3

C.B. 747, 1003. Section 6015(b)(1) is similar to former section

6013(e)(1). In analyzing section 6015(b)(1), we may look to

cases interpreting former section 6013(e)(1) for guidance. See

Cheshire v. Commissioner, 115 T.C. 183, 189 (2000), affd. 282

F.3d 326 (5th Cir. 2002); Butler v. Commissioner, supra at 283.

Respondent concedes that Ms. Ross meets the requirements in

subparagraphs (A) and (E) of section 6015(b)(1) but argues that

she is not entitled to relief for any tax liability attributable

to the horse activity and ER physician business because she does

not meet the other requirements under section 6015(b)(1).17 With

respect to the horse activity, respondent contends that Ms. Ross

has not satisfied the requirements of subparagraphs (B), (C), and

16
(...continued)
transferred between former spouses as part of a fraudulent scheme
and that the spouse requesting relief had actual knowledge of a
deficiency. Sec. 6015(c)(2), (3)(A)(ii), (C).
17
Respondent does not assert that Ms. Ross is not qualified
for relief with respect to understatements of tax attributable to
any other items of income, deduction, or credit on the joint
returns.
 - 33 -

(D) of section 6015(b)(1), and with respect to the ER physician

business, we interpret respondent’s argument to be an assertion

that Ms. Ross has not met the requirements of subparagraphs (C)

and (D).18

Petitioners’ deficiencies are partly attributable to their

claimed horse-activity losses. We have held that petitioners are

not entitled to deduct those losses. The record reflects that

Ms. Ross was the individual primarily involved in the horse

activity. Because the claimed losses from the horse activity are

not attributable to the nonrequesting spouse, Ms. Ross does not

satisfy subparagraph (B) of section 6015(b)(1).19 Accordingly, we

hold that she does not qualify for relief under section 6015(b)

with respect to the understatement attributable to the horse

activity.

We turn now to that part of the understatement attributable

to disallowed deductions claimed with respect to Dr. Phemister’s

ER physician business. We sustained respondent’s determination

regarding the disallowed expenses. To qualify for relief under

section 6015(b) with respect to the disallowed expenses, Ms. Ross

18
On brief respondent conceded that the ER physician
business was solely attributable to Dr. Phemister.
19
Ms. Ross also fails to satisfy subpar. (C) of sec.
6015(b)(1). Because she participated in the horse activity, she
had actual knowledge of the items giving rise to the
understatements of tax.
 - 34 -

must prove that she satisfies the requirements of subparagraphs

(C) and (D).

With respect to subparagraph (C), Ms. Ross must establish

that she neither knew of nor had reason to know of the erroneous

deductions. Respondent does not argue, and the record does not

reflect, that Ms. Ross had actual knowledge of these erroneous

deductions.20 Consequently, we focus our analysis with respect to

section 6015(b)(1)(C) on whether Ms. Ross had reason to know of

the erroneous deductions.

In an opinion discussing the knowledge requirement of former

section 6013(e)(1), the Court of Appeals for the Seventh Circuit

adopted the “reason to know” standard used in Price v.

Commissioner, 887 F.2d 959 (9th Cir. 1989). See Resser v.

Commissioner, 74 F.3d 1528, 1535-1536 (7th Cir. 1996), revg. and

remanding T.C. Memo. 1994-241. Under the Price standard as

adopted by the Court of Appeals, a taxpayer has reason to know of

an understatement if at the time the taxpayer signed the return

the taxpayer possessed enough knowledge of the facts underlying

the claimed deductions that it would have caused a reasonably

prudent taxpayer in the taxpayer’s position to question the

legitimacy of the deductions. Resser v. Commissioner, supra at

1536 (citing Stevens v. Commissioner, 872 F.2d 1499, 1505 (11th

20
At trial Ms. Ross credibly testified that she had no
involvement in the maintenance of records for Dr. Phemister’s ER
physician business or in the preparation of the returns.
 - 35 -

Cir. 1989), affg. T.C. Memo. 1988-63). If we find that Ms. Ross

had reason to know, then she had a “duty to inquire further”,

Resser v. Commissioner, supra at 1536, and if she failed to

satisfy that duty, we impute to her constructive knowledge of the

understatements attributable to the erroneous deductions, id. at

1541.

We consider several factors when assessing whether a spouse

had reason to know, including “the spouse’s level of education;

the spouse’s involvement in the financial and business activities

of the family; any substantial unexplained increase in the

family’s standard of living; and the culpable spouse’s

evasiveness and deceit about the family’s finances.” Id. at

1536. No single factor is controlling. We must decide whether a

spouse had reason to know “by considering the interplay or

balance of the factors”. Id.

Ms. Ross spent almost all of her married life at home with

her children. She had no substantive involvement in Dr.

Phemister’s ER physician business during the years at issue. She

credibly testified that she did not help Dr. Phemister maintain

books and records for his business and that she was not involved

in preparing the Schedules C for the ER physician business. In

addition, there is no evidence that the family’s lifestyle

changed as a result of Dr. Phemister’s unsubstantiated

deductions.
 - 36 -

On the other hand, Ms. Ross is a high school graduate who

completed a few college-level courses. She had some experience

working as a medical assistant, although we infer from the record

that her work probably occurred during the 1980s when she

assisted Dr. Phemister with his ER physician business. At trial

Ms. Ross admitted she realized Dr. Phemister was not a diligent

recordkeeper, but it is unclear whether her admission reflected

knowledge she gained after respondent audited petitioners’ tax

returns or whether she had some awareness of his inadequate

recordkeeping when she signed their returns.21 She participated

in some aspects of the family’s financial affairs; for example,

she paid many of the household bills from a joint checking

account she shared with Dr. Phemister.

On balance we are satisfied that on the dates she signed the

relevant returns Ms. Ross did not have sufficient knowledge of

the underlying facts to cause a prudent person in her position to

question whether the deductions Dr. Phemister claimed with

respect to his ER physician business were erroneous. Because she

21
We note that respondent’s audit was commenced in March
2004 after petitioners’ 1999 and 2000 returns were filed. Their
2001 return was filed shortly after the audit began, and their
2002 return was filed a few months later. The audit was in a
preliminary, information-gathering stage when it was transferred
to another auditor in October 2004. It was not until September
2005 that respondent began requesting more documents from
petitioners for their claimed Schedule C and horse-activity
deductions. Two months later Ms. Ross filed for legal separation
from Dr. Phemister. Petitioners’ 2003 and 2004 returns were
filed shortly thereafter.
 - 37 -

lacked such knowledge regarding the erroneous deductions, she did

not have a duty to inquire under Price v. Commissioner, supra at

965-966. We conclude, therefore, that Ms. Ross satisfies the

requirements of section 6015(b)(1)(C).

Finally, we consider whether Ms. Ross satisfies the

requirements of section 6015(b)(1)(D), which requires us to

evaluate whether it is inequitable to hold Ms. Ross liable for

the deficiencies in tax attributable to Dr. Phemister’s ER

physician business. During the years at issue Ms. Ross had no

meaningful involvement with Dr. Phemister’s ER physician business

and did not participate in any aspect of his business, including

his recordkeeping. The adjustments with respect to the ER

physician business are the result of Dr. Phemister’s failure to

substantiate the expenses that he claimed on his returns.

Respondent makes no allegation that the expenses were fraudulent

or that the ER physician business did not have expenses during

the years before us.

While it is clear that income from Dr. Phemister’s business

supported Ms. Ross and her family and was a substantial funding

source for the horse activity, Dr. Phemister’s income exceeded

his expenses in each of the years at issue and would have been a

source of support regardless of whether respondent disallowed the

expenses of his ER physician business. Consequently, we cannot
 - 38 -

conclude as respondent contends that the disallowed expenses

resulted in any meaningful financial benefit to Ms. Ross beyond

normal support.

After taking into account all of the facts and circumstances

that may be drawn from the record, we conclude that it would be

inequitable to hold Ms. Ross liable for the deficiencies in tax

attributable to Dr. Phemister’s ER physician business.

Because Ms. Ross satisfies all of the requirements for

relief under section 6015(b) with respect to the understatements

of tax resulting from the disallowance of the ER physician

business’ expense deductions, we hold that she is entitled to

relief under section 6015(b).

B. Section 6015(c)

Under section 6015(c), if the requesting spouse is no longer

married to or is legally separated from the spouse with whom she

filed the joint return, the requesting spouse may elect to limit

her liability for a deficiency as provided in section 6015(d).22

Sec. 6015(c)(1), (3)(A)(i)(I). In general, section 6015(d)

provides that any item giving rise to a deficiency on a joint

22
An election under sec. 6015(c) for any taxable year may be
made at any time after a deficiency is asserted but not later
than 2 years after the date on which the Secretary has begun
collection activities with respect to the individual making the
election. Sec. 6015(c)(3)(B). Respondent has not raised any
issue regarding the timeliness of Ms. Ross’ election under sec.
6015(c). On the basis of the record, we conclude that her
election was timely.
 - 39 -

return shall be allocated to the spouses as though they had filed

separate returns, and the requesting spouse shall be liable only

for his or her proportionate share of the deficiency that results

from such allocation.23 Sec. 6015(d)(1), (3)(A). Unallowable

deductions and omitted income items attributable to a business

are allocated to the spouse who owned the business. Sec. 1.6015-

3(d)(2)(iii) and (iv), Income Tax Regs. However, to the extent

that an item giving rise to a deficiency provided a tax benefit

on the joint return to the other spouse, that item shall be

allocated to the other spouse in computing his or her

proportionate share of the deficiency. Sec. 6015(d)(3)(B);

Hopkins v. Commissioner, 121 T.C. 73, 83-86 (2003). The spouse

who makes the section 6015(c) election bears the burden of

proving the portion of the deficiency that is properly allocable

to that spouse. See sec. 6015(c)(2).

Ms. Ross is eligible to request relief under section 6015(c)

because she and Dr. Phemister were divorced when she made her

election, see sec. 6015(c)(3)(A), and her election is not

invalidated by section 6015(c)(3)(A)(ii). However, respondent

argues, and we agree, that Ms. Ross does not qualify for section

23
In addition, the requesting spouse’s proportionate share
of the deficiency shall be increased by the value of any
disqualified asset transferred to her by the nonrequesting
spouse. Sec. 6015(c)(4). Respondent has not argued, and there
is no evidence, that any disqualified assets were transferred
between Ms. Ross and Dr. Phemister.
 - 40 -

6015(c) relief with respect to that part of the deficiencies

attributable to petitioners’ horse activity.

An election under section 6015(c) is ineffective with

respect to any portion of a deficiency if the Commissioner proves

by a preponderance of the evidence that the requesting spouse had

actual knowledge, when signing the return, of an item giving rise

to a deficiency that is otherwise allocable to the nonrequesting

spouse.24 Sec. 6015(c)(3)(C); Hopkins v. Commissioner, supra at

86. In cases involving erroneous deductions, a spouse is deemed

to have actual knowledge of an item giving rise to a deficiency

if she has actual knowledge of the factual circumstances that

made the deductions unallowable. King v. Commissioner, 116 T.C.

198, 204 (2001).

Although the horse activity was one in which both Ms. Ross

and Dr. Phemister participated and any items attributable to the

activity would normally be allocable at least in part to Dr.

Phemister,25 we conclude that when she signed the tax returns Ms.

24
An election under sec. 6015(c) is also invalid if the
Secretary demonstrates that assets were transferred between the
individuals filing the joint return as part of a fraudulent
scheme. Sec. 6015(c)(3)(A)(ii). Respondent has not argued, and
there is no evidence, that assets were transferred as part of a
fraudulent scheme.
25
In fact, because of the benefit rule of sec.
6015(d)(3)(B), the deficiencies (or a substantial percentage
thereof) attributable to the disallowance of the horse activity
deductions and losses might have been allocable to Dr. Phemister
but for the fact that respondent demonstrated Ms. Ross had actual
(continued...)
 - 41 -

Ross possessed actual knowledge of the factual circumstances that

made the deductions and resulting losses claimed with respect to

the horse activity unallowable. See sec. 6015(c)(3)(C). Ms.

Ross ran the day-to-day operations and was responsible for

maintaining records with respect to the activity. She was well

aware of all of the facts, including the defective recordkeeping,

that lead us to conclude, infra, the horse activity was not an

activity for profit. Therefore, we hold that Ms. Ross’ election

under section 6015(c) does not apply to that part of the

deficiencies attributable to the horse activity.26

Respondent also argues that Ms. Ross does not qualify for

section 6015(c) relief with respect to that part of the

deficiencies attributable to Dr. Phemister’s disallowed ER

physician business deductions. We find that Dr. Phemister was

the owner of this business and that the income and allowable

deductions associated with this business are allocable solely to

him. Accordingly, to prevent an allocation under section 6015(c)

and (d), respondent must prove that Ms. Ross had actual knowledge

25
(...continued)
knowledge at the time she signed the returns of the items giving
rise to those deficiencies. See Hopkins v. Commissioner, 121
T.C. 73, 83-86 (2003); sec. 1.6015-3(d)(5), Example (5), Income
Tax Regs.
26
Accuracy-related penalties under sec. 6662 are allocated
to the individual whose activity generated the penalty. Sec.
1.6015-3(d)(4)(iv)(B), Income Tax Regs. Accordingly, Ms. Ross
cannot avoid liability for the penalties arising from
petitioners’ horse activity.
 - 42 -

of the unallowable deductions when she signed the returns. Sec.

6015(c)(3)(C). Respondent did not do so.

In Sowards v. Commissioner, T.C. Memo. 2003-180, the

taxpayer sought relief from liabilities arising from

unsubstantiated deductions her husband claimed with respect to

his legal practice. We found, as we do here, that the

Commissioner failed to prove that the requesting spouse had

actual knowledge that the other spouse’s business deductions were

not allowable. Like the taxpayer in Sowards, Ms. Ross had no

involvement with Dr. Phemister’s ER physician business. She did

not know who kept his books and records, and there is no evidence

she reviewed any of his claimed deductions. She knew only that

he supplied his business’ books and records to an accountant who

used them to prepare petitioners’ returns.

On this record we conclude that respondent has not proven

actual knowledge. Consequently, we hold that Ms. Ross’ election

is valid with respect to that part of the deficiencies

attributable to items involving Dr. Phemister’s ER physician

business, which are allocable to Dr. Phemister under section

6015(d).27

27
Respondent does not argue that Ms. Ross does not qualify
for relief under sec. 6015(c) with respect to other items in the
notice of deficiency not specifically discussed in this opinion
and has not shown that Ms. Ross had actual knowledge of such
items. Therefore, Ms. Ross is entitled to relief under sec.
6015(c) for any deficiency attributable to the other items to the
(continued...)
 - 43 -

C. Section 6015(f)

Section 6015(f) provides an alternative means of relief for

a requesting spouse who does not otherwise qualify for relief

under subsection (b) or (c) of section 6015. Sec. 6015(f)(2).

Because we have not relieved Ms. Ross of all liability for the

deficiencies, we consider whether Ms. Ross is entitled to any

additional relief under section 6015(f).

Section 6015(f) permits relief from joint and several

liability where “it is inequitable to hold the individual liable

for any unpaid tax or any deficiency (or any portion of either)”.

Sec. 6015(f)(1). Under section 6015(f), the Secretary may grant

equitable relief to a requesting spouse on the basis of the facts

and circumstances of the requesting spouse’s case. Respondent

asserts that Ms. Ross does not satisfy the conditions for

granting relief under section 6015(f) as delineated in the

administrative procedures found in Rev. Proc. 2003-61, 2003-2

C.B. 296.

Pursuant to section 6015(f), the Commissioner has prescribed

guidelines in Rev. Proc. 2003-61, supra, modifying and

superseding Rev. Proc. 2000-15, 2000-1 C.B. 447, to be considered

in determining whether an individual qualifies for relief under

27
(...continued)
extent they are allocable to Dr. Phemister. We expect the
parties to resolve the exact allocation as part of the Rule 155
computation. See Hopkins v. Commissioner, supra at 87.
 - 44 -

section 6015(f).28 Where a request for relief under section

6015(f) is raised as an affirmative defense, this Court applies

these guidelines. See, e.g., Rowe v. Commissioner, T.C. Memo.

2001-325.

Rev. Proc. 2003-61, sec. 4.01, 2003-2 C.B. at 297, lists

seven conditions, all of which must be satisfied before the

Commissioner will consider a request for relief under section

6015(f). One of the threshold conditions is that the item for

which the spouse requests relief, absent certain exceptions, must

be attributable to the other spouse. Id. sec. 4.01(7).

Ms. Ross is deemed to have amended her petition to raise her

claim for relief under section 6015(f). Respondent opposes Ms.

Ross’ request for equitable relief with respect to the horse

activity, claiming Ms. Ross does not meet the threshold

requirements.

We agree with respondent that it would not be inequitable to

hold Ms. Ross liable for the deficiencies arising from the horse

activity. As we discussed previously, the horse activity is not

solely attributable to Dr. Phemister, and Ms. Ross was involved

with the daily operations of that activity. We conclude that Ms.

28
The guidelines set forth in Rev. Proc. 2003-61, 2003-2
C.B. 296, are effective for requests for relief filed, as in the
instant case, on or after Nov. 1, 2003. Id. sec. 7, 2003-2 C.B.
at 299.
 - 45 -

Ross is not eligible for relief under section 6015(f) from

deficiencies attributable to petitioners’ horse activity.

D. Conclusion

We grant Ms. Ross relief under section 6015(b) with respect

to the understatements attributable to Dr. Phemister’s ER

physician business, and we conclude that she is entitled to an

allocation under section 6015(c) as indicated herein. We deny

her relief with respect to understatements attributable to

petitioners’ horse-activity losses, finding she did not qualify

for relief under section 6015(b), (c), or (f). Consequently, Ms.

Ross remains jointly and severally liable for any deficiencies in

tax, additions to tax, and penalties attributable to the horse-

activity losses and any other portions of the deficiencies in

tax, additions to tax, and penalties which are not allocable to

Dr. Phemister under section 6015(c). See supra note 25.

To reflect the foregoing,

Decision will be entered

under Rule 155.