T.C. Memo. 2010-129
UNITED STATES TAX COURT
STEVE LACY LOWE AND JANICE MARIE LOWE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 16304-08. Filed June 14, 2010.
R determined tax deficiencies and accuracy-related
penalties pursuant to sec. 6662(a), I.R.C., for Ps’
2005 and 2006 tax years. Ps and R dispute whether Ps
are entitled to business expense deductions in excess
of gross income from their bass fishing contest
activity.
Held: Ps are not entitled to the excess business
expense deductions but are not liable for the sec.
6662(a), I.R.C., accuracy-related penalties for 2005
and 2006.
Steve Lacy Lowe and Janice Marie Lowe, pro sese.
Halvor R. Melom, for respondent.
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MEMORANDUM FINDINGS OF FACT AND OPINION
WHERRY, Judge: This case is before the Court on a petition
for redetermination of alleged Federal income tax deficiencies
that respondent determined for petitioners’ 2005 and 2006 tax
years. Respondent issued petitioners a notice of deficiency on
April 4, 2008. Petitioners then filed a timely petition with
this Court on July 2, 2008. A trial was held on June 29, 2009,
in Los Angeles, California.
Respondent concedes that petitioners substantiated all of
their claimed income and expenses for the years at issue. The
issue for decision is whether petitioners are entitled to
deductions claimed on their Schedule C, Profit or Loss From
Business, to the extent they exceed their gross income from those
activities. More specifically, the issue is whether petitioner
husband (Mr. Lowe) was engaged in his bass fishing activity for
profit. See sec. 183.1
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulated
facts and the accompanying exhibits are hereby incorporated by
reference into our findings. Petitioners were married and filed
joint Forms 1040, U.S. Individual Income Tax Return, for 2005 and
1
Except as otherwise indicated, all section references are
to the Internal Revenue Code of 1986, as amended and in effect
for the tax years at issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
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2006. Petitioners resided in California when they filed their
petition.
During the years at issue petitioner wife (Mrs. Lowe) worked
full time as a “controller” for Fry Steel Co., where she has
worked for over 38 years. She earned $177,219 and $184,181 in
2005 and 2006, respectively, with an additional $12,000 per year
for taking notes at the board of directors meetings.
From 1986 to 1999 Mr. Lowe’s only occupation was improving
petitioners’ home, for which he received no income. Mr. Lowe has
fished for as long as he can remember, fishing only
recreationally before 1999. Mr. Lowe became interested in
tournament fishing in 1999 when he attended a fishing tournament
with a first-place prize of $6,000.
In 2005 Mr. Lowe fished in 26 tournaments run by either
American Bass, FLW Strem Series, or Western Outdoor News (WON)
and reported gross income on petitioners’ Schedule C of $4,241.
In 2006 Mr. Lowe fished in 15 tournaments run by those same
organizations and reported $10,932 of gross income. The entry
fees ranged from $280 to $825 with an additional $325 for a “co-
angler” amateur in FLW events. When entering American Bass or
WON tournament team events, Mr. Lowe would list his wife as his
co-angler teammate and pay her entry fee, although she would not
actually compete. In these events Mr. Lowe would single-handedly
take on the rest of the competitors, most or all of whom
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presumably took advantage of the rules to compete as two-member
teams. To win or place, Mr. Lowe had to catch more fish with one
hook and line than his competition could catch with two hooks and
lines. The first-place prizes ranged from $4,000 up to $50,000
and, in some instances, a boat valued by petitioners at $25,000,
depending on the tournament. If a competitor won sufficient
points, during the year that competitor might qualify for a
yearend national fish-off tournament where first place would pay
$250,000.
Mr. Lowe was diagnosed with cancer on October 31, 2006, and
underwent chemotherapy from December 2006 through February 2007.
He did not participate in any fishing tournaments in 2007.
Petitioners have a voluminous library of magazines,
newspapers, books, and videotapes on bass fishing. Mr. Lowe
reads about and studies fishing 2 or 3 hours a night. Mr. Lowe
was a regular card-carrying member of American Bass-Professional
Bass Tournament Angler, FLW Outdoors, and US Anglers Choice in
earlier and/or later years and may, although the record is
unclear, have also been a member of these organizations in 2005
and 2006.
Mr. Lowe consulted friends, including Aaron Martens, about
making money in sports fishing and becoming successful in this
business. One important aspect of making a profit in the
competitive sport fishing business is obtaining commercial
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sponsorships to supplement winnings or reduce expenses. Towards
the end of 2006 Mr. Lowe consulted Kevin VanDam, a “leading money
winner in the bass fishing industry”, and Denny Brauer, one of
the “largest money [winners] in the business”, on how to make his
business more profitable. Mr. Lowe was told that the best way to
hook and land a sponsor was to win a major tournament.
Mrs. Lowe, a professional bookkeeper, assisted Mr. Lowe in
his recordkeeping. Mr. Lowe did not keep a separate bank account
for the activity, and he has no other source of earned income.
Mr. Lowe has several sponsors and receives $200 worth of lures
each year from his sponsors.
On their 2003 through 2006 Schedules C, Mr. Lowe listed his
principal business or profession as “PROFESSIONAL FISHING”. From
2003 to 2006 petitioners reported on their Federal income tax
returns the following amounts of Mrs. Lowe’s salary income, gross
income from the fishing activity, expenses from the fishing
activity, net profit or (loss) from the fishing activity, and
taxable income.
Gross Net Profit
Mrs. Income Expenses or (Loss)
Lowe’s From From From
Salary Fishing Fishing Fishing Taxable
Year Income Activity Activity Activity Income
2003 $166,366 $420 $33,007 ($32,587) $100,936
2004 168,966 2,550 34,865 (32,315) 103,713
2005 177,219 4,241 49,067 (44,826) 63,114
2006 184,181 10,932 48,608 (37,676) 146,484
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OPINION
I. Mr. Lowe’s Profit Objective
Respondent contends that the losses related to Mr. Lowe’s
fishing activity were not deductible because the fishing activity
was not engaged in for profit within the meaning of section 183.
Section 183(a) generally disallows deductions attributable to
activities not engaged in for profit. 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.”
The Court of Appeals for the Ninth Circuit, to which an
appeal in this case would lie absent stipulation to the contrary,
has held that an activity is engaged in for profit if the
taxpayer’s “predominant, primary or principal objective” in
engaging in the activity was to realize an economic profit
independent of tax savings. Wolf v. Commissioner, 4 F.3d 709,
713 (9th Cir. 1993), affg. T.C. Memo. 1991-212. Section 1.183-
2(b), Income Tax Regs., sets forth a nonexclusive list of factors
to be considered in evaluating a taxpayer’s profit objective:
(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
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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, from the activity; (8) the financial
status of the taxpayer; and (9) elements of personal pleasure or
recreation.
None of these factors is determinative in the evaluation of
profit objective, nor is the number of these factors for or
against the taxpayer necessarily conclusive in that respect.
Golanty v. Commissioner, 72 T.C. 411, 426 (1979), affd. without
published opinion 647 F.2d 170 (9th Cir. 1981); sec. 1.183-2(b),
Income Tax Regs. All facts and circumstances with respect to the
activity must be taken into account. Sec. 1.183-2(b), Income Tax
Regs.
1. The Manner in Which the Taxpayer Carries on the Activity
The fact that the taxpayer carries on the activity in a
businesslike manner may indicate that the activity is engaged in
for profit. Sec. 1.183-2(b)(1), Income Tax Regs. Three common
inquiries are considered in this context: (1) Whether the
taxpayer maintained complete and accurate books and records for
the activity; (2) whether the taxpayer conducted the activity in
a manner substantially similar to those of other comparable
activities that were profitable; and (3) whether the taxpayer
changed operating procedures, adopted new techniques, or
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abandoned unprofitable methods in a manner consistent with an
intent to improve profitability. Giles v. Commissioner, T.C.
Memo. 2005-28; sec. 1.183-2(b)(1), Income Tax Regs.
The first subfactor considers whether Mr. Lowe maintained
complete and accurate books and records of the activity. Mr.
Lowe retained the receipts from expenses related to the fishing
activity and then transcribed those expenses into a handwritten
ledger organized by expense category. No similar documents
concerning the income from the activity were introduced into
evidence. When Mr. Lowe was asked whether he maintained records
of his income, he explained: “Yes, * * * but it must have been
misplaced in the hurry to get everything and my evidence
together.”
At trial Mr. Lowe explained that Mrs. Lowe is a professional
bookkeeper and that she assisted Mr. Lowe in his recordkeeping.
However, there is little evidence that the minimal books and
records that were kept, were kept for the purpose of “cutting
expenses, increasing profits, and evaluating the overall
performance of the operation.” See Golanty v. Commissioner,
supra at 430. Petitioners stipulated that they “prepared no
records, reports, forecasts, schedules, analyses, or other
documents for” the activity. Mr. Lowe did not maintain a
separate bank account for the activity, nor is there any mention
in the record of a business plan. While petitioners kept a
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written ledger of the expenses of the activity, they did not
“prepare any business or profit plans, profit or loss statements,
balance sheets, or financial break-even analyses” for the
activity. See Dodge v. Commissioner, T.C. Memo. 1998-89, affd.
without published opinion 188 F.3d 507 (6th Cir. 1999). We
conclude this subfactor is neutral.
As to the second subfactor, Mr. Lowe opined that he carries
on his fishing activity “in the same manner as all the other
professionals in the United States.” There is no evidence in the
record to corroborate that Mr. Lowe had been successful in other
business activities or that he carried on the fishing activity in
a manner substantially similar to activities of the same nature
that were profitable. This subfactor favors respondent.
The third subfactor asks whether petitioners changed
operating procedures, adopted new techniques, or abandoned
unprofitable methods in a manner consistent with an intent to
improve profitability. Mr. Lowe “Looked back over the years and
seen [sic] that the profit margin is much more better [sic] for
the larger tournaments”; he explained he is “presently only
fishing in tournaments that exceed $25,000, $50,000; $25,000
cash, a $25,000 boat.” Mr. Lowe also explained that he was
always “acquiring and trying to acquire sponsors and learning” in
order to improve his business’ profitability. We have previously
found that working to acquire corporate sponsorship may indicate
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a profit motive. Sleeper v. Commissioner, T.C. Memo. 1997-367.
Although respondent asserts that Mr. Lowe did not receive money
from any of his sponsors, only discounted tackle, free bait, and
line, the taxpayer in Sleeper was not paid in cash either, but
“allowed to purchase lures at a discount.” Id. By fishing in
higher paying tournaments, talking to expert fishermen, as
discussed below, and working to acquire sponsors, Mr. Lowe
changed operating procedures in a manner that would bring about a
“material change” in the profitability of his activity. See
Golanty v. Commissioner, supra at 428. This subfactor favors
petitioners.
Mr. Lowe viewed himself as a professional bass fisherman
carrying on the activity in a manner similar to other fishing
activities carried on for profit and made changes with an intent
to improve profitability. His recordkeeping system is less than
desirable, and was apparently not used to analyze the financial
aspects of the business and adequately address profitability. We
conclude that Mr. Lowe carried on the fishing activity in a
manner that was businesslike in some respects but not others.
This factor is neutral.
2. The Expertise of the Taxpayer or His Advisers
“Preparation for the activity by extensive study of its
accepted business, economic, and scientific practices, or
consultation with those who are expert therein, may indicate that
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the taxpayer has a profit motive where the taxpayer carries on
the activity in accordance with such practices.” Sec. 1.183-
2(b)(2), Income Tax Regs.
We have no doubt that Mr. Lowe is, and was before
undertaking his competitive fishing activities, an accomplished
bass fisherman. He has certainly engaged in an extensive study
of the sport, as evidenced by his collection of books, magazines,
newspapers, and videos, as well as by the fact that he studies 2
to 3 hours a night. None of the titles of the magazines,
newspapers, books, or videos suggest that they are specifically
intended to address the economics or business of profitably
fishing for bass competitively. Nevertheless, since Mr. Lowe
sought to win tournaments to improve the profitability of this
activity, improving his fishing abilities was tantamount to
improving the profitability of his business. Mr. Lowe was a
skilled fisherman, winning at least two tournaments in 2005 and
three tournaments in 2006.
Mr. Lowe also consulted expert professional fishermen to
improve profitability. He testified that towards the end of 2006
he consulted with Denny Brauer and Kevin VanDam for about 45
minutes with each, discussing what he “should do to proceed a
little bit further into the business to make myself more
profitable.” Respondent contends that this advice was received
at the end of the last year at issue and therefore it was too
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late for Mr. Lowe to act on that advice. However, his seeking
this advice demonstrates that Mr. Lowe intended to continue the
activity while making it profitable and tends to show that he
viewed this activity as more than a hobby.
Mr. Lowe studied the art of bass fishing; he won tournaments
and sought expert advice. This factor favors petitioners.
3. The Time and Effort Expended by the Taxpayer in Carrying
on the Activity
The fact that the taxpayer devotes much of his
personal time and effort to carrying on an activity,
particularly if the activity does not have substantial
personal or recreational aspects, may indicate an
intention to derive a profit. A taxpayer’s withdrawal
from another occupation to devote much of his energies
to the activity may also be evidence that the activity
is engaged in for profit. * * * [Sec. 1.183-2(b)(3),
Income Tax Regs.]
Mr. Lowe clearly devotes a substantial amount of time to his
fishing activity, possibly up to 60 hours per week. He notes
that the fishing activity is his only job and that he has “no
other income.” Respondent concedes that this factor favors
petitioners.
4. The Expectation That Assets Used in the Activity May
Appreciate in Value
“The term ‘profit’ encompasses appreciation in the value of
assets, such as land, used in the activity.” Sec. 1.183-2(b)(4),
Income Tax Regs.
At trial Mr. Lowe admitted that none of his equipment, which
in fact depreciates, or other assets used in the fishing activity
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will increase in value. This factor weighs in favor of
respondent.
5. The Success of the Taxpayer in Carrying on Other Similar
or Dissimilar Activities
“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.
Petitioners did not address this factor at trial, and there
is no evidence that Mr. or Mrs. Lowe carried on any successful
businesses in a manner substantially similar to that of the
fishing activity. This factor favors respondent.
6. The Taxpayer’s History of Income or Losses With Respect
to the Activity
A series of losses during the initial or start-up
stage of an activity may not necessarily be an
indication that the activity is not engaged in for
profit. However, where losses continue to be sustained
beyond the period which 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. * * *
[Sec. 1.183-2(b)(6), Income Tax Regs.]
In the years at issue petitioners claimed $82,502 in losses
from an activity that has never been profitable. Mr. Lowe argues
that the years at issue were well within the startup stage of the
activity. Mr. Lowe has been a professional bass fisherman “since
2003”, and petitioners have reported income and expenses related
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to the fishing activity since 2003. Therefore, if the activity
began in 2003, it was only in its third and fourth years of
existence during the years at issue. We have previously
indicated that 5 years was an acceptable startup period for
charter boat fishing activities. See Busbee v. Commissioner,
T.C. Memo. 2000-182; Zwicky v. Commissioner, T.C. Memo. 1984-471.
While competitive freshwater sport fishing is a different
activity, we think a 5-year startup period is not excessive.
Mr. Lowe explained that “the money comes at the end. You
reap the benefits when everything falls into place.” He does not
believe “there’s a measuring stick as to how long it takes * * *
five, six, seven, 10 years.” While we do not agree that the
startup period is as open-ended as he contends, it appears that
his activity was still in the startup stage. We are concerned
that Mr. Lowe has equivocated from time to time as to how much
longer he will continue his fishing activity before determining
whether to sell or abandon it. He ascribed this inconsistency in
his correspondence and statements to respondent to his mental
confusion resulting from his cancer treatment. At trial Mr. Lowe
observed that his earnings had increased every year until the
effects of the cancer forced him to quit. This is substantiated
by petitioners’ tax returns and helps to demonstrate that the
activity was still growing during the startup phase.
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Because the fishing activity has never made a profit, but
was still in the startup stage during the years at issue, we find
this factor neutral.
7. The Amount of Occasional Profits, if Any, From the
Activity
“The amount of profits in relation to the amount of losses
incurred, and in relation to the amount of the taxpayer’s
investment and the value of the assets used in the activity, may
provide useful criteria in determining the taxpayer’s intent.”
Sec. 1.183-2(b)(7), Income Tax Regs. “[A]n opportunity to earn a
substantial ultimate profit in a highly speculative venture is
ordinarily sufficient to indicate that the activity is engaged in
for profit even though losses or only occasional small profits
are actually generated.” Id.
The fishing activity has yet to reel in any profits;
however, Mr. Lowe believed that he could make a substantial
amount of money if he won a tournament. If Mr. Lowe’s primary or
principal objective was to make a profit, it is not necessary for
him to show that his primary objective was reasonable. See sec.
1.183-2(a), Income Tax Regs. Mr. Lowe believed that it was “time
to reap the harvest” of his prior investment.
The Court has previously found that the mere aspiration and
qualification to win large cash prizes does not necessarily mean
that the activity was engaged in for profit. See Peacock v.
Commissioner, T.C. Memo. 2002-122. The activity must have been
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engaged in with the objective to make a profit. Id. Mr. Lowe
certainly wanted his fishing activity to earn money; however,
even a hobbyist may not want to lose money on his activity.
We have also previously found that a bass fishing activity
where the winnings were in excess of the tournament entry fees
“offered no basis for concluding that he [the taxpayer] would
ever show a profit from tournament fishing” after also
considering travel costs and the depreciation of the equipment.
Hoy v. Commissioner, T.C. Memo. 1991-575. Mr. Lowe’s winnings
were never close to covering his entry fees, let alone his travel
costs and the depreciation on his equipment. We find this factor
favors respondent.
8. The Financial Status of the Taxpayer
“Substantial income from sources other than the activity
(particularly if the losses from the activity generate
substantial tax benefits) 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.
Mrs. Lowe earned substantial income from her job at Fry
Steel Co., and the losses from Mr. Lowe’s fishing activity
resulted in substantial tax benefits. During the years at issue
Mrs. Lowe earned an average of about $180,000 a year from her
job, and petitioners were able to deduct an average of about
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$41,000 per year on their joint Federal income tax returns due to
Mr. Lowe’s fishing activity losses. Mr. Lowe was not employed
before the fishing activity and was able to pursue this activity
because of Mrs. Lowe’s substantial income. We also note that Mr.
Lowe fished for recreation and pleasure long before commencing
his competitive bass fishing activity. He clearly enjoyed that
activity and likely would have incurred significant fishing costs
yearly for personal pleasure had he not conducted his claimed
business activity. We find this factor favors respondent.
9. Elements of Personal Pleasure or Recreation
“The presence of personal motives in carrying on of an
activity may indicate that the activity is not engaged in for
profit, especially where there are recreational or personal
elements involved.” Sec. 1.183-2(b)(9), Income Tax Regs.
However, “We also note that a business will not be turned into a
hobby merely because the owner finds it pleasurable; suffering
has never been made a prerequisite to deductibility.” Jackson v.
Commissioner, 59 T.C. 312, 317 (1972).
Mr. Lowe testified that fishing used to be fun when he was
fishing recreationally, but “Fishing in 2005, 2006, 2007, 2008,
2009 is not fun.” Mr. Lowe’s fishing activity contained elements
of personal pleasure and recreation, but we find Mr. Lowe’s
testimony that the activity no longer was pleasurable during the
years at issue credible. This factor is neutral.
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10. Supplementary Element of Competitive Efforts for Profit
Additionally we find that Mr. Lowe’s competitive strategy
was not fully consistent with an intent to make a profit. As we
noted above, none of the factors set out in section 1.183-2(b),
Income Tax Regs., is necessarily determinative in the evaluation
of profit objective, and all facts and circumstances with respect
to the activity must be taken into account. Golanty v.
Commissioner, 72 T.C. at 426; sec. 1.183-2(b), Income Tax Regs.
All of the American Bass tournaments in which Mr. Lowe
fished were team tournaments. Mr. Lowe would enter Mrs. Lowe as
his partner and then fish the tournaments alone. This practice,
while allowing him to share the activity with his spouse, doubled
Mr. Lowe’s entry fee. We assume that had he fished with a
fishing partner, the partner would have paid his or her own share
of the entry fee. By fishing alone, Mr. Lowe also at least
halved and most likely much more than halved his chances of
winning. Mr. Lowe, against very stiff competition, would have
had to catch more fish, alone, than any of his competitors could
catch with both competitors fishing, in order to win a
tournament. We do not find this conduct consistent with the
intent to make a profit. If Mr. Lowe had been truly engaged in
the bass fishing activity for profit, he would have done
everything in his power to increase his chances of winning and
decrease his entry costs. We do note that under this strategy,
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had Mr. Lowe won, he would not have had to split the prize.
Unfortunately, when you do not win, that does not matter. With
such a large handicap we believe winning would have been
extraordinarily difficult and extremely improbable. We find this
factor favors respondent.
After considering all of the above factors as applied to the
unique facts and circumstances of this case, we conclude that Mr.
Lowe’s fishing activity was not engaged in for profit within the
meaning of section 183. Therefore petitioners are not entitled
to deduct expenses in excess of gross income from the activity.
II. Section 6662(a) Accuracy-Related Penalty
Subsection (a) of section 6662 imposes an accuracy-related
penalty of 20 percent of any underpayment that is attributable to
causes specified in subsection (b). Respondent asserts that
because petitioners did not engage in the fishing activity for
profit and were not allowed to deduct expenses exceeding the
gross income from the fishing activity, there was a substantial
understatement of income tax. Sec. 6662(b)(2). There is an
exception to the section 6662(a) penalty when a taxpayer can
demonstrate (1) reasonable cause for the underpayment and (2)
that the taxpayer acted in good faith with respect to the
underpayment. Sec. 6664(c)(1). Regulations promulgated under
section 6664(c) further provide that the determination of
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reasonable cause and good faith “is made on a case-by-case basis,
taking into account all pertinent facts and circumstances.” Sec.
1.6664-4(b)(1), Income Tax Regs.
Although we have determined that Mr. Lowe’s fishing activity
was not engaged in for profit, under the circumstances of this
close case we find reasonable cause for the tax underpayment and
that petitioners “made a reasonable and good faith error in
applying the law to the facts of this case.” See Connolly v.
Commissioner, T.C. Memo. 1994-218, affd. without published
opinion 58 F.3d 637 (5th Cir. 1995). Therefore petitioners are
not liable for the section 6662(a) accuracy-related penalties for
the years at issue.
The Court has considered all of petitioners’ and
respondent’s contentions, arguments, requests, and statements.
To the extent not discussed herein, we conclude that they are
meritless, moot, or irrelevant.
To reflect the foregoing,
Decision will be entered
under Rule 155.