Sernett v. Comm'r

T.C. Memo. 2012-334

UNITED STATES TAX COURT

JOHN A. SERNETT, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 25295-10. Filed December 3, 2012.

Michael J. Dwyer, Ward Rollin Anderson, and Rebecca S. Christensen, for

petitioner.

Blaine Charles Holiday, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

MARVEL, Judge: Respondent determined deficiencies in petitioner’s

Federal income tax of $25,190, $32,122, and $19,892 for 2005, 2006, and 2007,
 -2-

[*2] respectively. After a concession by respondent,1 the sole issue for decision is

whether petitioner’s sprint car racing activity during 2005-07 constituted an activity

not engaged in for profit within the meaning of section 183.2

FINDINGS OF FACT

Some of the facts have been stipulated. The stipulation of facts is

incorporated herein by this reference. Petitioner resided in Minnesota when he

petitioned this Court.

I. Background

During the years in issue petitioner was a successful, fully commissioned

telecommunications equipment salesperson for North American Communications

Resource, Inc. (NACR). Petitioner also raced sprint cars and operated a sprint car

racing activity (Sernett Motorsports).

Petitioner began racing sprint cars in 1975, when he was 19. Petitioner

earned his bachelor’s degree in business administration from Creighton University

in 1978. While at Creighton, petitioner drove sprint cars as a summer job. During

1
Respondent concedes that petitioner substantiated his claimed sprint car
racing expenses for 2005-07.
2
Unless otherwise indicated, all section references are to the Internal Revenue
Code (Code) for the years in issue, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
 -3-

[*3] 1982-83 petitioner earned all of his income driving sprint cars for others. In the

early 1980s petitioner worked for C.L. Boyd Co., managing its racing team and

marketing its construction equipment business. In all, petitioner raced for various

racing groups for 15 years before purchasing his own equipment in 1992.

II. Petitioner’s Racing Activity

In 1992 petitioner purchased his own sprint car and transporter to begin

Sernett Motorsports. Petitioner set up a separate business account for Sernett

Motorsports, and all income and expenses of the activity were paid into and out of

that account.

During the years in issue petitioner owned three sprint race cars and a full-

sized semitrailer for hauling his cars to racing events. At the time of trial petitioner

owned two cars and the semitrailer, which he estimated were worth a total of

$155,000. Petitioner also owned or leased a shop in Lakeville, Minnesota, where he

maintained his cars and prepared them for racing events.

During the years in issue petitioner kept the following records with respect

to Sernett Motorsports: (1) maintenance logs for the cars, (2) a journal

documenting his racing performance and how he tuned the cars for each race,

and (3) handwritten business records. Petitioner’s handwritten business records

consisted of one sheet of paper per year on which he recorded Sernett
 -4-

[*4] Motorsports’ racing income and between 18 and 30 envelopes into which he

placed receipts for various racing expenses.

Petitioner did not have a written business plan for Sernett Motorsports until

he was asked during the audit whether he had one. The business plan that petitioner

wrote during the audit identified four main sources of revenue and profit: (1) using

the novelty and marketing of Sernett Motorsports to brand himself and his full-time

employer, NACR; (2) strategically racing at events that would maximize prize

money and marketing potential; (3) building equity in racing equipment; and (4)

pursuing associate sponsorships.

To help Sernett Motorsports earn prize money, petitioner enlisted the help of

several racing colleagues when competing at events. His brother, Tim Sernett,

raced Sernett Motorsports’ second car. Dick Groenwald, a race car mechanic with

approximately 30 years of experience, and Scott Mudra, a professional race car

mechanic, provided technical advice on, and assistance with, tuning the cars to track

conditions. Petitioner also frequented racing supply shops and attended the

Performance Racing Industry Trade Show in Orlando, Florida.

In 2005 Sernett Motorsports competed in 10 events, earning total prize

money of $8,445. In 2006 Sernett Motorsports competed in 21 events, earning
 -5-

[*5] total prize money of $15,550. And in 2007 Sernett Motorsports competed in

16 events, earning total prize money of $7,435.

To help Sernett Motorsports secure corporate sponsorships, petitioner

engaged a professional design firm to design a full-color marketing brochure titled

“Marketing On The Move” in 2002. The brochure highlighted the marketing

opportunities available to potential corporate sponsors of Sernett Motorsports.

Petitioner used the brochure to solicit corporate sponsorships during the years in

issue.

Petitioner’s previous employer, Progressive Technologies (Progressive),

agreed to build a marketing strategy around Sernett Motorsports, and it sponsored

Sernett Motorsports for several years during the 1990s. In exchange Sernett

Motorsports displayed Progressive’s logo on its sprint cars and uniforms.

Petitioner secured commercial sponsors for Sernett Motorsports for 2005-06

from two local companies. In 2005 Advanced Manufacturing Concepts (AMC) and

Fast Arch paid $3,750 and $500, respectively, to sponsor Sernett Motorsports, and

in 2006 AMC paid $1,800 to sponsor Sernett Motorsports.

From 1992 to 2009 petitioner reported losses from Sernett Motorsports on

his Schedules C, Profit or Loss From Business. Petitioner first reported a profit

from Sernett Motorsports in 2010, after petitioning the Court in this case.
 -6-

[*6] Petitioner reported Sernett Motorsports’ gross income, total expenses, and net

profit or loss on the Schedules C attached to his 2000-10 Forms 1040, U.S.

Individual Income Tax Return (2000-10 returns), as follows:

Year Gross income Total expenses Net profit or loss

2000 $54,195 $111,164 ($56,969)
2001 31,990 117,381 (85,391)
2002 31,645 127,762 (96,117)
2003 11,360 91,777 (80,417)
2004 22,419 88,261 (65,842)
2005 14,795 76,998 (62,203)
2006 24,939 96,126 (71,187)
2007 8,620 61,208 (52,588)
1
2008 89,889 136,049 (46,160)
2009 5,230 25,186 (19,956)
2010 21,812 14,452 7,360
Total 316,894 946,364 (629,470)
1
Petitioner concedes he overstated Sernett Motorsports’ gross receipts and
expenses by $83,384 each on the Schedule C attached to his 2008 return.

III. Petitioner’s Employment as a Salesperson

Petitioner began working for Progressive as a telecommunications

equipment salesperson in 1992. In 2003 NACR acquired Progressive, and NACR

has employed petitioner as a fully commissioned salesperson ever since. Because

of liability concerns, NACR did not allow petitioner to display NACR’s logo on

any of Sernett Motorsports’ racing equipment during live events, but it allowed
 -7-

[*7] petitioner to photoshop NACR’s logo onto photographs of Sernett

Motorsports’ equipment and to send the altered photographs to his customers.

Petitioner has enjoyed significant success as a salesperson. He attained

“President’s Club” status, which is awarded to approximately the top 20% of

producers in the industry, for his efforts in 15 of the 18 years preceding trial in this

case. As reported on his 2005-10 Forms 1040 petitioner received wages and

deferred compensation from NACR as follows:

Deferred
Year Wages compensation

2005 $209,434 $11,326
2006 235,835 20,000
2007 194,593 20,500
2008 261,569 20,500
2009 87,322 16,500
2010 133,318 22,000

IV. Petitioner’s 2005-07 Federal Income Tax Returns

Petitioner timely filed his 2005-07 returns. Petitioner reported Sernett

Motorsports’ income and expenses on the Schedules C attached to his 2005-07

returns. The Schedules C listed petitioner as the proprietor of, and petitioner’s

home address as the business address for, Sernett Motorsports. The principal

business of Sernett Motorsports was reported as “Auto Racing Sales” for 2005 and
 -8-

[*8] 2007 and as “Auto Racing & Sales” for 2006. Petitioner reported Sernett

Motorsports’ gross income and total expenses for 2005-07 on his Schedules C as

follows:

2005 2006 2007

Gross income $14,795 $24,939 $8,620
Total expenses 76,998 96,126 61,208

Respondent examined petitioner’s 2005-07 returns and issued a notice of

deficiency to petitioner. In the notice of deficiency respondent determined that

petitioner did not operate Sernett Motorsports for profit, reclassified petitioner’s

Schedule C income as other income, and disallowed petitioner’s Schedule C

expense deductions in their entirety.3

OPINION

I. Burden of Proof

Generally, the Commissioner’s determination of a deficiency is presumed

correct, and the taxpayer bears the burden of proving that the determination is

improper. Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933). If,

3
We note that under sec. 183(b)(2), expenses attributable to an activity not
engaged in for profit are deductible to the extent of gross income derived from the
activity. Accordingly, petitioner is entitled to deduct Sernett Motorsports’ expenses
to the extent of its gross income even if we find that he did not operate Sernett
Motorsports for profit.
 -9-

[*9] however, a taxpayer produces credible evidence4 with respect to any factual

issue relevant to ascertaining the taxpayer’s tax liability for any tax imposed by

subtitle A or B and satisfies the requirements of section 7491(a)(2), the burden of

proof on any such issue shifts to the Commissioner. Sec. 7491(a)(1). Section

7491(a)(2) requires a taxpayer to demonstrate that he or she (1) complied with

requirements under the Code to substantiate any item, (2) maintained all records

required under the Code, and (3) cooperated with reasonable requests by the

Secretary5 for witnesses, information, documents, meetings, and interviews. See

also Higbee v. Commissioner, 116 T.C. 438, 440-441 (2001).

Petitioner argues that the burden of proof should shift to respondent under

section 7491(a) because he produced credible evidence and satisfied the

requirements of section 7491(a)(2). However, because we decide this case on the

preponderance of the evidence, the burden of proof is irrelevant. See Blodgett v.

4
“‘Credible evidence is the quality of evidence which, after critical analysis,
the court would find sufficient upon which to base a decision on the issue if no
contrary evidence were submitted (without regard to the judicial presumption of IRS
correctness).’” Higbee v. Commissioner, 116 T.C. 438, 442 (2001) (quoting H.R.
Conf. Rept. No. 105-599, at 240-241 (1998), 1998–3 C.B. 747, 994-995).
5
The term “Secretary” means the Secretary of the Treasury or his delegate.
Sec. 7701(a)(11)(B).
 - 10 -

[*10] Commissioner, 394 F.3d 1030, 1039 (8th Cir. 2005), aff’g T.C. Memo.

2003-212; Knudsen v. Commissioner, 131 T.C. 185, 188-189 (2008).

II. Whether Sternett Motorsports Was Operated for Profit

A. Section 183 Generally

A taxpayer who is carrying on a trade or business may deduct ordinary and

necessary expenses incurred in connection with the operation of the business. Sec.

162(a). However, a taxpayer generally may not deduct expenses incurred in

connection with a hobby or other nonprofit activity to offset taxable income from

other sources. Sec. 183(a) and (b). 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.” An activity constitutes a “trade or business” within the

meaning of section 162 if it is conducted with continuity, regularity, and for the

primary purpose of realizing income or profit. Commissioner v. Groetzinger, 480

U.S. 23, 35 (1987). The U.S. Court of Appeals for the Eighth Circuit, to which an

appeal in this case would lie absent a stipulation to the contrary, see sec.

7482(b)(1)(A), (2), has stated that “[a]n activity is engaged in for profit if the

taxpayer has an actual, honest profit objective, even if it is unreasonable or

unrealistic.” Keating v. Commissioner, 544 F.3d 900, 904 (8th Cir. 2008), aff’g
 - 11 -

[*11] T.C. Memo. 2007-309; see also sec. 1.183-2(a), Income Tax Regs. Whether

the requisite profit objective exists is determined by looking at all the facts and

circumstances, Evans v. Commissioner, 908 F.2d 369, 373 (8th Cir. 1990), rev’g

T.C. Memo. 1988-468; sec. 1.183-2(a), Income Tax Regs., and greater weight is

given to objective facts than to a taxpayer’s statement of intent, Thomas v.

Commissioner, 84 T.C. 1244, 1269 (1985), aff’d, 792 F.2d 1256 (4th Cir. 1986);

sec. 1.183-2(a), Income Tax Regs.

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

considered in the evaluation of 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 in

value; (5) the success of the taxpayer in carrying on 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. This list is

nonexclusive, and the number of factors for or against the taxpayer is not

necessarily determinative. Rather, all facts and circumstances must be taken into

account, and more weight may be given to some factors than to others. See Dunn
 - 12 -

[*12] v. Commissioner, 70 T.C. 715, 720 (1978), aff’d, 615 F.2d 578 (2d Cir.

1980); sec. 1.183-2(b), Income Tax Regs.

B. Petitioner’s Racing Activity

We apply the factors listed in section 1.183-2(b), Income Tax Regs., as

follows.

1. The Manner in Which Petitioner Conducted the Activity

In deciding whether a taxpayer has conducted an activity in a businesslike

manner we consider whether the taxpayer: (1) maintained complete and accurate

books and records; (2) conducted the activity in a manner substantially similar to

other activities of the same nature that were profitable; and (3) changed operating

methods, adopted new techniques, or abandoned unprofitable methods in a manner

consistent with an intent to improve profitability. See Engdahl v. Commissioner, 72

T.C. 659, 666-668 (1979); sec. 1.183-2(b)(1), Income Tax Regs.

Petitioner contends that he operated Sernett Motorsports in a businesslike

manner by (1) investing heavily in capital assets, (2) analyzing his performance

after each season, (3) consulting with various advisers, (4) racing only in races

offering significant prize money, (5) maintaining accurate records, and (6)

maintaining a separate checking account for Sernett Motorsports. Respondent

contends that Sernett Motorsports was not operated in a businesslike manner
 - 13 -

[*13] because petitioner (1) failed to maintain comprehensive books and records for

evaluating his racing activity, (2) lacked a written or credible business plan, (3)

commingled his personal funds with his business funds in Sernett Motorsports’

checking account, and (4) failed to take steps to reduce costs or to increase

profitability.

Although petitioner invested heavily in capital assets, such investment is

consistent with respondent’s theory that petitioner’s racing activity was simply an

expensive hobby. Petitioner kept accurate records, but he seemingly did so to

satisfy the Code’s recordkeeping requirements rather than as a tool to achieve

profitability. See Golanty v. Commissioner, 72 T.C. 411, 430 (1979), aff’d without

published opinion, 647 F.2d 170 (9th Cir. 1981); Nissley v. Commissioner, T.C.

Memo. 2000-178, 79 T.C.M. (CCH) 2105, 2110 (2000). Similarly, petitioner

testified that he consulted with his C.P.A. regarding various tax matters but he could

not testify with specificity regarding any financial advice that his C.P.A. may have

provided. We find, however, that there is no indication that he commingled his

personal funds with those of his racing activity.

Petitioner obtained marketing materials from a professional design firm to

help secure corporate sponsorships for Sernett Motorsports. These materials

indicate that he operated Sernett Motorsports in a businesslike manner.
 - 14 -

[*14] Petitioner did not have a written business plan during the years in issue.

Petitioner’s lack of a written business plan indicates that he did not operate Sernett

Motorsports in a businesslike manner.

We find credible petitioner’s testimony that he tried to minimize expenses and

maximize his chances of winning races. However, this is also consistent with

respondent’s theory that petitioner’s racing activity was an expensive hobby. Sprint

car racing is a competitive sport, and petitioner, no doubt, did whatever he could to

win races and minimize his expenses.

In short, petitioner conducted Sernett Motorsports in a manner consistent

both with the operation of a profit-seeking enterprise and with the enjoyment of an

expensive hobby. Accordingly, this factor is neutral.

2. The Expertise of Petitioner or His Advisers

Preparation for an activity by an extensive study of its accepted business,

economic, and scientific practices, or consultation with those who are experts

therein, may indicate a profit objective. Engdahl v. Commissioner, 72 T.C. at 668;

sec. 1.183-2(b)(2), Income Tax Regs. Efforts to gain experience and a willingness

to follow expert advice may also indicate a profit objective. See, e.g., Dworshak v.

Commissioner, T.C. Memo. 2004-249, 88 T.C.M. (CCH) 403, 406 (2004).
 - 15 -

[*15] Petitioner contends that his expertise and the expertise of those with whom he

consulted are indicative of a profit motive. Respondent contends that petitioner

lacked expertise with respect to creating a profitable racing enterprise and failed to

seek advice from experts on making Sernett Motorsports profitable.

Petitioner has a bachelor’s degree in business administration from Creighton

University and is a successful salesperson. He managed a racing team for C.L.

Boyd during the early 1980s and raced sprint cars for others for 15 years before

starting his own sprint car racing activity. Since then petitioner has been racing for

and managing Sernett Motorsports. Petitioner regularly consulted with a close

network of sprint car racing enthusiasts, frequented racing supply shops, and

attended the Performance Racing Industry Trade Show in Orlando, Florida. We are

satisfied that petitioner had the requisite expertise to run a sprint car racing business.

Accordingly, this factor favors petitioner.

3. Petitioner’s Time and Effort Devoted to the Activity

The fact that a taxpayer devotes personal time and effort to carry on an

activity may indicate an intention to derive a profit, particularly where there are no

substantial personal or recreational elements associated with the activity. Sec.

1.183-2(b)(3), Income Tax Regs.
 - 16 -

[*16] Petitioner contends that he spent significant time racing and preparing to race

and reduced the hours he worked for NACR during the racing season. Respondent

contends that petitioner’s testimony with respect to the amount of time he spent on

his racing activity is uncorroborated and self-serving and that it is anyway

insufficient to show that his racing activity was conducted with a profit motive.

Petitioner credibly testified that he spent 15-20 hours during the week before

a racing event preparing for the event. Petitioner explained that he disassembled the

cars after each race and then cleaned, inspected, and replaced various parts, as

required. He credibly testified that, during the years in issue, he raced between 10

and 16 weekends per racing season6 and that he traveled to events up to five hours

away from his shop in Lakeville, Minnesota. Petitioner also credibly testified that

he reduced the number of hours that he spent working for NACR from 40-50 per

week during the off-season to 20-25 per week during the racing season.

Although, as we find infra pp. 26-27, petitioner enjoys racing, we find that

petitioner also spent significant personal time and effort preparing his cars for

6
Petitioner’s records show that he raced on 6, 18, and 10 weekends in 2005,
2006, and 2007, respectively.
 - 17 -

[*17] racing events. See Foster v. Commissioner, T.C. Memo. 2012-207, slip op. at

18. Additionally, petitioner significantly reduced the hours he spent working his

lucrative, fully commissioned job for NACR so that he could prepare his cars for

racing events. Accordingly, this factor favors petitioner.

4. Expectation That Assets Used in the Activity May Appreciate

An activity may produce an overall economic profit, even if there is no

operational profit, when appreciation of the assets of the activity is taken into

account. Sec. 1.183-2(b)(4), Income Tax Regs.

Petitioner contends that his equipment should not have to appreciate for him

to show a profit motive. Respondent contends that petitioner introduced no

evidence that his equipment appreciated, and the record supports an inference that

petitioner’s equipment was not appreciating.

Petitioner has introduced no evidence that any of his racing equipment or

assets appreciated. See Rule 142(a)(1). However, the absence of asset

appreciation does not indicate that petitioner lacked a profit motive. See Foster v.

Commissioner, slip op. at 19. Accordingly, this factor is neutral.
 - 18 -

[*18] 5. Success in Carrying On Similar or Dissimilar Activities

The fact that a taxpayer engaged in similar activities and converted them from

unprofitable to profitable enterprises may indicate that the taxpayer is engaged in the

present activity for a profit, even though the activity is presently unprofitable. Sec.

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

To support his contention that he had success in carrying on similar activities,

petitioner merely points to his experience in the racing industry. Respondent

contends that petitioner produced no evidence showing that he successfully operated

similar activities.

Petitioner has introduced no evidence showing that he engaged in similar

activities and converted them from unprofitable to profitable enterprises. See Rule

142(a)(1). Accordingly, this factor is neutral. See Pirnia v. Commissioner, T.C.

Memo. 1989-627, 58 T.C.M. (CCH) 740, 743 (1989).

6. Petitioner’s History of Income or Loss From the Activity

A taxpayer’s history of income or loss with respect to an activity may

indicate the presence or absence of a profit objective. See Golanty v.

Commissioner, 72 T.C. at 426; sec. 1.183-2(b)(6), Income Tax Regs. However, a

series of startup losses or losses sustained because of unforeseen circumstances

beyond the control of the taxpayer does not necessarily indicate a lack of profit
 - 19 -

[*19] motive. Engdahl v. Commissioner, 72 T.C. at 669; Kahla v. Commissioner,

T.C. Memo. 2000-127, 79 T.C.M. (CCH) 1846, 1852 (2000), aff’d without

published opinion, 273 F.3d 1096 (5th Cir. 2001); sec. 1.183-2(b)(6), Income Tax

Regs.

Respondent contends that (1) petitioner’s racing activity has produced

persistent and significant losses since 1992 and (2) petitioner’s use of his racing

activity to boost his sales performance with NACR contradicts his claim of a profit

motive for his racing activity.

Sernett Motorsports lost money from 1992 through 2009. From 2000 through

2007 Sernett Motorsports had gross receipts of $199,963, total expenses of

$770,677, and total losses of $570,714. This history of significant, sustained losses

is persuasive evidence that petitioner did not operate Sernett Motorsports with a

profit motive. See Golanty v. Commissioner, 72 T.C. at 427.7

7
Petitioner’s returns show that Sernett Motorsports suffered losses of $46,160
and $19,956 for 2008 and 2009, respectively, and earned a profit of $7,360 for
2010. However, we give less weight to the reduced losses for 2008-09 and the
small profit for 2010 because the returns for 2008-09 were filed after respondent
began examining petitioner’s 2005-07 returns and the return for 2010 was filed after
the petition was filed in this case. See Easter v. Commissioner, T.C. Memo.
1992-188, 63 T.C.M. (CCH) 2590, 2593, 2595 (1992).
 - 20 -

[*20] To rebut this evidence petitioner points to his success as a salesperson for

NACR, arguing that some of this success is attributable to his operation of Sernett

Motorsports.8

Petitioner credibly testified that part of his success as a salesperson was

attributable to his operation of Sernett Motorsports. Petitioner explained that he

used Sernett Motorsports as a “marketing, promotional, bonding vehicle” and that

he used the racing activity to build long-term relationships with his telephone

equipment buyers. Petitioner introduced emails showing that he used Sernett

Motorsports as a marketing tool, and NACR’s president and CEO, Thomas M.

Roles, wrote in a letter dated April 29, 2008, that “Sernett Motorsports has a direct

contribution to * * * success in the telephone equipment business from a marketing

standpoint and is an important part of his overall success as a sales representative”.

We therefore find that petitioner continued operating Sernett Motorsports, at least in

part, because Sernett Motorsports helped him succeed in his job as a salesperson for

NACR.

Although Sernett Motorsports may have increased petitioner’s income from

NACR, the significant, sustained losses that it produced indicate that petitioner did

8
The parties stipulated that petitioner’s 35% commission rate with NACR
was not contingent upon his operation of Sernett Motorsports.
 - 21 -

[*21] not operate Sernett Motorsports with a profit motive. See Morken v.

Commissioner, T.C. Memo. 1986-535, 52 T.C.M. (CCH) 969, 972 (1986). To the

contrary, petitioner’s belief that his racing activity increased his income from NACR

lessened his concern about his losses from Sernett Motorsports. See id.9 Moreover,

petitioner’s generalized belief that his racing activity helped increase his income as a

salesperson is insufficient to overcome the objective evidence of significant,

sustained losses from 1992 through 2009, particularly when petitioner could not

quantify the effect of the racing activity on his commission income.

Petitioner does not contend, and the record does not suggest, that Sernett

Motorsports’ significant, sustained losses were startup losses or losses sustained

because of unforeseen circumstances beyond his control. Accordingly, this factor

favors respondent.

7. Amount of Occasional Profits

The amount of profits earned in relation to the amount of losses incurred,

the amount of the investment, and the value of the assets in use may indicate a

profit objective. See sec. 1.183-2(b)(7), Income Tax Regs. The opportunity to

earn substantial profits in a highly speculative venture may be sufficient to

9
Petitioner does not argue that his racing activity and his sales activity were
one activity within the meaning of sec. 1.183-1(d)(1), Income Tax Regs.
 - 22 -

[*22] indicate that the activity is engaged in for profit even though only losses are

produced. See id.

Petitioner contends that he had opportunities to earn significant profit from

prize money and sponsorship contracts. Respondent contends that petitioner’s

claimed expectations for earning significant profit were unrealistic.

a. Prize Money

Sernett Motorsports earned $31,430 in prize money during the years in issue.

The $15,000 purse structure that petitioner typically raced for had a top prize of

$2,250 and a second prize of $1,750. Petitioner testified that, had he placed higher

in the events, he could have earned between $225,000 and $350,000 in prize money

during the years in issue.10 However, petitioner testified that, before the years in

issue, he raced in the Knoxville Nationals for a top prize of $140,000 but that he had

stopped racing in that event because he did not feel that he was “competitive enough

to make money at that event.” Petitioner also testified at trial, in March 2012, that

he expected to earn prize money of approximately $25,000 in 2012.

10
Petitioner raced in 10, 21, and 16 events in 2005, 2006, and 2007,
respectively. Even if petitioner’s cars had finished first and second in each event, he
would have earned only $188,000 during the years in issue.
 - 23 -

[*23] As petitioner’s reason for not competing in the Knoxville Nationals during the

years in issue and petitioner’s more modest expectations for the then-upcoming

2012 racing season show, petitioner is capable of rationally judging his

competitiveness. Additionally, we find that petitioner could not have rationally

expected that Sernett Motorsports would earn significantly more prize money than it

earned during the years in issue.

b. Sponsorships

Sernett Motorsports earned $6,050 in corporate sponsorships from two local

businesses during the years in issue. Petitioner testified that he also sought more

lucrative sponsorships but was ultimately unsuccessful. Petitioner testified with

some detail regarding two of his proposals.

With respect to the first proposal, petitioner testified that he pursued a

$125,000, three-year sponsorship from Tires Plus in May 2004. Petitioner further

testified that he believed that he had a good chance of obtaining the sponsorship

from Tires Plus and that the proposal was dropped when Bridgestone acquired

Tires Plus in fall 2004. However, in a summary of his solicitations of corporate

sponsorships for Sernett Motorsports, petitioner wrote that he met with Tires Plus

in April 2003. Additionally, the written proposal for the sponsorship from Tires

Plus states that petitioner was then employed as a national account manager for
 - 24 -

[*24] Progressive, and NACR acquired Progressive in 2003. The written proposal

also states that petitioner had 25 years of racing experience. Petitioner started

racing in 1975, giving him 25 years experience by 2000. The proposal also has

several dated quotes, and all of them predate 2000.11 Accordingly, although we are

satisfied that petitioner proposed a sponsorship to Tires Plus, the record does not

reliably establish when this proposal was made.

With respect to the second proposal, petitioner testified that he pitched a

corporate sponsorship proposal to Jack Links in Laurens, Iowa, in September 2005.

The division manager at Jack Links, Karl Paepke, was impressed and arranged for

petitioner to meet with Jack Links’ marketing director, Peachy Hall, in Minong,

Wisconsin, in May 2006. Jack Links ultimately decided not to sponsor Sernett

Motorsports because Sernett Motorsports’ demographics did not correspond with

Jack Links’ target demographics at the time. Petitioner did not testify regarding the

terms of the proposed Jack Links sponsorship.

11
We also note, pursuant to Fed. R. Evid. 201(c)(1), that Bridgestone
Americas, Inc., then Bridgestone/Firestone, Inc., purchased a controlling stake in
Morgan Tire & Auto, Inc. (Morgan), in August 2001. See “Bridgestone/Firestone,
Inc. Announces Strategic Alliance With Morgan Tire & Auto”, Bridgestone, The
Americas, Media Center (Aug. 9, 2001),
http://www.bridgestoneamericas.com/news/news_index.asp?id=2001/010809a (last
visited Oct. 15, 2012). Under the terms of Morgan’s agreement with Bridgestone,
Morgan agreed to rename its retail centers “Tires Plus”. See id.
 - 25 -

[*25] We note that even if petitioner had secured a three-year sponsorship along

the lines of the unsuccessful Tires Plus proposal for the years in issue, Sernett

Motorsports would still have lost money. There is no credible evidence in the

record that any of petitioner’s other proposals would have brought Sernett

Motorsports close to returning a profit. Accordingly, we find that there was little or

no likelihood that Sernett Motorsports would earn significantly more sponsorship

money than it earned during the years in issue.

Because there is no credible evidence that the substantial losses sustained by

Sernett Motorsports were likely to be offset by greater amounts of prize money and

sponsorship income during the years in issue, this factor favors respondent.

8. Petitioner’s Financial Status

The fact that a taxpayer does not have substantial income or capital from

sources other than the activity in question may indicate that the activity is engaged

in for profit. See sec. 1.183-2(b)(8), Income Tax Regs. Substantial income from

sources other than the activity (especially if the losses from the activity would

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

where elements of personal pleasure or recreation are involved. See id.

Petitioner contends that his success selling telecommunications equipment

for NACR depends on his involvement with Sernett Motorsports and sprint car
 - 26 -

[*26] racing. Respondent contends that petitioner’s financial status indicates that he

did not operate Sernett Motorsports with a profit motive because he received

significant compensation from his employment with NACR during the years in issue

and Sernett Motorsports’ losses generated large tax savings.

During the years in issue, petitioner earned a significant income as a fully

commissioned salesperson for NACR. The losses petitioner incurred from operating

Sernett Motorsports provided substantial tax benefits. And, as we find infra pp. 26-

27, petitioner enjoyed racing. Accordingly, this factor favors respondent.

9. Elements of Personal Pleasure or Recreation

The existence of personal pleasure or recreation relating to an activity may

indicate the absence of a profit objective. See sec. 1.183-2(b)(9), Income Tax Regs.

However, an activity is not treated as an activity not engaged in for profit merely

because the activity may have recreational or pleasurable elements. Id.

Petitioner contends that he no longer enjoys racing as he once did and that he

raced solely for profit during the years in issue. Respondent contends that the

record shows that petitioner’s lifelong involvement in sprint car racing is motivated,

not by a desire to make a profit, but by his love of the sport.
 - 27 -

[*27] Petitioner testified that maintaining his cars has become a chore and that “the

thrill is basically gone”. Petitioner further testified that he continues racing because

“it makes me money”. We do not find petitioner’s self-serving, uncorroborated

testimony to be credible. See Tokarski v. Commissioner, 87 T.C. 74, 77 (1986).

Accordingly, this factor favors respondent.

10. Conclusion

Of the nine factors listed in section 1.183-2(b), Income Tax Regs., four favor

respondent, two favor petitioner, and three are neutral. Because Sernett

Motorsports was a mature activity during the years in issue, we place particular

emphasis in our analysis on its history of significant, sustained losses and on

petitioner’s inability to reduce Sernett Motorsports’ expenses or increase its income.

See Golanty v. Commissioner, 72 T.C. at 427 (history of sustained losses is

persuasive evidence of activity not entered into with profit motive). After

considering the factors, and the facts and circumstances of this case, we conclude

that petitioner did not have an actual, honest profit objective in operating Sernett

Motorsports during the years in issue. Accordingly, petitioner’s deductions for

expenses incurred with respect to Sernett Motorsports are subject to the limitations

of section 183.
 - 28 -

[*28] We have considered the parties’ remaining arguments, and to the extent not

discussed above, conclude those arguments are irrelevant, moot, or without merit.

To reflect the foregoing and respondent’s concession,

Decision will be entered

under Rule 155.