T.C. Summary Opinion 2013-35
UNITED STATES TAX COURT
SAL A. WESTRICH, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 24926-10S. Filed May 7, 2013.
Sal A. Westrich, pro se.
David J. Neuman, for respondent.
SUMMARY OPINION
VASQUEZ, Judge: This case was heard pursuant to the provisions of
section 7463 of the Internal Revenue Code (Code) in effect when the petition was
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filed.1 Pursuant to section 7463(b), the decision to be entered is not reviewable by
any other court, and this opinion shall not be treated as precedent for any other
case.
Respondent determined deficiencies in petitioner’s Federal income tax for
2007 and 2008 of $14,914 and $9,530, respectively, and accuracy-related penalties
under section 6662(a) of $2,983 and $1,906, respectively. The issues for decision
are: (1) whether petitioner is entitled to deductions arising from his research and
writing activity claimed on his Schedules C, Profit or Loss From Business, and (2)
whether petitioner is liable for accuracy-related penalties under section 6662(a).
Background
Some of the facts have been deemed stipulated under Rule 91(f) and are so
found. The stipulated facts and the accompanying exhibits are incorporated herein
by this reference. Petitioner resided in New York at the time the petition was
filed.
Petitioner was born in France and became a U.S. citizen in 1953. Since
1959 petitioner has been a professor of modern history at the Pratt Institute in
Brooklyn, New York. In 2000 petitioner began receiving retirement benefits from
1
Unless otherwise indicated, all section references are to the Code in effect
for the years in issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure. Amounts are rounded to the nearest dollar.
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the Pratt Institute and Social Security benefits. Petitioner was eligible to retire in
2000 but did not; instead he switched to teaching “half time” so could devote more
time to his research and writing activity.2
The subject matter of petitioner’s research and writing activity was
“French”, and he frequently traveled to France in connection therewith. Petitioner
initially focused on writing plays. One of his plays was produced in 2004, and
another had a public reading. However, petitioner did not realize any income from
these plays or any other plays he wrote. At some point petitioner decided he had
been “overly optimistic” regarding the potential success of writing plays and
switched to writing historical studies. However, as with the plays, petitioner did
not realize any income from the historical studies.3 Petitioner did not consult with
any accounting or financial advisers regarding his research and writing activity.
2
Before 2000 petitioner had some writing experience. In 1972 petitioner
published a book titled “The Ormée of Bordeaux: A Revolution During the
Fronde.” In 1985 he earned approximately $300 from publishing an essay about
the Holocaust, sometime in the early 1990s he earned approximately $200 from
publishing “The History of Basque Architecture” in Architecture Magazine, and
sometime in the late 1990s he earned $1,000 from an essay about Vincent Van
Gogh.
3
In 2010 petitioner received a contract from the History Press to write a
book titled “The Wines of New Jersey”. Petitioner finished the book around
October 2012. Although petitioner is “very optimistic” about the commercial
returns, he did not introduce any evidence regarding how much income he expects
to earn from the book.
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For 2000 through 2008 petitioner attached Schedules C to his Federal
income tax returns, which stated his principal business was “research-writer”.
Petitioner reported losses each year and never reported any business gross receipts
or income. All of the losses related to expenses for petitioner’s trips to France.
Petitioner characterized the expenses as “basically * * * living expenses.” The
expenses included renting a house in France and hiring a typist, a driver, and
someone to clean the house. Petitioner did not maintain any books or records of
these expenses.
On his Schedules C for 2007 and 2008 petitioner reported losses of $59,564
and $37,419, respectively.4 In 2007 petitioner reported wages of $52,707, annuity
income of $52,582,5 and taxable Social Security benefits of $16,162, resulting in
total taxable income of $121,451. In 2008 petitioner reported wages of $72,189
and taxable Social Security benefits of $22,296, resulting in total taxable income
of $94,485.
4
On his Schedules C for 2005 and 2006 petitioner reported losses of
$62,870 and $61,962, respectively. The record does not contain any evidence on
the amounts of losses incurred in 2000 through 2004.
5
From 1997 to 2007 petitioner received a $52,582 annuity payment each
year.
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Discussion
I. Petitioner’s Research and Writing Activity
Respondent argues that petitioner is not entitled to the loss deductions he
claimed on his Schedules C for the years at issue because his research and writing
activity was not engaged in for profit. Petitioner claims that he engaged in the
research and writing activity with an intent to realize profit. A taxpayer may not
fully deduct expenses regarding an activity under section 162 or 212 if the activity
is not engaged in for profit. Sec. 183(a), (c); see also Keanini v. Commissioner,
94 T.C. 41, 45 (1990). Under section 183(a), if an activity is not engaged in for
profit, no deduction attributable to that activity is allowed except to the extent
provided by section 183(b). In relevant part, section 183(b) allows deductions that
would have been allowable had the activity been engaged in for profit but only to
the extent of gross income derived from the activity (reduced by deductions
attributable to the activity that are allowable without regard to whether the activity
was 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.” For expenses to be fully deductible under section 162 or 212,
taxpayers must show that they engaged in the activity with the primary objective
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of making a profit. See Westbrook v. Commissioner, 68 F.3d 868, 875 (5th Cir.
1995), aff’g per curiam T.C. Memo. 1993-634; see also Foster v. Commissioner,
T.C. Memo. 2012-207.
The expectation of profit need not be reasonable, but the taxpayer must
conduct the activity with the actual and honest objective of making a profit.
Keating v. Commissioner, 544 F.3d 900, 904 (8th Cir. 2008), aff’g T.C. Memo.
2007-309. We give greater weight to objective facts than to the taxpayer’s
statement of intent. Sec. 1.183-2(a), Income Tax Regs.; see also Keating v.
Commissioner, 544 F.3d at 904. Evidence from years after the years in issue is
relevant to the extent it creates inferences regarding the taxpayer’s requisite profit
objective in earlier years. E.g., Foster v. Commissioner, T.C. Memo. 2012-207;
Bronson v. Commissioner, T.C. Memo. 2012-17.
Generally, a taxpayer bears the burden of proving that the requisite profit
objective exists. Westbrook v. Commissioner, 68 F.3d at 876; see also Rule
142(a); Foster v. Commissioner, T.C. Memo. 2012-207. In order to shift the
burden, the taxpayer, among other things, must introduce credible evidence with
respect to that issue. Sec. 7491(a)(1); see also Higbee v. Commissioner, 116 T.C.
438, 441 (2001). Credible evidence is evidence the Court would find sufficient
upon which to base a decision on the issue in favor of the taxpayer if no contrary
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evidence were submitted. Rendall v. Commissioner, T.C. Memo. 2006-174, aff’d,
535 F.3d 1221 (10th Cir. 2008); see also Higbee v. Commissioner, 116 T.C. at
442-443. As discussed below, petitioner failed to provide evidence for several of
the factors the Court considers in determining whether he had a profit objective. If
we were to consider solely the evidence petitioner presented, we would find as a
matter of fact that he did not engage in the research and writing activity for profit.
Therefore, petitioner failed to provide credible evidence within the meaning of
section 7491(a)(1), and the burden of proof remains with him.
Section 1.183-2(b), Income Tax Regs., provides a nonexhaustive list of the
following nine factors to be considered in determining whether an activity is
engaged in for profit: (1) whether the taxpayer carries on the activity in a
businesslike manner; (2) the expertise of the taxpayer and his or her advisers; (3)
the time and effort expended by the taxpayer in carrying on the activity; (4)
whether the taxpayer expects that the assets used in the activity might appreciate
in value; (5) whether the taxpayer has had success carrying on other similar
activities; (6) the taxpayer’s history of income or losses with respect to the
activity; (7) the amount of occasional profits, if any, which are earned; (8) the
taxpayer’s financial status; and (9) elements of personal pleasure or recreation.
All facts and circumstances are to be taken into account, and no single factor is
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determinative. Sec. 1.183-2(b), Income Tax Regs.; see also Keating v.
Commissioner, 544 F.3d at 904.
A. Manner in Which Petitioner Carried On the Activity
Section 1.183-2(b)(1), Income Tax Regs., provides that carrying on an
activity in a businesslike manner may be indicative of a profit objective. The
regulation further identifies three practices consistent with businesslike
operations: (1) maintaining complete and accurate books and records; (2)
conducting the activity in a manner substantially similar to that of profitable
businesses of the same nature; and (3) changing operational methods and
techniques to improve profitability. See id. The Tax Court has found establishing
a business plan to be a fourth practice evidencing businesslike operations. See
Sanders v. Commissioner, T.C. Memo. 1999-208; see also Dodds v.
Commissioner, T.C. Memo. 2013-76, at *13-*14.
Petitioner did not introduce any evidence of a business plan. He did not
maintain any financial books or ledgers for his research and writing activity.
Furthermore, petitioner commingled the financial affairs of his research and
writing activity with his personal finances. This commingling of personal and
activity funds is not indicative of businesslike practices. See Montagne v.
Commissioner, T.C. Memo. 2004-252, aff’d, 166 Fed. Appx. 265 (8th Cir. 2006).
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Perhaps the most important indication of whether an activity is being
performed in a businesslike manner is whether the taxpayer implements methods
for controlling losses, including efforts to reduce expenses and generate income.
See Foster v. Commissioner, T.C. Memo. 2012-207; Dodge v. Commissioner, T.C.
Memo. 1998-89, aff’d without published opinion, 188 F.3d 507 (6th Cir. 1999).
Petitioner provided no evidence showing that he tried to reduce his expenses or
implemented any cost-cutting measures. Rather, petitioner reported losses each
year.
Petitioner’s failure to produce any income was a key factor in his failure to
earn a profit. See Foster v. Commissioner, T.C. Memo. 2012-207; Dodge v.
Commissioner, T.C. Memo. 1998-89. Petitioner alleges that he stopped writing
plays and started writing historical studies in an attempt to improve profitability.
However, petitioner did not produce any evidence demonstrating that he made a
careful and thorough investigation of the potential profitability of this change
before making it. See Foster v. Commissioner, T.C. Memo. 2012-207 (citing
Taube v. Commissioner, 88 T.C. 464, 481 (1987)). This factor weighs against
finding petitioner’s research and writing activity was engaged in for profit.
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B. Expertise of Petitioner or His Advisers
A taxpayer’s expertise, research, and study of an activity, as well as his
consultation with experts, may be indicative of a profit intent. Sec. 1.183-2(b)(2),
Income Tax Regs. Taxpayers should not only familiarize themselves with the
undertaking, but should also consult or employ an expert, if needed, for advice on
how to make the operation profitable. Burger v. Commissioner, 809 F.2d 355, 359
(7th Cir. 1987), aff’g T.C. Memo. 1985-523. Courts have made clear that the
focus is upon expertise and preparation with regard to the economic aspects of the
particular business. Wesinger v. Commissioner, T.C. Memo. 1999-372 (citing
Golanty v. Commissioner, 72 T.C. 411, 432 (1979), aff’d without published
opinion, 647 F.2d 170 (9th Cir. 1981)).
When petitioner began his research and writing activity, he had more than
40 years of experience as a history professor. Thus, we find he had subject matter
expertise with respect to his historical studies projects. Petitioner also had some
limited prior experience with publishing his work. However, petitioner did not
establish that this limited experience provided him with any expertise on how to
make his research and writing activity a profitable venture. Moreover, despite
incurring significant losses and earning no income, petitioner never solicited the
aid of any professional business advisers. Because petitioner lacked expertise
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with respect to the economic aspects of his research and writing activity, this
factor weighs against finding petitioner’s research and writing activity was
engaged in for profit.
C. Time and Effort Expended
The fact that a taxpayer spends much time and effort in conducting an
activity may indicate that he or she has a profit objective, particularly if the
activity does not have substantial personal or recreational aspects. Sec. 1.183-
2(b)(3), Income Tax Regs.
Petitioner testified that he stopped teaching full time in 2000 so that he
could devote time to his research and writing activity, and he asserts on brief that
the creative process is “enormously time-consuming”. However, petitioner
presented no evidence regarding how much time and effort he actually spent on
his research and writing activity. This factor weighs against finding petitioner’s
research and writing activity was engaged in for profit.
D. Expectation That Assets Used in the Activity May Appreciate in Value
The expectation that assets used in the activity will appreciate in value
sufficiently to lead to an overall profit when netted against losses may indicate a
profit motive. Sec. 1.183-2(b)(4), Income Tax Regs. Petitioner had no assets
devoted to the research and writing activity. This factor is neutral.
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E. Success in Similar or Dissimilar Activities
If a taxpayer has previously engaged in similar activities and made them
profitable, this success may show that the taxpayer has a profit objective, even
though the activity is presently unprofitable. Sec. 1.183-2(b)(5), Income Tax
Regs. Success in unrelated activities may also be indicative of a profit objective in
the challenged activity. See Daugherty v. Commissioner, T.C. Memo. 1983-188
(finding that a taxpayer who started and maintained a profitable screws product
company had reason to believe he would be successful in a farming activity).
Conversely, a lack of such experience does not necessarily indicate the activity
was not engaged in with the objective of making a profit. Arwood v.
Commissioner, T.C. Memo. 1993-352.
Petitioner has not shown that his prior writing activities were profitable.
Petitioner’s publications before 2000 were sporadic and earned only limited
income. Thus, we cannot find, on the basis of petitioner’s prior writing
experience, that he engaged in the research and writing activity for profit.
However, we reject respondent’s argument that because petitioner earned so little
income from his prior publications, he knew that his researching and writing
activity would not be profitable. Instead, we find this factor to be neutral.
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F. History of Income or Loss
A taxpayer’s history of income or loss with respect to an activity may
indicate the presence or absence of a profit objective. Sec. 1.183-2(b)(6), Income
Tax Regs.; see also Golanty v. Commissioner, 72 T.C. at 426. A series of losses
during the startup phase of an activity does not necessarily indicate the activity is
not engaged in for profit. Sec. 1.183-2(b)(6), Income Tax Regs. But where losses
continue to be sustained beyond the customary startup period, that may be an
indication the activity is not engaged in for profit. Id.
Petitioner incurred losses each year of his research and writing activity, and
has never earned any income from it. Petitioner argues, however, that the activity
was still in its startup phase during the years at issue. While we appreciate that it
can take a writer many years to produce a play or a book, petitioner has provided
no evidence to support a finding that he was in a startup phase. Petitioner has
offered no evidence regarding what projects he was working on during these
alleged startup years; thus, we do not know whether petitioner spent several years
writing one work or started and stopped a new project every few months. Without
such information, we cannot conclude that petitioner was in the startup period for
eight years.
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Moreover, petitioner continued to travel to France and incur substantial
losses despite never earning any income. Petitioner’s continued spending of tens
of thousands of dollars on his research and writing activity despite substantial
losses and no income suggests the activity was not carried on for profit. This
factor weighs against finding petitioner’s research and writing activity was
engaged in for profit.
G. Amount of Occasional Profits
The amount of any occasional profits the taxpayer earned from the activity
may show that the taxpayer had a profit motive. See sec. 1.183-2(b)(7), Income
Tax Regs. An occasional small profit from an activity generating large losses or
from an activity in which the taxpayer has made a large investment would not
generally be determinative that the activity is engaged in for profit. Id. In
addition, “A small chance to make a large profit may indicate that a taxpayer has a
profit objective even if he or she has large continuous losses.” Lundquist v.
Commissioner, T.C. Memo. 1999-83, slip op. at 27 (citing section 1.183-2(b)(7),
Income Tax Regs.), aff’d without published opinion, 211 F.3d 600 (11th Cir.
2000).
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Between the time he started his research and writing activity in 2000 and the
years in issue,6 petitioner had never earned a profit. Petitioner argues that he is
“involved in intellectual and creative work in which the returns are uncertain but
the chance of a large return is great”. However, petitioner has failed to introduce
any evidence regarding what he was writing and how much profit he expected to
earn. Without knowing petitioner’s profit expectations, it is impossible for the
Court to determine whether they were reasonable. While we understand that one
successful book could be profitable enough to justify years of losses, petitioner
has failed to show it was reasonable for him to believe he was working on a book
with enough potential economic success to justify the substantial losses he
incurred year after year.
Petitioner argues that his publishing agreement with the History Press
establishes that his expectation of profit was reasonable. However, the losses
petitioner incurred during the years at issue were not related to “The Wines of
New Jersey”. Additionally, petitioner did not introduce any evidence regarding
the expected income from this book.7 It is unknown whether the potential profit
6
No evidence was presented that petitioner earned any profit after the years
in issue.
7
The publishing agreement establishes that petitioner is to receive royalties
(continued...)
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from this publishing agreement was significant enough to offset all the losses
petitioner incurred in his research and writing activity.
This factor weighs against finding petitioner’s research and writing activity
was engaged in for profit.
H. Financial Status
Substantial income from sources other than the activity in question,
particularly if the activity’s losses generate substantial tax benefits, may indicate
that the activity is not engaged in for profit. See sec. 1.183-2(b)(8), Income Tax
Regs. Petitioner received substantial income from sources other than his research
and writing activity and derived substantial tax benefits from deducting the losses
associated with his research and writing activity. In 2007 petitioner’s loss from
his research and writing activity offset 49% of his $121,451 taxable income. In
2008 petitioner’s loss from his research and writing activity offset 40% of his
$94,485 taxable income. This factor weighs against finding petitioner’s research
and writing activity was engaged in for profit.
7
(...continued)
based upon sales of the book, but there is no evidence regarding how many books
are expected to be sold and at what price.
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I. Elements of Personal Pleasure or Recreation
Personal motives for carrying on an activity may indicate 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. Petitioner did not testify as to the
enjoyment he derived, or lack thereof, from his research and writing activity, but it
is likely that he derived at least some personal pleasure from it (and the trips to
France); otherwise he would not have continued it each year while incurring such
significant losses. See Dodds v. Commissioner, T.C. Memo. 2013-76, at *23
(questioning whether taxpayer would have continued his money-losing horse
breeding activity for 17 years if he did not receive some satisfaction from the
work). This factor is neutral.
J. Conclusion
Considering the factors discussed above, we find that petitioner’s research
and writing activity was not engaged in for profit, and the related expenses are
therefore not deductible under section 162 or 212 for any of the years at issue.
Respondent’s determination of deficiencies based on that determination is
sustained.
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II. Accuracy-Related Penalties
Pursuant to section 6662(a) and (b)(1) and (2), a taxpayer may be liable for
a penalty of 20% of the portion of an underpayment of tax due to: (1) negligence
or disregard of rules or regulations or (2) a substantial understatement of income
tax. “Negligence” is defined as any failure to make a reasonable attempt to
comply with the provisions of the Internal Revenue Code; this includes a failure to
keep adequate books and records or to substantiate items properly. Sec. 6662(c);
sec. 1.6662-3(b)(1), Income Tax Regs. Negligence has also been defined as the
failure to exercise due care or the failure to do what a reasonable person would do
under the circumstances. See Allen v. Commissioner, 92 T.C. 1, 12 (1989), aff’d,
925 F.2d 348, 353 (9th Cir. 1991); Neely v. Commissioner, 85 T.C. 934, 947
(1985). “Disregard” means any careless, reckless, or intentional disregard. Sec.
6662(c). “Understatement” means the excess of the amount of the tax required to
be shown on the return over the amount of the tax imposed which is shown on the
return, reduced by any rebate. Sec. 6662(d)(2)(A). A “substantial
understatement” of income tax is defined as an understatement of tax that exceeds
the greater of 10% of the tax required to be shown on the tax return or $5,000.
Sec. 6662(d)(1)(A). The understatement is reduced to the extent that the taxpayer
has: (1) adequately disclosed his or her position and has a reasonable basis for
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such position, or (2) has substantial authority for the tax treatment of the item.
Sec. 6662(d)(2)(B). The burden of production is on the Commissioner to produce
evidence that it is appropriate to impose the relevant penalty. See sec. 7491(c);
Higbee v. Commissioner, 116 T.C. at 446.
The understatement of income tax on petitioner’s 2007 Federal income tax
return is substantial. Furthermore, for both 2007 and 2008, petitioner’s records
were insufficient to substantiate several of his claimed deductions, and he failed to
keep adequate books and records. Accordingly, respondent has met his burden of
production. See Smith v. Commissioner, T.C. Memo. 1998-33; sec. 1.6662-
3(b)(1), Income Tax Regs.
The accuracy-related penalty is not imposed with respect to any portion of
the underpayment as to which the taxpayer shows that he or she acted with
reasonable cause and in good faith. Sec. 6664(c)(1); Higbee v. Commissioner,
116 T.C. at 448. Petitioner offered no evidence that he acted with reasonable
cause and in good faith. Accordingly, we hold that petitioner is liable for a section
6662(a) accuracy-related penalty due to negligence or disregard of rules or
regulations.
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To reflect the foregoing,
Decision will be entered
for respondent.