Kaiser v. Comm'r

T.C. Summary Opinion 2016-13

UNITED STATES TAX COURT

CHRISTOPHER H. KAISER AND LINDA L. KAISER, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 29769-13S. Filed March 21, 2016.

Christopher H. Kaiser and Linda L. Kaiser, pro sese.

Carlton W. King, for respondent.

SUMMARY OPINION

PANUTHOS, Chief Special Trial Judge: This case was heard pursuant to

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

petition was filed. 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. Unless otherwise indicated, subsequent section references are
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to the Internal Revenue Code (Code) in effect for the years in issue, and all Rule

references are to the Tax Court Rules of Practice and Procedure.

In a notice of deficiency dated September 26, 2013, respondent determined

deficiencies of $17,319 and $16,675 in petitioners’ 2010 and 2011 Federal income

tax, respectively, and accuracy-related penalties under section 6662(a) of $3,463

and $3,335 for 2010 and 2011, respectively. After concessions,1 the issues for

decision are: (1) whether Linda Kaiser’s (petitioner’s) horse training activity was

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

petitioners are liable for the accuracy-related penalties under section 6662(a) for

the years in issue.

Background

Some of the facts have been stipulated and are so found. The stipulation of

facts and the attached exhibits are incorporated herein by this reference. At the

time the petition was timely filed, petitioners resided in New Hampshire.

1
The parties agreed in the stipulation of facts to other adjustments
determined in the notice of deficiency including that: (1) petitioners had
unreported income of $1,226 for 2010 from State tax refunds; (2) petitioners are
entitled to itemized deductions for medical expenses of $14,411 and $22,312 for
2010 and 2011, respectively; and (3) petitioners are entitled to deductions for
business use of their home (the financial consulting and insurance business) for
2010 and 2011 in the amounts claimed on petitioners’ Forms 1040, U.S.
Individual Income Tax Return, for those years.
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During the taxable years in issue petitioner operated a financial consulting

and insurance business from her home. The business was identified as “Kaiser

Consulting/Insurance Sales”. Petitioner also conducted a horse training activity

known as “The Forty Carrot Wisdom Co.”.

Before the years in issue petitioner lived in Vail, Colorado. She managed a

ski shop with approximately 45 employees from 1972 through 1982. Petitioner

later moved to New Hampshire where she became involved in real estate and

insurance activities. During the 1990s petitioner was a sales manager at a

multinational financial services company.

In 2000 petitioner decided to start a personal financial planning and

insurance business, but her goal was to retire and train Hanoverian horses.

Petitioner was a competent dressage rider. Since 1998 petitioner has owned

between one and four horses. In 2005 petitioner’s first foal was able to begin

training when it was four years old.

In 2005 petitioner was in a car accident and was unable to walk or ride

horses for many months. Because of this accident, petitioner was unable to train

her first foal. Nevertheless, at her foal’s first show, the foal was named the top

horse of the breed in New England.
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In 2009 petitioner had almost completely recovered from her accident and

began riding again. Petitioner purchased a couple of carriage horses to train.

Petitioner believed that she could “make good money” selling the trained carriage

horses.

In 2010 petitioner had a more serious car accident and was bedridden for

some time. Petitioner often worked from her bed in 2010 and 2011. Petitioner

required three surgical procedures because of the two accidents. Petitioner did not

spend any time with respect to the horse training activity in 2010 and spent very

little time in the activity in 2011. Petitioner sent the horses to a professional

trainer in North Carolina during the winter months in 2010 and 2011.2 In 201l

petitioner had four horses and gave some dressage lessons. Before 2010 petitioner

had bred goats and horses. In 2010 petitioner decided that she could no longer

afford to breed the goats or horses until her income increased.

Because petitioner could not work in her horse training activity after her

second accident, in 2010 she began to create a Web site to educate children about

animals. She posted approximately 15,000 photos of her horses, goats, chickens,

and roosters to the site. Petitioner’s sister-in-law wrote stories for the Web site.

2
Petitioner initially testified that the horses were boarded in another location
because she could not care for them on account of her injuries. She later explained
that they were boarded only during the winter months for training.
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Petitioner believed that the Web site would become operational in 2016.

Petitioner estimated that the Web site will generate at least $100,000 in income in

2016.

Petitioner did not keep separate books and records for her horse training

activity but rather kept track of her horse training expenses on a notepad. At some

point petitioner had a separate checking account for her horse training activity;

however, she closed the account before the years in issue because the bank

required a minimum balance of $5,000 in the account and she wanted to avoid

bank charges.

During the years in issue petitioner tried to sell her horses, but the market

had collapsed in 2008 and no one wanted to buy them except to turn them into

horse meat. Petitioner also tried to give her horses away a couple of times, but

none of the people that she felt were competent to care for them had room in their

barns. Petitioner felt that her horses were like her “children”, and she would not

give them to anyone that she felt would not properly care for them.

Petitioners’ property, including a barn, suffered damage from flooding in

2007. Some repairs to the property were made during the years in issue.

Petitioners attributed amounts incurred for the repairs to the horse training
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activity. The damage from flooding and required repairs also hindered petitioner

from conducting her horse training activity during the years in issue.

From 2008 through 2014 the gross receipts and expenses relating to the

horse training activity, the horse and goat breeding activity, and the Web site

activity were as follows:

Year Gross receipts Expenses
2008 --- $18,456
2009 --- 17,531
2010 --- 36,276
2011 $5,000 34,230
2012 7,922 28,296
2013 7,922 24,745
2014 5,000 22,493

As indicated, petitioner also conducted a financial planning and insurance

business from her home. Petitioner employed one person in this activity.

Petitioners jointly filed Forms 1040 for the years 2010 and 2011.

Petitioners reported gross receipts from the financial planning and insurance

business of $134,746 and $164,964 respectively. For each of the tax years in issue

petitioners reported on a separate Schedule C, Profit or Loss From Business, the

losses from the horse training activity. Petitioners netted the profit from the
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financial planning and insurance business against the losses claimed from the

horse training business as “Business Income or (loss)” on the Forms 1040 for 2010

and 2011. Respondent disallowed deductions for the claimed losses from the

horse training activity. Respondent does not question substantiation of the

amounts claimed but asserts that deductions for the claimed losses should be

disallowed because the horse training activity was not engaged in for profit within

the meaning of section 183. Petitioners dispute respondent’s determination.

Discussion

In general, the Commissioner’s determination set forth in a notice of

deficiency is presumed correct, and the taxpayer bears the burden of proving

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

to section 7491(a), the burden of proof as to factual matters shifts to the

Commissioner under certain circumstances. Petitioners have not asserted that the

burden of proof should shift or presented any evidence that it should. We

conclude that petitioners have the burden of proof in this matter.

The deductibility of a taxpayer’s expenses attributable to an income-

producing activity depends upon whether that activity was engaged in for profit.

See secs. 162, 183, 212. Section 162 provides that a taxpayer who is carrying on a

trade or business may deduct ordinary and necessary expenses incurred in
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connection with the operation of the business. Section 212 provides for a

deduction for expenses paid or incurred in connection with an activity engaged in

for the production or collection of income, or for the management, conservation,

or maintenance of property held for the production of income.

Section 183(a) and (b)(2)3 specifically precludes deductions for activities

not engaged in for profit except to the extent of the gross income derived from

such activities. For example, deductions are not allowable for activities that a

taxpayer carries on primarily as a sport, as a hobby, or for recreation. Sec. 1.183-

2(a), Income Tax Regs. For a taxpayer’s expenses in an activity to be deductible

under section 162 or section 212 and not subject to the limitations of section 183,

the taxpayer must show that he engaged in the activity with an actual and honest

objective of making a profit. Hulter v. Commissioner, 91 T.C. 371, 392 (1988);

Dreicer v. Commissioner, 78 T.C. 642, 645 (1982), aff’d without published

opinion, 702 F.2d 1205 (D.C. Cir. 1983); Hastings v. Commissioner, T.C. Memo.

2002-310. Although a reasonable expectation of a profit is not required, the

taxpayer’s profit objective must be actual and honest. Dreicer v. Commissioner,

78 T.C. at 645; sec. 1.183-2(a), Income Tax Regs. Whether a taxpayer has an

3
On these facts, the expense deductions would not be allowable without
regard to whether petitioner’s horse training activity is engaged in for profit under
sec. 183(b)(1).
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actual and honest profit objective is a question of fact to be resolved from all the

relevant facts and circumstances. Hulter v. Commissioner, 91 T.C. at 393;

Hastings v. Commissioner, T.C. Memo. 2002-310; sec. 1.183-2(a), Income Tax

Regs. Greater weight is given to objective facts than to a taxpayer’s mere

statement of intent. See Dreicer v. Commissioner, 78 T.C. at 645; sec. 1.183-2(a),

Income Tax Regs. The taxpayer bears the burden of establishing the requisite

profit objective. See Rule 142(a); Keanini v. Commissioner, 94 T.C. 41, 46

(1990); Hastings v. Commissioner, T.C. Memo. 2002-310.4

Regulations promulgated under section 183 provide the following

nonexclusive list of factors which normally should be considered in determining

whether an activity was engaged in for profit: (1) the manner in which the

taxpayer carried on the activity; (2) the expertise of the taxpayer or his advisers;

(3) the time and effort expended by the taxpayer in carrying on the activity; (4) the

expectation that the assets used in the activity may appreciate in value; (5) the

success of the taxpayer in carrying on other similar or dissimilar activities; (6) the

taxpayer’s history of income or losses with respect to the activity; (7) the amount

4
Petitioner is not entitled to a presumption that her horse training activity
was engaged in for profit under sec. 183(d) for either year in issue because she has
not presented evidence that gross income from her horse training activity exceeded
deductions for any two years in the period of seven consecutive taxable years
ending with either the first or second of the years in issue.
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of occasional profits, if any, which are earned; (8) the financial status of the

taxpayer; and (9) elements of personal pleasure or recreation. Sec. 1.183-2(b),

Income Tax Regs. No single factor, nor the existence of even a majority of the

factors, is controlling, but rather it is an evaluation of all the facts and

circumstances in the case, taken as a whole, that is determinative. Golanty v.

Commissioner, 72 T.C. 411, 426-427 (1979), aff’d without published opinion, 647

F.2d 170 (9th Cir. 1981); sec. 1.183-2(b), Income Tax Regs.

This case does not warrant an exhaustive discussion of the factors listed in

the regulations. There is little evidence in this record that petitioner operated the

horse training activity in a businesslike manner. There is nothing in this record

which reflects petitioner’s business plan or how she intended to make a profit.

While petitioner may have hoped to generate income from her horse training

activity, there is no information as to how her receipts compare with her expenses.

Petitioner had years of losses generated by the horse training activity and

acknowledged that she had no gross income for 2010 and very little gross income

for 2011. She spent little if any time in the horse training activity in the years in

issue. In those same years petitioner operated her financial planning and insurance

business and generated substantial gross receipts. Petitioner used the losses of the

horse training activity to offset income from the financial planning and insurance
 - 11 -

business. Petitioner had owned horses before engaging in the horse training

activity and acknowledged that she considered her horses to be like her children.

No doubt she experienced personal pleasure in owning her horses. Petitioner had

a consistent history of little to no gross income in the horse training activity.

While petitioner clearly has some level of business acumen in the operation of her

financial planning and insurance business, she did not carry over these practices to

the horse training activity.

We are satisfied from a careful review of this record that there is not

sufficient evidence which would lead the Court to believe that petitioner engaged

in the horse training activity with the actual and honest objective of making a

profit. Respondent’s determination in this regard is sustained.

Accuracy-Related Penalty

Section 6662(a) and (b)(1) and (2) imposes a penalty of 20% of the portion

of an underpayment of tax attributable to the taxpayer’s negligence, disregard of

rules or regulations, or substantial understatement of income tax. “Negligence”

includes any failure to make a reasonable attempt to comply with the Code,

including any failure to keep adequate books and records or to substantiate items

properly. See sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs. A “substantial

understatement” is an understatement of income tax that exceeds the greater of
 - 12 -

10% of the tax required to be shown on the return or $5,000. See sec. 6662(d);

sec. 1.6662-4(b), Income Tax Regs.

The section 6662(a) accuracy-related penalty does not apply with respect to

any portion of an underpayment if the taxpayer proves that there was reasonable

cause for such portion and that he acted in good faith with respect thereto. Sec.

6664(c)(1). The determination of whether a taxpayer acted with reasonable cause

and in good faith depends on the pertinent facts and circumstances, including the

taxpayer’s efforts to assess the proper tax liability; the knowledge and the

experience of the taxpayer; and any reliance on the advice of a professional, such

as an accountant. Sec. 1.6664-4(b)(1), Income Tax Regs. Generally, the most

important factor is the taxpayer’s effort to assess the taxpayer’s proper tax

liability. Id.

The Commissioner has the burden of production under section 7491(c) with

respect to the accuracy-related penalty under section 6662. To satisfy that burden,

the Commissioner must produce sufficient evidence showing that it is appropriate

to impose the penalty. Higbee v. Commissioner, 116 T.C. 438, 446 (2001).

Respondent determined the accuracy-related penalty for each year was due to

negligence or a substantial understatement of income tax. Respondent has

satisfied his burden. The record reflects that petitioners failed to report income
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from State tax refunds for 2010. Petitioner also failed to provide evidence that she

operated the horse training activity with the intent to make a profit. In addition,

the underpayments of tax are the result of substantial understatements of income

tax for 2010 and 2011 because the understatements of $17,319 and $16,675,

respectively, exceed $5,000, which is greater than 10% of the tax required to be

shown on the returns.5 Accordingly, because respondent has met his burden of

production, petitioners must come forward with persuasive evidence that the

accuracy-related penalties should not be imposed with respect to the

underpayments because they acted with reasonable cause and in good faith. See

sec. 6664(c)(1); Rule 142(a); Higbee v. Commissioner, 116 T.C. at 446-447.

Petitioners offered no evidence to show that there was reasonable cause for

their failure to report the income tax refunds. Neither have they demonstrated that

they acted with reasonable cause and in good faith with respect to reporting the

horse training activity as an activity that was engaged in for profit. Therefore, the

5
In the notice of deficiency respondent allowed itemized deductions for
medical expenses of $11,218 and $15,092 for 2010 and 2011, respectively.
Respondent’s concession to allow itemized deductions for medical expenses of
$14,411 and $22,312 for 2010 and 2011, respectively, would not reduce the
understatement of income tax below $5,000 for either year. The amounts required
to be shown on the returns for 2010 and 2011 were $27,168 and $25,871,
respectively.
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Court sustains respondent’s determination of accuracy-related penalties under

section 6662(a) for tax years 2010 and 2011.

We have considered all of the parties’ arguments, and, to the extent not

addressed herein, we conclude that they are moot, irrelevant, or without merit.

To reflect the foregoing,

Decision will be entered

under Rule 155.