T.C. Memo. 2016-71
UNITED STATES TAX COURT
AMY NDIAYE DELIA, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 18273-14. Filed April 20, 2016.
Amy Ndiaye Delia, pro se.
William J. Gregg, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
LAUBER, Judge: The Internal Revenue Service (IRS or respondent) deter-
mined a deficiency in petitioner’s 2011 Federal income tax of $5,5031 and an
1
All statutory references are to the Internal Revenue Code (Code) for the
year in issue, and all Rule references are to the Tax Court Rules of Practice and
Procedure. We round all monetary amounts to the nearest dollar.
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[*2] accuracy-related penalty of $1,101 under section 6662(a). The deficiency
stems from respondent’s disallowance of the deductions petitioner claimed with
respect to her sole proprietorship, to the extent those deductions exceeded her
income therefrom, on the ground that “such activity [wa]s not engaged in for
profit.” See sec. 183(a). We conclude that petitioner engaged in this activity
during 2011 with the genuine (if optimistic) intent to earn a profit but find that she
failed to substantiate certain of the expenses in question. We will sustain the
penalty only with respect to the portion of the underpayment attributable to these
unsubstantiated expenses.
FINDINGS OF FACT
The parties filed a stipulation of facts with accompanying exhibits that is
incorporated by this reference. Petitioner was born to a large family in Senegal,
where she learned and practiced the art of hair braiding. Although she had no
formal training in this field, she continued to practice it after arriving in the United
States. In 2004 she opened a salon near her home in Laurel, Maryland, called
Nanou’s African Braiding. This salon was housed in a booth inside a shopping
mall that included numerous other hair-braiding and beauty-related businesses.
Petitioner initially signed a five-year lease for the salon space. By its terms,
the lease was to renew automatically at the end of five years; petitioner did not
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[*3] have a clear understanding of this fact when she entered into the lease. When
the lease came up for renewal in 2009, in the midst of the financial crisis,
petitioner’s business was doing poorly and she was not eager to renew the lease.
But her landlord insisted that she honor her commitment, and she feared damage
to her credit rating if she refused. As a concession to petitioner’s faithful
performance of her obligations to that point, the landlord agreed to limit the
renewal period to three years.
Petitioner undertook reasonable, if limited, marketing efforts in connection
with her salon. She initially took out Yellowbook ads but found that these were
ineffective in reaching her intended market. She later created brochures and ad-
vertising fliers that she circulated by hand at neighborhood grocery stores and
shopping centers. She had the name of her salon painted on the side of her van in
the hope of attracting clients.
Petitioner maintained a Web site for the salon, and it was equipped with
landline telephone service. She kept distinct business records for the salon, inclu-
ding spreadsheets showing income and expenses and hard copies of some expense
receipts. She maintained a separate bank account for the salon during 2004-2010
but closed that account in 2010 in an effort to cut costs.
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[*4] Petitioner had a full-time job during 2011 as an event planner with Compass
Group USA, Inc. She spent most weekends at the salon in the hope of getting
walk-in customers, and she spent weekday evenings there to meet customers who
had called for appointments. The salon had fewer than 15 customers during 2011,
some of whom were repeat customers. Petitioner earned revenues in only five
months of that year, producing total gross receipts of $325. She closed the salon
in 2012 when the landlord let her out of her lease.
Petitioner has never reported a profit from her salon business. The salon
generated revenues in excess of $600 in 2010, and petitioner described the early
years as “much better than that.” But she reported a loss on her Schedule C, Profit
or Loss From Business, for every year from 2005 through 2012.
Petitioner credibly testified that her business failed for three main reasons.
The first was the financial crisis of 2008-2010, which had a very severe impact on
the African-American community in suburban Maryland. The second was a
change in taste among African-American women away from hair braiding. The
third was an over-concentration in her community of braiding salons and beauty
salons providing braiding services. The salons best situated to survive in this
environment were those run by licensed cosmetologists who could offer a full
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[*5] array of beauty services. Petitioner did not have a license and could not
compete effectively with those businesses.
For 2011 petitioner timely filed Form 1040, U.S. Individual Income Tax
Return, reporting wages of $82,503 from Compass Group. On Schedule C she
reported gross receipts of $325 and expenses of $16,131 attributable to the salon.
Her reported expenses consisted of $13,000 for rent on the salon lease; $590 for
hair products used in the salon; $909 for salon landline service; $600 for Web site
maintenance; $552 for cell phone expenses; and $480 for “supplies.” Following
examination of this return, the IRS issued her a timely notice of deficiency which
determined that she had failed to “establish that the business expenses shown on
* * * [her] tax return were paid or incurred during the taxable year and that the
expenses were ordinary and necessary to * * * [her] business.” The notice denied
petitioner’s Schedule C deductions to the extent they exceeded the salon’s income
and determined an accuracy-related penalty. While residing in Maryland, she
timely petitioned this Court for review.2
2
Petitioner was before this Court previously in Delia v. Commissioner, T.C.
Dkt. No. 8853-14S (June 2, 2015) (stipulated decision), which involved her 2010
tax year. On June 2, 2015, the Court in that case entered a stipulated decision
determining a deficiency of $828 and no penalty under section 6662(a).
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[*6] OPINION
A. Burden of Proof
The Commissioner’s determinations in a notice of deficiency are generally
presumed correct, and the taxpayer bears the burden of proving those determina-
tions erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). The
taxpayer bears the burden of proving his entitlement to deductions allowed by the
Code and of substantiating the amounts of claimed deductions. INDOPCO, Inc. v.
Commissioner, 503 U.S. 79, 84 (1992); sec. 1.6001-1(a), Income Tax Regs. Peti-
tioner does not contend, and the evidence does not establish, that the burden of
proof shifts to respondent under section 7491(a) as to any issue of fact.
B. Schedule C Deductions
1. “Trade or Business”
The first question is whether petitioner’s hair-braiding activity during 2011
was a trade or business engaged in for profit. If an activity “is not engaged in for
profit,” section 183 generally disallows deductions except to the extent of “the
gross income derived from such activity for the taxable year.” Sec. 183(a), (b)(2).
Section 162(a) allows as a deduction “all the ordinary and necessary ex-
penses paid or incurred during the taxable year in carrying on any trade or busi-
ness.” To be entitled to business-expense deductions without limitation by section
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[*7] 183, the taxpayer must show that she 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 pub-
lished opinion, 702 F.2d 1205 (D.C. Cir. 1983). Deductions are not allowable for
activities that a taxpayer carries on primarily as a sport, as a hobby, or for recrea-
tion. Sec. 1.183-2(a), Income Tax Regs.
In assessing the taxpayer’s profit motive, we accord greater weight to
objective facts than to subjective statements of intent. Keanini v. Commissioner,
94 T.C. 41, 46 (1990); sec. 1.183-2(a), Income Tax Regs. The taxpayer must es-
tablish that she “engaged in the activity with ‘the predominant, primary or prin-
cipal objective’ of realizing an economic profit independent of tax savings.” Giles
v. Commissioner, T.C. Memo. 2006-15, 91 T.C.M. (CCH) 684, 688 (quoting Wolf
v. Commissioner, 4 F.3d 709, 713 (9th Cir. 1993), aff’g T.C. Memo. 1991-212);
see Hulter, 91 T.C. at 392. Although a reasonable expectation of a profit is not
required, the taxpayer’s profit objective must be actual and honest. Dreicer, 78
T.C. at 645; sec. 1.183-2(a), Income Tax Regs. Whether a taxpayer has an actual
and honest profit objective is a question of fact to be resolved from all the relevant
facts and circumstances. Hulter, 91 T.C. at 393; Hastings v. Commissioner, T.C.
Memo. 2002-310; sec. 1.183-2(a), Income Tax Regs.
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[*8] The regulations set forth a nonexclusive list of nine factors relevant in as-
certaining whether a taxpayer conducts an activity with the intent to earn a profit.
The factors listed are: (1) the manner in which the taxpayer conducts the activity;
(2) the expertise of the taxpayer or his advisers; (3) the time and effort spent by the
taxpayer in carrying on the activity; (4) the expectation that assets used in the
activity may appreciate in value; (5) the success of the taxpayer in carrying on
other similar or dissimilar activities; (6) the taxpayer’s history of income or loss
with respect to the activity; (7) the amount of occasional profits, if any; (8) the
financial status of the taxpayer; and (9) elements of personal pleasure or recre-
ation. Sec. 1.183-2(b), Income Tax Regs.
No factor or group of factors is controlling, nor is it necessary that a major-
ity of factors point to one outcome. See Keating v. Commissioner, 544 F.3d 900,
904 (8th Cir. 2008), aff’g T.C. Memo. 2007-309, 94 T.C.M. (CCH) 383; Engdahl
v. Commissioner, 72 T.C. 659, 666 (1979); sec. 1.183-2(b), Income Tax Regs.
Certain factors may be accorded more weight in a particular case because they
have greater salience or persuasive value as applied to its facts. See Vitale v.
Commissioner, T.C. Memo. 1999-131, 77 T.C.M. (CCH) 1869, 1847, aff’d
without published opinion, 217 F.3d 843 (4th Cir. 2000); Green v. Commissioner,
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[*9] T.C. Memo. 1989-436, 57 T.C.M. (CCH) 1333, 1343 (noting that all nine
factors do not necessarily apply in every case).
We regard several of the regulatory factors as neutral in this case. The only
factor that weighs heavily against petitioner is the salon’s persistent history of
losses. Despite that fact, we are convinced that she conducted her hair-braiding
business with an actual and honest (if unduly optimistic) objective of making a
profit.
It is clear to us that petitioner had a genuine profit motive when she opened
her salon in 2004. She credibly testified that this business failed for reasons be-
yond her control, including the 2008-2010 financial crisis, an over-concentration
of similar businesses in her community, and a marked change in taste among her
prospective customers. It might have been prudent for her to have exited this
business before she did, but the long-term rental contract posed a serious obstacle.
She concluded, not unreasonably, that trying to salvage as much profit as she
could was preferable to risking damage to her credit rating by defaulting on her
lease commitment. She closed the business promptly after extricating herself from
the lease.
Petitioner had very little money, and the salon did not generate much. She
kept business records and undertook marketing efforts that seem reasonable rela-
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[*10] tive to the scale of her activity. Operating the salon during 2011 was not a
source of great personal pleasure or recreation, and it was surely not a “sport” or a
“hobby.” Sec. 1.183-2(a), Income Tax Regs. Although petitioner had a nostalgic
fondness for hair braiding, sitting in an empty booth in a shopping mall is not as
much fun as (say) riding horses. See Keating, 94 T.C.M. (CCH) at 384 (finding
taxpayer lacked profit motive in part because she “received much enjoyment and
satisfaction from her horse activity”); see also Judah v. Commissioner, T.C.
Memo. 2015-243, at *51 (same outcome where taxpayers got “substantial
enjoyment seeing their daughter ride horses”). And petitioner clearly did not
engage in this activity with a view to generating tax benefits by sheltering other
income. Her other income was modest, and the losses she suffered were genuine
out-of-pocket losses that dwarfed any resulting tax benefits.
We conclude that petitioner conducted her salon business during 2011 with
an “actual and honest objective of making a profit.” See Levy v. Commissioner,
91 T.C. 838, 871 (1988) (quoting Hutler, 91 T.C. at 392). She was thus entitled to
claim deductions for the expenses of that business to the extent she substantiated
them.
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[*11] 2. Substantiation
The burden of substantiating claimed deductions rests on the taxpayer. Sec.
6001; Rule 142(a); Hradesky v. Commissioner, 65 T.C. 87, 89 (1975), aff’d per
curiam, 540 F.2d 821 (5th Cir. 1976). Petitioner admitted at trial that she lacked
substantiation for certain of her reported expenses. She claimed a deduction of
$480 for “supplies,” but her business records show that amount, accrued at a flat
rate of $40 per month, as being attributable to “meals.” She offered no documen-
tation for any meal expense and did not show that meals were an ordinary and
necessary expense of her hair-braiding business. She claimed a deduction of $590
for hair products used in the salon, but she supplied substantiation for only $181
of such expenses. With respect to her alleged cell phone expense, she did not
substantiate the amount claimed ($552) and did not prove the extent to which she
used that phone for business purposes connected to the salon. Given the modest
scale of her salon activity during 2011, any business use of her cell phone was
likely to have been quite small.
In sum, we find that petitioner has failed to substantiate $480 of supplies
expenses, $409 of hair product expenses, and $552 of business-related cell phone
expenses. Her allowable Schedule C deductions for 2011 must thus be reduced by
$1,441, that is, from $16,131 to $14,690.
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[*12] C. Penalty
Section 6662 imposes a 20% penalty upon the portion of any underpayment
attributable to (among other things) negligence or disregard of rules or regulations.
The term “negligence” includes any failure to make a reasonable attempt to com-
ply with the tax laws, and “disregard” includes any careless, reckless, or inten-
tional disregard. Sec. 6662(c). Negligence also includes any failure to keep ade-
quate books and records or to substantiate items properly. Sec. 1.6662-3(b)(1),
Income Tax Regs.; see Olive v. Commissioner, 139 T.C. 19, 43 (2012), aff’d, 792
F.3d 1146 (9th Cir. 2015).
With respect to an individual taxpayer’s liability for a penalty, section
7491(c) places on the Commissioner the burden of production, thereby requiring
the Commissioner to come forward with sufficient evidence indicating that im-
position of a penalty is appropriate. Higbee v. Commissioner, 116 T.C. 438, 446-
447 (2001). Once the Commissioner meets his burden of production, the taxpayer
bears the burden of proving that the Commissioner’s determination is incorrect.
Ibid.; see Rule 142(a); Welch v. Helvering, 290 U.S. at 115. We find that respon-
dent has discharged his burden of production by showing that petitioner failed to
keep adequate records. See sec. 1.6662-3(b)(1), Income Tax Regs.
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[*13] Section 6664(c)(1) provides an exception to the imposition of the accuracy-
related penalty if the taxpayer establishes that there was reasonable cause for, and
that she acted in good faith with respect to, the underpayment. The decision as to
whether the taxpayer acted with reasonable cause and in good faith is made on a
case-by-case basis, taking into account all pertinent facts and circumstances. See
sec. 1.6664-4(b)(1), Income Tax Regs. Circumstances that may signal reasonable
cause and good faith “include an honest misunderstanding of fact or law that is
reasonable in light of all of the facts and circumstances, including the experience,
knowledge, and education of the taxpayer.” Ibid.
Petitioner understood the need to keep records documenting her expenses,
but her record-keeping was demonstrably incomplete. She lacked documentation
for several categories of expenses and treated certain items inconsistently (report-
ing an alleged expense for meals as “supplies” on her Schedule C). Given the
nature of her business, her claimed expense for meals was facially implausible.
We find that petitioner was negligent in preparing her 2011 return and will
therefore sustain an accuracy-related penalty on the portion of the underpayment
attributable to the unsubstantiated expenses.
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[*14] To reflect the foregoing,
Decision will be entered under
Rule 155.