MEMORANDUM FINDINGS OF FACT AND OPINION
KORNER, Judge: Respondent determined a deficiency in petitioners' 1984 Federal income tax of $ 46,203 and an addition to that tax under
*671 FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulation of facts and exhibits attached are incorporated herein by this reference.
Petitioners, David (hereinafter petitioner) and Gloria Crisp, resided in Glen Rose, Texas, when they filed the petition in this case. Their timely filed joint Federal income tax return for calendar year 1984 employed the cash receipts and disbursements method of accounting.
David Crisp has been a farmer/rancher since 1976. On November 15, 1983, he signed onto a cattle trading program run by the Shultz Cattle Corporation (Shultz). Under their agreement Shultz agreed to advise petitioner on the purchase, maintenance, and ultimate sale of 400 head of cattle. Shultz also agreed to act as bookkeeper. All decision-making power was petitioner's alone.
As part of the agreement, Shultz agreed to purchase the cattle on behalf of petitioner once the proper financing was in place. Shultz also helped petitioner locate and retain Republican Valley Cattle Feeders, Inc. (Feedyard), to house, feed, and care for the cattle, and Farmers State Bank and Trust Co. (Farmers), to help finance the transaction.
Petitioner financed*672 the purchase transaction as follows: On November 15, 1983, he transferred $ 14,000 to Shultz: its $ 8,000 consulting fee and $ 6,000 toward the purchase of the cattle. All other funds were supplied via a $ 296,000 line of credit set up at Farmers pursuant to a November 15, 1983 loan agreement between that bank and petitioner. One hundred ninety-eight thousand dollars of that loan was nonrecourse, backed only by a security interest in the cattle. The remaining $ 98,000 was recourse, additionally backed by a security interest in a supply of feed to be purchased for the cattle, a hedging account to be created, a second security interest in the cattle, and a $ 56,000 letter of credit from petitioners' personal bank.
As part of the loan agreement petitioner was required to hedge at least 50 percent of his cattle. Accordingly, he entered into a hedging agreement with a commodities broker and assigned the hedging account to Farmers. Petitioner also executed a security agreement formally granting Farmers a security interest in the cattle and feed to be purchased. All of these documents were executed in the latter part of calendar year 1983.
On December 23, 1983, petitioner purchased*673 both the cattle and a quantity of cattle feed, not in excess of a year's supply. These purchases were made via checks issued by Farmers to the Feedyard on petitioner's line of credit. Petitioner's prepaid feed expense for 1983 totaled $ 100,000. Petitioner bought the entire lot of feed at the market rate as of the date of purchase in a final, nonrefundable transaction. It is common business practice to prepay cattle feed expenses.
As part of their bookkeeping duties Shultz provided petitioner with an annual summary of the tax effects of his cattle trading activities. In conformity with Shultz's advice, petitioners deducted the $ 100,000 prepaid feed expense, as well as the $ 8,000 consulting fee on their 1983 joint Federal income tax return. Petitioner had no income from the cattle trading program in 1983. It thus yielded him a $ 108,000 net loss for that year. 2
In 1984 petitioner sold his cattle, hedging*674 interests, and remaining, unconsumed feed. The feed was sold at the market rate as of the date of sale. Petitioner realized a $ 11,756.56 net gain from the hedging transactions. In 1984 Shultz provided petitioner with both a "Settlement Summary," detailing petitioner's cattle activity for 1983 and 1984, as well as a "1984 Taxable Income Schedule," to help him prepare his 1984 Federal income tax return.
On their 1984 joint Federal income tax return petitioners reported the hedging gain as short-term capital gain. They also reported an adjusted basis in the cattle of $ 321,305.36. 3 This basis amount, drawn from Shultz's Settlement Summary and not its 1984 Taxable Income Schedule, included, inter alia, the $ 100,000 prepaid feed expense which petitioners deducted on their 1983 return. The total tax liability shown on their 1984 return was $ 3,359.94. Petitioners received no rebates with regard to that tax.
*675 In his notice of deficiency respondent adopted as correct Shultz's 1984 Taxable Income Schedule, which petitioners had not followed in their return. Accordingly, he recalculated petitioners' basis in the cattle to exclude some of the prepaid feed expense and recharacterized petitioners' gain from the hedging transaction as ordinary income. Respondent also determined an addition to petitioners' tax under
OPINION
Respondent asserts, and petitioners do not contest, that petitioner's participation in the Shultz cattle trading program was part of his business of farming. Accordingly, this opinion adopts that premise.
Issues (1), (2): Prepaid Feed Expense
The facts of this case give rise to two distinct issues with regard to petitioner's prepaid feed expense: the correctness of petitioners' 1984 treatment of this expense in and of itself, and the correctness of that treatment juxtaposed to any duty of consistency petitioners may*676 have incurred by deducting this expense on their 1983 return. Because our determination of the former issue renders the latter one moot, the latter issue will not be further discussed.
Both at trial and on brief the parties treated the prepaid feed expense issue as a question of whether those costs were either properly deductible or includable in basis in 1984. We find that the deductibility issue, though not raised by the pleadings, was nevertheless tried by implied consent of the parties and consequently is at issue in this case. Rule 41(b)(1). We are thus presented with the question of whether the feed expense was properly allocable to 1983 as a deduction, or to 1984, as either a deduction or as part of the cost of goods sold.
Only one of these positions can be correct. It is intrinsic to our system of annual accounting that each item of income and expense has a singular, correct treatment under a taxpayer's chosen method of accounting. See
Petitioners contend that their treatment of the feed expense on their 1983 return was erroneous: *677 that this expense was only deductible or chargeable to basis in 1984. In contrast, respondent argues that petitioners' 1983 deduction of the feed expense was appropriate and thus any treatment of this item in 1984 is groundless.
As farmers, petitioners are entitled to deduct feed costs as ordinary and necessary business expenses.
1. Payment v. Deposit: "A payment occurs only when the taxpayer's money is 'irretrievably out of pocket.'"
2. Business Purpose: *679 "A business purpose exists if the prepayment fixes maximum prices for feed, secures an assured feed supply, or secures preferential treatment in anticipation of a feed shortage."
3. Distortion of Income: Both this Court and the circuit to which this case is appealable have recognized the interrelationship of the distortion of income and business purpose tests.
4. At-Risk Limitation: Although otherwise allowable, petitioners' 1983 prepaid feed expense deduction may still be limited by the at-risk provisions of section 465, applicable to individuals engaged in the activity of farming on a farm-by-farm basis. Sec. 465(a)(1), 465(c)(1)(B), 465(c)(2)(A)(iii). In order for petitioners' 1983 deductions from the cattle trading activity to be fully allowed, their total "loss" from that activity cannot exceed their related "at-risk" amount for the year. Sec. 465(a)(1). Petitioners' loss is defined as the excess of their allowable deductions allocable to the activity, over their income therefrom. Sec. 465(d). Their at-risk amount is comprised of their total cash contributions, the adjusted basis of any property contributed, and recourse debt*681 with respect to the activity. Sec. 465(b)(1).
In 1983 petitioner contributed $ 14,000 to the cattle trading activity. He also borrowed $ 298,000, of which $ 98,000 was recourse debt. The collateralization of the recourse debt did not affect petitioner's ultimate personal liability therefor.
Petitioners thus had a total of $ 112,000 at risk with regard to their cattle trading activity. 4 Apart from the prepaid feed expense, petitioners have only proven the $ 8,000 consulting fee to be an allowable deduction related to this activity in 1983.
*682 Since all the requirements for deduction of petitioner's prepaid feed expense were met in 1983, we hold that this item was properly deductible in that year. Accordingly, petitioners' argument that this expense is somehow allocable to 1984 must necessarily fail. We hold for respondent on this issue.
Issue (3): Hedging Gain
In his notice of deficiency respondent determined petitioners' gain from the disposition of their hedging interests to be ordinary income to them in 1984. Petitioners bear the burden to prove this determination erroneous.
Gain from the sale or exchange of property is capital gain, unless the property falls within one of the categories of property excluded from the definition of "capital asset" by
Issue (4): Addition to Tax Under
In his notice of deficiency respondent determined that petitioners were liable for an addition to tax under
The legislative history of the substantial authority standard shows that Congress did not intend for it to be satisfied in the case of a return position that is "fairly unlikely to prevail in court upon a complete review of the facts and authorities." H. Rept. 97-760 (Conf.) at 575 (1982),
Neither did petitioners adequately disclose their treatment of these items. Adequate disclosure must be made on a return or in a statement attached to the return.
As a result, the entire deficiency determined by respondent constitutes an understatement under
Decision will be entered for the respondent.
Footnotes
1. All statutory references are to the Internal Revenue Code, as in effect for the year in issue, and all rule references are to the Tax Court Rules of Practice and Procedure, except as otherwise noted.↩
2. Schedule F of petitioners' 1983 joint Federal income tax return lists additional farm-related expenses. Petitioners have, however, offered insufficient proof either to substantiate these expenses or to prove that they were related to the cattle trading program.↩
3. In fact, Schedule F of petitioners' 1984 joint Federal income tax return lists $ 32,305.36 as the cattle's adjusted basis. However, as petitioners' calculation of their net loss regarding the cattle shows, this is a typographical error, and the intended amount was $ 321,305.36.↩
4. Petitioners contend that incurrence of the recourse debt was somehow an interested or related-party transaction within the meaning of sec. 465(b)(3)(A). We find no merit to this claim based on the record before us. We similarly dismiss petitioners' argument that their correct at-risk amount must not include the portion of their cash investment which was spent on the cattle. See sec. 465(b)(1)(A).↩