T.C. Memo. 2013-76
UNITED STATES TAX COURT
WILLIAM R. DODDS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 23609-11. Filed March 13, 2013.
Thomas Joe Doyle and Randi J. Winter, for petitioner.
Blaine Charles Holiday, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
KERRIGAN, Judge: Respondent determined the following deficiencies and
penalties with respect to petitioner’s Federal income tax for tax years 2007 and
2008:
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[*2] Penalty
Year Deficiency sec. 6662(a)
2007 $39,685 $7,937
2008 47,757 9,551
Unless otherwise indicated, all section references are to the Internal Revenue
Code in effect for the years at issue, and all Rule references are to the Tax Court
Rules of Practice and Procedure. All monetary amounts are rounded to the nearest
dollar.
The issues for consideration are (1) whether petitioner engaged in a horse
breeding activity with the objective of making a profit within the meaning of section
183 and (2) whether petitioner is liable for accuracy-related penalties under section
6662(a).
FINDINGS OF FACT
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. Petitioner
lived in Minnesota when he filed the petition.
Petitioner’s Accounting Practice
Petitioner is an accountant with a master’s degree in business taxation from
the University of Minnesota. Petitioner received his undergraduate degree from St.
Cloud State University. From 1983 to January 2012 petitioner ran a successful
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[*3] accounting firm that he wholly owned. Petitioner typically spent 70 to 80 hours
a week at his accounting firm during tax season but no more than 20 hours a week
the rest of the year. In tax years 2007 and 2008 petitioner earned over $240,000
and over $280,000, respectively, from his work as an accountant.
Petitioner’s Horse Breeding Activity
In 1995 petitioner decided to breed Morgan horses, purchasing two American
Morgan broodmares and one stallion. The leap from accountant to horse breeder
was not too great for petitioner; he grew up on a dairy farm and was generally
familiar with the care and maintenance of large animals, including cattle, swine,
sheep, and horses.
Petitioner wanted to breed Morgan horses because he liked their poise, grace,
and elegance. He describes them as spirited, bright-eyed, up-headed, and easy.
Petitioner was also attracted by the history of the Morgan horse; in particular, he
enjoyed the fact that Morgan horses played a role in the Civil War. Petitioner bred
his horses under the name Aerie Meadow Morgans. Petitioner continued to
maintain his accounting practice after he started breeding horses.
Before petitioner started his horse breeding activity, he moved to a property
with 18 acres of land. When petitioner purchased the land, it had a house with a
garage and a detached gazebo. To accommodate the horses on his property
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[*4] petitioner built several large structures, such as barns and lean-tos, and fenced
off approximately six acres for horse pastures.
Petitioner managed the horse breeding activity himself. He worked over
1,500 hours per year mucking stalls, feeding and grooming the horses, maintaining
the property and grounds, administering medicine, arranging artificial inseminations,
delivering foals, and making all breeding decisions. His son, daughter, and close
friend assisted occasionally with feeding, watering, and bedding the horses.
Petitioner sometimes gave his children and the close friend monetary gifts for their
assistance. Petitioner did not ride recreationally, and he did not allow others to ride
his horses recreationally. His horses were ridden only by experienced trainers for
training and show purposes.
Petitioner became a member of the American Morgan Association and the
North Central Morgan Association in 2000 and a member of the United States
Equestrian Federation in 2004. He also participated in horse shows. In both tax
year 2007 and 2008 petitioner participated in a local show, a regional show, and a
national show.
In 2006 petitioner obtained a patent for a new style of horse feeder.
Petitioner designed the feeder to reduce feed waste and the risk of injury to horses.
He contracted with a marketing company for the marketing and sale of his feeder.
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[*5] Petitioner advertised his horses on the Aeire Meadow Morgans Web site. He
also advertised his horses in two national magazines and in local magazines for
Minnesota and surrounding States. Petitioner had a business card for his breeding
activity which he distributed to potential buyers at horse shows and other venues.
Petitioner never had a written business plan. At first he attempted to breed
grade horses, i.e., horses that are a quality below show horses. Petitioner wanted to
sell the grade horses locally when they were weanlings so that he could avoid the
cost of raising the foals. He also wanted to avoid the high stud fees. Petitioner’s
plan was unsuccessful. In 2000 he sought advice from Charles and Cordia Pearson,
Morgan breeders, who convinced petitioner to geld his stallion and use their stallion
instead. Petitioner used their stallion until 2004.
In 2004 petitioner decided to try to produce world-caliber foals. He stopped
using the Pearsons’ stallion and began using all national or world champion stallions
or grand national stallions. Petitioner began seeking advice from horsetrainer Eileen
O’Bradovich, who had started to train petitioner’s horses, as well as from
professional horseman Jordy Johns and from a friend who grew up raising Arabian
horses. Ms. O’Bradovich helped petitioner pick out the right stallions to breed to
his mares. Her business, however, focused on training rather than breeding, and
Ms. O’Bradovich had never trained Morgan horses before.
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[*6] Petitioner also researched the Morgan horse bloodlines. He studied a set of
cards he purchased from the American Morgan Horse Association. The cards
detailed the old Morgan bloodlines and showed which horses were winning horses
and “golden cross”, i.e., world-champion, Morgan stallions. Petitioner used these
cards to determine which stallions he should use so that he could produce a world
caliber horse.
Petitioner did not maintain a separate bank account for his breeding activity.
Although petitioner used QuickBooks for his financial records, which allowed him
to separate his personal finances from his breeding activity, he commingled his
personal and horse breeding funds. Petitioner never made financial projections for
his breeding activity, nor did he maintain a budget for his breeding activity.
Petitioner was able to generate profit and loss statements from QuickBooks.
Petitioner retained receipts relating to all expenses incurred in connection
with the horse breeding activity for the years at issue. He also insured the buildings
he used in the horse breeding activity and a number of his horses. Petitioner
depreciated assets associated with his breeding activity.
Petitioner failed to make his horse breeding activity profitable. In tax year
2007 petitioner sold two horses. On his Schedule F, Profit or Loss From Farming,
for that year he reported $7,042 of gross income and $129,848 of expenses. In tax
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[*7] year 2008 petitioner sold four horses. On his Schedule F for tax year 2008
petitioner reported $11,018 of gross income and $155,676 of expenses. Petitioner
reported the following gross income, expenses, and net losses on his Schedules F for
tax years 1995 through 2011:
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[*8] Year Gross income Expenses Net loss
1995 n/a (1) ($13,550)
1996 n/a --- (13,639)
1997 n/a --- (11,751)
1998 n/a --- (41,152)
1999 n/a --- (61,916)
2000 n/a --- (56,617)
2001 n/a --- (40,264)
2002 -0- --- (50,356)
2003 $3,500 --- (78,951)
2004 13,359 --- (128,767)
2005 5,722 --- (125,317)
2006 7,500 $125,518 (118,018)
2007 7,042 129,848 (122,806)
2008 11,018 155,676 (144,658)
2009 3,161 170,584 (167,423)
2010 14,545 150,990 (136,445)
2011 7,210 185,065 (177,855)
1
The parties did not provide any information regarding the
expenses petitioner reported for tax years 1995 through 2005.
In total petitioner accumulated a net loss of $1,448,885 from his horse breeding
activity during those tax years.
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[*9] Petitioner timely filed his Forms 1040, U.S. Individual Income Tax Return,
for tax years 2007 and 2008. On each tax return petitioner reported his occupation
as “accountant”. On July 15, 2011, respondent sent petitioner a notice of deficiency
regarding tax years 2007 and 2008. Respondent disallowed petitioner’s Schedule F
sales and expenses for both years because petitioner did not show that he operated
the activity for the good faith purpose of making a profit. Respondent also
determined accuracy-related penalties under section 6662(a) for both tax years. In
response petitioner filed a petition with the Court. Petitioner contends that he
engaged in his horse breeding activity to make a profit during the years at issue and
that he is not liable for the accuracy-related penalties.
OPINION
Horse Breeding Activity
Respondent determined that petitioner’s horse breeding activity was not an
activity engaged in for profit within the meaning of section 183 and disallowed loss
deductions he claimed on his Schedules F for the years at issue. Petitioner claims
that he engaged in the horse activity with an intent to realize a 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
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[*10] 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 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.
Under section 183(d), an activity that consists in major part of the breeding,
training, showing, or racing of horses is presumed to be engaged in for profit if the
activity produces gross income in excess of the deductions for any two of seven
consecutive years, unless the Commissioner establishes to the contrary. See also
Wadlow v. Commissioner, 112 T.C. 247, 250 (1999). Petitioner’s horse breeding
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[*11] activity failed to produce income in excess of its deductions at any time during
its operation. Accordingly, the presumption does not apply in this case.
The expectation of a 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
evidence were submitted. Rendall v. Commissioner, T.C. Memo. 2006-174, aff’d,
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[*12] 535 F.3d 1221 (10th Cir. 2008); see Higbee v. Commissioner, 116 T.C. at
442-443. As discussed below, petitioner failed to provide evidence for many of the
issues. If we were to consider solely the evidence petitioner presented, we would
find that petitioner did not engage in the horse breeding activity for profit as a matter
of fact. Therefore, petitioner failed to provide credible evidence within the meaning
of section 7491(a)(1), and the burden of proof remains with petitioner.
Section 1.183-2(b), Income Tax Regs., provides a nonexhaustive list of the
following nine factors used to determine 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 advisors; (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 determinative. Sec. 1.183-2(b), Income Tax Regs.; see also
Keating v. Commissioner, 544 F.3d at 904.
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[*13] 1. Manner in Which Petitioner Carried On the Activity
The fact that the taxpayer carries on an activity in a businesslike manner and
maintains complete and accurate books and records may indicate a profit motive.
Sec. 1.183-2(b)(1), Income Tax Regs. Characteristics of a businesslike operation
include the preparation of a business plan and, in the case of horse breeding and
sales, a consistent and concentrated advertising program. Bronson v.
Commissioner, T.C. Memo. 2012-17 (citing Golanty v. Commissioner, 72 T.C. 411,
431 (1979), aff’d without published opinion, 647 F.2d 170 (9th Cir. 1981), Keating
v. Commissioner, T.C. Memo. 2007-309, and Dodge v. Commissioner, T.C. Memo.
1998-89, aff’d without published opinion,188 F.3d 507 (6th Cir. 1999)). The
regulations further provide that a profit motive is indicated when a taxpayer changes
operating methods or adopts new techniques with an intent to improve profitability.
Sec. 1.183-2(b)(1), Income Tax Regs.
Petitioner advertised his horses on the Aeire Meadow Morgans Web site, in
national and local magazines, and with his business cards at horse shows and other
venues. In those cases where we have found that an animal breeder operated in a
businesslike manner, generally the breeder not only participated in shows but
engaged in other forms of substantial advertising. See, e.g., Engdahl v.
Commissioner, 72 T.C. 659, 667 (1979); Keating v. Commissioner, T.C. Memo.
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[*14] 2007-309. The taxpayer’s advertising efforts, however, may not be
insubstantial compared to the cost of the activity. See Bronson v. Commissioner,
T.C. Memo. 2012-17. Because petitioner failed to provide any evidence regarding
the cost of his advertising efforts, we are unable to determine that his advertising
efforts were substantial compared to the cost of his horse breeding activity.
Petitioner failed to provide a business plan that included more than just
generalized goals. See Foster v. Commissioner, T.C. Memo. 2012-207. Petitioner
testified: “My initial plan wasn’t written, but my plan was to breed grade horses”.
When he abandoned that plan, petitioner testified that he was aiming to breed world
caliber foals that could become successful show horses. Petitioner’s plan is
inadequate for us to conclude that he had an established business plan. See Keating
v. Commissioner, T.C. Memo. 2007-309 (finding that the taxpayer’s plan “to raise
good quality horses, well-trained horses, horses that will give * * * [the taxpayer] a
good reputation, horses that will do well in the market” was inadequate for us to
conclude that the taxpayer had an established business plan).
Petitioner likewise failed to maintain a budget or to make any financial
projections, economic forecast, or other analyses demonstrating financial
management or planning. See Keating v. Commissioner, 544 F.3d at 904; Foster v.
Commissioner, T.C. Memo. 2012-207. Petitioner used profit and loss
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[*15] statements prepared with QuickBooks, but there is scant evidence that
petitioner used them for the important purposes of cutting expenses, increasing
profits, and evaluating the overall performance of the operation. See Golanty v.
Commissioner, 72 T.C. at 430; Foster v. Commissioner, T.C. Memo. 2012-207.
Petitioner retained all receipts and insured his buildings and some of the
horses. Petitioner, however, commingled the financial affairs of his horse breeding
activity with his personal finances. Although QuickBooks allowed petitioner to
separate his personal finances from his breeding activity, he paid all the expenses of
the horse activity from his personal account. 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).
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. Petitioner provided no evidence showing that he tried to reduce
his expenses, abandoned specific activities that had proven unprofitable, or
implemented any cost-cutting measures. Rather, petitioner maintained a steady
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[*16] pace of losses which skyrocketed to six figures in 2004, and petitioner
continued to hemorrhage money from 2004 to 2011, including the years at issue.
Petitioner’s failure to produce any significant 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 contends that he made changes
in his operations over the years in an effort to increase his income. Those changes
involved switching from the Pearsons’ stallion in 2000 and then switching to
national, world champion, or grand national stallions in 2004. Petitioner did not
produce any evidence demonstrating that he made a careful and thorough
investigation of the potential profitability of these changes before making them. See
Foster v. Commissioner, T.C. Memo. 2012-207 (citing Taube v. Commissioner, 88
T.C. 464, 481 (1987)).
On balance, we are not persuaded that petitioner carried on his horse activity
in a businesslike manner. This factor weighs against a profit objective.
2. Expertise of Petitioner and His Advisors
The taxpayer’s expertise, research, and extensive study of an activity, as well
as his or her consultation with experts, may be indicative of a profit motive. See
sec. 1.183- 2(b)(2), Income Tax Regs. As a successful accountant, petitioner did
not need to seek further business and tax advice when he started his breeding
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[*17] activity. Petitioner had knowledge about raising horses and other large farm
animals from growing up on a farm, but his knowledge was not extensive; there is
no indication that he garnered any horse breeding experience at that time. During
the course of his horse breeding activity, petitioner consulted with persons who
were knowledgeable about horse breeding, including professional breeders, a
professional trainer, and a professional horseman, and petitioner followed the advice
they gave him. See id.; see also Foster v. Commissioner, T.C. Memo. 2012-207.
Petitioner spent time studying the Morgan bloodlines, but the record does not
indicate that petitioner spent an extensive amount of time studying the bloodlines.
Petitioner, however, hired a trainer who lacked experience with Morgan horses. On
balance, this factor weighs slightly in favor of a profit objective.
3. Time and Effort Petitioner Expended in Carrying On the Activity
The taxpayer’s devotion of much of his or her personal time and effort to
carrying on an activity may indicate a profit motive, particularly if the activity
does not involve substantial personal or recreational aspects. Sec. 1.183-2(b)(3),
Income Tax Regs. Although petitioner continued to maintain his accounting
practice, he spent over 1,500 hours each year working on his horse breeding
activity, often performing hard manual and menial tasks such as feeding and
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[*18] walking the horses and mucking stalls. See Foster v. Commissioner, T.C.
Memo. 2012-207 (the taxpayers demonstrated the requisite profit objective when
they spent 20 hours a week doing hard manual and menial tasks in their horse
activity). This factor weighs in favor of a profit objective.
4. Expectation That the Horses May Appreciate in Value
An expectation that assets used in the activity will appreciate in value may
indicate a profit motive even if the taxpayer derives no profit from current
operations. Sec. 1.183-2(b)(4), Income Tax Regs. Petitioner credibly testified that
he expected his horses would appreciate because of his successful breeding program
and that he believed he could eventually produce a “golden cross” Morgan horse
capable of garnering stud fees exceeding $10,000 and a sale price exceeding
$100,000. Petitioner also provided some evidence that his 18-acre property
increased in value over time, from an estimated $207,000 in 2002 to an estimated
$361,900 in 2009.
A profit objective, however, may be inferred from such expected
appreciation of the activity’s assets only where the appreciation exceeds operating
expenses and would be sufficient to recoup the accumulated losses of prior years.
Foster v. Commissioner, T.C. Memo. 2012-207; see Golanty v. Commissioner, 72
T.C. at 427-428. The appreciation of petitioner’s horse breeding assets does not
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[*19] begin to approach the amount of losses petitioner has reported since the
beginning of his horse activity. Petitioner also failed to provide any evidence
linking his 18-acre property’s increase in value to his horse breeding activity.
Without more information, we cannot conclude that the property increased in value
because of petitioner’s horse breeding activity. On balance, this factor is neutral.
5. Petitioner’s Success in Similar Activities
Section 1.183-2(b)(5), Income Tax Regs., provides, in pertinent part: “The
fact that the taxpayer has engaged in similar activities in the past and converted
them from unprofitable to profitable enterprises may indicate that he is engaged in
the present activity for profit”. Although petitioner successfully ran his accounting
practice, his work as an accountant is not sufficiently similar to operating a horse
breeding activity to indicate that he could do so successfully. See Berry v.
Commissioner, T.C. Memo. 2000-109. This factor weighs against a profit
objective.
6. Petitioner’s History of Income or Losses
A history of continued losses with respect to an activity may indicate a lack
of a profit motive. See sec. 1.183-2(b)(6), Income Tax Regs. While a series of
losses during the initial or startup stage of an activity may not necessarily indicate
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[*20] a lack of a profit motive, a record of large losses over many years is
persuasive evidence that the taxpayer did not have such a motive. Golanty v.
Commissioner, 72 T.C. at 426; Foster v. Commissioner, T.C. Memo. 2012-207.
An activity’s cumulative losses should not be of such a magnitude that an
overall profit on the entire operation, including recoupment of past losses, could not
possibly be achieved. Bessenyey v. Commissioner, 45 T.C. 261, 274 (1965), aff’d,
379 F.2d 252 (2d Cir. 1967); Foster v. Commissioner, T.C. Memo. 2012-207. If
losses are sustained because of unforeseen or fortuitous circumstances beyond the
control of the taxpayer, such losses would not be an indication of the lack of a profit
motive. See sec. 1.183-2(b)(6), Income Tax Regs.
Petitioner realized no profits whatsoever in 17 years of engaging in his
horse breeding activity. He contends that his losses are not an indication that he
lacked a profit objective because the losses were caused by factors beyond his
control. Petitioner cites unexpected deaths, miscarriages, stillborn foals, and the
negative effect of the recession on horse sales. We acknowledge that horse
breeding is a speculative activity, but these events hardly account for an unbroken
string of 17 years of losses. Furthermore, petitioner did not show that his horse
breeding activity would have been profitable if events beyond his control had not
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[*21] occurred. See Burger v. Commissioner, 809 F.2d 355, 360 n.8 (7th Cir.
1987), aff’g T.C. Memo. 1985-523; Foster v. Commissioner, T.C. Memo. 2012-
207.
Petitioner also contends that because he switched from trying to breed grade
horses to world caliber horses in 2004, his horse breeding activity was in its initial
or startup stage in tax years 2007 and 2008. Petitioner, however, continuously
maintained a horse breeding activity from 1995 through 2011 with the same
knowledge, equipment, and space. The only change petitioner made was from
trying to produce one caliber of horse to trying to produce another caliber of horse.
We are unconvinced by this argument, and we decline to “reset the clock” in 2004
simply because petitioner altered the goal of his horse breeding activity.
Petitioner further contends that he could potentially earn a substantial profit
with one outstanding horse. The possibility of a speculative profit in a taxpayer’s
horse activity, however, is insufficient to outweigh the absence of profits for a
sustained period of years. See Foster v. Commissioner, T.C. Memo. 2012-207; see
also Chandler v. Commissioner, T.C. Memo. 2010-92, aff’d, 481 Fed. Appx. 400
(9th Cir. 2012); McKeever v. Commissioner, T.C. Memo. 2000-288. This factor
weighs heavily against a profit objective.
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[*22] 7. Amount of Petitioner’s Occasional Profits
The amount of profits in relation to the amount of losses incurred may provide
useful criteria in determining the taxpayer’s intent. Sec. 1.183-2(b)(7), Income Tax
Regs. Petitioner never earned a profit from his horse breeding activity. This factor
weighs against a profit objective.
8. Petitioner’s Financial Status
Substantial income from sources other than the activity may indicate that the
activity is not engaged in for profit. Sec. 1.183-2(b)(8), Income Tax Regs. A
taxpayer with substantial income unrelated to the activity can more readily afford a
hobby. Foster v. Commissioner, T.C. Memo. 2012-207. This is particularly true if
the losses from the activity might generate substantial tax benefits. Golanty v.
Commissioner, 72 T.C. at 429; Foster v. Commissioner, T.C. Memo. 2012-207.
Petitioner’s substantial income from his accounting firm allowed him to continue his
horse breeding activity despite 17 years of substantial losses. See Foster v.
Commissioner, T.C. Memo. 2012-207. Petitioner’s horse breeding activity also
generated generous tax savings in the form of net losses that offset petitioner’s
substantial accounting income. This factor weighs against a profit objective.
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[*23] 9. Elements of Personal Pleasure or Recreation
The presence of personal motives and recreational elements in carrying on an
activity may indicate that the activity is not engaged in for profit. Sec. 1.183-
2(b)(9), Income Tax Regs. Petitioner argues that neither he nor his family members
rode his horses and that his horse breeding activity required him to engage in hard
manual labor. We question, however, whether he would have continued his money-
losing horse breeding activity for 17 years unless he received some satisfaction from
the work. See Foster v. Commissioner, T.C. Memo. 2012-207 (the taxpayers’ horse
activity involved hard work, but the taxpayers would not have continued the losing
horse activity for many years had they not received satisfaction from the work). It is
more likely that such satisfaction, rather than a profit objective, accounts for
petitioner’s persistence. On balance, this factor is neutral.
Conclusion
After weighing all the facts and circumstances in the light of the relevant
factors, we conclude that petitioner did not engage in his horse breeding activity for
the years at issue with the requisite profit objective. Petitioner’s many years of
losses without a meaningful plan for recouping them are most persuasive. See id.
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[*24] Accordingly, we sustain respondent’s determination regarding petitioner’s
horse breeding activity.
Accuracy-Related Penalties Under Section 6662(a)
Respondent determined that petitioner is liable for accuracy-related penalties
pursuant to section 6662(a) for tax years 2007 and 2008. Section 6662(a) adds to a
tax 20% of any underpayment attributable to, among other things, (1) negligence or
disregard of rules or regulations within the meaning of section 6662(b)(1); or (2) any
substantial understatement of income tax within the meaning of section 6662(b)(2).
A substantial understatement of income tax is defined as an understatement that
exceeds the greater of $5,000 or 10% of the income tax required to be shown on the
return for the taxable year. Sec. 6662(d)(1)(A).
The Commissioner bears the burden of production with respect to this
penalty. Sec. 7491(c). This burden is satisfied if the Commissioner comes
forward with sufficient evidence indicating that it is appropriate to impose the
relevant penalty. Higbee v. Commissioner, 116 T.C. at 446. Respondent
determined that petitioner should have reported $58,092 on his 2007 Federal
income tax return and $70,846 on his 2008 Federal income tax return. Respondent
also determined that petitioner understated his income tax by $39,685 for tax year
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[*25] 2007 and by $47,757 for tax year 2008, which are both greater than $5,000
and greater than 10% of the income tax required to be shown on the returns for the
taxable years. Thus, respondent has carried his burden to show that petitioner
substantially understated his income tax for tax years 2007 and 2008.
If a taxpayer had reasonable cause for and acted in good faith regarding part
of the underpayment, no penalty is imposed on that part. See sec. 6664(c)(1); sec.
1.6664-4(a), Income Tax Regs. An important factor for demonstrating reasonable
cause and good faith is the extent of the taxpayer’s effort to determine the proper
tax liability. Sec. 1.6664-4(b)(1), Income Tax Regs. Petitioner, a successful
accountant, did not provide any evidence regarding what, if any, effort he made to
determine his proper tax liability at the time of filing his 2007 or 2008 tax return.
Each year petitioner sustained significant losses from his horse breeding activity,
and any gross income he received from that activity was substantially lower than his
losses. Yet, he did not seek advice about whether to continue to treat his horse
activity as engaged in for profit. Petitioner is well educated and familiar with
Federal income tax laws and regulations. His experience, knowledge, and education
weigh against him. See Brown v. Commissioner, T.C. Memo. 2011-83, aff’d, 693
F.3d 765 (7th Cir. 2012). Petitioner failed to show that he had reasonable cause for
and acted in good faith regarding the underpayment.
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[*26] We hold that petitioner is liable for the substantial understatement penalty
under section 6662(a) and (b)(2). We need not address the applicability of the
penalty on the grounds of negligence or disregard of rules or regulations within the
meaning of section 6662(b)(1) for tax years 2007 and 2008. See sec. 1.6662-2(c),
Income Tax Regs. Contentions we have not addressed are irrelevant, moot, or
meritless.
To reflect the foregoing,
Decision will be entered for
respondent.