T.C. Memo. 1997-247
UNITED STATES TAX COURT
MORGAN L. LUCID AND MARY J. LUCID, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 22933-95. Filed June 2, 1997.
Harry J. Kaplan, for petitioners.
Steven Walker, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GERBER, Judge: Respondent determined income tax
deficiencies for 1990 and 1991 in the amounts of $20,334 and
$49,727, respectively. Respondent also determined accuracy-
related penalties under section 6662(a)1 of $4,067 and $9,945 for
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable years in
(continued...)
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1990 and 1991, respectively. The issues for our consideration
are: (1) Whether, in 1990 and 1991, petitioners were engaged in
an activity for profit pursuant to section 183(a); and
(2) whether petitioners are liable for accuracy-related penalties
under section 6662(a) for the 1990 and 1991 taxable years.
FINDINGS OF FACT2
Petitioners resided in Fresno, California, at the time the
petition in this case was filed. Morgan L. Lucid (petitioner
husband) was a full-time plastic surgeon, and Mary J. Lucid
(petitioner wife) was a full-time psychotherapist licensed in
California until her retirement on June 30, 1986.
Petitioner husband is an experienced sailor and served in
the Navy during World War II. Petitioner husband has had
navigation experience with a sextant and the Geographical
Positioning System. He has taken courses in navigation, metal
welding, and meteorology. Petitioner husband has also made
engine, radar, and radio repairs, and was a certified scuba diver
and licensed ham radio operator. Petitioner wife is an
experienced sailor and has taken courses in meteorology, coastal
navigation, ham radio, and first aid. Petitioner wife has also
1
(...continued)
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
2
The parties' stipulation of facts and exhibits is
incorporated by this reference.
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lectured on subjects including cruising at sea, provisioning,
watch scheduling, cooking at sea, rescue equipment and its use,
safety at sea, and stowing a yacht.
Petitioners have always experienced personal pleasure from
yachting. For approximately 14 years, they owned a 34-foot
family yacht called Credence, which they used solely for personal
purposes. Their travels on Credence included trans-Atlantic,
trans-Pacific, east coast, west coast, and Caribbean offshore
cruises. In 1976, petitioner husband skippered Credence to
Hawaii and back, employing celestial navigation for the 45-day
trip. From September 1979 to March 1980, petitioners took time
off from their respective professions to sail Credence from San
Francisco to Florida via the Panama Canal. In 1981 and 1982,
petitioners took the summer months off to sail the Chesapeake Bay
and the coast of Maine. In 1983, petitioners sailed Credence,
with their son and niece, to the Azores, Ireland, and England,
utilizing only a sextant and a radio directional finder.
Overall, petitioners cruised at least 20,000 miles on Credence.
During 1984, petitioners sold Credence.
In early 1985, petitioners began using stationery printed
with the letterhead “Lucid Cruising, Offshore Outfitters and
Advisors”. Subsequently, they met with an accountant and an
attorney to discuss the formation of a corporate entity to sell
yachts and boating equipment under the name “Lucid Cruising”.
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Neither the attorney nor the accountant was experienced in
selling yachts. During March 1987, petitioners formed, in order
to protect themselves from liability, a subchapter C corporation
called “Lucid Cruising, Inc.” It was a wholly owned subsidiary
of Dr. Lucid's medical corporation, Morgan L. Lucid, M.D. Inc.,
which was incorporated on September 5, 1974. During October
1988, Lucid Cruising, Inc., was merged into its parent, Morgan L.
Lucid, M.D., Inc.; eventually, the merged corporation was renamed
“Morgan L. Lucid, Inc. Lucid Cruising” (Lucid Cruising), and S
corporation status was elected. Petitioners were the sole
shareholders of Lucid Cruising.
On December 30, 1985, petitioners indicated an interest in
pursuing a contract to be the sole west coast representative of
Kanter Yachts Corp. (Kanter Yachts). Petitioners believed that
steel and aluminum yachts afforded much more protection than
wooden or fiberglass yachts.
In 1986, petitioners became interested in acquiring a metal-
hulled sailboat. After examining and sailing in Lake Superior a
particular type of yacht, an Atlantic 45-foot owned by a Mr.
Donaldson, petitioners decided to lengthen the hull by 5 percent.
With the help of the architect who designed Mr. Donaldson's
yacht, petitioners made other changes to the vessel's design. On
June 6, 1986, petitioners requested that Kanter Yachts build a
yacht based on the detailed plans drawn by the architect.
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In a June 6, 1986, letter to Kanter Yachts, petitioners
inquired as follows:
Would you agree to list us as West Coast
representatives of your line, this being a month to
month agreement in which either party could cancel with
thirty days notice and in which our commission would be
protected to any potential buyer we had written to you
about for ninety days. We would agree to show the boat
at “In the Water Shows” here on the West Coast.
On June 23, 1986, Kanter Yachts replied that it would agree
to make the extensive changes required by petitioners. The
letter also contained the statement:
We also thank you for your offer to represent us on the
West Coast and we would be pleased to offer a 5%
finder's fee for any future contacts resulting in a
sale.
If petitioners had made successful referrals, they would have
made approximately $15,000 Canadian per referral.
In September 1986, petitioners and Kanter Yachts signed a
contract to build, for $296,894.11 Canadian,3 an Atlantic 47-foot
steel-hulled sailboat named “Brendan” based on petitioners’
architect’s design. During construction, Kanter Yachts suggested
lengthening the yacht by 1 foot, and Lucid Cruising agreed.
On October 9, 1986, petitioners informed Kanter Yachts:
We * * * appreciate that as your West Coast
representatives you will provide us with fliers and
assist us with our first boat shows on the East Coast.
You have an excellent product and we find it easy to be
3
The parties stipulated the amount shown in this opinion;
however, the contract reflects $283,430 Canadian. The Court has
chosen to follow the parties’ stipulated amount.
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enthused. For our part, we will plan on showing the
boat in Stamford [Connecticut] and Annapolis [Maryland]
in late summer and early fall of 1987. We would
appreciate any help you can provide in improving our
skills of showing a boat, obtaining space at the shows,
etc.
On December 30, 1986, petitioner husband noted that a
contract with Kanter Yachts had been signed on August 21, 1986.
The notes further stated:
The officers of Lucid Cruising met with the Kanters on
August 9th and came to an agreement that Lucid Cruising
would be the representative of Kanter Yachts on the
West coast. Mr. Kanter promised that he would be on
hand for the first show on the West Coast. He will pay
for the registration at this show. In turn this
company will receive 5 % of the cost of every yacht
sold as a result of our showing the yacht. The 5 %
will cover both the cost of the yacht and the extra
equipment on it.
Beginning in 1987, petitioners were becoming dissatisfied
with Kanter Yacht's handling of the contract to build Brendan.
In February 1987, Kanter Yachts was behind schedule in
constructing Brendan, and petitioners visited Kanter Yacht's
Canadian factory during February, April, June, and July 1987 in
order to verify the quality of workmanship and to ensure that the
yacht was being built according to the specifications. Each
factory visit was followed by a letter by petitioners,
summarizing the results of their visit and providing
specifications on how they wanted the Brendan to be built.
During that time, relations between petitioners and the owner of
Kanter Yachts deteriorated to the point that the parties were not
speaking to each other.
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The July 31, 1987, Lucid Cruising corporate minutes
mentioned the “decided strained feelings” with Kanter Yachts, and
that: “[Petitioners’] * * * dependence upon having a good
seaworthy yacht that is attractive to show is most important in
making this corporation solvent.” Petitioners decided to begin
an advertising campaign for the upcoming Seattle boat show
because Kanter Yachts would be responsible for the advertising
and registration for the Annapolis boat show.
In September 1987, petitioners took possession of the
Brendan in Canada but damaged it the next day while sailing. The
vessel was returned to Kanter Yachts for repairs. Petitioners'
insurance policy covered the damage to the sailboat. The
insurance contract was entitled, “The Travelers Personal Yacht
Policy” from The Travelers Insurance Companies. The policy read,
in part:
Private Pleasure Use Only
We do not provide any coverage under this policy while
the insured yacht is used for charter, hire, or any
other commercial purpose, unless approved by us in
writing.
The Brendan was returned to petitioners in January 1988. It was
shipped overland from Port Stanley, Ontario, Canada, to Seattle,
Washington. The sailboat was damaged by the trucking company in
transit. The damage was repaired, and petitioners showed the
Brendan at the Seattle boat show from January 16, 1988 through
February 28, 1988. Petitioners distributed their business cards
and brochures that were supplied by Kanter Yachts. Approximately
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33 people signed the visitors' book. The February 28, 1988,
Lucid Cruising corporate minutes contained the statement that
petitioners reminded Kanter Yachts that, if someone purchased a
yacht after viewing Brendan, they expected a 5-percent fee.
For the next 12 months, petitioners spent time equipping
Brendan for their projected cruise to New Zealand, which was
scheduled for May 1989. However, petitioners discovered problems
with Brendan and requested that Kanter Yachts rectify the
situation. In June 1988, petitioners took a cruise for a week to
the San Juan Islands in Washington State.
On July 12, 1988, petitioner wife, as a representative of
Lucid Cruising, wrote to Kanter Yachts regarding the planned
arrival of Brendan in Redwood City, California. The letter
states:
It is Morgan's hope that BRENDAN will be the yacht that
he has planned and looked forward to having. He
believes that after the leaks have been repaired, the
decks primed and recalked and epoxy that was spilled
next to the bulwarks cleaned he will forget the
problems that have plagued Brendan since her delivery
in Seattle and truly begin to enjoy her.
Additionally, petitioner wife stated that she was interested in
having the boat “returned to original value” and taking all steps
to protect their investment.
Sometime in July 1988, petitioners sailed Brendan for 5 days
from Washington State to Redwood City, California, where
petitioners docked Brendan. Until January 1989, Brendan was
permanently docked in Redwood City. This location was
approximately 50 minutes from petitioners' residence.
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The July 31, 1988, Lucid Cruising corporate minutes contain
a statement that petitioners, as the corporate officers, were
concerned over the problems with Brendan. Petitioners believed
that they “have not really had the opportunity to show [the
Brendan] * * * and realize some profit for the corporation.”
On August 31, 1988, petitioners wrote a letter to a magazine
that had covered the boat show and clarified that Brendan was not
for charter. The letter contains the statement that petitioners
“are representing Kanter [Y]achts on the West Coast and believe
that steel and aluminum yachts are the wave of the future for the
safety factor”. In August 1988, petitioners informed Kanter
Yachts that they had confidence that the shipyard would be able
to effect the repairs to Brendan, and “look[ed] forward to
enjoying BRENDAN for years to come.”
In September 1988, petitioners demonstrated Brendan at a
boat show in Alameda, California. Petitioners maintained a
visitors log for those who viewed the yacht, and over 300 people
signed it. At that time, petitioners distributed fliers
advertising Kanter Yachts, as well as their own business cards.
Prior to the show, petitioners advertised the showing of the
Brendan in two boating magazines.
The total time petitioners spent cruising on Brendan from
1987 through 1989 was as follows: (1) A 5-day cruise from
Seattle, Washington, to the San Juan Islands in Washington State
in 1988; (2) a 5-day cruise from Washington State to Coyote Point
in Redwood City, California, in 1988; (3) a day cruise from
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Coyote Point down the coast to the South San Francisco area in
1988; (4) a day cruise from Coyote Point to display the yacht at
the Alameda Boat show in the fall of 1988; and (5) a day cruise
from Coyote Point to San Francisco Boat Yard for repairs.
During January 1989, petitioners came to believe that
Brendan was dangerous and unseaworthy due to improper welding by
Kanter Yachts during construction. In February 1989, petitioners
demanded that Kanter Yachts purchase Brendan. However, Kanter
Yachts offered, instead, to repair the sailboat. On February 27,
1989, in corporate minutes subsequent to a meeting with the
representatives of Kanter Yachts, it was recorded: “Mrs. Lucid
explained that both her husband and she could not consider making
ocean passages in the yacht.”
On March 9, 1989, petitioners also wrote to Kanter Yachts:
We have studied your proposal #2 very carefully. We do
not enjoy the prospect of being without a boat for six
months, especially during the summer sailing season;
nor the trips at each stage of construction. However,
if we can reach an agreement I assure you that we will
do our utmost to assure a cordial working relationship.
The main or core problem is in the welding and as I
have learned aluminum is a very difficult metal to work
with.
* * * * * * *
* * * [The proposed agreement] assumes that Lucid
Cruising Inc. continues to represent Kanter Yacht
Corporation on the west coast. * * *
On April 1, 1989, to resolve the dispute, Kanter Yachts made
an agreement with Lucid Cruising, Inc. In the contract, Kanter
Yachts agreed to build petitioners a new yacht, named “Trinity”,
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based on the same plans as Brendan. The agreement stated in
part:
6. Upon completion of the new yacht Kanter at its
expense (including payment of any custom charges and
duty) shall transport it to San Francisco and
commission the yacht in the water. Sea trials if
required by Lucid shall be paid for by Lucid. Lucid
shall transfer title of Brendan to Kanter and in
exchange Kanter shall transfer title of the new yacht
to Lucid. * * *
* * * * * * *
14. It is understood that since Kanter has agreed to
replace the hull of Brendan by constructing a new
yacht, it is the intent that the new yacht's
specifications and equipment in every case must meet
but not exceed those for the yacht Brendan. * * *
On July 19, 1989, petitioners informed Kanter Yachts that
they were anxious to put the problems involving Brendan behind
them. Petitioners stated:
We were at a Marine Medicine meeting last week at Univ.
of Calif. Med school which was very good and raised our
urgency about getting back on the water and cruising.
Our winds have been delightful this summer and we miss
not sailing. There will be so many things that will
need to be done befroe [sic] we can cast off our lines
but we will continue to be patient.
By 1989, petitioners were no longer enthusiastic with
respect to the professionalism or acumen of Kanter Yachts. To
ensure that Kanter Yachts did not build the new boat, Trinity,
with the same flaws as Brendan, petitioners: (1) Hired an
independent third party to inspect the new hull during
construction as well as to inspect the factory; (2) flew from San
Francisco to Canada on a monthly basis to personally inspect the
ongoing construction of the new vessel; and (3) wrote
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approximately 12 letters to Kanter Yachts, detailing how they
wanted Trinity to be built. By October 1989, petitioners
considered requesting their attorney to intervene in the dispute
because they believed Kanter Yachts was unreceptive.
Petitioners anticipated receiving Trinity by October 1989,
pursuant to the contract signed between them and Kanter Yachts.
Petitioners were upset when Trinity was not completed in early
1990. In April 1990, petitioners canceled their registration to
show Trinity at the boat show in Alameda, California.
Also during April 1990, Trinity was shipped overland via
truck to petitioners. The sailboat was damaged in transit when
it hit an underpass in Berkeley, California. The hull of the
Trinity was seriously damaged. The ensuing repairs took
approximately 6 weeks.
Upon receipt of the Trinity, petitioners ceased contact with
Kanter Yachts. An adversarial relationship grew when petitioners
believed that the Trinity had various flaws. For example, the
keel bottom was not painted, there was no cover for the linear
drive, the batteries were dead, the head intake leaked, the guard
rail around the stern of the boat was unstable and needed
reinforcement. Additionally, the exhaust pipe was not properly
fitted, which caused waste water to spill into the boat.
Petitioners paid for the repairs in connection with the
Trinity. In July 1990, the repairs on the Trinity were
completed, and petitioners launched the vessel. Petitioners
discovered that the propeller shaft-fitting leaked, and it had to
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be repaired in dry dock. They requested that Kanter Yachts pay
for the repairs, and on July 18, 1990, Kanter Yachts' attorney
refused to undertake the repairs or to reimburse petitioners for
the repair costs. The attorney for Kanter Yachts advised
petitioners that:
With respect to the list of items referred to in
your letter, our client has carefully reviewed each
item and has determined that due to the picayune nature
of the items nothing further will be done.
In August 1990, petitioners wrote to their accountant, stating in
part:
We are also thinking of about [sic] closing the company
of Lucid Cruising since we feel at this time that in
all honesty we cannot endorse or represent the Kanter
Yacht, Inc., with the history that they have had with
us the past 3½ years. * * *
On November 20, 1990, petitioners' attorney wrote to Kanter
Yachts requesting $15,000 to settle their dispute. Petitioners
did not receive a response to their proposal from the attorney
representing Kanter Yachts.
Ultimately, petitioners decided that the cost of prosecuting
a lawsuit against Kanter Yachts, a Canadian company, would be
prohibitive. The dispute between petitioners and Kanter Yachts
was never resolved.
In July 1991, petitioners dissolved their corporation.
After the dissolution, petitioners modified Trinity at a cost of
$11,000 so that they could solely manage the vessel at sea. They
explained that they did not sell Trinity because sailboat prices
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were depressed and they would have received approximately one-
half of their cost.
In October 1991, petitioner husband retired from the
practice of plastic surgery and sold his business. In the same
month, petitioners began a 5-year retirement cruise on Trinity to
the South Pacific, including New Zealand and Australia. There
was no business purpose for the cruise.
By 1991, Lucid Cruising had incurred $496,827 in yacht
acquisition costs and operating expenses. Lucid Cruising also
reported on its Federal income tax returns the following items:
3/16/87 1987
7/31/87 1988 1988 1989 1990
1991
Income 0 $942 $500 0 0 0
Expenses $3,848 $11,631 $19,683 $65,649 $71,576 $10,819
1
Net Loss 3,848 10,689 19,183 65,649 71,576 10,819
1
In the stipulation, this figure appears to contain a typographical error.
The Court has chosen to follow the figure in the tax return.
Petitioners deducted substantially all the expenses related to
the Brendan as a business expense of Lucid Cruising in 1987 and
1988, respectively. In 1990, petitioners deducted substantially
all the expenses related to the Trinity as a business expense of
Lucid Cruising. Petitioners used the loss from Lucid Cruising to
offset their gross income from 1988 through 1991.
Petitioners' reported gross income without reference to
losses from Lucid Cruising or other activities was as follows:
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Year Gross Income
1988 $325,213
1989 346,593
1
1990 321,265
1
1991 229,757
1
The parties’ stipulation does not comport with
the amounts reflected in the tax returns. The Court
has chosen to follow the figures in the returns.
Kanter Yachts primarily relied on advertising to sell
yachts. The company expended approximately $51,000 to $74,000 in
advertising per year. Kanter Yachts had not sold a boat in any
of the 12 boat shows attended from 1987 through 1991. Manfred
Kanter (Kanter), proprietor of Kanter Yachts, did not believe
that petitioners represented Kanter Yachts during 1990.
OPINION
We must first decide whether petitioners were involved in
activities that were “not engaged in for profit” within the
meaning of section 183(c). Section 183(a), generally, provides
that, if an activity engaged in by an individual is not engaged
in for profit, no deduction attributable to such activity shall
be allowed, except as provided in section 183(b).4 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
4
In the case of an activity not engaged in for profit, sec.
183(b)(1) allows a deduction for expenses that are otherwise
deductible without regard to whether the activity is engaged in
for profit. Sec. 182(b)(2) allows a deduction for expenses that
would be deductible if such activity were engaged in for profit,
but only to the extent the total gross income derived from the
activity exceeds the deductions allowed by sec. 183(b)(1).
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paragraph (1) or (2) of section 212.” Section 162 allows a
deduction for all ordinary and necessary expenses paid or
incurred in carrying on a business. Section 212 allows a
deduction for all the ordinary and necessary expenses paid or
incurred for the production or collection of income, or for the
management, conservation, or maintenance of property held for the
production of income.
Whether deductions are allowable under sections 162 or 212
depends on whether the taxpayer engaged in the activity with the
objective of making a profit. Ronnen v. Commissioner, 90 T.C.
74, 91 (1988); Dreicer v. Commissioner, 78 T.C. 642, 645 (1982),
affd. without opinion 702 F.2d 1205 (D.C. Cir. 1983). The
taxpayer's expectation of profit need not be a reasonable one;
however, the taxpayer must have a bona fide objective to make a
profit. Hulter v. Commissioner, 91 T.C. 371, 393 (1988); Beck v.
Commissioner, 85 T.C. 557, 569 (1985); Allen v. Commissioner, 72
T.C. 28, 33 (1979); Dunn v. Commissioner, 70 T.C. 715, 720
(1978), affd. 615 F.2d 578 (2d Cir. 1980).
Whether a taxpayer has the requisite profit objective is a
question of fact to be resolved on the basis of all of the facts
and circumstances of the particular case at hand. Golanty v.
Commissioner, 72 T.C. 411, 426 (1979), affd. without published
opinion 647 F.2d 170 (9th Cir. 1981); Dunn v. Commissioner, supra
at 720. The taxpayer here bears the burden of proof on this
issue. Rule 142(a); Welch v. Helvering, 290 U.S. 111 (1933).
Greater weight is given to objective facts than a taxpayer's
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statement of intent. Independent Elec. Supply, Inc. v.
Commissioner, 781 F.2d 724 (9th Cir. 1986), affg. Lahr v.
Commissioner, T.C. Memo. 1984-472; Beck v. Commissioner, supra at
570; Thomas v. Commissioner, 84 T.C. 1244, 1269 (1985), affd. 792
F.2d 1256 (4th Cir. 1986); Dreicer v. Commissioner, supra.
Section 1.183-2(b), Income Tax Regs., provides a
nonexclusive list of factors relevant to the issue as to whether
the taxpayer has the requisite profit objective. These factors
are: (1) The manner in which the taxpayer carries 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 utilized by the
taxpayer 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 of occasional profits, if any, which are
earned; (8) the financial status of the taxpayer; and (9) whether
elements of personal pleasure or recreation are involved. Not
all of these factors are applicable in every case. Brannen v.
Commissioner, 722 F.2d 695, 704 (11th Cir. 1984), affg. 78 T.C.
471 (1982); Taube v. Commissioner, 88 T.C. 464, 479-480 (1987);
Abramson v. Commissioner, 86 T.C. 360, 371 (1986); Allen v.
Commissioner, supra at 34. No one factor nor a majority of the
factors is necessarily determinative, and we do not reach our
conclusion by simply counting the factors that support each
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party's position. Taube v. Commissioner, supra at 480; Dunn v.
Commissioner, supra at 720.
The Manner in Which the Taxpayer Carries On the Activity.
Generally, the fact that a taxpayer carries on an activity in a
businesslike manner and maintains complete and accurate books and
records may indicate that the activity is engaged in for profit.
Sec. 1.183-2(b)(1), Income Tax Regs.
Petitioners advertised in various boating magazines and
journals. They attended two boat shows in Seattle, Washington,
and Alameda, California, respectively, in 1988. Petitioners,
however, had no written business plan and did not take reasonable
steps to implement their stated objectives. Petitioners'
principal contention is that they could not carry on their yacht-
related activities because they lacked a demonstration boat to
represent Kanter Yachts and display or sell boating equipment.
We are not convinced that the lack of either Brendan or Trinity
formed an insuperable barrier to selling boating equipment or
yachts.
Petitioners failed to conduct even a basic investigation of
the profitability of selling yachts and boating equipment before
entering into the activity. Their business plan assumed that
they would earn income through the sales of yachts and boating
equipment. Petitioners' primary method of selling Kanter Yachts
was through boat shows. Petitioner husband testified that he was
hoping to eventually sell three yachts per year. However,
despite the fact that Brendan was demonstrated in both the
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Seattle and Alameda boat shows in 1988 and over 300 people signed
the visitors' log, there were no sales. Kanter testified that
his company, Kanter Yachts, relies primarily on advertising to
sell yachts, and that it had not sold a boat in any of the 12
boat shows they attended from 1987 through 1991.
Petitioners' stated intention to make a profit did not
comport with the fact that Lucid Cruising had nearly half a
million dollars of accumulated costs by 1991. If petitioners had
sold the three yachts projected, per year, for a commission of
$15,000 Canadian on each yacht, it would have taken nearly 11
years of consistent sales merely to recover their costs already
incurred.5
Other than the self-serving statements in the corporate
minutes, there is nothing in the record showing that petitioners
were authorized dealers or representatives of boating and/or
boating equipment manufacturers. The record does not reflect any
sales of boating equipment that would have ameliorated the length
of time necessary to break even.
Petitioners' marketing and advertising activities were
minimal. Although petitioners advertised in various magazines,
they did not promote their activities between September 1988
through July 1991. Petitioners ceased their selling activity
5
Five hundred thousand dollars of capitalization divided by
$15,000 commission per yacht multiplied by three yachts per year
equals nearly 11 years. Although the parity between U.S. and
Canadian currency varied during this period, we provide these
figures for illustrative purposes only.
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several weeks after the Alameda Boat show in September 1988.
That was when Brendan began experiencing problems which sidelined
petitioners' plans. Moreover, petitioners could not recall their
advertising budget. In comparison, Kanter Yachts' annual
advertising budget ranged from $51,000 to $74,000. In 1990 and
1991, petitioners did not pursue any of the 300 visitors to their
yacht from the Seattle and the Alameda boat shows.
Finally, the record demonstrates that petitioners did not
objectively treat Brendan or Trinity as business assets.
Petitioners used the yachts for personal sailing. In this
regard, Brendan was not commercially insured. After the
dissolution of petitioners' corporation, Lucid Cruising, they
retained Trinity and used it for extensive personal sailing.
The Expertise of the Taxpayer or His Advisers. Petitioners
were experienced sailors, and petitioner husband had experience
maintaining yachts. However, petitioners had no experience with
selling yachts or sailboat equipment.
Time and Effort Expended by the Taxpayer in Carrying On the
Activity. Petitioners spent minimal time carrying out the
activity in 1990 and 1991. The fact that a taxpayer devotes
little time to the activity may indicate a lack of profit motive.
Sec. 1.183-2(b)(3), Income Tax Regs. Here, petitioners did not
actively promote or advocate their yacht-related activity between
September 1988 through 1991. Also, petitioner husband worked
full-time as a plastic surgeon until his retirement in October
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1991. Around the same time, petitioners chose to terminate the
activity.
Petitioners spent several months in 1990 and 1991 addressing
issues with Kanter Yachts. We find that petitioners were
genuinely motivated by the desire to maintain their investment in
the yachts. On the other hand, we think that the minimal amount
of time petitioners spent in this activity does not support their
contention that they were engaged in this activity with a profit
objective in 1990 or 1991.
Expectations That Assets Used in the Activity May Appreciate
in Value. Petitioners did not present any evidence that the
yachts used in their activity would appreciate in value or that
the yachts were obtained for such purposes. In fact, petitioners
testified that the market for yachts was depressed in 1991.
Petitioners assert that this was the reason they did not dispose
of Trinity after their corporation, Lucid Cruising, was dissolved
in 1991.
The Success of the Taxpayer in Carrying On Other Similar or
Dissimilar Activities. Petitioners have not presented any
evidence that they had been previously engaged in activities
consisting of selling yacht equipment or yachts themselves. Sec.
1.183-2(b)(5), Income Tax Regs. Petitioners, however, were
financially successful in their business professions.
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The Taxpayer's History of Income and Losses With Respect to
the Activity. Petitioners' yacht-related activity generated
losses over a period of 5 years, which petitioners used to offset
taxable income from other sources. A record of substantial
losses over many years and the unlikelihood of achieving a
profitable operation are important factors bearing on the
taxpayer's intention regarding the activity. Cannon v.
Commissioner, 949 F.2d 345, 352 (10th Cir. 1991), affg. T.C.
Memo. 1990-148; Golanty v. Commissioner, 72 T.C. at 426-427. The
presence of such losses in the formative years of a business is
not inconsistent with an intent to achieve a later profitable
level of operation; however, the goal must be to realize a profit
on the entire operation, which presupposes sufficient future net
earnings from the activity to recoup the losses. Golanty v.
Commissioner, supra at 427.
In the present case, petitioners reported operating losses
over 5 years totaling $496,827. Petitioners contend that the
losses were attributable to unforeseen circumstances that were
beyond petitioners' control. Sec. 1.183-2(b)(6), Income Tax
Regs. Generally, losses sustained because of unforeseen
circumstances beyond the control of the taxpayer do not
necessarily indicate that the activity was not engaged in for
profit. Engdahl v. Commissioner, 72 T.C. 659, 669 (1979); sec.
1.183-2(b)(6), Income Tax Regs. However, the overall picture
reveals that petitioners did not operate an activity for profit
during the taxable years at issue, 1990 and 1991. They made no
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attempts to change their operating methods to become profitable.
They did not advertise or pursue potential customers.
Petitioners took no measures to reduce their expenditures for
unprofitable activities.
The Financial Status of the Taxpayer. When petitioners
purchased Brendan and Trinity, they were receiving significant
professional income. Petitioners earned gross income of: (1)
$325,213 in 1988; (2) $346,593 in 1989; (3) $321,265 in 1990, and
(4) $229,757 in 1991. Petitioner husband's income as a plastic
surgeon allowed petitioners to maintain the activity, and upon
his retirement, petitioners dissolved their S corporation, Lucid
Cruising, and terminated their activity. At that point, there
was no need to shelter petitioners' income by means of the yacht
activities’ claimed losses.
The Presence of Elements of Personal Pleasure or Recreation.
Although there were many self-serving business-type
statements in Lucid Cruising's corporate minutes, it is readily
apparent that petitioners were highly motivated by the pleasure
and recreation from these activities. They were seasoned
recreational sailors for at least 14 years, prior to acquiring
Trinity. Both Brendan and Trinity were custom-built according to
specifications for petitioners. Petitioners have not shown that
business was the primary purpose for acquiring the yachts.
We accordingly hold that petitioners have failed to prove
that they were engaged in the activity of selling boating
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equipment and yachts during 1990 and 1991 with the bona fide
objective of making a profit.
Respondent also determined accuracy-related penalties under
section 6662(a) for 1990 and 1991. Section 6662(a) provides for
a penalty of 20 percent of any portion of the underpayment
attributable to the taxpayer's negligence or disregard of the
rules or regulations. Sec. 6662(a).
Petitioners contend that they are not liable for the penalty
because they had substantial authority for their deductions.
They argue, generally, that the weight of the authorities
supports their position that their yacht activity was carried on
for profit. Specifically, petitioners rely on Pryor v.
Commissioner, T.C. Memo. 1991-109. In Pryor, we found that the
taxpayer was engaged in his sailboat charter activity with a
profit motive in part because he carried on the activity in a
business like manner. He made a written 12-year projection that
was essentially a cash-flow analysis before entering into the
activity. He also anticipated appreciation in the residual value
of his sailboats. However, a portion of the taxpayer's losses
were attributable to unanticipated expenses of repairs to his
sailboats.
In contrast, petitioners here possessed no written business
plan. Their expectations of a profit from their activity were
based more on their own self-serving and unrealistic
expectations. They did not consult with others in yacht and
boating equipment sales. Petitioners did not attempt to assuage
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their losses by changing their approach. Hence, Pryor v.
Commissioner, supra, is distinguishable.
Petitioners also rely on Dickson v. Commissioner, T.C. Memo.
1983-723, in which we found that despite losses, due to economic
conditions, the taxpayer was engaged in the business of
chartering his boat with a profit motive. We also found that the
taxpayer actually and honestly expected his boat to appreciate.
However, this case is inapposite; petitioners did not purchase
and hold Brendan or Trinity in order to derive gains from long-
term appreciation. There is also nothing on the record from
which we can conclude that the value of the yachts would have
increased.
Petitioners also cite Jackson v. Commissioner, 59 T.C. 312
(1972). In Jackson, we determined that the taxpayer was in the
trade or business of renting his yacht. Despite bad weather and
damage to the yacht, which forced the taxpayer to cancel most
charters, he took other steps to carry on his activity for
profit. For example, the taxpayer changed the venue of his
activity to the Virgin Islands, where his sailing vessel was in
demand. The taxpayer also began a national advertising campaign.
In that regard, he engaged a celebrity to advertise his business
throughout the nation. We find petitioners' reliance on Jackson
to be distinguishable. Here, petitioners did not take alternate
steps to carry on their yacht-related activity in a profit-
oriented manner. Petitioners' cessation of their activity
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between 1988 and 1991 militates against the notion that
petitioners sought to derive profit from that activity.
These cases do not represent authority for petitioners'
position. Accordingly, respondent's determination regarding the
accuracy-related penalty is sustained.
Decision will be entered for
respondent.
Lucid v. Commissioner
Court: United States Tax Court
Date filed: 1997-06-02
Citations: 1997 T.C. Memo. 247, 73 T.C.M. 2892, 1997 Tax Ct. Memo LEXIS 282
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