TINNELL v. COMMISSIONER

                        T.C. Memo. 2001-106



                      UNITED STATES TAX COURT



                  JAMES TINNELL, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 20318-97.                       Filed May 4, 2001.


     W. Leslie Sully, Jr., for petitioner.

     Paul L. Dixon, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     MARVEL, Judge:   Respondent determined the following

deficiencies, additions to tax, and penalties with respect to

petitioner’s Federal income taxes:1



     1
      All section references are to the Internal Revenue Code in
effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure. Monetary amounts are
rounded to the nearest dollar.
                               - 2 -

                                Additions to tax and penalties
                                  Sec.         Sec.      Sec.
  Year          Deficiency     6651(a)(1)      6654     6662(a)
  1991           $146,062       $15,132       $10,810   $29,212
  1992            100,517         8,041         4,384    20,103
  1993            405,936        38,703         4,837    81,187
  1994            134,217        15,582        10,107    26,843

     Following concessions,2 the issues for decision are:3

     (1)   Whether petitioner’s mining activity for 1991, 1992,

1993, and 1994 constituted an activity engaged in for profit

within the meaning of section 183; and

     (2)   whether petitioner is liable for the accuracy-related

penalty due to negligence under section 6662(a) for each year in

issue.




     2
      In a Stipulation of Settled Issues filed with the Court,
the parties agreed: (1) Petitioner’s claims of alimony paid in
1991 and 1992 were overstated by $57,595 and $600, respectively;
(2) petitioner understated capital gain in 1992 by $23,380; (3)
petitioner understated royalty income from Zila, Inc., in 1992 by
$3,726; and (4) petitioner is not liable for additions to tax
pursuant to sec. 6651(a)(1) or sec. 6654, as determined in
respondent’s notices of deficiency, for 1991, 1992, 1993, and
1994. In a second Stipulation of Settled Issues filed with the
Court, the parties agreed: (1) In 1991, petitioner was entitled
to claim a net operating loss deduction of $128,461 instead of
the $23,995 originally claimed; (2) in 1993, petitioner
originally claimed a net operating loss carryforward deduction of
$101,898, and the parties agreed there is no net operating loss
carryforward available for deduction, unless and except to the
extent any determination by the Court with respect to the
Schedule C mining activity in 1991 or 1992 results in a
carryforward of net operating loss; and (3) in 1993, petitioner
understated ordinary income from the exercise of stock options in
Zila, Inc., by $282,979.
     3
      The only other issues for decision are computational.
                                - 3 -

                           FINDINGS OF FACT4

     The parties have stipulated some of the facts, which we

incorporate in our findings by this reference.      Petitioner was a

resident of Las Vegas, Nevada, when the petition in this case was

filed.

     Petitioner graduated from the University of Arkansas School

of Medicine in 1962.   In 1965, petitioner began practicing

medicine in Lewisburg, Tennessee.     Five years later, petitioner

relocated his medical practice to Chattanooga, Tennessee.

Petitioner has been engaged in the practice of medicine at all

relevant times.

I.   Delta Roofing Mills

     In or about 1973, petitioner and his father purchased Delta

Roofing Mills, a roofing manufacturing business in Slidell,

Louisiana, for approximately $1 million.       Petitioner participated

in the management and marketing of Delta Roofing Mills, which

tripled its gross sales while petitioner and his father owned it.

Five years after petitioner and his father purchased Delta

Roofing Mills, they sold it to Republic Gypsum Corp. for

approximately $3 million and split the net sale proceeds.


     4
      In his opening brief, petitioner set forth “Proposed
Findings of Fact” that were in essence ultimate findings of fact.
By neglecting to follow Rule 151(e), which requires petitioner to
include numbered proposed findings of fact, petitioner has
“assumed the risk that we have not considered the record in a
light of * * * [his] own illumination.” Monico v. Commissioner,
T.C. Memo. 1998-10.
                                     - 4 -

II.    Zila Pharmaceuticals, Inc.

       In 1974, petitioner relocated his medical practice from

Chattanooga, Tennessee, to Las Vegas, Nevada.         In conjunction

with his medical practice, petitioner began doing research on

herpes.         During the late 1970's, petitioner invented a cream

called Herpaway (cream) for the topical treatment of herpes.

       In September 1980, petitioner and his partner, Dr. Edwin D.

McKay, formed a pharmaceutical manufacturing business called Zila

Pharmaceuticals, Inc., a Nevada corporation, to manufacture and

distribute the cream.5        Effective September 1, 1988, Zila

Pharmaceuticals, Inc., became a wholly owned subsidiary of Zila,

Inc. (Zila), a Delaware corporation.         Today, the cream is called

Zylactin and is being sold as an over-the-counter treatment for

herpes.         At the time of trial, Zila had over 200 employees and a

market capitalization of approximately $200 million.         At all

relevant times, petitioner has received royalties from Zila from

sale of the cream.

III.       Petitioner’s Mining Activities

           A.    Commencement of Petitioner’s Mining Activities

       In 1978, petitioner began reading prospecting books and

became interested in mining.         Petitioner attended shows and

seminars about mining and purchased numerous books on geology and


       5
      Before the formation of Zila Pharmaceuticals, Inc.,
petitioner acquired a corporate shell company called Dusenberg
Replicar, which later became Zila Industries.
                               - 5 -

mining at the University of Nevada bookstore.     Petitioner also

learned how to read geological mining maps.   Petitioner began

searching for gold and other precious metals on Federal land in

Clark County, Nevada.   By 1979, petitioner began locating mining

claims near Searchlight, Nevada.

     On March 5, 1980, petitioner formed Jetco Enterprises, Inc.

(JEI), a Nevada corporation.   Although petitioner apparently

planned to conduct his mining activities through JEI at some

point, petitioner did not use JEI during the years at issue or in

prior years to report the results of his mining activities.

Instead, petitioner conducted his mining activities as a sole

proprietorship doing business as Jetco Mining.6    Over the years,

petitioner employed his two sons, his daughter, and an ex-

brother-in-law in his mining activity.7




     6
      JEI, through and including the years at issue, did not file
Federal income tax returns. JEI, however, issued shares of
stock, held board meetings, kept minutes of corporate activities,
and otherwise observed all the formalities of a corporation. At
the time of trial, JEI was in good standing with the secretary of
state of Nevada. Petitioner is the sole shareholder and
president of JEI. Petitioner’s sons, L.R. Tinnell and Jaye E.
Tinnell, are secretary and treasurer, respectively. JEI’s fiscal
tax year ends Jan. 31.
     7
      At the time of trial, petitioner still employed his two
sons in his mining operation.
                                  - 6 -

     During 1980, petitioner located and staked at least 47 lode

mining claims in Clark County, Nevada.8     During the 1980's,

petitioner conducted exploration and development activities with

respect to his claims.      As of February 2000, petitioner had on

file and of record more than 300 lode mining claims.      A “Resource

Management Plan” map, dated August 1, 1997, prepared by and for

the U.S. Department of the Interior, Bureau of Land Management

(BLM), indicated there is “high mineral potential” on and around

petitioner’s mining claims.

         B.   Petitioner’s Early Efforts To Generate Income From
              Mining

     Petitioner engaged in business discussions regarding his

mining activities with various parties and entities.      In December

1982, petitioner discussed the possible sale of ore to Cash

Industries of Idaho (Cash Industries) for processing at Cash

Industries’ facilities.     During December 1982 and January 1983,

petitioner and Cash Industries conducted a sampling program and

numerous assays on petitioner’s claims.     No sale resulted.

     In April 1983, petitioner engaged in discussions with Lud

Carrao, the owner of a construction company, regarding a joint

venture in mining.     The venture was subject to proof of the

economic and commercial value of petitioner’s claims.     Petitioner



     8
      Most of petitioner’s claims were located in the Newberry
Mountains southeast of Searchlight, Nevada, which is an area
recognized for its high mineral potential.
                                 - 7 -

engaged in negotiations with Mr. Carrao, but no agreement was

reached.

     In May 1983, Century Capital Corp. explored investment in

petitioner’s mining venture but never raised any money for the

venture.9

     In November 1983, petitioner engaged in discussions with

Canorex International, Inc., of Colorado regarding a lease of

petitioner’s claims.   No agreement was reached.

     In 1983 and 1984, petitioner pursued a gold mining venture

in Lochiel, Arizona, on the U.S.-Mexico border.    The operation

produced an ounce to an ounce and a half of gold per day.    The

price of gold had fallen significantly, however, and the

operation was not profitable.    Soon thereafter, the operation was

shut down.

     Upon discontinuing mining in Arizona, petitioner moved his

equipment to Colorado and began another mining operation with a

“guy with a placer operation”.    The Colorado “guy” misrepresented

the amount of gold available, however, and petitioner terminated

his involvement in the operation.

     Petitioner returned to Las Vegas, Nevada, and, disappointed

with the last two unsuccessful ventures in Arizona and Colorado,

did not attempt to develop any mining ventures except his own



     9
      Century Capital Corp. was also involved in the private
placement of Zila.
                               - 8 -

claims.   Petitioner continued to talk to people about mining, to

read about mining, and to go to meetings about mining during this

period.

     In 1986, petitioner and a local real estate attorney,

Darrell Clark, representing Great Western Basin Corp. (Great

Western), negotiated a mining lease.   The lease was conditioned

on testing and sampling of petitioner’s claims.    An independent

geologist prepared a report for Great Western that set forth

numerous recommendations and conclusions.    In September 1986,

petitioner and Great Western entered into a lease whereby

petitioner agreed to lease his mining claims to Great Western for

the purposes of prospecting, exploring, drilling, mining, and

operating the property for ores and minerals.    Great Western made

no payments to petitioner, however, and defaulted on the lease.

     In 1988, petitioner began consulting with Kent Kjelberg at

the Rattlesnake Mine in California.    Petitioner provided

extensive equipment and knowledge to the Rattlesnake Mine.

Petitioner was not paid for the use of his equipment or for the

information he provided, but he was promised a portion of the

income produced from the Rattlesnake Mine.    Ultimately,

petitioner received only an old grader.

     In or about 1988, petitioner began to disengage from his

pharmaceutical activities at Zila and began spending more time on

his mining activities.
                               - 9 -

      C.   Petitioner’s Mining Plan of Operations

     On May 5, 1989, petitioner submitted a proposed mining plan

of operations to the BLM for approval.10   On January 12, 1993,

the BLM approved petitioner’s plan of operations.   During the

BLM’s investigation of petitioner’s plan of operations, from 1989

through 1993, petitioner incurred substantial expenditures to

develop a production mill, purchase an induction furnace,11 and



     10
       In order to initiate mining activity on Federal land, a
claimant must first file a 2-week notice, which allows the
claimant to disturb up to 2 acres of land per year. If the
claimant desires to disturb more than 2 acres, a plan of
operations must be approved by the BLM. Once a plan of
operations is filed, the BLM conducts an investigation before
approving the plan. In petitioner’s case, the BLM’s
investigation lasted approximately 3 to 4 years, during which
petitioner was allowed to erect facilities on his claims with the
knowledge of the BLM. The expenses incurred in erecting those
facilities are reflected in petitioner’s tax returns for those
years.
     11
      At some point, petitioner entered into a contract with
Inductotherm to perform a series of test smelts to determine
whether recoveries from his claims could be enhanced through the
use of induction smelting. Inductotherm provided an induction
furnace in Los Angeles, and petitioner and his son L.R. Tinnell
performed a series of seven smelts at Inductotherm’s facilities
(which created doré bars). Petitioner and L.R. Tinnell performed
tests on the doré bars, the results of which were favorable.
Thereafter, petitioner communicated with Union Miniere in
Belgium, which sent a local representative to perform an analysis
on petitioner’s doré bars. On the basis of a favorable report
from Union Miniere, petitioner began making arrangements to
upgrade his mill capacity. In 1993, petitioner purchased an
induction furnace from Ajax Magnathermic in order to increase the
capacity of his mill from 1 ton per hour to 10 tons per hour.
The purchase price of the induction furnace was about $50,000.
Petitioner made approximately 15 doré bars with the induction
furnace. The induction furnace, however, has not been operated
since 1996.
                              - 10 -

secure mineral surveys.   Further, beginning in 1991, petitioner

caused various claims to be surveyed with the objective of

patenting those claims.   On January 20, 1994, petitioner applied

for a mineral patent for some of his claims.12   To date, however,

petitioner has not received any patents with respect to his

claims.

      D.   Tinnell Prospect

     In 1992 and early 1993, petitioner explored and prospected

an area known as the Tinnell Prospect, consisting of a group of

claims in the northwest corner of petitioner’s claim block.

Horizon Securities, a securities firm that does private

placements for young companies, sent a geologist, Michael

Cruson,13 to perform a geologic evaluation of the area.   Mr.

Cruson prepared a report, dated January 15, 1993, and made three

recommendations:   (1) No further work is justified on the claims

covered by the Tinnell Prospect; (2) any future work in the area



     12
      Petitioner claimed that since 1994 there was a moratorium
on the issuance of mineral patents from the BLM. Apparently,
petitioner missed the deadline to apply for a mineral patent by 1
day, and his application was returned to him.
     13
      Michael Cruson has a geological engineering degree and a
Ph.D. in geology from the Colorado School of Mines. Mr. Cruson
has been engaged in the business of geological engineering since
1973. Mr. Cruson’s clients include major oil companies in the
United States; i.e., Phelps Dodge, Texaco, Chevron, Exxon; and
major mining companies in the United States; i.e., Kenicott,
Mobil, Newmont, and Cypress AMAX. At the time of trial, Mr.
Cruson was conducting a feasability study on the Sarmish gold
deposit site in Pakistan that was discovered in the early 1970's.
                               - 11 -

should be to the southeast where documented gold shows are

concentrated;14 and (3) the onsite sample preparation and

assaying methods should be carefully evaluated.   As a result of

Mr. Cruson’s recommendations, petitioner abandoned the claims

covered by the Tinnell Prospect.   Thereafter, petitioner devoted

his attention to the Quartette Mine.

      E.    Quartette Mine

     From 1991 through March 1996, petitioner pursued the

development and exploration of the Quartette Mine near

Searchlight, Nevada.    The Quartette Mine was owned by the Miller

family.15   The Millers were interested in having petitioner lease

their mine so that petitioner could transport rock from the

Quartette Mine to his mill site where it would be crushed and

processed.16

     Petitioner hired Mr. Cruson to evaluate the Quartette Mine.

Mr. Cruson prepared a report, dated December 10, 1993, containing

six conclusions and five recommendations.   Significantly, Mr.


     14
      This area was located near petitioner’s mill site (also
known as the Roman mine site) and represents the bulk of
petitioner’s claim area.
     15
      L.R. Tinnell was married to one of the Millers.    They were
divorced by 1993 but remained relatively close.
     16
      In November 1993, petitioner formed Complex Resources
Development (CRD) to take advantage of the development of the
Quartette Mine and petitioner’s claims. CRD was intended to be
the operating company of a future joint venture controlling the
Quartette mining operations. CRD never became active and never
filed a Federal income tax return.
                              - 12 -

Cruson concluded that “The Quartette Mine was a significant

producer of high grade gold ore.”   Mr. Cruson recommended that

petitioner:   (1) Acquire control of the Quartette Mine; (2) carry

out a detailed geologic study to determine the ore controls and

outline exploration targets; (3) examine the feasibility of

applying new geophysical or geochemical techniques at the

Quartette Mine; (4) develop a detailed history of the Quartette

Mine to determine cutoff grades during production; and (5) test

the targets defined by the earlier geologic study by drilling.

Petitioner followed all the recommendations outlined in Mr.

Cruson’s report.

     On April 1, 1994, petitioner17 acquired the rights to mine

and purchase the Quartette Mine ore.    Exploratory drilling to

determine the economic viability of the mine was conducted from

September 7 to November 5, 1994.    Mr. Cruson and his partner,

Kent E. Carter, prepared an evaluation of the Quartette Mine,

dated January 20, 1995, that stated:    “Overall the scout drilling

and exploration program was a resounding success”.    Mr. Cruson

“strongly recommended” that petitioner continue excavating, begin

preliminary mine planning, and initiate a second round of

drilling and exploration designed to delineate the new copper-


     17
      The lease for the Quartette Mine was not made part of the
record, and we assume the parties to the lease were the owners of
the Quartette Mine and petitioner. Nevertheless, because JEI did
not function as a tax reporting entity during the years at issue,
we attribute the mining activities to petitioner.
                              - 13 -

gold vein discovery.   Mr. Cruson estimated the total budget for

the next phase of drilling would be about $250,000.

     Petitioner recovered approximately 4 ounces of gold from the

Quartette Mine, and the project was abandoned in 1996.

      F.   Petitioner’s Sale of Decorative Rock

     After petitioner abandoned his efforts to develop the

Quartette Mine, petitioner expanded his business to include the

sale of decorative rock in an effort to generate revenue.    In

1994 and 1995, petitioner “tried to break into the wholesale

market” and realized it was almost impossible.    Thereafter,

petitioner opened a “rock yard” for the retail sale of rock and

gravel from his claims.   Petitioner purchased an advertisement in

the telephone directory yellow pages.   At the time of trial,

petitioner had been selling decorative rock for 4 years.18

During those years, petitioner’s gross income from the sale of




     18
      When petitioner’s plan of operations was approved, the
BLM, acting in error, granted petitioner permission to dispose of
sand and gravel from what petitioner claimed would be “tailings”
from his placer operations. Subsequently, inspectors from the
BLM observed stockpiles of what appeared to be decorative rock,
and BLM Law Enforcement reported that petitioner was selling
decorative rock in the Las Vegas market. On Feb. 8, 1999, the
Las Vegas Field Office of the BLM sent a decision to petitioner
directing him to halt the sale of “tailings” and “non-locatable”
minerals. On or about Apr. 30, 1999, petitioner filed an appeal
from the BLM decision. Petitioner hired a mining law attorney to
represent him with respect to the BLM’s decision and a geologist
to determine whether petitioner is mining “locatable” minerals.
At the time of trial, the matter was still on appeal, and
petitioner was still selling decorative rock.
                                 - 14 -

decorative rock has grown steadily, and petitioner continues to

generate substantial income from the sale of decorative rock.

       G.    Financing of Mining Activities

      Petitioner financed most of his mining activity with

royalties from Zila, the sale of Zila stock, and the exercise of

stock options in 1993.     Since 1980, no outside investor has

supplied capital for any of petitioner’s mining activities.

Petitioner sold shares of Zila stock when he needed money and

borrowed money secured by his Zila stock.

IV.   Petitioner’s Tax Returns

      A.    Mining Activities

      On petitioner’s Federal income tax returns for tax years

through 1997, petitioner treated all of his mining activities as

a single Schedule C activity doing business as Jetco Mining.19

For the years 1980 through 1988, petitioner had no income from

mining activities.    During the years from 1989 through 1999,

petitioner reported, either directly on a Schedule C or

indirectly through JEI, gross revenues and expenses from his

mining activities as follows:




      19
      JEI initially made an election to be treated for tax
purposes as a “pass-through” S corporation but did not file any
tax returns until 1998. Respondent does not assert that any
expenses claimed by petitioner with respect to the taxable years
at issue are disallowable because of the failure of JEI to file
Federal income tax returns.
                                - 15 -

                               Cost of goods
                               sold and other
     Year         Revenue      cash expenses    Depreciation

     19891          -0-           $113,273        $19,063
     1990           -0-            166,786         23,102
                                  2               2
     1991           -0-             359,627         41,265
                                  2               2
     1992            $700           286,217         41,902
                                  2               2
     1993           -0-             400,292         32,829
                                  2               2
     1994           2,100           591,704         45,664
     1995           2,900          558,142         73,315
     1996           -0-            488,521         76,476
     1997          32,364          363,923         41,101
                                  3               3
     1998         126,170           464,900         93,624
                                  3               3
     1999         373,566           322,328         83,960
     1
       For taxable years 1989 and 1990, petitioner’s original
returns were examined, and no change resulted. For those same
years, petitioner filed amended returns that claimed additional
losses from his mining activities. These claims were examined by
respondent and resulted in loss carryforwards allowed in 1991.
     2
       The parties agree that these amounts are deductible unless
disallowed by sec. 183. Respondent does not assert that any of
petitioner’s mining expenses with respect to the taxable years
1991 through 1994 should be disallowed as a result of the
application of sec. 616 or 617.
     3
       Expenses claimed on returns filed on behalf of JEI.

     B.     Zila Royalties and Stock Options

     From 1989 through 1998, petitioner reported royalty income

from Zila as follows:
                              - 16 -



                     Year        Royalty Income
                     1989           $82,933
                     1990           185,578
                     1991           213,507
                                   1
                     1992            180,895
                     1993           222,439
                     1994           224,717
                     1995           277,663
                     1996           305,002
                     1997           344,332
                     1998           372,119
     1
      Petitioner originally reported $177,169 of royalty income
in 1992. The parties stipulated an increase in this amount to
$180,895.

     In 1993, petitioner exercised options to purchase 380,000

shares of Zila stock worth $1,116,250 for an exercise price of

$285,000.   After taking into account Zila’s blockage discount of

$282,979, petitioner realized ordinary income of $548,271 on the

exercise of his stock options.    On petitioner’s 1993 Federal

income tax return, he claimed an additional discount of $282,979,

asserting that the sale of his Zila shares was restricted.

Petitioner reported the income from the exercise of his Zila

stock options on a supporting schedule attached to his 1993

return and attached an additional schedule fully describing the

total options exercised, the exercise amount, the fair market

value, the exercise price, the per-share blockage discount

applied by Zila, the amount of ordinary income to petitioner
                              - 17 -

reported by Zila,20 and the additional discount for restrictions

on stock taken by petitioner (marketability discount).   The

schedule contained the following statement concerning the

marketability discount:

     THIS DISCOUNT TAKEN BECAUSE TAXPAYER FEELS THAT STOCK
     WOULD BE SEVERELY EFFECTED IF HE PUT ALL THESE SHARES
     ON MARKET IN ONE BLOCK. IN ADDITION TAXPAYER CANNOT
     SELL SHARES FOR THESE YEARS PER SEC REGULATIONS.
     THEREFORE, PRESENT VALUE IS LESS.

Petitioner, however, did not make the disclosure on Form 8275,

Disclosure Statement, or Form 8275-R, Regulation Disclosure

Statement.   Petitioner and respondent have agreed that petitioner

is entitled to only a single discount of $282,979.

     C.   Medical Practice

      From 1989 through 1998, petitioner reported income and

losses from his medical practice as follows:

                     Year      Income (Loss)
                     1989        ($10,617)
                     1990         (15,235)
                     1991          (3,732)
                     1992          12,738
                     1993          36,723
                     1994          20,574
                     1995          10,547
                     1996           8,151
                     1997           5,449
                     1998           7,689




     20
      The additional schedule indicated the amount of
petitioner’s ordinary income as “ORDINARY INCOME-1099". We
assume this indicates that petitioner’s ordinary income was
reported on Form 1099.
                                - 18 -

During this period, petitioner spent most of his time and effort

on his mining activities and relatively little time maintaining

his medical practice.

                                OPINION

I.   Section 183(a) Deductions

     A.     In General

     Section 183(a) provides that if an activity is not engaged

in for profit, no deduction attributable to the activity shall be

allowed except as provided in section 183(b).     Section 183(b)(1)

allows those deductions that otherwise are allowable regardless

of profit objective.     Section 183(b)(2) allows those deductions

that would be allowable if the activity was engaged in for

profit, but only to the extent that gross income attributable to

the activity exceeds the deductions permitted by section

183(b)(1).     Section 183(c) defines “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.”

     Deductions are allowable under section 162 for the expenses

of carrying on an activity that constitutes a trade or business

of the taxpayer.     See sec. 162(a); sec. 1.183-2(a), Income Tax

Regs.     To be engaged in a trade or business with respect to which

deductions are allowable under section 162, “the taxpayer must be

involved in the activity with continuity and regularity,” and
                              - 19 -

“the taxpayer’s primary purpose for engaging in the activity must

be for income or profit”.   Commissioner v. Groetzinger, 480 U.S.

23, 35 (1987); see also Warden v. Commissioner, T.C. Memo. 1995-

176, affd. without published opinion 111 F.3d 139 (9th Cir.

1997).

     This case is appealable to the Court of Appeals for the

Ninth Circuit, which applies a primary purpose standard to test

whether an alleged business activity has the requisite profit

motive under sections 162 and 183.     Before a deduction is

allowed, “‘it must be shown that the activity was entered into

with the dominant hope and intent of realizing a profit.’”

Vorsheck v. Commissioner, 933 F.2d 757, 758 (9th Cir. 1991)

(quoting Brannen v. Commissioner, 722 F.2d 695, 704 (11th Cir.

1984), affg. 78 T.C. 471 (1982)); see also Wolf v. Commissioner,

4 F.3d 709, 713 (9th Cir. 1993), affg. T.C. Memo. 1991-212;

Machado v. Commissioner, T.C. Memo. 1995-526, affd. without

published opinion 119 F.3d 6 (9th Cir. 1997); Warden v.

Commissioner, supra.   We apply that standard here.

     Whether the requisite profit objective exists is a question

of fact to be resolved after considering all the pertinent facts

and circumstances.   See Golanty v. Commissioner, 72 T.C. 411, 426

(1979), affd. without published opinion 647 F.2d 170 (9th Cir.

1981); sec. 1.183-2(b), Income Tax Regs.    The taxpayer’s

expectation of profit need not be reasonable, but it must be bona
                                - 20 -

fide.     See Golanty v. Commissioner, supra at 425-426.     Although

our analysis focuses on the subjective intention of the taxpayer,

greater weight is given to objective facts than to a taxpayer’s

mere statement of intent.     See Independent Elec. Supply, Inc. v.

Commissioner, 781 F.2d 724, 726 (9th Cir. 1986), affg. Lahr v.

Commissioner, T.C. Memo. 1984-472; Dreicer v. Commissioner, 78

T.C. 642, 645 (1982), affd. without opinion 702 F.2d 1205 (D.C.

Cir. 1983); Churchman v. Commissioner, 68 T.C. 696, 701 (1977);

sec. 1.183-2(a), Income Tax Regs.     Petitioner bears the burden of

proving he had the requisite profit objective.     See Rule 142(a);

Golanty v. Commissioner, supra at 426.

        Section 1.183-2(b), Income Tax Regs., sets forth a

nonexclusive list of factors to be considered in determining

whether the taxpayer has the requisite profit objective.       The

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 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, which are

earned; (8) the financial status of the taxpayer; and (9)

elements of personal pleasure or recreation.     No single factor is
                                 - 21 -

determinative, and not all factors are applicable in every case.

See Allen v. Commissioner, 72 T.C. 28, 34 (1979); sec. 1.183-

2(b), Income Tax Regs.

     In making our evaluation of the foregoing factors, we may

consider evidence from years subsequent to the years in issue “to

the extent it may create inferences regarding the existence of a

profit motive in the earlier years.”      Hillman v. Commissioner,

T.C. Memo. 1999-255 (citing Hoyle v. Commissioner, T.C. Memo.

1994-592).   “[A]ctual profits or losses in those and subsequent

years have probative, although not determinative, significance in

such evaluation.”    Smith v. Commissioner, T.C. Memo. 1993-140.

     Petitioner contends that he had a good faith objective to

realize a profit from his mining activities during the years at

issue and, therefore, his deductions with respect to his mining

activities should not be limited by section 183.     Respondent

argues that an analysis of the relevant objective factors reveals

that petitioner lacked a bona fide objective to make a profit.

     B.   Applying the Factors

           1.   The Manner in Which Petitioner Conducted the
                Activity

     In deciding whether a taxpayer has conducted an activity in

a businesslike manner, we consider whether complete and accurate

books and records were maintained, whether the activity was

conducted in a manner substantially similar to other activities

of the same nature that were profitable, and whether changes in
                                 - 22 -

operating methods, adoption of new techniques, or abandonment of

unprofitable methods were made in a manner consistent with an

intent to improve profitability.     See Engdahl v. Commissioner, 72

T.C. 659, 666-667 (1979); sec. 1.183-2(b)(1), Income Tax Regs.

                  a.   Petitioner’s Record Keeping

     While a taxpayer need not maintain a sophisticated cost

accounting system, the taxpayer should keep records that enable

the taxpayer to make informed business decisions.     See Burger v.

Commissioner, 809 F.2d 355, 359 (7th Cir. 1987), affg. T.C. Memo.

1985-523.   For a taxpayer’s books and records to indicate a

profit motive, the books and records should enable a taxpayer to

cut expenses, increase profits, and evaluate the overall

performance of the operation.     See Abbene v. Commissioner, T.C.

Memo. 1998-330.

     The record in this case confirms that petitioner kept

extensive records of his mining activities, including financial

and tax records such as spreadsheets, bank statements, canceled

checks, and invoices and operational records such as production

records, test reports, consultant reports, correspondence, and

related documents.     Petitioner produced these records both to the

revenue agents who audited his tax returns for the years at issue

and to an accountant, Steven Klovanish, whom petitioner hired to

assist him in the audit.     Although petitioner and respondent

disagree as to the organizational state of the records, Mr.
                              - 23 -

Klovanish testified that petitioner’s records for the years at

issue were in an “organized condition” and, with the exception of

1 year, corresponded with petitioner’s tax returns.21

     Although we are satisfied that petitioner kept books and

records of his mining activities during the years at issue, we

are not convinced that petitioner’s record keeping represented

anything other than an effort to maintain substantiation of the

expenses claimed on his returns or that his record keeping was

businesslike.   As we have stated:

          The purpose of maintaining books and records is
     more than to memorialize for tax purposes the existence
     of the subject transactions; it is to facilitate a
     means of periodically determining profitability and
     analyzing expenses such that proper cost saving
     measures might be implemented in a timely and efficient
     manner. * * * [Burger v. Commissioner, T.C. Memo.
     1985-523 (citing Golanty v. Commissioner, 72 T.C. at
     430).]

See also Steele v. Commissioner, T.C. Memo. 1983-63 (checks

served as adequate substantiation for claimed expenses but were

not businesslike records).

     In this case, petitioner has made no showing that he kept

the kinds of books and records that would have enabled him to

evaluate the financial condition of his mining activities.    It



     21
      Mr. Klovanish could not tie some of the numbers on
petitioner’s tax return for 1 year to petitioner’s records but
suggested that this might be due to the fact that he did not have
information from petitioner’s prior accountant to ascertain what
adjustments the prior accountant had made in preparing the tax
return.
                              - 24 -

appears from the record that petitioner did not maintain a

general ledger or appropriate accounting journals, nor did he

have financial statements, profit and loss projections, budgets,

break-even analyses, marketing surveys, or other books and

records of the type that would have permitted him to periodically

monitor the financial condition of his mining operation.

Moreover, petitioner has made no showing that he used the books

and records that he did maintain for the purpose of “cutting

expenses, increasing profits, and evaluating the overall

performance of the operation.”   Golanty v. Commissioner, supra at

430; see also Sullivan v. Commissioner, T.C. Memo. 1998-367

(generally no profit motive where lack of evidence that taxpayer

used records to improve losing venture), affd. without published

opinion 202 F.3d 264 (5th Cir. 1999).

     Petitioner did produce evidence that he submitted a mining

plan of operations that was approved by the BLM on January 12,

1993.   This plan of operations, however, was not a financial plan

to monitor the profitability of petitioner’s mining operation.

Rather, the plan of operations was an operational plan required

by law if a claimant wishes to disturb more than 2 acres of land

per year on his claims.   Thus, the plan of operations is not

evidence that petitioner kept businesslike financial records.
                              - 25 -

     Petitioner has failed to demonstrate that he maintained

accurate and businesslike books and records with respect to his

mining activities during the years at issue.

                b.   Similarity to Other Activities of the
                     Same Nature

     Neither petitioner nor respondent offered any evidence as to

the manner in which profitable mining businesses are conducted.

See Wesinger v. Commissioner, T.C. Memo. 1999-372; Filios v.

Commissioner, T.C. Memo. 1999-92, affd. 224 F.3d 16 (1st Cir.

2000); sec. 1.183-2(c), Example (4), Income Tax Regs.   Thus, we

are not in a position to evaluate whether petitioner’s mining

activity was conducted in a manner substantially similar to that

of other profitable mining activities.

                c.   Changes Made To Foster Profitability

     There are numerous examples in the record demonstrating that

petitioner made changes in operating methods, adopted new

techniques, and/or abandoned unprofitable methods in the course

of conducting his mining activities.   See Engdahl v.

Commissioner, supra at 666-667; sec. 1.183-2(b)(1), Income Tax

Regs.

     Petitioner continually increased the capacity of his mill

site and mine (also known as the Roman mine) and periodically

developed or improved the methods he used in his mining activity.

For example, petitioner originally employed a leaching process of

cyanidation for the recovery of precious metals.   Petitioner was
                              - 26 -

not completely satisfied with the leaching process and changed

methods to employ the gravity separation method.    In order to

employ this new method, petitioner acquired a jaw crusher, a cone

crusher, a ball mill circuit, a screw classifier, and a wier jig

and table to concentrate material.     Petitioner also switched from

using cyanide as a lixiviant in the concentration process to

using bromine, after attending a Landall Mining Symposium in

Reno, Nevada.   In early 1993, petitioner purchased a $50,000

induction furnace to improve recoveries through induction

smelting.   Petitioner originally had a propane furnace, which was

not powerful enough to melt platinum.    Lastly, L.R. Tinnell

developed a proprietary fire assaying method for assaying

refractory ores to augment the standard fire assaying method used

in the industry.

     Petitioner pursued several mining prospects but quickly

abandoned those that he concluded had no potential to be

profitable.   For example, in Mr. Cruson’s January 15, 1993,

geological report on the Tinnell Prospect, Mr. Cruson recommended

that “No further work is justified on the claims covered by the

Tinnell Prospect.”   Pursuant to Mr. Cruson’s recommendation,

petitioner decided to cease work on the Tinnell Prospect.    In

1983 and 1984, petitioner pursued a gold mining venture in

Lochiel, Arizona, but quickly abandoned that effort after

realizing the operation would not be profitable.    Petitioner then
                              - 27 -

moved his equipment to Colorado and began another mining

operation, which he also quickly terminated when he discovered he

had been misled.

     In 1996, following the loss of the Quartette Mine project,

petitioner began to investigate the sale of decorative rock as an

income source and opened a rock yard in Las Vegas.    Petitioner

took out an advertisement in the telephone directory yellow pages

with respect to his decorative rock business.    Petitioner’s

revenue from the sale of decorative rock in the 3 years prior to

trial was significant, growing steadily from year to year; i.e.,

$32,364 in 1997, $126,170 in 1998, and $373,566 in 1999.

     Petitioner continually searched for operating methods and

business ventures to reduce his losses, generate revenue, and

improve profitability.   Ultimately, petitioner was successful in

generating substantial revenue from the sale of decorative rock.

Thus, we are convinced that the changes petitioner implemented

before, during, and after the years at issue have the potential

to affect the long-range profitability of petitioner’s mining

activity materially and favorably.     See Golanty v. Commissioner,

72 T.C. at 428 (changes must be sufficient to change materially

the prospect of profitability).

               d.   Summary

     Petitioner’s changes in operating methods, adoption of new

techniques, and abandonment of unprofitable methods to improve
                              - 28 -

profitability are counterbalanced by petitioner’s failure to

demonstrate that he maintained accurate and businesslike books

and records and to introduce evidence regarding the operation of

successful mining ventures.   See Engdahl v. Commissioner, 72 T.C.

at 666-667; sec. 1.183-2(b)(1), Income Tax Regs.   We, therefore,

must conclude that this factor is neutral.

          2.   The Expertise of Petitioner or His Advisers

     Preparation for an activity by extensive study of its

accepted business, economic, and scientific practices or

consultation with industry experts may indicate a profit motive

where the taxpayer carries on the activity in accordance with

such practices.   See sec. 1.183-2(b)(2), Income Tax Regs.

     Petitioner demonstrated that he had a thorough understanding

of the scientific and economic aspects of mining and that he

regularly consulted with industry experts.    In 1978, petitioner

began reading prospecting books and became interested in mining.

Petitioner attended shows and seminars about mining and purchased

numerous books on geology and mining.    Petitioner also learned

how to read geological mining maps.    Petitioner learned about

mining both from self-teaching methods and experience over the

years.   Petitioner also did consulting work in or about 1988 with

Kent Kjelberg at the Rattlesnake Mine and provided his expertise

and equipment to help develop the mine.
                                 - 29 -

     Petitioner hired advisers, including geologists and

accountants, and sought advice from Government officials

regularly.    See Jorgenson v. Commissioner, T.C. Memo. 2000-38.

For example, petitioner used Mr. Cruson on at least two occasions

to advise him on the Tinnell Prospect and the Quartette Mine.      In

1999, petitioner hired a geologist to prepare a report detailing

the occurrence of uncommon variety materials on petitioner’s

claims in the Newberry Mountains in southern Nevada.

     Petitioner also employed one of his sons at the mine.      The

evidence demonstrates that L.R. Tinnell has a thorough

understanding of both the technical and business aspects of

mining.    L.R. Tinnell graduated from the University of Nevada,

Las Vegas, and also took a graduate-level course in economic

geology.     L.R. Tinnell was responsible for dealing with

Government agencies, such as the U.S. Fish and Wildlife Service,

the Nevada Department of Environmental Protection, and the Mine

Safety and Health Administration, on behalf of petitioner.      L.R.

Tinnell was also in charge of underground mining and tests,

negotiations with Government agencies, and coordinating assays.

     This factor favors petitioner.

             3.   Petitioner’s Time and Effort Devoted to the
                  Activity

     The fact that a taxpayer devotes personal time and effort to

carry on an activity may indicate an intention to derive a

profit, particularly where there are no substantial personal or
                               - 30 -

recreational elements associated with the activity.     See Daley v.

Commissioner, T.C. Memo. 1996-259; sec. 1.183-2(b)(3), Income Tax

Regs.   A taxpayer’s withdrawal from another occupation to devote

most of his energies to the activity may be evidence that the

activity was engaged in for profit.     See sec. 1.183-2(b)(3),

Income Tax Regs.

     Respondent does not dispute that petitioner devoted a

substantial amount of time and effort to his mining activities.

In or about 1988, petitioner began to disengage from his

pharmaceutical and medical activities and to spend more time in

his mining activity.    Petitioner estimated he spent about 90

percent of his time on mining and only 10 percent of his time

working in his medical practice during the years at issue.

Petitioner’s estimate is corroborated by the small amount of

revenue petitioner derived from his medical practice in the 10

years prior to trial.    Further, the record demonstrates that

petitioner spent an enormous amount of his time, personal

finances, and energy over the past 20 years on his mining

activities.

     This factor favors petitioner’s position.

           4.   The Expectation That Assets Used in the Activity
                Would Appreciate in Value

     The term “profit” encompasses revenue from operations and

appreciation in the value of assets, such as land.     Sec. 1.183-

2(b)(4), Income Tax Regs.
                                - 31 -

     Thus, the taxpayer may intend to derive a profit from
     the operation of the activity, and may also intend
     that, even if no profit from current operations is
     derived, an overall profit will result when
     appreciation in the value of land used in the activity
     is realized since income from the activity together
     with the appreciation of land will exceed expenses of
     operation. * * * [Id.]

     Petitioner presented insufficient evidence to enable us to

evaluate this factor adequately.     Consequently, we do not

consider this factor in our analysis.

           5.     Petitioner’s Success in Other Entrepreneurial
                  Activities

     That a taxpayer has engaged in similar activities in the

past and converted them from unprofitable to profitable

enterprises may indicate that the taxpayer is engaged in the

present activity for a profit, even though the activity is

presently unprofitable.    See sec. 1.183-2(b)(5), Income Tax Regs.

     The record demonstrates that petitioner had at least two

successful entrepreneurial ventures before commencing his mining

activities.     First, in or about 1973, petitioner and his father

purchased Delta Roofing Mills, a roofing manufacturing business

in Slidell, Louisiana, for approximately $1 million.    Within 5

years, petitioner and his father tripled the company’s gross

sales and sold it to Republic Gypsum Corp. for approximately $3

million.

     Second, during the late 1970’s, petitioner invented the

cream.   In September 1980, petitioner and his partner formed Zila
                                 - 32 -

Pharmaceuticals, Inc., which later became a wholly owned

subsidiary of Zila.     At the time of trial, Zila had over 200

employees and a market capitalization of approximately $200

million.   The cream, which is now called Zylactin, is still on

the market as an over-the-counter treatment for herpes, and

petitioner has received substantial royalties from his invention.

     The record demonstrates that petitioner has realized profits

from other successful business ventures.     This factor favors

petitioner’s position.

           6.     Petitioner’s History of Income or Loss
                  From the Activity

     A taxpayer’s history of income or loss with respect to any

activity may indicate the presence or absence of a profit

objective.      See Golanty v. Commissioner, 72 T.C. at 426; sec.

1.183-2(b)(6), Income Tax Regs.     The magnitude of the activity’s

losses in comparison with its revenues is an indication that the

taxpayer did not have a profit motive.     See Dodge v.

Commissioner, T.C. Memo. 1998-89 (citing Burger v. Commissioner,

809 F.2d at 360), affd. without published opinion 188 F.3d 507

(6th Cir. 1999).     “[A] series of startup losses or losses

sustained because of unforeseen circumstances beyond the control

of the taxpayer may not indicate a lack of profit motive.”        Kahla

v. Commissioner, T.C. Memo. 2000-127 (citing Engdahl v.

Commissioner, 72 T.C. at 669; sec. 1.183-2(b)(6), Income Tax

Regs.).
                               - 33 -

     In this case, petitioner’s losses in comparison with his

revenues are substantial.   From 1980 through 1991, petitioner did

not report any income from his mining activities, and from 1989

through 1991, petitioner reported $723,656 in net losses.    From

1992 through 1999, petitioner reported a total of $537,800 in

revenue and $3,347,724 in losses.

     This factor favors respondent’s position.

          7.   The Amount of Occasional Profits Generated
               by the Activity

     The amount of profits earned in relation to the amount of

losses incurred, the amount of the investment, and the value of

the assets in use may indicate a profit objective.    See sec.

1.183-2(b)(7), Income Tax Regs.     Profit means economic profit,

independent of tax savings.   See Drobny v. Commissioner, 86 T.C.

1326, 1341 (1986); Seaman v. Commissioner, 84 T.C. 564, 588

(1985).

     Petitioner conceded on brief that he did not realize any

economic profit until 1999 and only began generating “meaningful

revenue” in 1997.22   Petitioner contends, however, that section

1.183-2(b)(7), Income Tax Regs., best describes his mining



     22
      During the years at issue in this case, petitioner
reported over $1.6 million in costs and expenses related to his
mining activities and only $2,800 of revenue. In the subsequent
5 years, however, petitioner reported $535,000 in revenue and
approximately $2.2 million in costs and expenses. In 1999,
petitioner’s revenue of $373,566 surpassed his operating costs
and expenses of $322,328, exclusive of depreciation.
                               - 34 -

activity:   “[A]n opportunity to earn a substantial ultimate

profit in a highly speculative venture is ordinarily sufficient

to indicate that the activity is engaged in for profit even

though losses or only occasional small profits are actually

generated.”    Respondent’s argument on brief with respect to this

factor consisted solely of the following sentence:   “The

petitioner has never reflected a profit from his mining activity,

and his losses have been substantial.”

     A mining venture is speculative and may take years to

realize a profit.   A mining venture nevertheless may present an

opportunity to earn substantial profits, particularly if the

mining claims involved have “high mineral potential” as at least

some of petitioner’s claims apparently did.   Petitioner presented

the testimony of an expert geologist who confirmed that

petitioner’s efforts with respect to the Quartette Mine were

worth pursuing and that some of petitioner’s claims merited

development.   While speculative, petitioner’s mining activity

offered the potential to generate significant income, and that

possibility may be sufficient to indicate that petitioner engaged

in the activity for profit even though only losses were produced.

See sec. 1.183-2(b)(7), Income Tax Regs.

     Petitioner believed he could and would earn a profit from

his many activities.   The objective facts also support

petitioner’s contention that a profit was attainable.     In 6 of
                              - 35 -

the 8 years prior to trial, petitioner earned revenue on sales of

decorative rock in increasing amounts.   Petitioner testified that

he continued to generate revenue from sales of decorative rock in

2000 and that his gross revenue during the first 2 months of 2000

was approximately $55,000, an increase of 200 percent compared to

revenue earned in the first 2 months of 1999.   Referencing the

“Resource Management Plan” map prepared by and for the BLM that

acknowledged the “high mineral potential” on and around

petitioner’s mining claims, petitioner testified that

there is “absolutely” gold and silver on his claims and that he

intends to “go back to the gold when the price turns”.

     The possibility of a speculative profit becomes less

speculative when a taxpayer shows he actually realized a profit

in years subsequent to those at issue.   See Hillman v.

Commissioner, T.C. Memo. 1999-255; Hoyle v. Commissioner, T.C.

Memo. 1994-592; Smith v. Commissioner, T.C. Memo. 1993-140

(actual profits or losses in subsequent years have probative,

although not determinative, significance).   Here, petitioner’s

efforts to generate revenue from the production and sale of

decorative rock are succeeding, as revenue has increased steadily

each year, and in 1999 petitioner’s mining activities generated a

profit before depreciation.   This factor favors petitioner’s

position.
                               - 36 -

          8.    Petitioner’s Financial Status

     That the taxpayer does not have substantial income or

capital from sources other than the activity in question may

indicate that the activity is engaged in for profit.   See sec.

1.183-2(b)(8), Income Tax Regs.   Substantial income from sources

other than the activity (especially if the losses from the

activity generate substantial tax benefits) may indicate a lack

of profit motive, particularly where there are elements of

personal pleasure or recreation involved.   See id.

     Respondent argues that little financial pressure or

incentive existed to pursue work that was consistently profitable

because petitioner could fund his mining activities with the

royalties he received from Zila and with the proceeds from the

sale of Zila stock.23   Petitioner contends that the tax benefits

he realized were relatively small in comparison to the out-of-

pocket expenditures he made and that his financial commitment to

his mining activity confirms his intention to make a profit from

the activity.

     Petitioner’s income from Zila royalties and stock was

substantial during the years at issue; however, petitioner

invested a substantial portion of that money each year in his

mining activities.   Petitioner financed his mining activity with


     23
      With respect to his medical practice, however, petitioner
did not earn more than $36,723 in any year from 1989 through
1998, and he sustained losses in 3 of those years.
                                - 37 -

Zila royalties and from the sale of Zila stock.    Petitioner sold

his Zila stock as he needed money and borrowed money that was

secured by his Zila stock.

     By the time of trial, petitioner had sold most of his Zila

stock and had used the proceeds from the sale of the stock and

all of his Zila royalties for many years to fund his mining

activity.    Petitioner’s financial commitment to his mining

activity apparently led respondent to concede in his reply brief

that it “is probably true” petitioner’s mining expenditures were

not motivated by tax savings.

     This factor favors petitioner’s position.

            9.   Elements of Personal Pleasure or Recreation

     The existence of personal pleasure or recreation relating to

the activity may indicate the absence of a profit objective.    See

sec. 1.183-2(b)(9), Income Tax Regs.

     Petitioner argues that mining is not the sort of activity a

person engages in for personal pleasure and that the frustrations

in dealing with Federal, State, and local government regulatory

agencies and the harsh working conditions offset any elements of

personal pleasure derived from mining.    Respondent contends that

personal enjoyment can coexist with demanding labor and that

petitioner loves being at the mine and is tired of working with

sick people.
                               - 38 -

     The record confirms that mining is an extremely laborious

activity that requires substantial time, energy, and financial

support.   Mining also entails numerous health risks, including

heat prostration in the summer months, silicosis, and cyanide

poisoning.    Despite these risks and hardships, there is evidence

suggesting that petitioner derives some personal pleasure from

his mining activities.   During the audit and at trial, petitioner

acknowledged that he enjoyed being outdoors, and that he was

“tired of dealing with sick people”.

     On balance, we are convinced that the small element of

personal pleasure that petitioner derived from being outdoors and

from his reduced involvement in his medical practice did not

outweigh the hardships and danger involved in the mining activity

or the substantial depletion of petitioner’s royalty income and

Zila stock.   Moreover, some component of personal pleasure does

not negate a bona fide profit motive.   “[A] business will not be

turned into a hobby merely because the owner finds it

pleasurable; suffering has never been made a prerequisite to

deductibility.   ‘Success in business is largely obtained by

pleasurable interest therein.’”    Jackson v. Commissioner, 59 T.C.

312, 317 (1972) (quoting Wilson v. Eisner, 282 F. 38, 42 (2d Cir.

1922)); see also sec. 1.183-2(b)(9), Income Tax Regs.

     This factor favors petitioner’s position.
                                 - 39 -

       C.   Conclusion

       After considering the factors listed in section 1.183-2(b),

Income Tax Regs., all contentions presented by the parties, and

the unique facts and circumstances of this case, we conclude that

petitioner entered into the activity of mining with a dominant

hope and intent of realizing a profit.       See Wolf v. Commissioner,

4 F.3d at 713; Vorsheck v. Commissioner, 933 F.2d at 758; Machado

v. Commissioner, T.C. Memo. 1995-526; Warden v. Commissioner,

T.C. Memo. 1995-176.     We hold that petitioner’s mining activity

during the years in issue was an activity engaged in for profit

within the meaning of section 183.

II.    Section 6662(a) Penalty

       In his notices of deficiency, respondent determined that

petitioner was liable for an accuracy-related penalty due to

negligence or disregard of rules or regulations for each of the

years in issue.     Section 6662 authorizes respondent to impose an

accuracy-related penalty equal to 20 percent on the portion of an

underpayment attributable to, among other things, negligence or

disregard of rules or regulations.        See sec. 6662(a), (b)(1), and

(c).    “Negligence” includes any failure to make a reasonable

attempt to comply with the provisions of the internal revenue

laws, to exercise ordinary and reasonable care in the preparation

of a tax return, to keep adequate books and records, or to

substantiate items properly.     Sec. 6662(c); Allen v.
                                - 40 -

Commissioner, 925 F.2d 348, 353 (9th Cir. 1991), affg. 92 T.C. 1

(1989); Bunney v. Commissioner, 114 T.C. 259, 266 (2000); sec.

1.6662-3(b)(1), Income Tax Regs.    The term “disregard” includes

any careless, reckless, or intentional disregard.    Sec. 6662(c);

sec. 1.6662-3(b)(2), Income Tax Regs.

     The penalty imposed by section 6662(a) and (b)(1) will not

apply if a taxpayer shows there was reasonable cause for any

portion of an underpayment and the taxpayer acted in good faith

with respect to that portion.    See sec. 6664(c)(1); sec. 1.6664-

4(a), Income Tax Regs.   The determination of whether a taxpayer

acted in good faith is made on a case-by-case basis, taking into

account all the pertinent facts and circumstances.    See Compaq

Computer Corp. v. Commissioner, 113 T.C. 214, 226 (1999); sec.

1.6664-4(b)(1), Income Tax Regs.

     Petitioner bears the burden of proving that respondent’s

determination is erroneous.   See Rule 142(a); Allen v.

Commissioner, 925 F.2d at 353; Axelrod v. Commissioner, 56 T.C.

248, 258 (1971).

     A.   Stipulated and Computational Issues

     Respondent proposed several adjustments with respect to

petitioner’s returns for the years in issue.    Some of the

adjustments were settled before trial, as reflected in the

stipulations of settled issues, or are computational.     See supra

note 2.   Petitioner introduced evidence at trial, and argued on
                               - 41 -

brief, in support of his position that the accuracy-related

penalty should not be imposed with respect to the mining

deductions or the exercise of Zila stock options.   Petitioner,

however, did not present any evidence concerning the accuracy-

related penalty as it relates to the remaining settled or

computational issues.   Consequently, we hold that petitioner has

failed to prove that the accuracy-related penalty should not

apply with respect to the remaining settled and computational

issues.   See Rule 149(b).   We sustain respondent’s determination

as to the settled and computational issues, excluding only the

adjustment with respect to petitioner’s exercise of his Zila

stock options discussed separately below.

     B.   Exercise of Zila Stock Options

     In 1993, petitioner was required to report ordinary income

of $548,271 from his exercise of stock options to purchase

380,000 shares of Zila, after taking into account an exercise

price of $285,000 and Zila’s per-share blockage discount of

$282,979.   On petitioner’s 1993 Federal income tax return,

however, he reduced the amount of ordinary income derived from

his exercise of his Zila stock options (and shown on a Form 1099

issued to him) by an additional $282,979, claiming that he was

entitled to an additional discount because the sale of the shares

was restricted.   Petitioner disclosed this additional discount on

a schedule that fully described the total options exercised, the
                              - 42 -

exercise amount, the fair market value, the exercise price, the

per-share blockage discount applied by Zila, the amount of

ordinary income reported on Form 1099, and the additional

discount for restrictions on stock taken by petitioner

(marketability discount).   The schedule contained the following

statement concerning the marketability discount:

     THIS DISCOUNT TAKEN BECAUSE TAXPAYER FEELS THAT STOCK
     WOULD BE SEVERELY EFFECTED IF HE PUT ALL THESE SHARES
     ON MARKET IN ONE BLOCK. IN ADDITION TAXPAYER CANNOT
     SELL SHARES FOR THESE YEARS PER SEC REGULATIONS.
     THEREFORE, PRESENT VALUE IS LESS.

In the second Stipulation of Settled Issues filed with the Court,

petitioner and respondent agreed that petitioner is entitled to

only one discount of $282,979 and that, in 1993, petitioner

understated ordinary income from the exercise of Zila stock

options by $282,979.

     The applicable regulations regarding the accuracy-related

penalty as to negligence, which became effective for returns due

after December 31, 1991, and applied to returns filed for 1993,

contained an adequate disclosure exception.    See sec. 1.6662-

2(d), Income Tax Regs.   These regulations provided that no

penalty under section 6662(a) and (b)(1) will be imposed where a

taxpayer has made an adequate disclosure of a nonfrivolous

position in accordance with the provisions of section 1.6662-

4(f)(1), (3), (4), and (5), Income Tax Regs.    See secs. 1.6662-1,

1.6662-3(c)(1) and (2), Income Tax Regs.   Under the regulations,
                                - 43 -

disclosure was adequate with respect to an item or a position on

a return only if it was made on Form 8275 or Form 8275-R attached

to the return or to a qualified amended return for the taxable

year.     See Kelly v. Commissioner, T.C. Memo. 1996-529; sec.

1.6662-4(f)(1), Income Tax Regs.24

     The disclosure petitioner made on his 1993 return did not

satisfy the regulations’ definition of an adequate disclosure

and, thus, is insufficient to avoid the accuracy-related penalty

under section 6662(a) and (b)(1).     The regulations explicitly

state that an adequate disclosure statement for purposes of the

accuracy-related penalty as to negligence must be made on Form

8275 or Form 8275-R.    See Kelly v. Commissioner, supra; sec.

1.6662-4(f)(1), Income Tax Regs.     Petitioner did not attach a

Form 8275 or Form 8275-R to his 1993 return and, therefore,



     24
      For returns due before Dec. 31, 1991, taxpayers were
entitled to rely on Notice 90-20, 1990-1 C.B. 328, which states
that “disclosure must be full and substantive and be clearly
identified as being made to avoid imposition of the accuracy-
related penalty.” See also Kelly v. Commissioner, T.C. Memo.
1996-529. Notice 90-20, supra, also provided that “The
disclosure must be made on the return or on a properly completed
Form 8275, Disclosure Statement Under Section 6661, attached to
the return.” Sec. 1.6662-4(f)(1), Income Tax Regs., in effect
for 1993, sets forth stricter requirements than those set forth
in Notice 90-20, supra, in order to avoid the imposition of the
accuracy-related penalty under sec. 6662(a) and (b)(1).
     In addition, the provisions of sec. 1.6662-4(f)(2), Income
Tax Regs., which permit disclosure in accordance with an annual
revenue procedure for purposes of the substantial understatement
penalty, do not apply for purposes of the accuracy-related
penalty imposed for negligence. See sec. 1.6662-3(c)(2), Income
Tax Regs.
                                - 44 -

failed to meet the strict requirements of sections 1.6662-3(c)(1)

and (2) and 1.6662-4(f)(1), Income Tax Regs.

     Even though petitioner did not make an adequate disclosure

sufficient to avoid the penalty under the applicable regulations,

petitioner may still be relieved of liability for the accuracy-

related penalty if he shows there was reasonable cause for the

understatement and he acted in good faith with respect to the

understatement.     See sec. 6664(c); sec. 1.6664-4(a), Income Tax

Regs.     We decide whether petitioner acted with reasonable cause

and in good faith after reviewing all the facts and circumstances

and taking into account a variety of factors.    See sec. 1.6664-

4(b), Income Tax Regs.     The most important factor is the extent

of petitioner’s effort to assess his proper tax liability.     See

sec. 1.6664-4(b)(1), Income Tax Regs.

     Petitioner contends that he claimed the additional

marketability discount after consultation with his accountant and

that, at all times, he “reasonably relied upon the expertise and

advice of a certified public accountant in the preparation and

filing of” his tax return.25    The only evidence petitioner


     25
      Petitioner also argued that any understatement
attributable to an undervaluation of the Zila stock should be
reduced if (i) the tax treatment is supported by substantial
authority, or (ii) there was adequate disclosure of relevant
facts on his return. See sec. 6662(d)(2)(B). By its terms, and
as indicated by the regulations, the exception in sec.
6662(d)(2)(B) applies only to an accuracy-related penalty imposed
on an underpayment attributable to any substantial understatement
                                                    (continued...)
                              - 45 -

presented to indicate that he “reasonably relied upon the

expertise and advice” of his accountant, however, was his own

self-serving testimony, which we are not required to accept.     See

Tokarski v. Commissioner, 87 T.C. 74, 76 (1986).   Petitioner’s

1993 return does not indicate that the marketability discount was

taken on the advice of his accountant or that petitioner

consulted his accountant.   Further, there is no evidence that

petitioner retained an expert to value the stock before claiming

the marketability discount.   To the contrary, the schedules

indicate that the additional discount was taken because

petitioner felt that the stock was restricted and that an

additional discount was warranted.26

     We find that petitioner has failed to prove that there was

reasonable cause for the understatement and that he acted in good

faith in applying an additional discount to reduce the value of

the Zila stock acquired by exercising his stock options.    We

hold, therefore, that petitioner is liable for an accuracy-

related penalty with respect to the additional income generated

by the exercise of his Zila stock options.




     25
      (...continued)
of income tax. See sec. 6662(b)(2), (d)(2)(B); sec. 1.6662-4(a),
Income Tax Regs.
     26
      Petitioner’s reporting position regarding the additional
discount was inconsistent with the Form 1099 furnished by Zila,
which allowed a blockage discount of only $282,979.
                               - 46 -

III.    Conclusion

       We have considered the remaining arguments of both parties

for results contrary to those expressed herein and, to the extent

not discussed above, find those arguments to be irrelevant, moot,

or without merit.

       To reflect the foregoing,


                                          Decision will be entered

                                     under Rule 155.