IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
_____________________
No. 94-40652
_____________________
BILLIE R. WESTBROOK and
MADELINE M. WESTBROOK,
Petitioners-Appellants,
versus
COMMISSIONER OF INTERNAL
REVENUE,
Respondent Appellee.
_________________________________________________________________
Appeal from the United States Tax Court
_________________________________________________________________
October 30, 1995
Before KING and JONES, Circuit Judges, and KAZEN*, District
Judge.
PER CURIAM:
Billie R. Westbrook and Madeline M. Westbrook appeal the
United States Tax Court's affirmance of the Commissioner's
determination of deficiencies and additions to tax for negligence
and for substantial understatement of tax liability for the tax
years 1984-1987. Finding no error, we affirm.
I. FACTUAL AND PROCEDURAL BACKGROUND
Billie R. Westbrook ("Dr. Westbrook") has been a
veterinarian since 1955. He and Madeline M. Westbrook ("Mrs.
*
District Judge of the Southern District of Texas,
sitting by designation.
Westbrook") were married in 1952. In 1962, Dr. Westbrook founded
the Spring Branch Veterinary Clinic (the "Clinic"), at which he
worked on a full time basis during the years at issue, 1984-1987.
Dr. Westbrook worked at the Clinic from 8 a.m. to 6 p.m. on
weekdays, and on Saturday and Sunday mornings, and he was on call
for emergencies twenty-four hours a day, seven days a week.
During the years in issue, the Clinic's average gross revenues
approximated $725,000, and the Westbrooks reported annual income
from the Clinic ranging from $114,828 to $224,343.
Mrs. Westbrook has performed services for the Clinic without
compensation since its inception. Her primary role has been in
marketing the Clinic, although she has also served as the
receptionist and "kennel person." Mrs. Westbrook also handled
public relations for the Texas Veterinary Medical Association,
through which she was able to obtain free advertising for the
Clinic by using animals owned by the Westbrooks. Mrs.
Westbrook's public relations activities included bringing animals
to schools and nursing homes.
A. Burton Farm
In October 1976, the Westbrooks purchased Burton Farm, a
299.2 acre farm, with its mineral rights, located in Lee County,
Texas. In 1976 and 1977, after investigating the cattle
business, the Westbrooks commenced a cattle-raising operation by
purchasing twenty Angus cows and one Angus bull. The Westbrooks
did not have a business plan for their cattle-raising operation,
2
and they did not keep detailed records of the venture. In April
1983, the Westbrooks sold their herd and ceased the cattle
operation. During the years at issue, 1984-1987, the Westbrooks
neither kept animals nor performed farming activities at Burton
Farm. Nevertheless, they reported net losses for farming
operations at Burton Farm from 1976 through 1987.
In the late 1970s, oil was discovered on Burton Farm, and
the Westbrooks commenced oil and gas production in commercial
quantities. On August 16, 1983, the Westbrooks entered a lease
agreement giving WCS Petroleum Co. ("WCS") the exclusive right to
explore, drill, and produce oil and gas at Burton Farm. In
return, the Westbrooks received a royalty interest--a fractional
share of oil production, free of development and operational
expenses. During 1984-1987, the Westbrooks reported net income
from oil and gas production on Burton Farm, although they
reported net losses from farming operations on Burton Farm for
those years.
The Westbrooks arranged for Danny Nowell, a production
manager with WCS, to reside at Burton Farm and look after the
Burton Farm property and the oil wells. Nowell lived at Burton
Farm from 1983 or 1984 until sometime between 1985 and 1987.
Nowell repaired the perimeter fence in order to keep cattle
inside, but he did not upgrade the fence in a manner designed to
deter oil theft. No oil was stolen from Burton Farm during the
time that WCS was lessee. The Westbrooks made no written claims
3
to WCS for reimbursement for physical damage to the property, as
the lease required, because they incurred no covered damages.
B. Billenbrook Farm
The Westbrooks purchased a 211-acre farm in Austin County,
Texas known as Billenbrook Farm in 1980. The Westbrooks did not
calculate the number of years that it would take to recoup their
investment in the farm or in the livestock they planned to keep
at the farm, but their son did prepare a "preliminary business
outline" stating: "The purpose of this venture is to build
capital assets with the limited physical involvement of the
principals [the Westbrooks and their son]."
The Westbrooks' activities on Billenbrook Farm generally
consisted of raising cattle and miniature horses. First, they
investigated and then engaged in "embryo transplant" cattle-
raising from 1982 to 1984. Although the Westbrooks investigated
the process of embryo transplants and examined existing
operations, they failed to obtain appraisals or make income
projections. The Westbrooks never calculated how much it would
cost to achieve their professed goal of building a purebred herd,
nor did they calculate the cost of production for each embryo-
transplant calf. In 1982, they purchased two Angus heifers to
use in the embryo transplant process, and, during 1984, they
maintained 14-16 head of cattle on Billenbrook Farm. The
Westbrooks kept cattle on Billenbrook Farm until 1987, but they
discontinued the embryo transplants in 1986 because they were
losing money from that operation.
4
In 1983, the Westbrooks investigated the miniature horse
business and purchased twenty-seven miniature horses. They did
not make any written financial projections regarding the
miniature horses, or calculate how long it would take to recoup
their investment in the horses. The Westbrooks did not insure
the horses except when they moved them. They failed to keep
fertility records or to perform pregnancy tests on the horses.
They never mated any of their mares with another owner's stud,
nor offered their stallion's stud services to horses owned by
others. The Westbrooks never sold any miniature horses. In
August 1985, the Westbrooks donated their entire herd of
miniature horses to a tax-exempt, charitable organization.
The Westbrooks reported net losses from operations at
Billenbrook Farm in each year from 1980 to 1987. Starting in
1984, they reduced their time spent at Billenbrook Farm out of
concern for the profitability of the Clinic. The Westbrooks
finally ceased operations at Billenbrook Farm when oil and gas
production began at Burton Farm, causing a "drastic change" in
their lives.
C. Billenbrook Farms, Inc.
On January 18, 1982, the Westbrooks formed Billenbrook
Farms, Inc., a subchapter S corporation with its principal place
of business on Billenbrook Farm. Dr. Westbrook owned 100 % of
the stock of Billenbrook Farms, Inc. during 1984-1987 and all
expenses incurred by the corporation were funded by cash provided
5
by the Westbrooks, either as a contribution or a loan.
Billenbrook Farms, Inc. engaged in the activities of breeding and
raising purebred dogs and maintaining pygmy goats. In February
1985, the Westbrooks sold its entire stock of dogs and ceased the
dog operation, after determining that success would require a
larger stock of dogs and a greater percentage of Dr. Westbrook's
time than they were willing to commit. Billenbrook Farms, Inc.
also raised pygmy goats, although it failed to maintain breeding
records for the goats or sell any of them. The goats were
treated as an ancillary operation to Billenbrook Farm's miniature
horses, and they were taken by Mrs. Westbrook to nursing homes,
schools, and petting zoos as part of her public relations efforts
for the Clinic. In September 1985, the Westbrooks donated their
entire stock of pygmy goats to a tax-exempt, charitable
organization. Billenbrook Farms, Inc. reported net losses on its
income tax returns in each year from 1983 through 1986.
D. The Westbrooks' Business Records
Except for Billenbrook Farm, for which the Westbrooks' son
created a brief preliminary business outline, the Westbrooks did
not make formalized business plans for any of their activities.
The Westbrooks maintained one checking account, from which they
paid the expenses for the Clinic, Burton Farm, and Billenbrook
Farm. Billenbrook Farms, Inc. maintained a separate account.
Dr. Westbrook annotated each check with a description of the
relevant activity, such as "Burton" or "Billenbrook," and he then
6
sent copies of the checks to his accountant, John Braden.
Relying upon Dr. Westbrook's annotations, Mr. Braden entered the
check information into a computer program under the designated
activity, and the program created an income statement and a
balance sheet for each of the Clinic, Burton Farm, and
Billenbrook Farm. Braden also used this program to create
financial statements for Billenbrook Farms, Inc.
Dr. Westbrook and his staff made some errors in annotating
the checks and in disbursing funds from the wrong checking
account; therefore, the financial statements created by Braden
contained errors that the Westbrooks subsequently failed to
correct. As a result, some expenses related to the Westbrooks'
individual federal income tax returns were reported and deducted
on the Billenbrook Farms, Inc. federal income tax return, while
some expenses incurred by Billenbrook Farms, Inc. were deducted
on the Schedules F of Burton Farm or Billenbrook Farm, which were
part of the Westbrooks' individual return.
E. Procedural History
On June 27, 1991, the Commissioner mailed the Westbrooks a
Notice of Deficiency informing them of the Commissioner's
determination of additional tax liabilities for the years 1984
through 1987. Following a trial, on December 29, 1993, the tax
court sustained the Commissioner's determination of additional
tax liability based upon its findings that Dr. and Mrs. Westbrook
had no business or profit motive with respect to Burton Farm,
7
Billenbrook Farm, or Billenbrook Farms, Inc.1 The tax court also
sustained the Commissioner's application of negligence and
substantial understatement penalties. On February 28, 1994, the
Westbrooks filed a motion for reconsideration claiming that
approximately 55% of the deductions disallowed by the tax court
had been placed on the wrong schedules of their return, and
asking to be allowed to reclassify the expenses reported for
Burton Farm, Billenbrook Farm, and Billenbrook Farms, Inc., so
that these expenses would be properly deductible. The tax court
denied the motion for reconsideration, and the Westbrooks
appealed.
II. STANDARD OF REVIEW
We review the decision of the tax court under the same
standards that we apply to district court decisions. Thus, we
review the tax court's factual findings for clear error, and
examine issues of law de novo. Park v. Commissioner, 25 F.3d
1289, 1291 (5th Cir.), cert. denied, 115 S. Ct. 673 (1994);
McKnight v. Commissioner, 7 F.3d 447, 450 (5th Cir. 1993). A
finding of fact is clearly erroneous when, although there is
enough evidence to support it, the reviewing court is left with a
firm and definite conviction that a mistake has been committed.
United States v. United States Gypsum Co., 333 U.S. 364, 395
1
The Commissioner had conceded the deductibility of
Billenbrook Farms, Inc.'s losses for 1984 through February 1985.
The tax court's finding that the Westbrooks lacked a profit
motive with respect to Billenbrook Farms, Inc. is thus limited to
the corporation's activities after February 1985.
8
(1948); Henderson v. Belknap (In re Henderson), 18 F.3d 1305,
1307 (5th Cir.), cert. denied, 115 S. Ct. 573.
We review the tax court's denial of the Westbrooks' motion
for reconsideration under an abuse of discretion standard.
George v. Commissioner, 844 F.2d 225, 229 (5th Cir. 1988).
III. DISCUSSION
The tax court sustained the Commissioner's determination of
deficiencies totaling $236,157.502 for the years 1984-1987, and
additions to tax for the same years for negligence (totaling
$135,050.19) and for substantial understatement (totaling
$59,039.33). In sustaining the Commissioner's deficiencies, the
tax court held that: (1) the Westbrooks were not engaged in a
trade or business on Burton Farm during the years at issue; (2)
the Westbrooks were not entitled to deductions related to their
royalty interest in oil and gas produced on Burton; (3) the
Westbrooks did not operate Billenbrook Farm for profit during the
years at issue; (4) the activities of Billenbrook Farms, Inc.
after February 1985 were not for profit; (5) deductions taken by
Billenbrook Farms, Inc. after February 1985 were not for ordinary
and necessary business expenses; (6) Billenbrook Farms, Inc. was
not entitled to deductions erroneously reported on its return
2
The deficiencies assessed for each year were:
1984 $ 38,624.25
1985 $112,712.20
1986 $ 72,272.50
1987 $ 12,548.55.
9
that relate to activities of Burton Farm or Billenbrook Farm;
(7) the Westbrooks are liable for additions to tax for negligence
for each of the years at issue; and (8) the Westbrooks are liable
for additions to tax for substantial understatement of tax for
the years at issue.3 The Westbrooks filed a motion for
reconsideration, requesting that the court allow them to
recharacterize expenses listed on their tax returns for 1984-1987
and the tax returns of Billenbrook Farms, Inc. for those years,
which was denied by the tax court.
On appeal, the Westbrooks contend that the tax court
committed clear error in finding that they had no good faith
intention of making a profit from their activities at Burton
Farm, Billenbrook Farm, or the activities of Billenbrook Farms,
Inc. They further contend that the tax court abused its
discretion in refusing to permit them to supplement the record
after the trial to demonstrate that expenses, which were
mistakenly listed on the wrong return, would be properly
deductible if correctly recorded. The Westbrooks also contend
that the tax court's finding that they negligently prepared their
returns was clearly erroneous, and that the tax court erred in
determining that the Westbrooks lacked substantial authority for
their deductions and thus were liable for substantial
understatement penalties. The Commissioner maintains that the
3
The tax court also held that deductions taken by
Billenbrook Farms, Inc. for the educational expenses of the
Westbrooks' son, William Westbrook, while he attended business
school at SMU, were improper; however, the Westbrooks do not
challenge this holding on appeal.
10
tax court's determinations were correct. We will address each
argument in turn.
A. Profit Motive
As a general rule, Internal Revenue Code ("IRC") §§ 162(a)
and 212 allow for the deduction of ordinary and necessary
expenses incurred in the carrying on of a trade or business (§
162(a)) or for the production or collection of income (§ 212(1))
or for the maintenance of property held for the production of
income (§ 212(2)). 26 U.S.C. §§ 162, 212. To be engaged in a
trade or business under § 162, a taxpayer "must be involved in
the activity with continuity and regularity and . . . 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). Similarly, the standard for deductibility under § 212
is whether the expenditures were made "primarily in furtherance
of a bona fide profit objective independent of tax consequences."
Agro Science Co. v. Commissioner, 934 F.2d 573, 576 (5th Cir.),
cert. denied, 502 U.S. 907 (1991). "If an individual incurs a
loss in a trade or business, or in any transaction entered into
for profit unconnected with a trade or business, IRC § 165(c)
permits the individual to deduct the loss." 26 U.S.C. § 165(c);
Faulconer v. Commissioner, 748 F.2d 890, 892-93 (4th Cir. 1984).
IRC § 183 governs allowable deductions for expenses incurred
in an activity "not engaged in for profit." 26 U.S.C. § 183.
Section 183(a) provides that no deductions shall be allowed for
11
an activity not engaged in for profit except as provided in this
section. Id. Section 183(b) provides that, in relation to an
activity not engaged in for profit, a taxpayer can take those
deductions which would be allowable without regard to profit
motive, and can take deductions which would be allowed if the
activity were engaged in for profit, but only to the extent "that
gross income derived from such activity for the taxable year
exceeds the deductions allowable." Id. In sum, section 183
allows deductions for expenses incurred in an activity not
engaged in for profit, but only to the extent of gross income
from that activity; therefore, taxpayers may not deduct losses
incurred in an activity not engaged in for profit.
Section 183(c) defines an activity not engaged in for profit
as an activity other than one for which deductions are allowable
under §§ 162 or 212. Id. The Treasury Regulations promulgated
pursuant to § 183 establish an objective test for determining
whether a taxpayer is engaging in an activity for profit:
The determination whether an activity is engaged in for
profit is to be made by reference to objective
standards, taking into account all of the facts and
circumstances of each case. Although a reasonable
expectation of profit is not required, the facts and
circumstances must indicate that the taxpayer entered
into the activity, or continued the activity, with the
objective of making a profit. . . . In determining
whether an activity is engaged in for profit, greater
weight is given to objective facts rather than to the
taxpayer's mere statement of his intent.
Treas. Reg. § 1.183-2(a); Estate of Power v. Commissioner, 736
F.2d 826, 830 (1st Cir. 1984). The regulations under § 183 also
list nine factors to be considered in determining whether a
12
taxpayer has a profit motive with regard to a certain activity:
(1) the extent to which the taxpayer carries out the activity in
a businesslike manner; (2) the expertise of the taxpayer or his
advisors; (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 other similar or dissimilar activities; (6) the
taxpayer's history of income or losses attributable to the
activity; (7) the amount of occasional profits, if any, which are
earned; (8) the taxpayer's financial status; and (9) any elements
of personal pleasure or recreation in the activity. Treas. Reg.
§ 1.183-2(b)(1)-(9). Courts have consistently relied on these
nine factors, originally derived from court opinions, to
determine whether a profit motive exists for purposes of
deduction of losses under §§ 162 and 212. Independent Elec.
Supply, Inc. v. Commissioner, 781 F.2d 724, 727 (9th Cir. 1986);
Faulconer, 748 F.2d at 896-902; Nickerson v. Commissioner, 700
F.2d 402, 404 (7th Cir. 1983). These factors are not exclusive,
and no one factor or mathematical preponderance of factors is
determinative. Faulconer, 748 F.2d at 894; Nickerson, 700 F.2d
at 404-05.
The profit motive inquiry is a question of fact, our review
of which is limited to a determination of whether the tax court
committed clear error. Agro Science Co., 934 F.2d at 576-77;
Thomas v. Commissioner, 792 F.2d 1256, 1259 (4th Cir. 1986). The
Commissioner's assessment of a deficiency is presumptively
13
correct and the taxpayer bears the burden of proving it wrong.
United States v. Janis, 428 U.S. 433, 440-41 (1976); Welch v.
Helvering, 290 U.S. 111, 115 (1933). Thus, the Westbrooks bear
the burden of proving that their activities at Burton Farm,
Billenbrook Farm, and Billenbrook Farms, Inc. were engaged in
with the primary purpose of earning a profit. See Faulconer, 748
F.2d at 893; Nickerson, 700 F.2d at 404.
1. Burton Farm
The Tax Court determined that the Westbrooks' losses from
Burton Farm were not deductible because they were not engaged in
any animal activity during the years at issue which constituted a
trade or business under § 162. The Tax Court also rejected the
Westbrooks' argument that their disallowed Burton Farm expenses
were incurred to protect their oil and gas royalties, finding
that the Westbrooks presented no evidence that they incurred
expenses related to oil and gas production at Burton Farm.
During 1984 through 1987, the Westbrooks claimed
depreciation deductions for items such as a windmill, fences,
barns, troughs, and a tractor, as well as operational expenses
including repairs, maintenance, supplies, fuel oil, insurance,
legal fees, and travel and entertainment on their Schedule F for
Burton Farm. However, in the tax court, the Westbrooks
stipulated that they neither kept animals nor conducted farming
operations at Burton Farm during the years at issue. The Tax
Court's finding that the Westbrooks were not engaged in a trade
14
or business of farming or raising animals at Burton Farm from
1984-1987 thus cannot be considered clearly erroneous. The
Westbrooks argue that their operational and depreciation expenses
are nevertheless deductible as expenses of oil and gas production
on Burton Farm, or, alternatively, because the deductions should
be offset against the appreciation in value of the land at Burton
Farm.
The tax court found that the Westbrooks failed to present
evidence that the expenses listed on their 1984-1987 Schedules F
for Burton Farm related to oil and gas production. The tax court
noted that the oil and gas lease entered by the Westbrooks and
WCS imposed no operational obligations on the Westbrooks. No oil
was stolen from Burton Farm during the years at issue, nor was
any physical damage to the property sustained from oil
development or drilling. Although the Westbrooks argue that the
perimeter fence was repaired to protect against oil theft, Dr.
Westbrook testified that any repairs to the fence were made by
Mr. Nowell to keep Mr. Nowell's cattle on the property, not to
keep oil thieves off of the property. We conclude that the tax
court did not clearly err in holding that the Westbrooks
presented no evidence that deductions taken on the Burton Farm
Schedule were incurred in relation to oil and gas production.
Because the taxpayer bears the burden of proving its entitlement
to a deduction, see Hendricks v. Commissioner, 32 F.3d 94, 98
(4th Cir. 1994), we affirm the tax court's holding that the
15
deductions listed on Burton Farm's Schedule F for 1984-1987 were
not allowable as costs incurred in oil and gas production.
The Westbrooks additionally argue that their farm-related
depreciation and operational expenses should be offset against
the appreciation in the value of the land. This argument lacks
merit. First, we note that the Westbrooks did not demonstrate
appreciation in the value of Burton Farm during 1984-1987 with
specific evidence, although, given the production of oil on the
land, such appreciation is plausible. However, Treasury
Regulation § 1.183-1(d)(1) provides that farming and the holding
of land for speculation constitute a single activity only if the
income derived from farming exceeds deductions not directly
attributable to the holding of the land, thus reducing the net
cost of retaining the land. Treas. Reg. § 1.183-1(d)(1); see
Estate of Power v. Commissioner, 736 F.2d 826, 829 (1st Cir.
1984). The Westbrooks, however, seek to deduct farming losses
based on the appreciation in value of the land, which actually
increased the cost of retaining the land.
The Westbrooks also argue that many of the items listed on
the Burton Farm Schedule F--such as depreciation of a one-eighth
interest in embryo transplant cattle--were related to Billenbrook
Farm activities and would be properly deductible if reclassified.
Because this argument was the subject of the motion for
reconsideration, it will be addressed in relation to the denial
of that motion.
16
In sum, we conclude that the tax court did not clearly err
in disallowing farming expense deductions with relation to Burton
Farm because the Westbrooks neither raised animals nor conducted
farming operations on Burton Farm from 1984 to 1987.
2. Billenbrook Farm
The tax court held that the Westbrooks' Billenbrook Farm
activities--embryo-transplant cattle and other cattle raising and
miniature horse breeding--were not engaged in for profit under §
183; therefore, losses incurred in carrying out those activities
were not deductible. The tax court determined whether the
Westbrooks were motivated by profit by applying the nine factors
of Treasury Regulation § 1.183-2(b)(1)-(9).
On appeal, the Westbrooks present a novel "process of
elimination" argument. As they explain, a taxpayer's expenses
can only be classified into three categories: personal expenses,
business expenses, or expenses incurred in other profit-seeking
activities. They argue that if no elements of recreation,
pleasure, sport or hobby exist with respect to an activity, that
activity, by default, must be a business or an activity conducted
for the production of income. The Westbrooks reason that because
the tax court made no fact findings that their activities at
Billenbrook Farm were motivated by personal pleasure, recreation,
hobby or sport, the only proper legal conclusion is that they
were motivated by profit. We reject the Westbrooks' unique
profit motive analysis as contrary to existing precedent. First,
17
personal pleasure or recreational motivation is only one of the
nine factors included in the treasury regulations, and the case
law clearly holds that no one factor can be determinative.
Treas. Reg. § 1.183-2(b)(9); see, e.g., Hendricks, 32 F.3d at 98;
Faulconer, 748 F.2d at 895. Furthermore, the Westbrooks have the
burden of proof to affirmatively establish a profit motive.
Faulconer, 748 F.2d at 893. Holding that a profit motive exists
because the tax court did not find a personal pleasure or
recreation motive would turn this burden on its head. Whether
the requisite profit motive is present must be determined by
examining all the facts and circumstances, Nickerson, 700 F.2d at
404; therefore, a balancing of the nine factors and any other
relevant consideration is the proper method for determining
whether a profit motive exists. See, e.g., Hendricks, 32 F.3d at
98; Burger v. Commissioner, 809 F.2d 355, 358 n.4 (7th Cir.
1987); Estate of Power, 736 F.2d at 829; Brannen v. Commissioner,
722 F.2d 695, 704 (11th Cir. 1984); Golanty v. Commissioner, 72
T.C. 411, 426 (1979), aff'd, 647 F.2d 170 (9th Cir. 1981); Givens
v. Commissioner, 58 T.C.M. (CCH) 255, 258 (1989).
Considering the facts and circumstances, we conclude that
the tax court's finding of no profit motive with respect to
Billenbrook Farm is not clearly erroneous. The tax court
determined that the Westbrooks did not carry on the activity in a
business-like manner. Treas. Reg. § 1.183-2(b)(1). The
Westbrooks failed to make complete and accurate records.
Although the Westbrooks professed a desire to build a purebred
18
herd of cattle through the embryo transplant process, they made
no cost estimates related to that goal and took no steps to
achieve it. The Westbrooks kept no records of births, fertility
or mating of their miniature horses, nor did they keep track of
how many horses died. Although these were ostensibly breeding
operations, the Westbrooks also did not keep records of
fertility, pregnancy, or calving performance of either their
commercial or embryo-transplant cattle.
Another relevant factor is the expertise of the taxpayers
and consultation with expert advisors. Treas. Reg. § 1.183-
2(b)(2). The Westbrooks have some personal expertise in animal
husbandry, evidenced by Dr. Westbrook's profession of veterinary
medicine. Although the Westbrooks studied and consulted experts
regarding the technical and scientific aspects of horse and
cattle raising, they did not seek expert advice regarding the
economic or business aspects of these activities. The Westbrooks
made no financial projections with regard to either miniature
horse-breeding or cattle-raising, nor did they estimate the
return of capital invested in these activities.
In determining the existence of profit motive, we also
consider the time and effort expended by the taxpayer in carrying
on the activity. Treas. Reg. § 1.183-2(b)(3). Dr. Westbrook
worked full time, including Saturday and Sunday mornings, at the
Clinic. Additionally, he was on call for emergencies with his
Clinic patients twenty-four hours a day, seven days a week. Mrs.
Westbrook was involved in an ongoing public relations campaign
19
for the Clinic and the Texas Veterinary Medical Association, in
addition to participating in other animal husbandry, community,
and church organizations. Neither Dr. nor Mrs. Westbrook had
much time left to devote to the Billenbrook Farm activities.
The Westbrooks endured a long series of losses from their
activities at Billenbrook Farm. Although a series of losses
during the start-up stage of a business does not necessarily
indicate a lack of profit motive, the Westbrooks' losses extended
beyond any initial period. Treas. Reg. § 1.183-2(b)(6);
Hendricks, 32 F.2d at 99. From 1980-1987, the Westbrooks
reported losses totalling approximately $510,000 from raising
miniature horses, embryo-transplant cattle, and commercial
cattle. These losses were not demonstrated to be attributable to
unforeseen or fortuitous circumstances. The Westbrooks ignored
their losses from cattle-raising on Burton Farm when they
established operations at Billenbrook Farm. Treas. Reg. § 1.183-
2(b)(5) (the success of the taxpayer in other similar or
dissimilar activities). They made no sales of miniature horses
or embryo-transplant cattle, and they realized no occasional
profits. Treas. Reg. § 1.183-2(b)(7).
Substantial income from other sources may indicate that the
activity is not engaged in for profit. Treas. Reg. § 1.183-
2(b)(8); Hendricks, 32 F.3d at 99. During the years in issue,
the Westbrooks' net income from the Clinic approximated $685,000
and their income from oil and gas production exceeded $700,000.
20
The Westbrooks argue that a profit motive exists because
they received no personal pleasure or recreation from the
Billenbrook Farm activities. While this fact is relevant to the
profit motive analysis, see Treas. Reg. § 1.183-2(b)(9), we
believe the tax court did not clearly err in finding it
outweighed by other facts establishing the lack of a profit
motive. Similarly, the Westbrooks contend that the tax court
erred in failing to consider the appreciation in the value of the
Billenbrook Farm land during 1984-1987. Because the Westbrooks
failed to present evidence that the land did appreciate, we
reject this argument. See Hendricks, 32 F.2d at 100 ("[T]he mere
expectation that land values may appreciate is not sufficient, in
itself, to demonstrate that an activity was engaged in for
profit.") In sum, we conclude that the tax court's finding that
the Westbrooks lacked a profit motive with respect to their
Billenbrook Farm activities was not clearly erroneous.
3. Billenbrook Farms, Inc.
The tax court concluded that Billenbrook Farms, Inc.'s
activities after February 1985 were not engaged in for profit
under § 183. After February 1985, Billenbrook Farms, Inc.'s sole
activity was raising pygmy goats, which it donated to a tax-
exempt organization in September 1985. The Westbrooks again
argue that because they obtained no personal pleasure or
recreation from raising pygmy goats, that activity necessarily
was profit-motivated. As we stated above, the proper analysis
21
for determining whether a profit motive exists is a balancing of
the nine factors and other relevant objective considerations.
The Westbrooks did not present evidence of records pertaining to
the goats, any sales of goats, any business analysis regarding
the profitability of maintaining goats or any plans or attempt to
market them. The goats were primarily used by Mrs. Westbrook in
her public relations campaign for the Clinic, as she took them to
schools and petting zoos. Upon these facts, we conclude that the
tax court's finding that Billenbrook Farms, Inc. lacked a profit
motive after February 1985 was not clearly erroneous.
B. Motion for Reconsideration
In its memorandum opinion, the tax court rejected the
Westbrooks' argument that certain expenses of Burton Farm or
Billenbrook Farm that were erroneously reported on Billenbrook
Farms, Inc.'s income tax return were nevertheless deductible
because Dr. Westbrook owned all of the stock of Billenbrook
Farms, Inc. In so holding, the tax court noted:
if petitioners had properly substantiated these
expenses, they could have deducted many, if not all of
them on their individual tax returns, not as flow-
through deductions from Billenbrook Farms, Inc., but as
deductions related to income-seeking activity of their
own. However, petitioners did not make this argument
and we decline to reach this issue on our own
initiative; petitioners did not substantiate these
expenses.
Relying on this language, the Westbrooks filed a motion for
reconsideration, asking the tax court to allow them to supplement
the record in order to substantiate and reclassify these
22
expenditures. The Westbrooks sought to reclassify some
deductions listed on the forms for Burton Farm, Billenbrook Farm,
and on the tax return of Billenbrook Farms, Inc. as expenses
incurred for the Clinic. The Westbrooks conceded in their motion
that their request to reclassify expenses should have been made
before trial. The tax court denied the motion for
reconsideration. On appeal, the Westbrooks contend that the tax
court abused its discretion in denying the motion because the
Commissioner did not raise substantiation of the expenses as an
issue for trial.
Reconsideration of proceedings is generally denied in the
absence of "substantial error" or "unusual circumstances." See
CWT Farms, Inc. v. Commissioner, 79 T.C. 1054 (1982), aff'd, 755
F.2d 790 (11th Cir. 1985), cert. denied, 477 U.S. 903 (1986). A
motion for reconsideration is not granted "to resolve issues
which could have been raised during the prior proceedings." Id.
We review the denial of a motion for reconsideration under an
abuse of discretion standard. See Tweeddale v. Commissioner, 841
F.2d 643, 646 (5th Cir. 1988); CWT Farms, 79 T.C. at 1057.
We find that through the exercise of reasonable diligence,
the Westbrooks could have presented reclassification evidence at
trial. See Tweeddale, 841 F.2d at 646. The Westbrooks argue
that the Commissioner waived substantiation of expenses because
substantiation was not listed as an issue for trial in the pre-
trial memorandum. However, the Westbrooks forget that taxpayers
bear the burden of proving their entitlement to a deduction.
23
United States v. General Dynamics Corp., 481 U.S. 239, 245
(1987). Even if the Commissioner had stipulated that the amounts
were spent, the Westbrooks would still be required to demonstrate
that the expenditures were related to a particular trade or
business under § 162, such as the Clinic, or an income-producing
activity under § 212. Furthermore, the record reveals that
although the parties stipulated to several exhibits documenting
or identifying expenses of the farms, the stipulations indicate
that "the truth of assertions within stipulated exhibits is not
necessarily agreed to and may be rebutted or corroborated with
additional evidence." Additionally, the Commissioner did not
stipulate to any reclassification of expenses in relation to
different entities. The Westbrooks failed to present evidence at
trial justifying reclassification of expenses, although the
record provides no indication that the reclassification evidence
was unavailable at the time of trial. No extraordinary
circumstances exist to justify or excuse the failure of the
Westbrooks to present such evidence. Therefore, the tax court
did not abuse its discretion by denying the motion for
reconsideration.
C. Negligence Penalty
The Commissioner assessed additions to tax against the
Westbrooks for negligence under IRC § 6653(a)(1) and (2) for the
24
1984-1987 taxable years.4 The tax court sustained these
determinations because the Westbrooks presented insufficient
evidence that they were not negligent in preparing their return.
On appeal, the Westbrooks argue that the § 6653 negligence
penalty cannot apply to them because all of their actions--"from
the choice of their one checking account bookkeeping system, to
the determination of what was deductible or not"--were taken on
the advice of their accountant, John Braden.
Section 6653(a)(1) imposes an addition to tax equal to 5% of
the underpayment of tax if any part of the underpayment is
attributable to negligence or intentional disregard of the rules
or regulations. 26 U.S.C. § 6653(a)(1). Section 6653(a)(2)
provides for a further addition to tax equal to 50% of the
interest due on the portion of the underpayment attributable to
negligence or intentional disregard of the rules and regulations.
26 U.S.C. § 6653(a)(2). " `Negligence' includes any failure to
reasonably attempt to comply with the tax code, including the
lack of due care or the failure to do what a reasonable or
ordinarily prudent person would do under the circumstances."
4
The negligence penalty found at § 6653(a)(1) and (2) in
the 1984, 1985, and 1986 Internal Revenue Code is enacted as §
6653(a)(1)(A) and (B) in the 1987 Internal Revenue Code. For
simplicity, we will use the citations from the 1984-1986 codes
for all four years. The amounts of the penalties for each year
are as follows:
1984 1985 1986 1987
§ 6653(a)(1) $ 1,931.21 $ 5,635,61 $ 3,613.63 $ 627.28
§ 6653(a)(2) $25,840.40 $59,949.78 $32,711.19 $4,741.09.
25
Heasley v. Commissioner, 902 F.2d 380, 383 (5th Cir. 1990);
Sandvall v. Commissioner, 898 F.2d 455, 458 (5th Cir. 1990).
The tax court's determination of negligence is a factual
finding which we review for clear error. Portillo v.
Commissioner, 932 F.2d 1128, 1135 (5th Cir. 1991); Sandvall, 898
F.2d at 459. In addition, because the Commissioner's
determinations are presumed correct, the taxpayer bears the
burden of establishing the absence of negligence. Portillo, 932
F.2d at 1135; Sandvall, 898 F.2d at 459; see also Goldman v.
Commissioner, 39 F.2d 402, 407 (2d Cir. 1994); Accardo v.
Commissioner, 942 F.2d 444, 452 (7th Cir.), cert. denied, 503
U.S. 907 (1991).
The record demonstrates that the Westbrooks took business
expense deductions that were not supported by the facts,
primarily because the deductions were taken in relation to the
wrong farming activity. For example, a goat house, goats, a barn
and a tractor, located at and used by Billenbrook Farm, were
listed on the Burton Farm depreciation schedule, although no
animals were raised and no farming was performed at Burton Farm
during 1984-1987. Furthermore, expenses of Billenbrook Farm's
cattle and miniature horse-raising ventures were deducted on
Billenbrook Farms, Inc.'s corporate income tax returns. This
circuit has previously concluded that a negligence penalty is
correctly assessed in cases where deductions claimed on returns
are not supported by the facts. Portillo, 932 F.2d at 1135;
Sandvall, 898 F.2d at 459.
26
The Westbrooks argue that the tax court's determination of
negligence is clearly erroneous because they relied on the advice
of their accountant, John Braden, with respect to "everything
they did." It is true that a taxpayer may avoid a negligence
penalty if he reasonably relies on an accountant's or a lawyer's
advice on a matter of tax law. See United States v. Boyle, 469
U.S. 241, 251 (1985); Chamberlain v. Commissioner, 1995 WL 568705
at *2; Heasley v. Commissioner, 902 F.2d at 383. However, the
underpayment of tax in this case did not result from Mr. Braden's
misinterpretation of a matter of tax law. Rather, the
Westbrooks' negligence was an example of garden-variety careless
record-keeping--they failed to record expenses with the activity
in which the expenses were incurred. The Westbrooks maintain
that any errors resulted from their one-checking account
bookkeeping system, which was created by Mr. Braden. While this
may be true, no legal support exists for the proposition,
apparently urged by the Westbrooks, that because an accountant
recommends a particular bookkeeping system, the taxpayers are
insulated from penalties if they negligently use that system,
causing an underpayment of tax.
The Westbrooks also argue that a negligence penalty is
inappropriate because they reasonably relied on Mr. Braden to
prepare their returns. A taxpayer may rely on an accountant to
prepare his income tax return, and thus avoid a negligence
penalty, if the taxpayer demonstrates that (1) the return
preparer was supplied with all necessary information, and (2) the
27
incorrect return was a result of the preparer's mistakes. Cramer
v. Commissioner, 101 T.C. 225, 251 (1993), aff'd, 64 F.3d 1406
(9th Cir. 1995); Weis v. Commissioner, 94 T.C. 473, 487 (1990);
Pessin v. Commissioner, 59 T.C. 473, 489 (1972). The Westbrooks
have not satisfied this burden. Two groups of errors in the
classification of deductions are demonstrated by the evidence.
First, expenses related to Billenbrook Farm were deducted on the
Burton Farm Schedules F. The record reveals that these errors
may have been caused by Dr. and Mrs. Westbrook's making incorrect
notations on the checks. Mr. Braden relied on those notations in
determining how to classify the expenses among the Westbrooks'
various activities. Mr. Braden testified, however, that some of
the Billenbrook/Burton errors may have resulted from his staff
person miscoding a check with a correct notation when entering it
into the computer program. The Westbrooks fail, however, to
direct this court to a portion of the record indicating which
mistakes, if any, were made by Mr. Braden, and which were made by
the Westbrooks themselves. Second, expenses of Billenbrook Farm
were deducted by Billenbrook Farms, Inc. on its corporate income
tax return. Mr. Braden testified that, after the audit, he
discovered that these expenses were miscoded because Dr. and Mrs.
Westbrook and their son, William Westbrook, wrote checks from the
Billenbrook Farms, Inc. account to pay expenses of the
Billenbrook Farm sole proprietorship activities. Therefore, the
Billenbrook Farm/Billenbrook Farms, Inc. classification errors
were caused by the Westbrooks' failure to give Mr. Braden correct
28
information. Because the Westbrooks have not demonstrated that
they provided Mr. Braden with correct information, or that the
errors on their returns were a result of his mistakes, we
conclude that the tax court's finding of negligence was not
clearly erroneous. Therefore, the Commissioner's assessment of
negligence penalties under § 6653(a)(1) and (2) for 1984-1987 is
affirmed.
D. Substantial Understatement Penalty
The Commissioner also assessed additions to tax for
substantial understatement of tax liability for 1984-1987 under
IRC § 6661.5 The tax court affirmed these determinations because
the Westbrooks presented no evidence contesting the additions.
Section 6661(a) of the IRC provides for an addition to tax
of 25% of the amount of any underpayment attributable to a
substantial understatement of income tax for the taxable year.
26 U.S.C. § 6661(a). A substantial understatement of income tax
exists if the amount of the understatement exceeds the greater of
10% of the tax required to be shown on the return, or $5,000. 26
U.S.C. § 6661(b)(1). The Westbrooks had substantial
understatements of tax liability in each year from 1984-1987.
5
The amounts of the penalties for each year were:
1984 $ 9,656.06
1985 $28,178.00
1986 $18,068.13
1987 $ 3,137.14.
29
The amount of an understatement may be reduced by the
portion of the understatement which the taxpayer shows is
attributable to either (1) the tax treatment of any item for
which there was substantial authority; or (2) the tax treatment
of any item with respect to which the relevant facts were
adequately disclosed on the return. 26 U.S.C. § 6661(b)(2)(B).
Substantial authority exists when "the weight of the authorities
supporting the treatment is substantial in relation to the weight
of the authorities supporting contrary positions." Treas. Reg. §
1.6661-3(b)(1); Accardo, 942 F.2d at 453. The taxpayers bear the
burden of proving that the Commissioner's determination of
substantial underpayment is incorrect. Weis, 94 T.C. at 490.
The Westbrooks argue that substantial authority exists that
their Burton Farm, Billenbrook Farm, and Billenbrook Farms, Inc.
deductions were proper business expenses of profit-motivated
activities. The Westbrooks took the position that their
deductions were proper because they were for expenses incurred in
a trade or business under § 162 or a profit-motivated activity
under § 212. The Westbrooks argued that they were necessarily
motivated by profit because they derived no pleasure from their
Burton Farm, Billenbrook Farm or Billenbrook Farms, Inc.
activities. As is shown in Part III.A.2 of this opinion, there
is not only no substantial authority for this position, but in
fact no authority at all. The great weight of legal authority
holds that profit motive is determined by weighing all the facts
and circumstances, using the nine factors of Treas. Reg. § 1.183-
30
2(b), only one of which is whether elements of personal pleasure
or hobby exist. Treas. Reg. § 1.183-2(b)(9); see, e.g.,
Hendricks, 32 F.3d at 98; Burger, 809 F.2d at 358 n.4; Estate of
Power, 736 F.2d at 829; Brannen v. Commissioner, 722 F.2d at 704;
Golanty v. Commissioner, 72 T.C. at 426; Givens, 58 T.C.M. (CCH)
at 258. Because substantial authority does not exist for the
Westbrooks' position, the Commissioner correctly assessed the
substantial underpayment penalty.
IV. CONCLUSION
For the foregoing reasons, we AFFIRM the judgment of the tax
court.
31