PURSUANT TO INTERNAL REVENUE CODE SECTION 7463(b),THIS OPINION MAY NOT BE TREATED AS PRECEDENT FOR ANY OTHER CASE. T.C. Summary Opinion 2015-48
UNITED STATES TAX COURT
JOSHUA W. PINGEL, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 13225-12S. Filed August 10, 2015.
Joshua W. Pingel, pro se.
Laurie B. Downs, for respondent.
SUMMARY OPINION
PARIS, Judge: This case was heard pursuant to the provisions of section
7463 of the Internal Revenue Code in effect when the petition was filed.1
1 Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986, as amended and in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. -2-
Pursuant to section 7463(b), the decision to be entered is not reviewable by any
other court, and this opinion shall not be treated as precedent for any other case.
Respondent determined a deficiency of $7,147 in petitioner’s Federal
income tax and a section 6662 accuracy-related penalty of $1,429.40 for 2008.
The issues for decision are whether petitioner: (1) was engaged in the
activity of “travel guide writer” for profit during 2008 and (2) is liable for a
section 6662 accuracy-related penalty.
Background
Some of the facts have been stipulated and are so found. The stipulated
facts and facts drawn from stipulated exhibits are incorporated herein by this
reference. Petitioner resided in Colorado when he filed his petition.2
For 10 days in 2007 petitioner vacationed in Australia. While on vacation,
he decided to pursue travel as a career. In December 2007 petitioner began laying
the groundwork for what he hoped would be an exciting and profitable career as a
travel guide writer by organizing Virgin Backpacking, LLC (LLC), as a Colorado
LLC and obtaining an employer identification number for the LLC from the
Internal Revenue Service (IRS). Petitioner originally set up the LLC to be taxed
2 Petitioner’s trial was held at the Milwaukee, Wisconsin, trial session because he had moved to Wisconsin before trial. -3-
as a partnership with the business purpose of Internet sales, but he later amended
the LLC to a sole proprietorship. Petitioner never transferred or contributed any
assets to the LLC. As of the time of trial the LLC was not current with its filings
with the State of Colorado.
Petitioner’s plan was to be a part of the online travel market by writing a
blog3 about his international travels. Petitioner had some backpacking experience
and planned to use his knowledge to write about the niche of international,
lightweight backpacking.4 Petitioner organized the LLC to sell camping gear
through affiliate sales5 and the books petitioner planned to write about his travels.
To earn income through affiliate sales, petitioner had to fill out forms for the
desired product manufacturers to be allowed to provide links on his Web site to
3 “Blog” is a truncation of the expression “Web log”, which is a regularly updated Web site or Web page written in an informal or conversational style and typically run by an individual or small group. Oxford Dictionary, http://www.oxforddictionaries.com/us/definition/american_english/blog (last visited June 22, 2015). 4 At trial petitioner defined “lightweight backpacking” as traveling with a backpack weighing no more than 12 pounds. 5 “Affiliate sales” is a marketing arrangement by which an online retailer pays a commission to an external Web site for traffic or sales generated from its referrals. Oxford Dictionary, http://www.oxforddictionaries.com/us/definition/america_english/affilated- marketing (last visited June 22, 2015). -4-
the manufacturers’ Web sites. Petitioner provided no links to manufacturer Web
sites on his Web site that would allow for affiliate sales.
I. Petitioner’s Travels
In early 2008 petitioner left his position as a “senior client relationship
manager” at Computershare. He took a distribution of $43,891 from his Fidelity
Investments section 401(k) account to finance his travels.
In June 2008 petitioner’s adventure began. Over the next 5-1/2 months,
petitioner made his way across the continents of Europe and Africa and even
made a foray into the Middle East.
Throughout his journey petitioner updated his blog with anecdotes and
pictures from his travels. While petitioner included details about some of the sites
he saw, places he stayed, and food he ate, many of his explanations do not give
enough details for a reader to find the specific site, lodgings, or restaurant
described. For example in petitioner’s Paris blog entry he states: “[W]e hit up
The [sic] BEST ice cream in Europe. * * * there are a couple of places that serve it
and pricing is much higher at one (the ‘tourist’ one as Jeff put it) than at the other
one. We walked past the tourist one, which had a huge crowd and walked down
the street about half a block to the other one.” Petitioner does not give any more
details about where in Paris the best ice cream in Europe can be found. -5-
Petitioner did keep copies of all his receipts, flight confirmations, lodging
confirmations, tour confirmations, rail passes, shuttle confirmations, bank
statements, tour vouchers, credit card statements, and other miscellaneous receipts
from the trip.
II. Petitioner’s Books
Petitioner realized as he traveled, and even more so after he returned to the
United States, that the market was already saturated with international
backpacking blogs and that his plan for generating income through affiliate sales
from his blog would not be profitable. Petitioner then shifted his focus to writing
books about his travels and the insights he gained while traveling.
Petitioner has written three books since returning from his travels. The first
book centers on petitioner’s time in Africa and his journey from Cape Town,
South Africa, to Nairobi, Kenya. Petitioner’s plan was to sell this book for the
price of $14.99 per book. There is no evidence in the record as to how petitioner
arrived at this price. He has revised the book over the years and stated its purpose
is to be informative about places to visit, stay, and eat, along with his personal
thoughts and experiences. -6-
Petitioner’s second book is entitled Road to the World: A 19 Day Q&A to
Get You on Track for Personal and Professional Success.6 Petitioner began
writing this book in 2011. Although petitioner wrote about his travels that
“[m]any lessons were learned and now he is sharing some of those lessons with
you in this book”, he referenced his travels in only 1 of the 19 chapters of the
book.
As of the date of trial, petitioner’s third book was still in production. It is a
book of his Africa photos that include inspirational sayings with each photo.
Petitioner paid an independent self-publishing Web site $26 to publish a test copy
of this book.
As of the date of trial, none of the books had been published or were subject
to publisher commitments to publish, nor could petitioner estimate when the books
would be published. Petitioner planned to self-publish his books, not to obtain a
publishing contract. Outside of speaking with family, friends, co-workers, and
other travelers, petitioner did not know what the potential demand for or interest in
6 Petitioner wrote his second book under the pen name Rayland Crowder, which is a combination of the first and last names, respectively, of the two main characters on the television show “Justified”. Petitioner did not research whether there were any copyright limitations on using the characters’ names. -7-
these books would be. As of the date of trial, petitioner had not earned any
income from his books.
III. Back in the USA
In early 2009, in addition to his efforts to develop his writing and marketing
after his trip, petitioner contacted a former client and obtained employment in
Texas to finance petitioner’s product development courses and provide for basic
necessities. During this time petitioner was not able to update his blog or publish
his books because he was working in excess of 14 hours a day. Petitioner held this
job until March 31, 2011.
To increase his knowledge and understanding of the world of travel writing,
petitioner began corresponding with a travel blog expert in 2010. Petitioner
enrolled in this expert’s travel writing courses, and he enrolled in other specialized
courses in the areas of marketing, product creation, and sales generation over the
next few years.
In 2010 petitioner accidentally deleted his blog while making revisions. As
of the date of trial, petitioner’s blog had not been reposted, and he had received no
income from his blog.
Petitioner timely filed his 2008 Federal income tax return (return). He listed
“world travel guide” as his principal business on the Schedule C, Profit or Loss -8-
From Business, attached to the return. On the Schedule C, petitioner did not
report any business gross receipts or gross income. He claimed total expenses of
and reported a net business loss of $39,138. As part of his net business loss,
petitioner claimed deductions for travel expenses of $19,347, deductible meals and
entertainment expenses of $6,314, and other expenses of $5,431.
Petitioner reported wages of $29,299, taxable interest of $52, ordinary
dividends of $3, and a pensions and annuities distribution of $43,891, for total
income of $73,190 for 2008. Petitioner reduced his total income to $34,107 by
reporting a Schedule C business loss of $39,138.
Respondent issued petitioner a notice of deficiency for 2008 dated March
13, 2012, wherein he disallowed in full petitioner’s deductions for travel,
deductible meals and entertainment, and other expenses and determined a
deficiency of $7,147 and a section 6662 accuracy-related penalty of $1,429.40.7
Respondent’s determination for all of the disallowed expenses was that petitioner
had not “established that you incurred, or if incurred, paid this amount during the
taxable year for ordinary and necessary business purposes”.
7 Respondent also reduced the amount of petitioner’s deduction for student loan interest. That determination was computational and will be not discussed further. -9-
IV. Procedural History of Petitioner’s Case
On May 24, 2012, petitioner timely filed a petition with the Court.
Petitioner states in his petition that “[t]he IRS determined that I did not have a
business; rather a hobby. My Sch C was truly a business and not a hobby.”
Petitioner goes on to aver that he: (1) “acted in a business like [sic] manner”, (2)
had “a profit motive”, and (3) did “not have profitable years yet because I have not
completed the trail guide book.” Petitioner also states: “There is not a pleasure
motive as backpacking is extremely difficult work.”
Respondent’s answer denies that he questioned whether petitioner’s activity
was a business or a hobby and reiterates that his determination was that
petitioner’s deductions were disallowed because they were not “incurred and paid
for ordinary and necessary business purposes.” Respondent also denies that
petitioner had the intent to operate a business and that petitioner had a profit
motive.
Respondent then changed course in his pretrial memorandum. The only
issues listed for trial in the pretrial memorandum are whether petitioner: (1) was
engaged in an activity for profit under section 183 and (2) was liable for an
accuracy-related penalty under section 6662. Petitioner did not file a pretrial
memorandum. - 10 -
Respondent did not file an amended or supplemental answer to assert an
increased deficiency under his new theory that petitioner was not engaged in an
activity for profit under section 183.8
Discussion
Generally, the Commissioner’s determination of a deficiency is presumed
correct, and the taxpayer bears the burden of proving it incorrect. See Rule
142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Moreover, deductions are
a matter of legislative grace, and the taxpayer bears the burden of proving his
entitlement to any deductions claimed. INDOPCO, Inc. v. Commissioner, 503
U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).
I. Burden of Proof
Under section 7491(a) the burden of proof may shift to the Commissioner if
the taxpayer produces credible evidence with respect to any relevant factual issue
and meets other requirements.
Additionally, respondent bears the burden of proof for any new matter that
departs from the determination in the notice of deficiency. See Rule 142(a);
8 Respondent allowed petitioner’s 2008 Schedule C deductions for depreciation expenses of $5,128; legal and professional expenses of $550; office expenses of $1,728; and supply expenses of $640 for the same activity. Under respondent’s new theory, his determination should have been that all of petitioner’s deductions should be disallowed. - 11 -
Dagres v. Commissioner, 136 T.C. 263, 277-278 (2011); see also Papineau v.
Commissioner, 28 T.C. 54, 57 (1957). New matter includes a new theory that
“‘alters the original deficiency or requires the presentation of different evidence.’”
Dagres v. Commissioner, 136 T.C. at 278 (quoting Wayne Bolt & Nut Co. v.
Commissioner, 93 T.C. 500, 507 (1989)); Estate of Falese v. Commissioner, 58
T.C. 895, 898-899 (1972); Papineau v. Commissioner, 28 T.C. at 57; Tauber v.
Commissioner, 24 T.C. 179, 185 (1955).
The Court need not determine which party bears the burden of proof
because the case will be decided on the preponderance of the evidence. See
Knudsen v. Commissioner, 131 T.C. 185 (2008), supplementing T.C. Memo.
2007-340; Cyman v. Commissioner, T.C. Memo. 2009-144. - 12 -
II. Section 1839
A. General Law
Generally, the Internal Revenue Code allows deductions for ordinary and
necessary expenses incurred in conducting a trade or business or for the
production of income. Secs. 162(a), 212(1). To determine whether and to what
extent section 183 and the regulations thereunder apply, the activity of the
taxpayer must be ascertained. Sec. 1.183-1(d), Income Tax Regs. Under section
183, if an activity is not engaged in for profit, then no deduction attributable to
that activity is allowed except as provided for in section 183(b). The phrase
“activity not engaged in for profit” means any activity other than one with respect
to which deductions are allowed for the taxable year under section 162 or under
paragraph (1) or (2) of section 212. Sec. 183(c). “Profit” for purposes of section
183(a) means economic profit, independent of tax savings. See Antonides v.
9 Generally, the Court’s concerns surrounding new theories are surprise or prejudice to either party. Both parties were aware that sec. 183 would be the main issue at trial, and all of the exhibits referenced at trial were joint exhibits. See Bhattacharyya v. Commissioner, T.C. Memo. 2007-19, 2007 WL 247821, at *6 (both parties relied on the same exhibits at trial and the taxpayer was aware before trial of new issues the Commissioner planned to raise). When the Court asked petitioner whether the issues set forth in respondent’s pretrial memorandum were the issues for trial, he responded in the affirmative. - 13 -
Commissioner, 91 T.C. 686, 694 (1988), aff’d, 893 F.2d 656 (4th Cir. 1990);
Hulter v. Commissioner, 91 T.C. 371, 393 (1988).
The standard to decide whether a taxpayer is carrying on a trade or business
so that his expenses are deductible under section 162 is to examine whether the
taxpayer’s primary purpose and intention in engaging in the activity is to make a
profit. Dreicer v. Commissioner, 78 T.C. 642, 643 (1982), aff’d without published
opinion, 702 F.2d 1205 (D.C. Cir. 1983). The taxpayer’s expectation of profit
need not be a reasonable one, but merely bona fide. Id.; sec. 1.183-2(a), Income
Tax Regs. Whether a taxpayer expects to realize a profit is a question of fact and
is resolved by examining all of the facts and circumstances of the case. Dreicer v.
Commissioner, 78 T.C. at 643-644; sec. 1.183-2(a), Income Tax Regs.
The Court examines the facts and circumstances of the case using the
relevant factors in section 1.183-2(b), Income Tax Regs. Dreicer v.
Commissioner, 78 T.C. at 644. Such factors include: (1) the manner in which the
taxpayer carries on the activity, (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 carrying on other similar or dissimilar activities, (6) the
taxpayer’s history of income or losses with respect to the activity, (7) the amount - 14 -
of occasional profits, if any, which are earned, (8) the financial status of the
taxpayer, and (9) whether elements of personal pleasure or recreation are involved.
Sec. 1.183-2(b), Income Tax Regs. No one factor is determinative. Id. Simple
numerical majority will not indicate a lack of profit motive or vice versa, and the
Court may accord certain factors greater weight than others. Id.; see also Golanty
v. Commissioner, 72 T.C. 411, 426 (1979), aff’d without published opinion, 647
F.2d 170 (9th Cir. 1981); Allen v. Commissioner, 72 T.C. 28, 34 (1979). Each of
these factors will be analyzed in turn, and the Court will give greater weight to the
objective factors listed above. See Keanini v. Commissioner, 94 T.C. 41, 46
(1990); Dreicer v. Commissioner, 78 T.C. at 645; see also sec. 1.183-2(a), Income
Tax Regs.
B. Petitioner’s Pursuits as an International Travel Guide Writer
Petitioner listed world travel guide10 (activity) as his principal business on
the Schedule C attached to the return. The Court will apply the section 183 factors
to all the facts and circumstances surrounding the activity.
10 Although petitioner does not use the term “writer” on the Schedule C as his profession, it is evident from the documents entered into evidence and petitioner’s testimony that his intended profession was that of a travel guide writer and not merely a travel guide. - 15 -
1. Manner in Which the Activity Is Conducted
Whether petitioner carried on the activity in a businesslike manner and
maintained complete and accurate books and records may indicate whether he
engaged in the activity for profit. See sec. 1.183-2(b)(1), Income Tax Regs.
Carrying on the activity in a manner substantially similar to that of other similar
activities that are profitable and changing operating methods or adopting new
techniques or abandoning unprofitable methods in a manner consistent with an
intent to improve profitability may also indicate a profit motive. Id.
Before beginning his travels, petitioner formed the LLC to implement the
activity. Petitioner obtained an employer identification number for the LLC, but
he did not identify the LLC on the Schedule C attached to the return. Furthermore,
as of the date of trial, he had not contributed or transferred any assets to the LLC,
and the LLC’s filings were not current with the State of Colorado.
Petitioner did not maintain any books or records for the activity. He had no
written business plan and no estimate as to when his Web site would be
operational, when his books would be published, or when he would begin to earn
income from the activity. Although petitioner documented and retained receipts
for his travel-related expenses, merely maintaining receipts is not enough to
indicate a profit motive. See Golanty v. Commissioner, 72 T.C. at 430; Rowden v. - 16 -
Commissioner, T.C. Memo. 2009-41, 2009 WL 415601, at *5. There must be
additional evidence showing petitioner used the receipts to “evaluate the
profitability of his operations,” and without more, such evidence is not persuasive
of his profit motive. See Rowden v. Commissioner, 2009 WL 415601, at *5.
There is no such evidence here.
Furthermore, petitioner did not investigate the activity before embarking on
his trip. Petitioner incurred over $39,000 in expenses before doing any research
into the activity’s profitability. This is an indication that the activity was not
engaged in for profit. See McCarthy v. Commissioner, T.C. Memo. 2000-197,
2000 WL 863151, at *4; see also Burger v. Commissioner, T.C. Memo. 1985-523,
1985 WL 15145, at *5 (taxpayers who “undertook the activity with no concept of
what their ultimate costs might be, how they might operate at the greatest cost
efficiency, how much revenues they could expect, or what risks could impair the
generation of revenues” did not “operate in a businesslike manner”), aff’d, 809
F.2d 355 (7th Cir. 1987). It was not until well into petitioner’s travels and upon
his return that petitioner investigated and determined the level of competition and
degree of difficulty involved in the activity. Additionally, petitioner admitted his
approach to the activity was ad hoc; he testified to using a “ready, fire, aim”
method of learning from his mistakes along the way. - 17 -
The Court finds that the activity was not carried on in a businesslike manner
or operated in a manner similar to that of other similar activities, or that petitioner
made changes to his operation methods or adopted any new techniques in the year
in issue. As such, this factor weighs against petitioner in determining whether the
activity was engaged in for profit.
2. Expertise of Petitioner or His Advisors
This factor concerns petitioner’s preparation for the activity by “extensive
study of its accepted business, economic, and scientific practices, or consultation
with those who are expert therein” to indicate his profit motive. See sec. 1.183-
2(b)(2), Income Tax Regs. Where such preparation was undertaken or experts
consulted, but the taxpayer did “not carry on the activity in accordance with such
practices,” then lack of profit motive may be indicated, unless the taxpayer was
“attempting to develop new or superior techniques which may result in profits
from the activity.” Id.
Petitioner sought out and obtained expert advice regarding the activity.
Petitioner contacted noted experts in the activity; additionally, he contacted
experts regarding the creation, development, and marketing of products embodied
in courses he has taken. While these actions are to petitioner’s credit, he did not
perform them until after his trip when he determined the marketplace to be highly - 18 -
competitive and already developed and in years beyond the year in issue.
Petitioner failed to perform basic due diligence before embarking on his proposed
course of action. See Westerbrook v. Commissioner, T.C. Memo. 1993-634, 1993
WL 540784, at *7 (“a taxpayer need not make a formal market study” but “should
undertake a basic investigation of the factors that would affect profit”), aff’d, 68
F.3d 868 (5th Cir. 1995). Given the timeframe in which petitioner sought expert
advice, the Court finds this factor weighs against petitioner’s having a profit
motive in 2008.
3. Time and Effort Expended
Extensive time and effort devoted to an activity, “particularly if the activity
does not have substantial personal or recreational aspects, may indicate an
intention to derive a profit.” Sec. 1.183-2(b)(3), Income Tax Regs. Furthermore,
withdrawal from another occupation to devote time and energy towards the
activity may be evidence of a profit motive. Id. The fact that a taxpayer devoted
“a limited amount of time to an activity does not necessarily indicate a lack of
profit motive where the taxpayer employs competent and qualified persons to
carry on such activity.” Id.
The record reflects that petitioner devoted his time and effort to the activity
in 2008 through his traveling and blog posts. Additionally, petitioner left his job - 19 -
in 2008 to have more time to pursue the activity. Although petitioner has devoted
some degree of time to researching, drafting, revising, and educating himself in
the finer points of blogging, marketing, and sales, most, if not all, of these tasks
were undertaken in years not in issue here.
Petitioner admitted that since 2008 he has not done much writing.
Petitioner testified that the employment he obtained upon his return to the States
did keep him from writing for the next couple of years. “[T]here must be some
conscientious intent and effort to engage in and continue in the writing field for
the purpose of producing income and a livelihood in order to have writing qualify
as a trade or business”. Wright v. Commissioner, 31 T.C. 1264, 1267 (1959),
aff’d, 274 F.2d 883 (6th Cir. 1960).11 While petitioner did travel and write in
2008, he did no more writing for the next two years. “Carrying on a business * * *
implies an occupational undertaking to which one habitually devotes time,
attention, or effort with substantial regularity.” Fahs v. Crawford, 161 F.2d 315,
317 (5th Cir. 1947). This factor weighs against petitioner.
11 The Court understands petitioner’s argument that Wright is outdated law because of technological advancements in the publishing world. While the publishing world has advanced since 1959, Wright is still good law and pertinent to the Court’s discussion. - 20 -
4. Expectation That Assets Used in Activity May Appreciate in Value
For the purposes of a section 183 analysis, “[t]he term ‘profit’ encompasses
appreciation in the value of assets * * * used in the activity.” Sec. 1.183-2(b)(4),
Income Tax Regs. A taxpayer may realize an overall profit when appreciation in
the value of assets combined with any income from the activity will exceed
expenses of operation. Id.
Petitioner claimed a depreciation deduction of over $5,000 for assets not
listed on the Schedule C. Petitioner credibly testified that the depreciation
deduction was for his computer and photography equipment. These assets will not
appreciate in value.
The only other assets referred to in the record are petitioner’s original work
product--the blog and books he wrote. Petitioner’s blog was accidentally deleted
in 2010 and as of the time of trial had yet to be reposted. Although petitioner
testified about potential prices for two of the books, he has not sold any books.
There is not sufficient evidence in the record to decide whether petitioner expected
these assets to appreciate. Accordingly, the Court cannot conclude that this factor
supports a finding of profit motive. See Shah v. Commissioner, T.C. Memo.
2015-31, at *11. - 21 -
5. The Success of the Taxpayer in Carrying On Other Similar or Dissimilar Activities
“The fact that the taxpayer has engaged in similar activities in the past and
converted them from unprofitable to profitable enterprises may indicate that he is
engaged in the present activity for profit, even though the activity is presently
unprofitable.” Sec. 1.183-2(b)(5), Income Tax Regs. Petitioner credibly testified
that this was the first time he had engaged in an activity of this nature and that he
was a novice entrepreneur. Therefore, this factor is neutral.
6. The Taxpayer’s History of Income and Losses With Respect to the Activity
If a taxpayer has engaged in an activity for multiple years, “a series of losses
during the initial or start-up stage of an activity may not necessarily be an
indication that the activity is not engaged in for profit.” Id. subpara. (6).
Continued sustained losses beyond the initial or startup period required to bring
the activity to profitability, if not explainable as “due to customary business risks
or reverses” may be indicative of the lack of profit motive. Id. However, “[a]
series of years in which net income was realized would * * * be strong evidence
that the activity is engaged in for profit.” Id. - 22 -
Petitioner began the activity in 2008, the year in issue. Petitioner claimed a
business loss of $39,139 for 2008. It is not uncommon to incur losses in the first
year of an activity. There is no evidence in the record, however, that future profits
will cover the startup losses. See Golanty v. Commissioner, 72 T.C. at 426-427.
This factor weighs against petitioner.
7. The Amount of Occasional Profits, if Any, Which Are Earned
This factor concerns the amount of profits in relation to the losses incurred,
investments made in the activity, and assets used in the activity. Sec. 1.183-
2(b)(7), Income Tax Regs. The activity had no profits in 2008.
Petitioner testified that aside from attending some courses and seminars
about the activity in the following years, he was not involved to the extent he had
wished because of other work obligations.12 Furthermore, the income-generating
aspects of petitioner’s activity--his blog and books--were not operational,
published, or available for sale at the time of trial, and petitioner could not
12 Petitioner filed Schedules C with his 2009 and 2010 Federal income tax returns. Petitioner listed his profession as “consulting travel guide” on both Schedules C. Petitioner reported gross receipts or sales of $49,146 for 2009 and none for 2010. A business loss was reported for each year. Petitioner testified that he had not sold any copies of his books and had no affiliated sales from his blog. It is not clear from the record what activity generated the gross receipts or sales reported for 2009. - 23 -
estimate when said items would be operational or available for sale. With no
estimation of or plan for profits, petitioner incurred tens of thousands of dollars of
expenses. “The magnitude of the activity’s losses in comparison with its revenues
is an indication that petitioner did not have a profit motive with respect to the
activity.” Miller v. Commissioner, T.C. Memo. 1998-463, 1998 WL 906689, at *6
(citing Smith v. Commissioner, T.C. Memo. 1997-503, and Burger v.
Commissioner, T.C. Memo. 1985-523). Consequently, this factor weighs against
petitioner.
8. The Financial Status of the Taxpayer
“The fact that the taxpayer does not have substantial income or capital from
sources other than the activity may indicate that an activity is engaged in for
profit.” Sec. 1.183-2(b)(8), Income Tax Regs. Substantial income from sources
other than the activity (particularly if the losses from the activity generate
substantial tax benefits) may indicate that the activity was not engaged in for profit
especially if there were personal or recreational elements involved. Id.
In 2008 petitioner terminated his employment to pursue the activity and
took a sizable distribution from his section 401(k) retirement account to finance
his travels. Petitioner credibly testified that he was required to obtain other - 24 -
employment when he returned from traveling to provide for basic necessities
because the activity was not immediately profitable.
Petitioner did have some wage income, taxable interest, ordinary dividends,
and a taxable section 401(k) distribution in 2008. The record is silent as to
whether petitioner had income from any other sources, but petitioner did realize
the tax benefits of the deductions generated from the activity to shelter his wage
income, taxable interest, ordinary dividends, and section 401(k) distribution in
2008. This fact, coupled with the fact that there were elements of personal
pleasure and recreation in the activity as discussed below, tips the balance of this
factor against petitioner.
9. Elements of Personal Pleasure or Recreation
The presence of personal motives in carrying on an activity may indicate the
activity was not engaged in for profit, particularly where there are recreational or
personal elements involved. Sec. 1.183-2(b)(9), Income Tax Regs. Where there
are no elements of personal recreation, the inference is strong that there was a
profit motive. Id. But “[a]n activity will not be treated as not engaged in for profit
merely because the taxpayer has purposes or motivations other than solely to make
a profit.” Id. The fact that the taxpayer enjoyed the activity and derived personal - 25 -
pleasure from engaging in it is not sufficient alone to cause the activity to be
classified as not engaged in for profit. Id.
Petitioner did derive substantial personal pleasure and recreation from the
activity and readily admitted he enjoyed traveling, regardless of any hardships
suffered during his travels. In fact it was while traveling on vacation that
petitioner decided to attempt to make a career out of the activity. This factor, in
combination with the other factors reviewed by the Court, weighs against
C. Conclusion
After review of the factors and all of the facts and circumstances
surrounding the activity, the Court finds that petitioner was not engaged in the
activity for profit in 2008.13
Although from his pretrial memorandum forward in this case respondent has
asserted that petitioner’s activity was not engaged in for profit under section 183,
no amended answer was filed asserting an increase in the deficiency. Because
13 The Court understands that 2008 was the first year petitioner engaged in the activity. While the Court finds that petitioner was not engaged in the activity for profit in 2008, this finding does not mean that the activity is forever doomed to be merely a hobby. See Feistman v. Commissioner, T.C. Memo. 1982-306, aff’d without published opinion, 718 F.2d 1110 (9th Cir. 1983). - 26 -
respondent has failed to follow the necessary procedural requirements to assert an
increase in the deficiency, his determination is limited to the deficiency in the
notice of deficiency dated March 13, 2012.
III. Accuracy-Related Penalty
Section 6662(a) and (b)(1) and (2) authorizes a 20% penalty on the portion
of an underpayment of income tax attributable to: (1) negligence or disregard of
rules or regulations or (2) a substantial understatement of income tax. Under
section 7491(c), the Commissioner bears the burden of production with regard to
penalties. Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Once the
Commissioner has met the burden of production, the taxpayer has the burden of
proving that the penalties are inappropriate because of reasonable cause or
substantial authority. See Rule 142(a); Higbee v. Commissioner, 116 T.C. at 446-
447; Hall v. Commissioner, 729 F.2d 632, 635 (9th Cir. 1984), aff’g T.C. Memo.
1982-337.
There is a “substantial understatement” of income tax for any year if the
amount of the understatement for the taxable year exceeds the greater of 10% of
the tax required to be shown on the tax return or $5,000. Sec. 6662(d)(1)(A);
Higbee v. Commissioner, 116 T.C. at 448. - 27 -
Here, the understatement of income tax is $7,147, which is greater than
$5,000, which in turn is greater than 10% of the tax required to be shown on the
return. Thus, the understatement is substantial for purposes of the section 6662(a)
accuracy-related penalty. The Court concludes that respondent met his burden of
production in showing that petitioner substantially understated his Federal income
tax for 2008.
Pursuant to section 6664(c)(1), no penalty shall be imposed under section
6662 with regard to any portion of an underpayment if it can be shown that there
was reasonable cause for such portion and that the taxpayer acted in good faith
with respect to such portion. Whether a taxpayer acted with reasonable cause and
in good faith is decided on a case-by-case basis, taking into account all pertinent
facts and circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs. Generally, the
most important factor is the extent of the taxpayer’s effort to assess his proper tax
liability. Id.; see also Remy v. Commissioner, T.C. Memo. 1997-72.
Petitioner did not address the accuracy-related penalty at trial or in his
opening brief. In his answering/reply brief, petitioner devotes one paragraph to
the accuracy-related penalty, merely reiterating that the activity was an active trade
or business. No evidence was presented to explain petitioner’s efforts to ascertain
his correct tax liability for 2008 beyond his belief that the activity in which he was - 28 -
engaged was a trade or business. Petitioner did not present any reasonable cause
or good faith arguments.
Petitioner has not met his burden of proving that he acted in good faith and
with reasonable cause, and the Court sustains the section 6662(a) accuracy-related
penalty for a substantial understatement of income tax.14
To reflect the foregoing,
Decision will be entered
for respondent.15
14 The notice of deficiency states that the sec. 6662 penalty was attributable to one of the following: (1) negligence or disregard of rules or regulations; (2) substantial understatement of income tax; or (3) substantial valuation misstatement (overstatement). Because the Court finds that there was a substantial understatement of income tax, a discussion of whether petitioner was negligent is not warranted. A substantial valuation misstatement is not applicable here. 15 The Court finds that respondent is limited to his original determination in the notice of deficiency dated March 13, 2012. See supra p. 25-26.