Rowden v. Comm'r
Opinion
MEMORANDUM FINDINGS OF FACT AND OPINION
MARVEL,
Respondent determined deficiencies of $ 5,074 and $ 7,396 in petitioner's 2002 and 2003 Federal income taxes and accuracy-related penalties under
(1) Whether petitioner was in the trade or business of environmental consulting and aircraft maintenance during 2002 and environmental aviation during 2003;
(2) whether petitioner substantiated deductions claimed on Schedules C, Profit or Loss From Business; and
(3) whether petitioner is liable for the accuracy-related penalties under
FINDINGS OF FACT
The parties have stipulated some of the facts, which we incorporate in our findings by this reference. Petitioner resided in Oklahoma when his petition was filed.
During 2002 and 2003 petitioner was employed full time as an environmental engineer by Engineering and Environment, Inc. (EEI), a government contractor. He earned $ 52,611 and $ 60,889, respectively. Petitioner's employment contract was renewable annually. During 2002 petitioner also performed environmental consulting services that were an outgrowth of services he had performed and been paid for before 2002.
Petitioner grew up in a family of pilots and enjoys working on and being around airplanes. Petitioner has been a licensed pilot for about 25 years. In the 1980s petitioner completed a 2-year program at the Spartan School of Aeronautics in Tulsa, Oklahoma. After passing written and oral Federal Aviation Administration (FAA) tests, petitioner obtained a mechanic's certificate *43 with airframe and powerplant ratings. 3 In 2000, after passing another FAA test, petitioner obtained an inspection authorization. 4 Petitioner also attended specialized aviation-related seminars; in August 2002 petitioner attended a seminar on aircraft rigging held by the Cessna Pilots Association.
On August 25, 2002, petitioner purchased a *44 50-percent interest in a 1975 Cessna 182P aircraft (Cessna) from DenRow Limited, L.C. (DenRow), for $ 30,000 using loan proceeds. DenRow is owned by petitioner's brother, William J. Rowden (Mr. Rowden), 5 a commercial airline pilot, and Mr. Rowden's wife. DenRow retained the other 50-percent interest in the Cessna. The Cessna continued to be hangared at the Prague, Oklahoma, municipal airport, although occasionally it was stored at the Lawton, Oklahoma, municipal airport where in 2003 petitioner rented hangar space.
Under the purchase agreement, petitioner was responsible for one-half of the maintenance, repair, storage, and *45 operation costs of the Cessna. When petitioner purchased his interest in the Cessna, it was not in airworthy condition because its engine required a major overhaul. 6 At some point during the years at issue, petitioner sent the engine to an outside shop for an overhaul, at a cost of approximately $ 25,000.
During the years at issue petitioner spent 20 to 30 hours weekly working on the Cessna, on airplanes owned by other people, and on related matters. Neither Mr. Rowden nor DenRow paid petitioner for work he performed on the Cessna.
During the years at issue the Cessna was for sale. Petitioner followed market prices using various sources for aircraft valuation, such as trade periodicals. In 2007 the Cessna was appraised at $ 93,000. As of the date of trial Mr. Rowden did not believe the Cessna could be sold at a profit.
Petitioner timely filed his 2002 and 2003 Forms 1040, U.S. Individual Income Tax Return (2002 and 2003 returns). On the 2002 return he reported *46 two businesses on two Schedules C (2002 Schedules C1 and C2). The 2002 Schedule C1 described petitioner's business as "Env [Environmental] Consulting", and the 2002 Schedule C2 described petitioner's other business as "Aircraft Maintenance". Petitioner reported one business on a Schedule C attached to the 2003 return (2003 Schedule C) and described his business as "Environmental Aviati[on]". On his Schedules C petitioner reported gross income and expenses and net profit or loss, as shown in the following table:
| Net profit | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Schedule C | Gross income | Expenses |
| Net profit | |||
| Schedule C | Gross income | Expenses | or (loss) |
| 2002 Schedule C1 | -0- | $ 9,780 | ($ 9,780) |
| 2002 Schedule C2 | $ 450 | 11,364 | (10,914) |
| 2003 Schedule C | 2,238 | 27,531 | (25,293) |
The following table compares the adjusted gross income (AGI) that petitioner would have reported if he had not engaged in his activities with the AGI that he actually reported on his 2002 and 2003 returns:
| AGI without | ||
| Year | the activities | AGI reported |
| 2002 | $ 53,807 | $ 33,113 |
| 2003 | 63,137 | 37,844 |
In the notice of deficiency respondent disallowed all 2002 Schedule C1 and 2003 Schedule C deductions. Respondent also disallowed deductions for tools, parts, and training expenses totaling $ 8,744 claimed on the 2002 Schedule C2. 7 Respondent disallowed *47 these Schedule C deductions for the following reason: "Your deductions * * * have been adjusted to reflect the amount verified as paid or incurred for business purposes." Because respondent disallowed the deductions for business use of home of $ 511 and $ 504 claimed on the 2002 Schedule C1 and 2003 Schedule C, respondent allowed additional home mortgage interest deductions of $ 511 and $ 504 for 2002 and 2003, respectively. Respondent made computational adjustments to self-employment tax for 2003 and determined that petitioner was liable for accuracy-related penalties under
OPINION
The Commissioner's determinations are presumed correct, and the taxpayer ordinarily bears the burden of proving that those determinations are erroneous.
Respondent contends that petitioner may not deduct his Schedule C expenses because none of the Schedule C activities was a trade or business. 8*49
I. The Environmental Consulting Activity in 2002 9*50
Petitioner testified that he engaged in the environmental consulting activity "when available" and that the aviation activity had become his priority. During 2002 petitioner reported no gross income from the activity and only performed follow-up services; he attended two client meetings and conducted online research related to the activity. Petitioner did not introduce any evidence regarding how much time he spent on the activity. We conclude petitioner failed to establish that in 2002 he engaged in the environmental consulting activity with the requisite continuity and regularity. See
Petitioner contends that respondent has conceded the profit-motive issue. We disagree. Respondent has not conceded the issue; respondent argued during trial and on brief that to establish that petitioner was engaged in a trade or business petitioner must prove he engaged in an activity with continuity and regularity and with the primary purpose of making a profit. See
Absent a stipulation to the contrary, see
While the taxpayer's expectation of profit need not be reasonable, it must be in good faith.
Petitioner testified that the environmental aviation activity reported on the 2003 Schedule C combined two activities: Environmental consulting and aircraft maintenance. Petitioner received his 2003 Schedule C gross income from two clients for performing annual inspections in the course of the aircraft maintenance activity. 11*55 The record establishes that most 2003 Schedule C expenses, such as interest on the aviation loan, the Cessna insurance, and parts expenses, were incurred for petitioner's aircraft maintenance activity. Consequently, for purposes of this opinion we treat the environmental aviation activity as a continuation of the 2002 aircraft maintenance activity.
In deciding whether a taxpayer has conducted an activity in a businesslike manner we consider: (1) Whether complete and accurate books and records were maintained; (2) whether the activity was conducted in a manner substantially similar to those of other activities of the same nature that were profitable; and (3) whether changes in operating methods, adoption of new techniques, or abandonment of unprofitable methods were done in a manner consistent with an intent to improve profitability. See
Petitioner's recordkeeping was disorganized and unreliable. For example, although petitioner retained all receipts for his expenses, petitioner's files mistakenly contained receipts for unrelated years. Petitioner did not introduce any records pertaining to gross income, such as copies of customer work orders, logbooks, or customer invoices. Petitioner testified that approximately 25 percent of the parts he purchased were used for airplanes other than the Cessna and that *56 he kept records for larger inventory items. However, petitioner did not introduce any inventory records into evidence.
We are not convinced that petitioner's recordkeeping represented anything other than an effort to substantiate expenses claimed on his return. For a taxpayer's books and records to indicate a profit motive, the taxpayer should use books and records for measuring profits, cutting expenses, and evaluating the overall performance of the operation.
Petitioner testified that he had engaged in the aircraft maintenance activity since 1996. However, he offered no evidence regarding the past performance of the activity and whether he considered changes in his operating methods.
We conclude that during the years at issue petitioner did not conduct his aircraft maintenance activity in a businesslike manner. This factor favors respondent's position.
Preparation for *57 an activity by an extensive study of its accepted business, economic, and scientific practices or consultation with those who are experts therein may indicate a profit objective.
The fact that a taxpayer devotes personal time and effort to carrying on an activity may indicate an intention to derive a profit, particularly where there are no substantial personal or recreational elements associated with the activity.
The term "profit" encompasses appreciation of assets used in the activity.
Petitioner claims that his business's value increased because the Cessna appreciated after the overhaul and because the Cessna ownership provided his business additional client exposure. The only evidence in the record that the Cessna was an advertising tool is petitioner's uncorroborated testimony, which we are not required to accept. See
Even if we were to conclude, however, that petitioner had a good-faith expectation of selling the overhauled Cessna at a profit, we must still examine whether petitioner had a good-faith expectation of realizing a profit on his entire operation.
The fact that a taxpayer has engaged in similar activities 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.
A taxpayer's history of income or loss with respect to any activity may indicate the presence or absence of a profit objective. See
Petitioner testified that he had been providing maintenance services, such as aircraft maintenance, rigging, inspection, sale, and refurbishing since 1996. However, petitioner introduced no credible evidence regarding the financial performance of his aircraft maintenance activity before the years at issue. The failure to introduce such evidence raises a presumption that the evidence would be unfavorable to petitioner. See
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
During 2002 and 2003 the aircraft maintenance activity generated net losses which significantly reduced petitioner's AGI. Petitioner offered no credible evidence regarding what profits, if any, his aircraft maintenance activity generated between 1996 and 2001. Failure of a party to introduce evidence within his possession which, if true, would be favorable to him gives rise to the presumption that such evidence is unfavorable.
The fact that a taxpayer does not have substantial income or capital from sources other than the activity in question may indicate that the activity is engaged *63 in for profit. See
During 2002 and 2003 petitioner was employed as an environmental engineer, earning $ 52,611 and $ 60,889, respectively. Petitioner is single and has no children. Although the income did not support a lavish lifestyle, it provided petitioner with a comfortable living and allowed him to conduct the aircraft maintenance activity at a loss. This factor favors respondent's position.
The presence of personal pleasure or recreation relating to the activity may indicate the absence of a profit objective. See
Petitioner grew up around airplanes and has been a licensed pilot for 25 years. He enjoys working on airplanes and takes pride in his workmanship *64 and in his family's aviation history. We cannot overlook significant elements of recreation and pleasure that petitioner derived from working on airplanes. This factor favors respondent's position.
Petitioner relies on The determination whether an activity is engaged in for profit is to be made by reference to
After a review of the objective factors discussed above, we are not convinced that petitioner engaged in his aircraft maintenance activity with the objective of making a profit.
After considering the factors listed in
Because we have sustained respondent's determination that petitioner's aircraft maintenance activity was not a trade or business under
With respect to the 2002 Schedule C2, respondent allowed $ 2,620 in deductions. This amount exceeds petitioner's $ 450 gross income from the activity. Consequently, no additional deductions are allowed for 2002.
For 2003 petitioner did not claim any deductions that are allowable under
| Expense | Amount substantiated |
| Insurance | $ 529 |
| Office expense | 186 |
| Rent of other business | |
| property | 1,200 |
| Supplies | 1,020 |
| Tools | 1,570 |
| Training certifications | 313 |
| Professional subscription | 110 |
| Total | 4,928 |
Although we hold that in 2002 and 2003 petitioner's aircraft maintenance activity did not constitute a trade or business under
Respondent contends that petitioner is liable for the accuracy-related penalty on the grounds of substantial understatement of income tax under
The Commissioner bears the initial burden of production with respect to the taxpayer's liability for the
The accuracy-related penalty is not imposed with respect to any portion of the underpayment if the taxpayer can establish that he acted with reasonable cause and in good faith.
In his posttrial briefs petitioner did not address why the penalties should not be imposed. Petitioner did not contend that he was not negligent or that he had reasonable cause or acted in good faith. Therefore, we *69 sustain respondent's determination to impose the
We have considered all arguments raised by either party, and to the extent not discussed, we find them to be irrelevant, moot, or without merit.
To reflect the foregoing,
Footnotes
1. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. Monetary amounts are rounded to the nearest dollar. ↩
2. Petitioner concedes that he is not entitled to deduct the $ 9,829 depreciation expense for 2003 and unreimbursed employee expenses of $ 6,596 and $ 5,083, before application of the 2 percent floor of
sec. 67(a) , for 2002 and 2003, respectively. After the latter concession petitioner's remaining miscellaneous itemized deductions do not exceed the 2-percent floor ofsec.67(a)↩ and therefore also are not at issue.3. A certified mechanic may perform or supervise the maintenance, preventive maintenance, or alteration of an aircraft or a part thereof for which he is rated.
14 C.F.R. sec. 65.81(a) (2003) . A certified mechanic with an airframe rating may also approve and return to service an airframe or related part or appliance after he has performed, supervised, or inspected its maintenance or alteration.14 C.F.R. sec. 65.85 (2003) . A certified mechanic with a powerplant rating has similar additional privileges with respect to a powerplant, propeller, or any related part. See14 C.F.R. sec. 65.87 (2003)↩ .4. In general, a holder of an inspection authorization may inspect and approve for return to service any aircraft or related part after a major repair or major alteration; he may also perform certain other types of inspections. See
14 C.F.R. sec. 65.95 (2003)↩ .5. At the time of trial Mr. Rowden held a mechanic's certificate with airframe and powerplant ratings and an inspection authorization, and he was a flight instructor for single-engine and multi-engine aircraft and instruments and a commercial glider pilot. Mr. Rowden bought undervalued airplanes, used them for charter and instruction, and then sold them. DenRow purchased the 1975 Cessna 182P (Cessna) in 2000 for $ 43,000. During the years at issue petitioner was not a partner, member, or agent of DenRow, and he was not involved in making any of its business decisions.↩
7. Respondent contends that in the notice of deficiency he erroneously allowed the 2002 Schedule C2 deductions totaling $ 2,620, but he does not assert an increased deficiency for 2002.↩
8. In the notice of deficiency respondent disallowed the deductions as not verified as paid or incurred for business purposes. At trial respondent argued that petitioner did not engage in the trade or business of environmental consulting and aircraft maintenance during 2002 and environmental aviation during 2003. Petitioner does not contend that the argument represents a new issue on which respondent should have the burden of proof. See
Rule 142(a)↩ . In addition, petitioner listed the profit-motive issue with respect to the aviation-related activities in his trial memorandum as one for decision.9. Although respondent states in his reply brief that petitioner has conceded the issue of the environmental consulting activity because he failed to address it on brief, petitioner in his opening brief continues to challenge the full amount of deficiency and identifies the 2002 Schedule C1 amounts as still in dispute. Nevertheless, we agree with respondent that petitioner does not address the environmental activity elsewhere in briefs, and we note that petitioner also agrees with respondent's proposed finding of fact that "Petitioner failed to introduce credible evidence that he was in the environmental consulting business in 2002." We address the environmental consulting activity for the sake of completeness.
10. In both
Hildebrand v. Commissioner , 28 F.3d 1024, 1027 (10th Cir. 1994)Krause v. Commissioner , 99 T.C. 132 (1992)Cannon v. Commissioner , 949 F.2d 345, 350 (10th Cir. 1991)T.C. Memo. 1990-148 , the Court of Appeals for the Tenth Circuit applied the dominant or primary objective test at the partnership level in analyzing whether a partnership was engaged in an activity for profit undersec. 183↩ .11. While petitioner's testimony is not clear as to whether such annual inspections were performed in the course of environmental consulting services or aircraft maintenance services, petitioner contends in his brief that his 2003 Schedule C gross income was derived from "aircraft activities".
12. Petitioner also testified that he spent between 20 and 40 hours weekly on the aircraft maintenance activity.↩
13. Respondent argues that petitioner has conceded the issue of penalties because petitioner does not address it in his brief. We address the issue for the sake of completeness because petitioner lists the issue as one for decision in his reply brief.↩
2009 T.C. Memo. 41 (Rowden v. Comm'r) — published by Counsel Stack Legal Research, free access to 12M+ legal documents.