Wesley v. Comm'r ( 2007 )

T.C. Memo. 2007-78
UNITED STATES TAX COURT
DANON EUGENE WESLEY, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 407-06. Filed April 2, 2007.
Danon Eugene Wesley, pro se.
Bryan E. Sladek, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
COHEN, Judge: Respondent determined a deficiency of $8,936
with regard to petitioner’s Federal income tax liability for 1996
and a 25-percent addition to tax under section 6651(a)(1) for
failure to file his tax return timely. After a concession by
petitioner, the issues for decision are whether petitioner was
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engaged in the trade or business of recording and producing music
during 1996 and whether he is liable for the addition to tax.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue.
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulated
facts are incorporated in our findings by this reference.
Petitioner resided in Detroit, Michigan, at the time he
filed his petition. Petitioner’s primary employment for the year
in issue was as an engineer.
Petitioner has written and recorded music since at least
1985. Between 1985 and 1996, petitioner occasionally sent taped
recordings of his music to various record companies in the hopes
of obtaining a recording contract. Petitioner recorded these
tapes at a local recording studio. Petitioner saved receipts
from some of these visits to the recording studio, specifically
those from late 1987 and early 1988, which total approximately
$615. In 1996, petitioner spent $20,462 to purchase and install
professional recording equipment in his home.
Petitioner filed his Form 1040, U.S. Individual Income Tax
Return, for 1996 on January 8, 2004. Petitioner reported gross
wages of $95,246 from his employment as an engineer in 1996. He
claimed the $20,462 that he spent to purchase and install the
home recording equipment as an expense related to his business as
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a recording studio/producer on his Schedule C, Profit or Loss
From Business, for 1996. Petitioner received no income from his
recording activity in 1996 and thus reported a net business loss
of $20,462 for that year. As of the time of trial of this case
in September 2006, petitioner had not received any income from
his recording activity.
OPINION
Section 162 permits a taxpayer to deduct ordinary and
necessary expenses incurred during the taxable year in carrying
on any trade or business. Section 183 generally limits the
amount of deductions for an activity not entered into for profit
to the amount of the activity’s income. See sec. 183(b). The
notice of deficiency determined that the costs of petitioner’s
recording activities were startup expenses not currently
deductible. The parties agree, however, that the controlling
issue is whether petitioner was engaged in a trade or business
with regard to his recording activity during 1996. We decide
that issue on the preponderance of the evidence, regardless of
the burden of proof.
In order to establish that he was engaged in a trade or
business, the taxpayer must be continuously and regularly
involved in the activity for the primary purpose of making a
profit. Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987); see
also sec. 1.183-2(a), Income Tax Regs. Whether the taxpayer
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engages in an activity with the primary purpose of making a
profit is a question of fact to be resolved based on all the
facts and circumstances in a particular case. Golanty v.
Commissioner, 72 T.C. 411, 426 (1979), affd. without published
opinion 647 F.2d 170 (9th Cir. 1981); sec. 1.183-2(a), Income Tax
Regs. While the focus of the test for whether a taxpayer engaged
in an activity with the intention of making a profit is on the
subjective intention of the taxpayer, greater weight is given to
the objective facts than is given to the taxpayer’s mere
statement of his intent. See Stasewich v. Commissioner, T.C.
Memo. 2001-30; sec. 1.183-2(a), Income Tax Regs.
Section 1.183-2(b), Income Tax Regs., provides a
nonexclusive list of relevant factors to be weighed when
considering whether a taxpayer engaged in an activity for profit.
No one factor is determinative of whether an activity is engaged
in for profit. Brannen v. Commissioner, 722 F.2d 695, 704 (11th
Cir. 1984), affg. 78 T.C. 471 (1982); Golanty v. Commissioner,
supra at 426; sec. 1.183-2(b), Income Tax Regs. The relevant
factors are: (1) The manner in which the taxpayer carried on the
activity; (2) the expertise of the taxpayer or his advisers;
(3) the time and effort expended by the taxpayer in carrying on
the activity; (4) the expectation that the assets used in the
activity may appreciate in value; (5) the success of the taxpayer
in carrying on other activities for profit; (6) the taxpayer’s
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history of income or losses with respect to the activity; (7) the
amount of occasional profits, if any, that are earned from the
activity; (8) the financial status of the taxpayer; and
(9) whether elements of personal pleasure or recreation are
involved in the activity. Sec. 1.183-2(b), Income Tax Regs.
The maintenance of complete and accurate books and records,
and other indications that petitioner conducted his recording
activity in a businesslike manner, would indicate that petitioner
may have engaged in the activity for profit. See sec. 1.183-
2(b)(1), Income Tax Regs. Petitioner did not, however, carry on
his recording activity in a businesslike manner. Petitioner did
not keep regular records of expenses and has presented to the
Court only a few receipts for studio time in the latter part of
1987 and early 1988, 8 years before the year in issue. There is
no evidence that his expenditure of $20,462 was an ordinary and
necessary business expenditure for a profit-seeking recording
artist in a similar situation. See Dickie v. Commissioner, T.C.
Memo. 1999-138.
A taxpayer’s substantial investment of time and effort in
carrying on an activity, especially if the activity does not have
many personal or recreational aspects, may indicate that the
taxpayer has a profit objective. See sec. 1.183-2(b)(3), Income
Tax Regs. Even if a taxpayer devotes little time and effort to
the activity, a profit objective may be indicated by his
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employment of qualified persons to conduct the activity for him.
See id. There is no evidence regarding how much time petitioner
spent pursuing his recording activity during the year in issue.
Petitioner’s effort with regard to his recording activity in
prior years consisted of occasionally sending taped submissions
to record companies in the hopes of attaining a recording
contract. There is no evidence of regular or continuous steps to
promote his recording endeavors prior to or during the year in
issue. Petitioner did not devote the time and effort
commensurate with the profit-seeking pursuit of developing a
recording business. See McMillan v. Commissioner, T.C. Memo.
1989-441.
Although a taxpayer receives no income from operating his
enterprise, he may intend to derive a profit from the potential
appreciation of his business assets. See sec. 1.183-2(b)(4),
Income Tax Regs. There is no evidence that petitioner’s
recording equipment would potentially appreciate, and we infer
that such equipment would instead experience wear and tear over
time and thus depreciate in value.
A taxpayer’s success in carrying on similar activities and a
history of income with respect to his current activity may be
evidence of a profit-seeking motivation in engaging in the
activity. See sec. 1.183-2(b)(5) through (7), Income Tax Regs.
Although petitioner had engaged in his recording activity since
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at least 1985, petitioner received no income and had no success
from his endeavors in or prior to the year in issue. In the
decade since the taxable year in issue, petitioner has received
no income from his recording activity.
Substantial income from sources other than the activity may
indicate that the activity is not engaged in for profit. See
sec. 1.183-2(b)(8), Income Tax Regs. A taxpayer with substantial
income unrelated to the activity can more readily afford a hobby.
See Stasewich v. Commissioner, supra. Petitioner earned a
substantial income in 1996 from his employment as an engineer and
had the financial means to make a large expenditure for an
unrelated personal pursuit or hobby.
Finally, the presence of personal motives and recreational
elements in carrying on an activity may indicate that the
activity is not engaged in for profit. Sec. 1.183-2(b)(9),
Income Tax Regs. Although musical and artistic endeavors
generally have personal and recreational elements, a taxpayer’s
personal enjoyment in pursuing the activity is not sufficient to
negate a profit motive if the other factors listed in section
1.183-2(b), Income Tax Regs., indicate such profit motive. See
id. The economic factors discussed above collectively support
the conclusion that petitioner was not engaged in his recording
activity for profit. The personal and recreational elements
inherent in that activity are the most compelling factors in this
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case. The preponderance of the evidence leads to the conclusion
that the activity was not engaged in for profit.
Petitioner relies on Gestrich v. Commissioner, 74 T.C. 525
(1980), affd. without published opinion 681 F.2d 805 (3d Cir.
1982), for support of his position that his attempts at obtaining
a recording contract amount to an active trade or business. In
that case, we held that the taxpayer was engaged in the trade or
business of being an author because his primary effort was
directed toward his self-employment as a writer, he spent a
significant amount of time working on his book, he had been paid
for his works in prior years, and he was actively attempting to
have his book published. Gestrich v. Commissioner, supra at 529.
For the reasons set forth above, petitioner’s case is
distinguishable from Gestrich.
Petitioner also relies on a case in which the Court of
Appeals for the Tenth Circuit reversed a lower court’s oral
finding that a taxpayer was not engaged in a trade or business as
a photographic journalist or author, where the taxpayer spent 30
hours per week on his nature photography project, shot 200 rolls
of film, produced 3,000 slides, submitted his work unsuccessfully
to several publishers, and maintained detailed technical records
regarding his endeavor to produce a photographic book. Snyder v.
United States, 674 F.2d 1359, 1362-1363 (10th Cir. 1982). The
appellate court in that case did not make its own finding that
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the taxpayer was engaged in a trade or business with regard to
his photographic endeavor, but remanded the case to the trial
court to resolve the questions of whether the taxpayer was
primarily motivated by his love of photography as a hobby or by a
good faith expectation of profit and whether the taxpayer devoted
enough time over a substantial period to be engaged in a trade or
business. Id. at 1364. The District Court was warned on remand
that the mere fact that a taxpayer author has not yet produced a
book does not necessitate the conclusion that he is not engaged
in a trade or business. Id. at 1363.
The Court of Appeals for the Tenth Circuit in Snyder
emphasized that a taxpayer must both possess a good faith profit-
making purpose and spend a substantial amount of time over a
significant period engaged in the activity in order for that
activity to be considered a trade or business. Id. at 1364. For
the reasons stated above, including the minimal time and effort
disclosed in the record, we conclude that petitioner was not
engaged in a trade or business with regard to his recording
activity.
Respondent also determined an addition to tax for late
filing pursuant to section 6651(a)(1) because petitioner did not
file his 1996 return until January 8, 2004. There is no evidence
that petitioner applied for an extension of time to file his
return.
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The parties have stipulated that petitioner filed his 1996
return late. The stipulation satisfies respondent’s burden of
production under section 7491(c) with respect to additions to tax
and penalties. To avoid the addition to tax for late filing,
petitioner has the burden of proving that the failure to file did
not result from willful neglect and was due to reasonable cause.
See United States v. Boyle, 469 U.S. 241, 245 (1985). To prove
reasonable cause, a taxpayer must show that he or she exercised
ordinary business care and prudence but nevertheless could not
file the return when it was due. See Crocker v. Commissioner, 92
T.C. 899, 913 (1989); sec. 301.6651-1(c)(1), Proced. & Admin.
Regs.
Because petitioner failed to present any explanation for his
late filing, respondent’s determination with regard to the
section 6651(a)(1) addition to tax is sustained.
To reflect the foregoing,
Decision will be entered
for respondent.