Smith v. Comm'r ( 2007 )

T.C. Memo. 2007-368
UNITED STATES TAX COURT
RHETT RANCE SMITH AND ALICE AVILA SMITH, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 11902-05, 13225-05, Filed December 17, 2007.
13226-05, 13227-05,
13228-05.
Robert J. Stientjes, Thomas C. Pliske, Shine Lin, and
Anthony S. Gasaway, for petitioners.
Anne W. Durning, Nicholas J. Richards, Laura Beth Salant,
and Chris J. Sheldon, for respondent.
1
Cases of the following petitioners are consolidated
herewith for purposes of trial, briefing, and opinion: Joel
Rance and LaRhea Smith, docket No. 13225-05; J. Zane and Shannon
R. Creese Smith, docket No. 13226-05; and Rhett Rance and Alice
Avila Smith, docket Nos. 13227-05 and 13228-05. A pretrial
procedural issue was decided with respect to Rhett Rance and
Alice Avila Smith in docket No. 11902-05. See Smith v.
Commissioner, T.C. Memo. 2006-187.
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MEMORANDUM FINDINGS OF FACT AND OPINION
GERBER, Judge: Respondent determined the following income
tax deficiencies and penalties with respect to petitioners in
these consolidated cases:
Accuracy-Related
Penalty
Petitioners Year Deficiency Sec. 6662
Rhett Rance & 1998 $311,514 $62,302.80
Alice Avila Smith 1999 368,777 73,755.40
2000 373,183 74,638.40
2001 110,429 22,085.80
2002 87,535 None
Joel Rance & 1998 988,392 197,678.40
LaRhea Smith 1999 1,254,421 250,884.20
2000 439,132 87,826.40
2001 256,486 51,297.20
J. Zane & Shannon 1998 375,999 75,199.80
R. Creese Smith 1999 765,397 153,079.40
2000 386,956 77,391.20
2001 290,027 58,005.40
Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended and in effect for the years
under consideration, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
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After concessions2 of the parties, the issues remaining for
our consideration are:
1. Whether petitioners, Rhett Rance and Alice Avila Smith;
Joel Rance and LaRhea Smith; and J. Zane and Shannon R. Creese
Smith, are entitled to charitable contribution deductions with
respect to interests in family limited partnerships contributed
to a charitable organization and, if so, what the values of the
charitable contributions are;
2. whether petitioner J. Zane Smith’s dog breeding activity
constitutes an activity engaged in for profit within the meaning
of section 183(a);
3. whether petitioner J. Zane Smith’s cow and dairy farm
activity constitutes an activity engaged in for profit within the
meaning of section 183(a);
2
A large portion of the trial was devoted to the question
of whether an offshore employee leasing arrangement lacked
economic substance and/or was a sham. After presentation of
their case in chief, petitioners conceded that the arrangement
lacked substance and was a sham. Petitioners accordingly
conceded unreported income and overstated interest deductions
related to the offshore arrangement. They also conceded the
applicability of sec. 6662(a) penalties attributable to the
unreported income and overstated interest deductions.
Petitioners conceded that the 6-year period for assessment under
sec. 6501(e)(1)(A) applied with regard to their 1998, 1999, and
2000 tax years. Respondent conceded that petitioners Rhett Rance
Smith (Rhett) and Alice Avila Smith (Alice) substantiated cash
charitable contributions of $217,481 for the year 2002 and that
they are entitled to reduce their 2002 income by $214,970.
Respondent also conceded the issue he raised at trial, that the
contributions of business interests were not completed gifts.
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4. whether petitioner Rhett Rance Smith’s cutting horse
activity constituted an activity engaged in for profit within the
meaning of section 183(a); and
5. whether petitioners are liable for section 6662(a)
accuracy-related penalties for negligence or disregard of rules
or regulations with respect to the above-referenced charitable
contribution deductions and/or their section 183 activities.
FINDINGS OF FACT
Background
Petitioners Rhett Rance Smith (Rhett) and Alice Avila Smith
(Alice) are married and resided in Scottsdale, Arizona, at the
time their petitions were filed. They timely filed Forms 1040,
U.S. Individual Income Tax Return, for 1998, 1999, 2000, 2001,
and 2002. On April 15, 2005, respondent sent notices of
deficiency to Rhett and Alice for their 1998, 1999, 2000, and
2001 tax years. On March 25, 2005, respondent sent a notice of
deficiency to Rhett and Alice for their 2002 tax year.
Petitioners Joel Rance Smith (Rance) and LaRhea Smith
(LaRhea) are married and resided in Eagle Point, Oregon, at the
time their petitions were filed. They timely filed Forms 1040 for
1998, 1999, 2000, and 2001. On April 15, 2005, respondent sent
notices of deficiency to Rance and LaRhea for their 1998, 1999,
2000, and 2001 tax years.
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Petitioners J. Zane Smith (Zane) and Shannon R. Creese Smith
(Shannon) are married and resided in Earlville, New York, at the
time their petition was filed. They timely filed Forms 1040 for
1998, 1999, 2000, and 2001. On April 15, 2005, respondent sent
notices of deficiency to Zane and Shannon for their 1998, 1999,
2000, and 2001 tax years.
Rance and LaRhea Smith are the parents of Rhett and Zane
Smith.
Noncash Charitable Contributions
Each couple claimed deductions for noncash charitable
contributions of interests in their family limited partnership
(FLPs) which, essentially, was to hold interests in their closely
held, family-owned Arizona C corporation Beneco, Inc. (Beneco).
Beneco had been incorporated in 1989 with 1,000 initially issued
shares of stock, held as follows:
Petitioners Shares
Rance 250.5
LaRhea 250.5
Rhett and Alice 249.5
Zane and Shannon 249.5
Total 1,000.0
Beneco’s business was to provide a qualified retirement plan
and trust and qualified health and welfare trust services to
contractors who work under prevailing State and Federal wage laws,
including the Federal Davis-Bacon Act. For its taxable years
ended March 31, 1997 through 2004, Beneco did not pay a dividend.
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During December 1995, petitioners’ attorney, Robert A.
Kelley, Jr. (Attorney Kelley), who specialized in tax and estate
planning, established three separate Arizona FLPs in each of which
one couple owned a limited partnership interest of approximately
98 percent and the couple’s wholly owned corporation, as general
partner, owned the remaining 2 percent as follows:
FLP Limited Partner General Partner
Jireh LP J. Rance & J.A. Rohi Corp.
LaRhea Smith
Mustard Seed LP J. Zane & Z&S Consulting, Inc.
Shannon R. Smith
Zerubbabel LP Rhett R. & Bull Run Enters.,
Alice A. Smith Inc.
Each partnership agreement provided that partners could not
transfer a partnership interest without prior written consent of
all the other partners and that control over the partnership was
vested in the general partner (the couple’s wholly owned
corporation).
During 1995, Rance and LaRhea transferred their 51-percent
ownership interest in Beneco to Jireh Limited Partnership (Jireh).
Jireh is treated as a partnership for Federal tax purposes, and
its only asset is 501 shares of Beneco stock. Sometime after
December 20, 1995, Zane and Shannon transferred into Mustard Seed
Limited Partnership (Mustard Seed) their 249.5 shares of Beneco
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stock which, during the years at issue, were its sole asset.
Sometime after December 20, 1995, Rhett and Alice transferred into
Zerubbabel Limited Partnership (Zerubbabel) their 249.5 shares of
Beneco stock which, during the years at issue, were its sole
asset.
Christian Community Foundation (CCF), a section 501(c)(3)
charity for tax purposes, was incorporated in 1980 under the laws
of Colorado. On or about December 19, 1995, Attorney Kelley sent
a letter to CCF, enclosing a check for $1,000 and an Application
to Begin a Charitable Project. CCF set up the Zacchaeus
Foundation (Zacchaeus), a donor-advised fund, for petitioners and
assigned to it account No. 06022.
Attorney Kelley advised CCF that for 1995, Rance and LaRhea
would be contributing an FLP interest having a value of $350,000
and that Rhett and Alice and Zane and Shannon would each be
contributing an FLP interest having a value of $185,000. Attorney
Kelley further advised that petitioners would be making annual
gifts in amounts to be determined by their income for the
particular year. He further advised that all of the gifts of FLP
interests that were made to the project would be reacquired via
irrevocable life insurance trusts that were to be funded by life
insurance and that application had been made for the insurance.
In 1996, the irrevocable trust of each couple and CCF
executed a separate Agreement for the Purchase and Sale of Limited
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Partnership Interest. Each agreement provided that upon the death
of the later to die of the couple, CCF had the right to require
the trustee to buy CCF’s entire limited partnership interest.
Similarly, the trust could require CCF to sell its interest to the
trustee. CCF or the trust could exercise the right to buy or sell
within “sixty * * * days from the date the * * * [trust] collects
the death benefits” from a specified life insurance policy. It
was intended that the sale or purchase transaction be funded by a
life insurance policy.
Sometime later, Attorney Kelley left the United States, and
petitioners hired Attorney Frederick Meyer (Attorney Meyer).
Attorney Meyer conducted a review of petitioners’ documents,
including wills, family limited partnerships, and insurance
trusts, and he discovered what he considered to be inadequacies.
Attorney Meyer believed that the partnership agreements should
reflect a fiduciary duty to the charity and an obligation to share
cashflow with the charity. Edward Kramer (Mr. Kramer),
petitioners’ certified public accountant (C.P.A.), and Rance did
not believe this was necessary but reluctantly agreed to make the
changes. In 1997 the limited partnership agreements were revised
to accommodate the recommended changes. Petitioners did not rely
on Attorney Meyer with respect to valuation questions. They
relied on Mr. Kramer to take care of valuing the partnership
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interests. Petitioners paid annual administrative fees to CCF.
From 1995 through 2001, Rance and LaRhea assigned interests in
Jireh to CCF and claimed the following noncash charitable
contributions deductions:
Percent Assigned Claimed
Date Per Tax Return Contribution
12/20/95 10.9157% $350,000
12/29/97 9.9133 Unknown
12/29/00 1.5988 145,000
12/31/01 11.272 480,000
Although Form 8283, Noncash Charitable Contributions, for 2000
indicated that an interest of 1.5988 percent had been contributed
to CCF, the actual percentage contributed was 3.22 percent.
Pursuant to Rance and LaRhea’s request, during the period
1995 to 2002, CCF directed their contributed interests in Jireh to
Zacchaeus. During the years 1998 through 2001, Rance and LaRhea
did not transfer any Beneco stock to CCF. Rance and LaRhea
attached section B of Form 8283 to their 2000 return and described
the donated property as “1.5988% Units Jireh Ltd” with an
appraised fair market value of $145,000. The Declaration of
Appraiser, part III on Form 8283 for 2000, was signed by Mr.
Kramer and stated that the appraisal date was September 1, 1999.
No such appraisal was attached to Rance and LaRhea’s 2000 return
or made a part of the record.
The Donee Acknowledgment, part IV on Form 8283 for 2000, was
signed by Valerie Cornelius, Director of Operations for CCF, next
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to the typed date December 29, 2000. Attached to Rance and
LaRhea’s 2000 return was a letter, dated January 31, 2001,
thanking them for their charitable donation on December 29, 2000,
and stating that “No goods or services were provided for this
donation.”
Likewise, Rance and LaRhea attached section B of Form 8283 to
their 2001 return and reported the donated property as “11.272%
Units (BENECO Stock) JIREH Ltd” with an appraised fair market
value of $480,000. Mr. Kramer made the handwritten notation on
part III, Declaration of Appraiser, of Rance and LaRhea’s 2001
Form 8283 “see attached 11/19/01 report 11/19/2001 Frank E. Koehl
Jr.” The Form 8283 was not signed by Frank E. Koehl, Jr. (Mr.
Koehl). Also attached to Rance and LaRhea’s 2001 return was a
one-page letter, dated November 19, 2001, from Mr. Koehl, to Rance
referring to an $8,500-per-share valuation of Beneco as of March
31, 2000. No such appraisal was attached to Rance and LaRhea’s
2001 return. The Donee Acknowledgment, part IV on Form 8283 for
2001, was signed by Valerie Cornelius, and the title “President”
and the date “12/26/2001” were typed next to her name. The
typewritten title “President” and the date “12/26/2001” were both
crossed out, and the title “Treasurer” and the date “4/13/2002”
were handwritten. No letter of acknowledgment, gratitude, or
statement that no goods or services were received was attached to
the 2001 return.
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Also attached to Rance and LaRhea’s 2001 return were two
documents, each captioned “Assignment of Limited Interest In Jireh
Limited Partnership with Consent Attached”, one signed by Rance
and the other by LaRhea. Each assignment described the assignment
to CCF of an FLP interest valued at $240,000 and included CCF’s
acknowledgment by its president, John C. Mulder, who signed in
that capacity.
From 1995 through 2001, Zane and Shannon assigned interests
in Mustard Seed to CCF and claimed corresponding noncash
charitable contribution deductions on their personal income tax
returns, as follows:
Percent Assigned Claimed
Date Per Tax Return Contribution
12/20/95 11.5857% $185,000
12/29/97 1.95 Unknown
12/31/98 4.11036 90,000
12/31/01 8.864 188,000
Zane and Shannon requested that CCF direct any contributed
interests in Mustard Seed to Zacchaeus for the period 1995 to
2002. During the years 1998 through 2001, Zane and Shannon did
not transfer any Beneco stock to CCF. Form 8283 attached to Zane
and Shannon’s 1998 return did not include section B, the portion
of the form designated for gifts over $5,000. No appraisal or
reference to a specific appraisal was mentioned in or attached to
Zane and Shannon’s 1998 tax return. An “Assignment and Agreement”
was attached to their 1998 return signed by Zane and Shannon and a
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representative of CCF assigning and acknowledging a transfer of an
FLP interest with a stated value of $90,000 as of December 31,
1998. The 1998 return did not have any reference to whether
Zane and Shannon received goods or services in connection with
their contribution.
During 1998, Zane and Shannon assigned “an economic interest
in that percentage of their limited partnership interest in the *
* *[Mustard Seed] which has a value of $90,000 as of December 31,
1998, including all interest in the capital * * * of the
partnership, but specifically excluding any right * * * to
exercise any vote”. Form 8283 attached to Zane and Shannon’s 2001
return contains the statement that the donated property was
“8.864% units of (Beneco stock) the Mustard Seed LP” with an
appraised fair market value of $188,000.
Section B, part III, Declaration of Appraiser, on Zane and
Shannon’s Form 8283, attached to their 2001 return contained the
handwritten notation “see Ltr Attached Frank E. Koehl Jr” on the
line to be used for the signature of the appraiser. The
Declaration of Appraiser and Donee Acknowledgment appeared to be
signed by Mr. Koehl, and Valerie Cornelius for CCF. The
typewritten date of appraisal in part III was “11/19/2001”. Mr.
Kramer made the handwritten notation “see Ltr Attached Frank E.
Koehl Jr”. Also attached to Zane and Shannon’s 2001 return was a
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one-page November 19, 2001, letter from Mr. Koehl to Rance
referring to an $8,500-per-share valuation for Beneco as of March
31, 2000. Also attached to Zane and Shannon’s 2001 return was an
acknowledgment from CCF of its receipt of the limited partnership
interest, advising that “No goods or services were provided for
this donation.” Finally, there was attached an assignment of an
FLP interest in Mustard Seed, along with a signed consent from CCF
by its president.
From 1995 through 2001, Rhett and Alice assigned interests in
Zerubbabel to CCF and claimed corresponding noncash charitable
contribution deductions on their personal income tax returns, as
follows:
Percent Assigned Claimed
Date Per Tax Return Contribution
12/20/95 11.587% $185,000
12/29/97 3.92 Unknown
12/29/00 2.2851 100,000
12/31/01 13.674 290,000
Although Rhett and Alice’s Form 8283 for 2000 contained the
statement that an interest of 2.2851 percent had been contributed
to CCF, the actual percentage contributed was 4.57 percent.
Pursuant to Rhett and Alice’s request, CCF directed their 1995-
2001 assigned interests in their FLP (Zerubbabel) to Zacchaeus.
Rhett and Alice did not donate Beneco stock to CCF during the
years 1998 through 2001.
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Rhett and Alice attached Form 8283 to their 2000 return and
in section B, part I, Information on Donated Property, described
the donated property as “2.2851% Units Interest Zerubbabel Ltd”,
stating that it had an appraised fair market value of $100,000.
The Declaration of Appraiser was signed by Mr. Kramer and
contains the statement that the appraisal date was September 1,
1999. No appraisal was attached to Rhett and Alice’s 2000
return, and no appraisal dated September 1, 1999, was provided to
respondent or the Court. No signature appeared in the Donee
Acknowledgment portion, part IV, of the first section B attached
to the return. A second section B was also attached to the 2000
return bearing the Donee Acknowledgment signature of Valerie
Cornelius on behalf of CCF. Also attached to the 2000 return was
an acknowledgment of the contribution from CCF, dated January 31,
2001, which included the statement “No goods and services were
provided for this donation.”
Rhett and Alice attached two Forms 8283, section B to their
2001 return and, in each, described the donated property as
“13.674% Units (Beneco Stock) Zerrubbable Ltd” with a stated
value of $290,000. The signature line of the Declaration of
Appraiser was blank on one of the forms. The other had the
handwritten notation “see attached 11/19/01 report Frank E. Koehl
Jr” with a typewritten address in Princeton, New Jersey, and a
typewritten appraisal date of November 19, 2001. Mr. Kramer made
the handwritten notation “see attached 11/19/01 report Frank E.
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Koehl Jr”. No appraisal report was attached to the 2001 return.
Attached to the 2001 return was a letter dated November 19, 2001,
from Mr. Koehl, stating that the value of Beneco stock, as of
March 31, 2000, was $8,500 per share. No detail or explanation
as to how the valuation was done was attached to the 2001 return.
Also attached to the 2001 return was an assignment of a portion
of their FLP by Rhett and by Alice, along with consents and
acknowledgment by the president of CCF, signed and dated in late
December 2001.
Rhett and Alice assigned an interest in Zerubbabel to
Crossmen Ministries in 2002 and claimed a $247,500 charitable
deduction for that contribution. Crossmen Ministries was a Texas
nonprofit corporation that petitioners organized during 2002.
LaRhea, Rance, and Rhett were the officers of Crossmen
Ministries. During 2002, Crossmen Ministries was affiliated with
World Bible Way Fellowship, Inc. (World Bible Way). During 2002,
World Bible Way was a section 501(c)(3) tax-exempt entity which
held a group exemption letter, permitting subordinate entities
not listed as tax exempt to qualify for tax-exempt status because
of their affiliation with World Bible Way.
Rhett and Alice did not donate Beneco stock to World Bible
Way or Crossmen Ministries during the years at issue. Rhett and
Alice attached section B of Form 8283 to their 2002 return. It
described the donated property as “11.67% Of FLP Beneco Stk” with
an appraised fair market value of $247,500. That Form 8283
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contained no Declaration of Appraiser, and no appraisal is
attached. The name and address of the charitable donee was
typewritten in section B, part IV, Donee Acknowledgment, but no
signature appeared thereon.
Also attached to Rhett and Alice’s 2002 return was a
document titled “Assignment of Limited Interest in Zerubbabel
Limited Partnership with Consent Attached” wherein Alice, as a
limited partner of Zerubbabel, assigned an interest in the FLP to
Crossmen Ministries. That typewritten document reflected, in two
separate locations, the value of the interest to be $91,050 as of
December 27, 2002. However, both the $91,050 values were crossed
out by hand and “$123,750” was handwritten in its place, along
with three sets of initials. The document reflected that Alice
signed the document on December 27, 2002, and Crossmen Ministries
accepted the assignment to be effective as of December 27, 2002.
Mr. Kramer served as petitioners’ C.P.A. for the period 1995
through 2002. He prepared individual income tax returns,
corporate returns, partnership returns, payroll tax returns,
annual reports, personal property tax returns, and other
documents for petitioners and their related entities. Mr.
Kramer, at the times he was responsible for the preparation of
petitioners’ tax returns, was aware of section 170 and the
reporting requirements for noncash charitable contributions
during the years at issue. He was also aware that the noncash
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charitable contribution regulations required that taxpayers use
an appraiser who represented that he was in the business of
conducting appraisals for the general public. Mr. Kramer was not
a certified appraiser.
In addition to preparing petitioners’ returns, Mr. Kramer,
for purposes of a 1995 tax year noncash charitable contribution,
performed a September 30, 1995, valuation of Beneco. Mr.
Kramer’s valuation did not state that it was prepared for income
tax purposes or provide the date of any contributions to the
charitable donee. Mr. Kramer’s 1995 estimated fair market value
of a 100-percent interest of Beneco stock was $6,400,000, as of
September 30, 1995. In valuing petitioners’ FLPs, Mr. Kramer
simply chose to value the Beneco stock because it was the FLPs’
only asset and the valuations of the FLPs depended in great part
on the valuation of the Beneco stock. The 1995 valuation of the
Beneco stock was used for the charitable contribution deductions
of FLP interests claimed for the 1998 through 2000 tax years.
The methodology Mr. Kramer used to value the FLP interests
petitioners contributed was to obtain an appraised value of the
Beneco stock and then to discount that value for minority
interest and lack of marketability factors. No separate discount
was used with respect to the FLP interests contributed to the
charitable organization. Mr. Kramer valued the Beneco stock and
did not separately assess the value of the partnership units.
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After his 1995 valuation, sometime around 1999-2000, Mr. Kramer
advised petitioners to hire a certified appraiser.
On April 5, 2000, Rance, as president of Beneco, retained
Management Planning, Inc. (MPI), to prepare economic and
financial analyses and evaluations of Beneco, and three limited
partnerships (Jireh, Mustard Seed, and Zerubbabel) for a fee of
$12,500. Mr. Koehl of MPI transmitted by a letter dated November
19, 2001, an evaluation of the “common stock of Beneco, Inc.,” as
of March 31, 2000, concluding that the aggregate freely traded
equity capital of Beneco had a value of $9,195,000.
Mr. Koehl opined that the average lack of marketability
discount for private placements of nonpublicly traded stocks was
27.5 percent, and he decided to use a lack of marketability
discount of 7.5 percent because he was valuing a controlling
interest. Mr. Koehl concluded that the outstanding common stock
of Beneco had a fair market value of $8.5 million (or $8,500 per
share, based on 1,000 shares issued and outstanding) as of March
31, 2000, on a going-concern controlling-interest basis. Mr.
Koehl and MPI did not prepare a separate valuation of
petitioners’ limited partnerships, Jireh, Mustard Seed, or
Zerubbabel. Mr. Koehl’s valuation of Beneco contained the
statement that it was prepared for management information, income
tax reporting, and other corporate purposes. Mr. Koehl’s
valuation did not contain a date for any contributions of an FLP
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interest to any particular donee, and it did not contain a
separate valuation of each FLP. The valuations by Mr. Kramer and
Mr. Koehl were the only valuations referenced in petitioners’
returns.
Rance’s Schedule F Activity
Rance began his cutting horse activity with a few horses in
1999. During the years at issue, Rance maintained several horses
in his cutting horse activity. For the taxable years 1998
through 2005 Rance reported the following total income, expenses,
and net losses:
Year Income Expenses Net Losses
1998 -0- $124,291 $124,291
1999 -0- 76,352 76,352
2000 -0- 65,486 65,486
2001 $1,736 83,630 81,894
2002 3,817 83,691 79,874
2003 4,583 48,903 44,320
2004 4,084 66,677 62,593
2005 1,959 44,474 42,515
Total 16,179 593,504 577,325
The expenses were generally attributable to depreciation, animal
and land maintenance, mortgage interest, and training. Other
than the Schedules F, Profit or Loss From Farming, which were
part of the tax returns and banking records, Rance did not
maintain books and records of his horse cutting activity.
Rance rides his own horses at horse futurities (shows), and
he first rode horses when he was a child and continued to ride
when he attended college. He became involved in the cutting
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horse activity in the 1980s and discontinued the activity during
1987 because it was expensive, competitive, and risky, and he had
a champion mare that had achieved success by winning the Pacific
Coast Derby. During 1996, Rance and LaRhea purchased
approximately 70 to 75 acres of land in Oregon. In October 1998,
they began construction of a house, an office, a barn, fences,
and stalls. The property was to be for their personal residence
and activities as well as for conducting part of their Beneco
business. Construction was completed in November 1999, after
which Rance and LaRhea moved to the Oregon property.
The barn had four horse stalls, a tack room, a feed room,
and storage for hay and related farm equipment. During 1999,
Rance purchased P.K., a driving horse which pulled carts and
wagons and which Rance rode. Also during 1999, Rance purchased
Leo, a western pleasure mule, which he rode around the Oregon
property to check fences and tend the property. P.K. was sold
sometime during 2000 or 2001. Rance also purchased Popcorn, a
Royal Dartmoor pony mare that was in foal. Popcorn was a hunter/
jumper, and she was sold, along with her foal, sometime in 2001
or 2002.
Rance again became involved in cutting horse activity
because he could afford horses with better pedigrees. He
purchased a 4-year-old, Dual Docs (Dual Docs), in 2001 for
$30,000 and placed him in training in Medford with Bobby and
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Jolene Nelson. Semen was collected from Dual Docs, and he was
used for live breeding, resulting in revenue of several thousand
dollars. Dual Docs was entered in competitions and then sold in
2004 for $22,500.
Rance, sometime in 2001 or 2002, acquired cutting horse
reining mares named Mitzi and I Gotta Lotta. He then determined
that they could not be entered into competitions, and he allowed
high school girls to ride them in 4-H Club activities and other
events. I Gotta Lotta was sold in 2003 for $6,000 and Mitzi was
sold in 2004 for $6,300 for reported gains of $839 and $230,
respectively.
Zane’s Dog Breeding, Showing and Judging Activity
Zane first became interested in showing dogs after his
parents bought him his first Staffordshire Bull Terrier and took
him to a dog show at age 12. During grade school and high
school, Zane owned and learned to show Staffordshire Bull
Terriers. By 1995 or 1996, when Zane had substantial experience
and had developed a reputation, he began contemplating conducting
the dog breeding activity on a much more serious level. During
the years at issue, he was considered a worldwide expert in and
primarily focused on Staffordshire Bull Terriers and American
Staffordshire Terriers.
Zane became a championship show judge in 1985 at age 22, the
youngest in recent history, and has judged in shows all over the
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world. Zane has not won more than nominal amounts showing dogs,
and he did not earn any income from judging during the years at
issue.
Zane did not have a written business plan for his dog
breeding activity. He did not keep a separate checking account
for his dog breeding activity. When he wrote a check, he noted
the purpose of the expense. At the end of the year, Zane
summarized the expenses for his C.P.A. for purposes of preparing
his returns. Zane spent approximately 10 to 20 hours each week
on the dog breeding activity and was showing one or two dogs
regularly and three or four dogs less often.
Zane had two Staffordshire Bull Terriers living with him in
New York from 1996 through 2003, and his other dogs lived with
professional handlers. In addition, Zane coowned some dogs that
lived with his coowners. Zane had no income from the dog
breeding activity in any of the years 1996, 1997, 1998, 1999, and
2000. Zane’s 1997 Schedule C, Profit or Loss From Business,
reflected no income and $52,683 in expenses. Zane’s Schedules F
attached to his other returns were entitled “Cattle Crops–-Dog
Breeding” and for 2004 included the term “Organic Dairy Milk”.
Some of them reflected income, but the source was not specified.
The following table shows the losses Zane claimed for the
dog breeding activity for the years 1997 through 2004:
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Tax Total Total Total
Year Income Expenses Losses
1997 -- $52,683 ($52,683)
1998 –- 61,490 (61,490)
1999 -- 28,826 (28,826)
2000 –- 51,409 (51,409)
2001 -- 80,152 (80,152)
2002 –- 56,818 (56,818)
2003 $5,673 7,651 (1,978)
2004 –- 6,064 (6,064)
Total 5,673 345,093 (339,420)
Most of the expenditures were for travel, advertising, and show
expenses. For example, in 1997, of the $52,683 of total expenses
claimed, $28,676 was for show expenses, $10,850 for travel, and
$9,800 for advertising. Accordingly, $49,326 of the $52,683
(almost 94 percent) was for shows, travel, and advertising. Most
of the expenses were associated with showing dogs and judging dog
shows.
According to a March 2004 report from Synbiotics, Zane had
44 semen straws stored from the dog Malcolm. Synbiotics
calculated that 7.9 inseminations could be accomplished from the
44 straws.
Zane’s Cow and Dairy Farm Activity
Zane had an interest in cattle as a boy, and in July 1998,
he purchased a 400-acre property in Earlville, New York, known as
Goose Hill Farm. Zane had an interest in genetics and animal
husbandry beginning with the Staffordshire Bull Terriers when he
was a boy. Zane developed an interest in Normande cows, and he
- 24 -
believed that they are good milking cows and grazing animals. He
built his personal residence at Goose Hill Farm with the intent
to raise cows.
In 2000, Zane also purchased the Columbus Dairy, consisting
of 225 acres and located 15 miles from Goose Hill Farm. A
milking parlor and dairy operation were built at the Columbus
Dairy, and calves were raised on the Goose Hill Farm property.
After purchasing the Columbus Dairy, Zane worked to reclaim the
pasture land for grazing.
He studied and researched the various types of cattle that
could be bred. Zane recognized that family dairy farms were not
doing well, and he decided that, to be profitable, his cattle
activity had to find a niche in the market that would let it
compete as to product and price. After much research he decided
to raise Normande cattle. The Columbus Dairy became an organic
dairy farm. At the Columbus Dairy, Zane built a milking parlor
and other buildings for the milking operation. Milking started
sometime in 2002.
Normande cows are good producers of milk in France but are
largely used for beef consumption in the United States. After
visiting many farmers and ranchers throughout the United States,
Zane acquired a herd of Normande cows that he believed would be
the best milk producers. He intended to further breed the
acquired herd so his activity could become competitive in the
dairy farming industry.
- 25 -
Zane had a 7-year business plan involving the importation of
bull semen from France, as he could not import Normande cows to
breed with his cows to produce offspring that he believed could
produce a higher quantity and better quality of milk. At the
same time, Zane was working to convert his land from a
conventional to a certified organic farm. Zane believed that if
his farm could be certified as organic, he would be able to sell
the milk at a price three times that of conventional milk.
By the time of trial, Zane’s animal breeding was
progressing, and he hoped he could focus more on the cow activity
and less on the dog breeding. The farm was certified organic in
2006. His gross revenues exceeded $100,000 for 2004, 2005, and
2006. Zane expects the revenue to triple in 2007 because of the
organic certification. In operating this activity, Zane has
consulted with experts, done marketing, maintained separate
checking account records, and has focused on ways to maximize
revenue.
During August 2001, Zane purchased 77 Normande cows from
Keith Miller of Stuart, Iowa. Beginning in May 2001, David
Hughes (Mr. Hughes) had become Zane’s part-time farm manager in
exchange for a place to live at the Columbus Dairy. Beginning in
January 2002, Mr. Hughes became Zane’s full-time employee. Zane
paid Mr. Hughes approximately $29,000 to $30,000 in cash wages
- 26 -
and also provided him a double-wide trailer to live in and
allowed him personal use of a pickup truck. Mr. Hughes performed
the farm labor and Zane was the decision maker for the activity.
Zane decided to graze his cattle rather than confine them
because he believed that grazing positively affected the
longevity of the cattle. He also leased an additional 60 acres
of a farm adjacent to Columbus Dairy for the purpose of grazing
cows. All milk cows were grazed at the Columbus Dairy property
and on the adjacent leased land. Automatic milking equipment was
placed in service in October 2001, and milking operations
commenced during 2002. Zane began reporting the cattle activity
and deducting expenses in his 1998 tax year. Zane kept a
separate bank account for the Columbus Dairy.
Penalties--Reliance
Through the 2001 tax year, Mr. Kramer prepared Rance and
LaRhea’s tax returns. Mr. Kramer understood that one of the
purposes of the Oregon property was to raise and breed horses.
He believed that Rance and LaRhea purchased the Oregon property
on account of their concerns about “Y2K” and their desire to have
a self-sustaining facility. Mr. Kramer told Rance and LaRhea
from the beginning of their Schedule F activity that they needed
to show revenues in order to avoid “hobby loss classification”.
The only revenue Mr. Kramer was aware of was the sale of one
horse in the second or third year.
- 27 -
Mr. Kramer advised Rance to combine his Oregon Schedule F
activity with Zane’s New York Schedule F activity to keep them
from being classified as hobbies. Rance and Zane did not follow
Mr. Kramer’s advice on forming a joint venture. Mr. Kramer did
not know how Zane used his property. Mr. Kramer did not ask for
or see any of Zane’s underlying financial records in connection
with his Schedule F activity.
Mr. Kramer included on the returns all the expenses
petitioners listed for him. Mr. Kramer knew the dog breeding
business was expensive and that it was speculative, with a very
small percentage of success. Mr. Kramer knew that it was very
difficult to earn money in the dog breeding business. Mr. Kramer
did not question the travel expense claimed on Zane’s 1998
Schedule F because he knew that Zane traveled overseas as well as
around the country. Mr. Kramer knew that expenses incurred at
the Westminster dog show were extensive. Mr. Kramer understood
that Zane had a cattle breeding activity separate from the dairy
operation.
OPINION
Burden of Proof
Petitioners, for the first time on brief, raise the issue of
whether the burden of proof shifted to respondent under section
7491(a). Under that section the burden of proof may shift to the
- 28 -
Commissioner with respect to a factual issue affecting the
taxpayer’s liability for tax where the taxpayer introduces
credible evidence with respect to such a factual issue and meets
certain substantiation requirements set forth in section
7491(a)(2)(A) and (B).
Respondent contends that petitioners’ argument as to the
burden of proof was untimely raised and that, even if it had been
timely, it is petitioners’ burden to show that they have met the
requirements of section 7491(a)(2), which they have not done. We
agree with respondent that petitioners’ attempt to raise section
7491 for the first time in their posttrial brief is untimely.
Under section 7491 petitioners must, for example, show that
they cooperated during the audit and that they met substantiation
requirements. Petitioners’ attempt on brief to show that they
met the requirements by the simple expediency of stating that
respondent did not question the substantiation or that they
cooperated will not suffice. Petitioners, by raising those
allegations on brief, do not afford respondent the opportunity to
test the allegations by cross-examination or by producing
evidence to show otherwise. Therefore, we hold that petitioners’
attempt to shift the burden under section 7491 causes prejudice
- 29 -
and is untimely.3 See, e.g., Deihl v. Commissioner, T.C. Memo.
2005-287.
Accordingly, petitioners continue to bear the burden of
proof with respect to the noncash charitable contribution issue
and the question of whether they carried on various activities
for profit within the meaning of section 183. Respondent does
bear the burden of production with respect to the section 6662
penalty. See sec. 7491(c). That burden is to come forward with
sufficient evidence regarding the appropriateness of applying a
particular addition to tax or penalty against the taxpayer. Sec.
7491(c); Wheeler v. Commissioner, 127 T.C. 200 (2006); Higbee v.
Commissioner, 116 T.C. 438 (2001).
Noncash Charitable Contributions
Petitioners are members of the same family comprising a
father (Rance) and two sons (Rhett and Zane) and their respective
spouses. Together, they owned and operated Beneco, a corporation
that provides business services in connection with qualified
retirement and health and welfare plans. Rance and his wife
owned slightly over 50 percent of Beneco, and Rhett and Zane,
along with their wives, each owned one-half of the remaining
minority interest. Petitioners claimed noncash charitable
contributions of FLP interests. The FLPs were created and
3
In any event, petitioners have not shown compliance with
the substantiation requirements of sec. 7491(a)(2) so as to
warrant a shift in the burden of proof as to any of the factual
issues relevant to their liability for tax.
- 30 -
designed to hold interests in Beneco, which were to be
contributed to the FLPs by petitioners. The issues concerning
these contributions are whether petitioners complied with the
reporting requisites of section 170 and underlying regulations so
as to be entitled to the charitable contribution deductions. If
we find that petitioners complied with those requisites, we will
go on to consider the values of the interests contributed in
order to decide the amounts of any allowable charitable
contribution deductions.
Section 170(a)(1) provides:
There shall be allowed as a deduction any charitable
contribution * * * payment of which is made within the
taxable year. A charitable contribution shall be
allowable as a deduction only if verified under
regulations prescribed by the Secretary.
If the contribution consists of property other than cash, the
value of the contribution is generally the fair market value of
the donated property at the time of contribution. Sec. 1.170A-
1(c)(1), Income Tax Regs.
Respondent argues that petitioners are not entitled to the
noncash charitable contribution deductions claimed because they
failed to comply with the reporting requirements of section 170
and the underlying regulations. Petitioners acknowledge that
they failed to fully comply with some of the requirements for
noncash charitable contribution deductions. Petitioners argue,
however, that they are nevertheless entitled to the deductions
- 31 -
for the noncash charitable contributions because they
substantially complied (that the information provided is
sufficient to meet the requirements) and because they had
“reasonable cause * * * for [any] failure to fully comply.”
A charitable contribution is allowable as a deduction only
if verified under regulations prescribed by the Secretary. Sec.
170(a)(1); Hewitt v. Commissioner, 109 T.C. 258, 261 (1997),
affd. without published opinion 166 F.3d 332 (4th Cir. 1998).
The obligation to substantiate charitable contribution deductions
is clear and unambiguous. Blair v. Commissioner, T.C. Memo.
1988-581. No deduction is allowed for a contribution in excess
of $5,000 unless the taxpayer meets the substantiation
requirements of section 1.170A-13(c)(2), Income Tax Regs. Todd
v. Commissioner, 118 T.C. 334, 340 (2002); sec. 1.170A-
13(c)(1)(i) Income Tax Regs. Section 1.170A-13(c)(2)(i), Income
Tax Regs., generally provides that a taxpayer must comply with
the following three requirements:
(A) Obtain a qualified appraisal (as defined in
paragraph (c)(3) of this section) for such property
contributed. If the contributed property is a partial
interest, the appraisal shall be of the partial interest.
(B) Attach a fully completed appraisal summary (as
defined in paragraph (c)(4) of this section) to the tax
return (or, in the case of a donor that is a partnership or
S corporation, the information return) on which the
deduction for the contribution is first claimed (or
reported) by the donor.
(C) Maintain records containing the information
required by paragraph (b)(2)(ii) of this section.
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Additionally, for contributions of $250 or more, a taxpayer
must obtain a contemporaneous written acknowledgment from the
donee organization. Sec. 170(f)(8)(A). The acknowledgment must
be obtained by the earlier of the date the return is filed or its
due date. Sec. 170(f)(8)(C). The acknowledgment must include
the amount of cash and a description of any property other than
cash along with certain information about any goods or services
provided by the donee. Sec. 170(f)(8)(B).
The purpose of these provisions has been described as
providing the Commissioner with sufficient return information to
effectively monitor the possibility of overvaluations of
charitable contributions. Hewitt v. Commissioner, supra at 265.
Section 1.170A-13(c)(3)(i) and (ii), Income Tax Regs.,
contains the specific requirements that a “qualified appraisal”
must:
(1) Be made not earlier than 60 days before the date of the
contribution nor later than the due date of the return, including
extensions, on which a deduction is first claimed or reported;
(2) be prepared, signed and dated by a qualified appraiser;
(3) contain the name address, identifying number, and
qualifications of the qualified appraiser;
(4) contain a statement that it was prepared for income tax
purposes;
(5) contain a description of the property in sufficient
detail for a person who is not generally familiar with the type
- 33 -
of property to ascertain that the property that was appraised is
the property that was contributed;
(6) include the terms of any agreement of understanding
entered into or expected to be entered into by or on behalf of
the donor or donee that relates to the use, sale, or other
disposition of the property, including an agreement that
restricts temporarily or permanently a donee’s right to dispose
of the property;
(7) show the date on which the property was contributed;
(8) show the fair market value of the property on the date
of contribution;
(9) show the method of valuation and the specific bases for
the valuation; and
(10) show the date on which the appraisal was made.
The Secretary promulgated the above-referenced regulations
in response to the Deficit Reduction Act of 1984 (DEFRA), Pub. L.
98-369, sec. 155(a), 98 Stat. 691. DEFRA section 155 instructs
the Secretary to provide heightened substantiation reporting
requirements for certain noncash charitable contributions. DEFRA
section 155 provides:
(3) Appraisal summary.--For purposes of this
subsection, the appraisal summary shall be in such form and
include such information as the Secretary prescribes by
regulations. Such summary shall be signed by the qualified
appraiser preparing the qualified appraisal and shall
contain the TIN of such appraiser. Such summary shall be
acknowledged by the donee of the property appraised in such
manner as the Secretary prescribes in such regulations.
- 34 -
(4) Qualified appraisal.--The term “qualified
appraisal” means an appraisal prepared by a qualified
appraiser which includes—
(A) a description of the property appraised,
(B) the fair market value of such property on
the date of contribution and the specific basis for the
valuation,
(C) a statement that such appraisal was
prepared for income tax purposes,
(D) the qualifications of the qualified
appraiser,
(E) the signature and TIN of such appraiser,
and
(F) such additional information as the
Secretary prescribes in such regulations.
See Bond v. Commissioner, 100 T.C. 32, 37 (1993). In Bond
this Court considered whether certain aspects of the above-
referenced regulations were mandatory or directory and whether
the taxpayer in that case had substantially complied so as to be
entitled to a charitable contribution deduction. In reaching the
conclusion that the requirements were directory, the Court
expressed the following rationale:
Under the above test we must examine section 170 to
determine whether the requirements of the regulations
are mandatory or directory with respect to its
statutory purpose. At the outset, it is apparent that
the essence of section 170 is to allow certain
taxpayers a charitable deduction for contributions made
to certain organizations. It is equally apparent that
the reporting requirements of section 1.170A-13, Income
Tax Regs., are helpful to respondent in the processing
and auditing of returns on which charitable deductions
- 35 -
are claimed. However, the reporting requirements do
not relate to the substance or essence of whether or
not a charitable contribution was actually made. We
conclude, therefore, that the reporting requirements
are directory and not mandatory. [Id. at 41; citation
omitted.]
Bond involved the contribution of two blimps to a qualified
charity. The parties agreed upon the value, the fact that the
appraiser was qualified, and all other regulatory requirements
except whether the taxpayers’ failure to obtain and attach to
their return a separate written appraisal containing the
information specified in the regulations would result in the
disallowance of a charitable contribution deduction. The Court
noted that substantially all of the information specified in the
regulations had been provided, except the qualifications of the
appraiser on the Form 8283 attached to the return. The Court
concluded that the taxpayers in Bond had substantially complied
and that disallowance of the deduction under those circumstances
would be too harsh a sanction (essentially that the purposes of
the statute had been substantially achieved).
Subsequently, in Hewitt v. Commissioner, 109 T.C. 258
(1997), the Court again considered these regulations in a
situation where taxpayers donated to a charitable organization
their shares of stock of a corporation that was not publicly
traded. They claimed deductions in amounts that the parties
agreed represented the fair market value of the stock. However,
- 36 -
the taxpayers did not obtain qualified appraisals before filing
their returns for the years at issue. The values or deductions
claimed were not based upon appraisals; instead they were based
upon average per-share prices of the stock traded in arm’s-length
transactions at approximately the same time as the gifts. Even
though the values were undisputed, the Court found that the
taxpayers had not complied with section 170 and section 1.170A-
13, Income Tax Regs., and that they were not entitled to
deduct any amount in excess of the amount allowed by the
Government, which was their basis.
In Hewitt the Government disallowed the value of the stock
in excess of basis because of the lack of qualified appraisals.
The Government agreed that the taxpayers made charitable
contributions, that the donee was charitable, and that the
claimed values represented fair market values of the
contributions. The taxpayers in Hewitt maintained that they
should be allowed the deductions because the value used was the
average price per share as traded in bona fide, arm's-length
transactions. Relying on the holding in Bond v. Commissioner,
supra, the taxpayers in Hewitt contended that they had
substantially complied with the requirements of section 1.170A-
13, Income Tax Regs., and that they were relieved of any
obligation to obtain a qualified appraisal. Hewitt v.
Commissioner, supra at 262.
- 37 -
Unlike the taxpayers in Bond, the taxpayers in Hewitt did
not provide information on the Form 8283 that satisfied most of
the requirements of the regulation. In holding that the
taxpayers were not entitled to a deduction in excess of their
basis (for the full fair market value), the Court provided the
following rationale:
Petitioners herein furnished practically none of
the information required by either the statute or the
regulations. Given the statutory language and the
thrust of the concerns about the need of respondent to
be provided with appropriate information in order to
alert respondent to potential overvaluations, * * *
petitioners simply do not fall within the permissible
boundaries of Bond v. Commissioner, supra, where an
appraisal summary, which was completed by a qualified
appraiser, contained most of the required information
and could therefore be treated as a written appraisal,
was attached to the return. Cf. D’Arcangelo v.
Commissioner, T.C. Memo. 1994-572 (respondent prevailed
where no qualified appraisal was obtained).
* * * * * * *
Moreover, it is clear that the principal objective
of DEFRA section 155 was to provide a mechanism whereby
respondent would obtain sufficient return information
in support of the claimed valuation of charitable
contributions of property to enable respondent to deal
more effectively with the prevalent use of
overvaluations. See S. Comm. on Finance, Deficit
Reduction Act of 1984, Explanation of Provisions
Approved by the Committee on March 21, 1984, S. Prt.
98-169 (Vol. 1), at 444-445 (S. Comm. Print 1984);
Staff of Joint Comm. on Taxation, General Explanation
of the Revenue Provisions of the Deficit Reduction Act
of 1984 (J. Comm. Print 1985); cf. Atlantic Veneer
Corp. v. Commissioner, 85 T.C. 1075, 1084 (1985), affd.
812 F.2d 158 (4th Cir. 1987). Such need exists even
though in a particular case, such as this, it turns out
that the taxpayer’s deduction was in fact based on the
fair market value of the property. This happenstance is
insufficient to constitute substantial compliance with
- 38 -
a statutory condition to obtaining the claimed
deduction. As we see it, what petitioners are seeking
is not the application of the substantial compliance
principle but an exemption from the clear requirement
of the statute and regulations in a situation where
there is no overvaluation of the charitable
contribution. We are not prepared to follow that path
to decision. [Hewitt v. Commissioner, supra at 264-266].
Petitioners also rely on Bond v. Commissioner, 100 T.C. 32
(1993). In particular, they contend that in Bond this Court:
determined that the substantiation rules of DEFRA
section 155 and the Treasury Regulations thereunder are
directory rather than mandatory. As such, the Tax
Court does not require that taxpayers fully and
absolutely comply with the substantiation requirements
of the regulations in order to qualify for a charitable
contribution deduction. In Bond, the Tax Court used a
“substantial compliance” analysis to determine that a
taxpayer, who failed to meet the substantiation
requirements of DEFRA section 155 and the regulations,
nevertheless, was entitled to a charitable deduction
for a non-cash contribution.
Petitioners go on to attempt to equate the concept of
“substantial compliance” with the concept of “reasonable cause”.
Petitioners contend that
Although not specifically mentioning reasonable cause,
the decision of the Tax Court in Bond is a clear
reflection of the principal that [exceptions exist] to
the heightened substantiation reporting requirements
such as substantial compliance and reasonable cause.
We note that for charitable contributions made after June 3,
2004, Congress, in the American Jobs Creation Act of 2004 (AJCA),
Pub. L. 108-357, sec. 883, 118 Stat. 1631, which added
section 170(f)(11), specifically codified the substantiation
- 39 -
requirements and also provided an exception where there is
reasonable cause for failure to comply with the substantiation
requirements for noncash charitable contributions. Petitioners
contend that the reasonable cause exception in AJCA was a
codification of preexisting law. Respondent contends that the
reasonable cause exception was not the law before the 2004
enactment. We agree with respondent.
Petitioners rely, in great part, on the legislative history
surrounding the 1984 enactment of DEFRA section 155, which in
effect, directed the Secretary to promulgate the qualified
appraisal regulations. It appears that a reasonable cause
exception was considered by Congress, but no such exception was
included in DEFRA, and none appeared in the regulations issued
pursuant to the regulatory mandate of DEFRA section 155. We find
no sound basis for accepting petitioners’ contention that a
reasonable cause exception existed before the 2004 enactment of
that exception.
Because the charitable contribution deductions we consider
are for years before and unaffected by AJCA, we are left to
decide whether petitioners substantially complied, like the
taxpayers in Bond v. Commissioner, supra, or whether the
information included on and with their income tax returns was
insufficient to meet the statutory and regulatory requirements
- 40 -
like that of the taxpayers in Hewitt v. Commissioner, 109 T.C.
258 (1997).
Petitioners, during 1995, consulted with Attorney Kelley
concerning income and estate tax planning. Attorney Kelley
directed and assisted petitioners in setting up an FLP for each
couple. Each couple also established a corporation to be the
general partner of their FLP, and the individuals were made the
limited partners of their respective partnerships. The general
partner (the controlled corporation of each couple) had operating
authority over each FLP. A limited partner’s interest could not
be transferred without permission of all other partners in the
FLP. Each couple contributed their Beneco stock, along with
other assets, to their FLP in 1995.
Attorney Kelley assisted petitioners with their donations of
interests in their limited partnerships to CCF. CCF anticipated
that petitioners would make gifts of interests in the FLPs in
1995 and in future years. It was understood that the transferred
FLP interests would be reacquired from CCF (or other charitable
donee), and irrevocable life insurance trusts were created that
would be used to fund the reacquisition of the contributed
interest upon each donor’s death.
At the time of the contributions of the FLP interests, CCF,
and later Crossmen Ministries, received FLP interests that could
not be transferred without petitioners’ and their wholly owned
- 41 -
corporate general partners’ consent. Therefore, the interests
could not be converted to cash or other property that could be
used to fund charitable activities without petitioners’
agreement. By the end of 1998, the sole asset in each FLP was
Beneco stock. Beneco did not pay any dividends before 1995, and
no dividends were paid thereafter and through the years in issue.
The decision for Beneco to pay dividends appeared to rest solely
with petitioners. Therefore, the donee-charity would likely be
relegated to waiting until the deaths of petitioners before
receiving cash or property that could be used to fund charitable
activity.
Zane and Shannon’s 1998 contribution and Rhett and Alice’s
2000 contribution consisted solely of economic interests in their
respective FLPs. It is not clear what status or role CCF played
in the respective FLPs. No express distinction was made between
limited partners and any charitable donees who held interests in
the FLPs.
The contributions were ascribed values in round dollar
amounts (e.g., $145,000) that were converted to percentages
in each FLP on the basis of the Beneco stock values petitioners
used to establish the amounts of the deductions. As described
below, the Forms 8283 attached to the returns were prepared in an
inattentive and incomplete manner.
- 42 -
Initially, we note that valuations petitioners relied
on were based on valuations of the Beneco stock from which the
valuations of the contributed interests in the family limited
partnerships were derived. Although the values of the FLP
interests were substantially dependent upon the values of the
Beneco stock, the noncash charitable contribution, in each
instance, was an interest in an FLP. Mr. Koehl was asked to
appraise both the Beneco stock and the FLP interests. The
record, however, does not contain a separate appraisal report for
the FLP interests. Mr. Koehl prepared a valuation of the Beneco
stock as of March 31, 2000, but it was not attached to any of
petitioners’ 2001 or 2002 returns in connection with their
claimed charitable contributions of FLP interests.
Although petitioners obtained two separate appraisals,
respondent contends that neither is a qualified appraisal within
the meaning of section 1.170A-13(c)(3), Income Tax Regs. The
first appraisal was of the Beneco stock and was performed by
petitioners’ C.P.A., Mr. Kramer. Although Mr. Kramer is a
C.P.A., it has not been shown that he had appraisal expertise.
His report, dated November 17, 1995, stated a $6,400,000 value
for a 100-percent interest in Beneco stock as of September 30,
1995. Mr. Kramer’s valuation report is terse and provides only
limited details of the analysis and underpinnings for his value
conclusion. On petitioners’ Forms 8283 for 2000, the Declaration
- 43 -
of Appraiser was signed by Mr. Kramer, and references were made
to a September 1, 1999, appraisal. Petitioners did not produce a
September 1, 1999, appraisal report, and no such appraisal report
was attached to their returns.
The second appraisal was performed Mr. Koehl of Management
Planning, Inc., a company in the valuation business. Mr. Koehl
determined that the aggregate enterprise value of Beneco, on a
controlling interest basis, was $8.5 million as of March 31,
2000. Mr. Koehl did not prepare a separate analysis or valuation
of the partnership interests. His report appears to have been
completed after the due date for filing petitioners’ 2000
returns. Forms 8283 for 2001 referred to Mr. Koehl’s valuation,
and Rhett and Alice’s 2002 contribution was apparently based upon
that same appraisal report by Mr. Koehl. Some of the returns
had a one-page letter from Mr. Koehl that fell far short of
meeting the statutory and regulatory requirements for an
appraisal summary. Other returns had no letter, summary, or
appraisal report attached.
At trial, petitioners’ expert, Scott Springer, valued the
partnership interests as of the dates of the contributions. This
report, however, was prepared for purposes of trial and did not
purport to be a qualified appraisal within the meaning of the
regulations under consideration.
Accordingly, the appraisals petitioners relied on for
claiming deductions were not made for the period beginning 60
- 44 -
days before any of the contributions and ending on the due dates
of the corresponding returns. See sec. 1.170A-13(c)(3)(i)(A),
Income Tax Regs. Additionally, the 1995 report by Mr. Kramer did
not specifically state that it was prepared for income tax
purposes. See sec. 1.170A-13(c)(3)(ii)(G), Income Tax Regs. The
appraisal reports did not contain the dates (or expected dates)
of the contributions of the interests in the FLPs to the donee or
the values on these dates. See sec. 1.170A-13(c)(3)(ii)(C), (I),
Income Tax Regs. Respondent, referencing section 1.170A-
13(c)(3)(ii)(D), Income Tax Regs., also notes that the
restrictions on the donee’s right to use or dispose of the
donated property, as set forth in the partnership agreements, and
purchase and sale agreements, were not disclosed.
The Forms 8283 and the documents attached to petitioners’
returns failed to comply with the section 1.170A-13(c)(4), Income
Tax Regs., requirements that an appraisal summary be signed and
dated by a qualified appraiser who prepared the qualified
appraisal and include the information specified in section
1.170A-13(c)(4)(ii), Income Tax Regs. That regulation section
requires that the summary contain, inter alia, a description of
the property in sufficient detail for a person who is not
generally familiar with the type of property to ascertain that
the property that was appraised is the property that was
- 45 -
contributed; the manner of acquisition and the date of
acquisition; the cost or other basis of the property; and the
name, address and identifying number of the qualified appraiser
who signs the appraisal summary. Section B of Form 8283 is the
form designed for the appraisal summary.
The Forms 8283 attached to the returns were in many respects
either improperly or incompletely prepared. Zane and Shannon did
not attach a Schedule B to the Form 8283 that was attached to
their 1998 income tax return. Instead they completed section A,
which is expressly intended to be used for noncash charitable
contributions worth $5,000 or less. As a result, their 1998
return contained no declaration by appraiser and no
acknowledgment of the donee.
On the Forms 8283 attached to Rance and LaRhea’s and Rhett
and Alice’s 2000 returns, Mr. Kramer signed the Declaration of
Appraiser and referred to an appraisal dated September 1, 1999,
that was not attached to the returns or shown to have existed.
Rance and LaRhea’s return reflected that an interest of 1.5988
percent of the partnership with a value of $145,000 was
contributed to CCF. The parties have now agreed and stipulated
that Lance and LaRhea contributed a 3.22-percent interest with a
total value of $145,000. Rhett and Alice’s return reflected that
an interest of 2.2851 percent of the partnership with a value of
$100,000 was contributed to CCF. The parties have now agreed and
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stipulated that Rhett and Alice contributed a 4.57-percent
interest with a total value of $100,000.
Each couple claimed a charitable contribution deduction for
2001. In each instance, the Declaration of Appraiser attached to
the return referred to the letter dated November 19, 2001, from
Mr. Koehl to Rance wherein he opined that the value of Beneco as
of March 31, 2000, was $8.5 million. Mr. Koehl did not sign the
Declaration. Instead, Mr. Kramer wrote Mr. Koehl’s name in the
signature area designated for the “qualified appraiser”. Mr.
Koehl’s letter stating an $8.5 million value was attached to some
of the returns, but it was terse and fell far short of meeting
the summary appraisal requirements.
For 2002, Rhett and Alice’s return contained the description
of the donated property as “11.67% OF FLP BENECO STK”. The
Declaration of Appraiser in section B of Form 8283 was left
blank, and the Donee Acknowledgment portion was unsigned. The
Donee Acknowledgment stated that the donee was CCF; however, the
assignment document attached to the return indicated that the
donee was Crossmen Ministries. Typed on the assignment was
“$91,050" as the amount of the contribution. That amount,
however, was crossed out and “$123,750” was handwritten below it.
Only the assignment for Alice was attached to the return although
Rhett had apparently signed a similar document.
Under these circumstances we consider whether petitioners’
compliance was substantial or whether they failed to meet the
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statutorily mandated regulatory requirements. Bond v.
Commissioner, 100 T.C. 32 (1993), and Hewitt v. Commissioner, 109
T.C. 258 (1997), considered together, provide a standard by which
we can consider whether petitioners provided sufficient
information to permit respondent to evaluate their reported
contributions, as intended by Congress. If they provided
sufficient information, their “substantial compliance” would
adequately serve the purposes intended by Congress.
We hold that petitioners did not provide sufficient
information and/or submit the documents required to have
substantially complied and they are, therefore, not entitled to
deductions for noncash charitable contributions of FLP interests,
as determined by respondent. Petitioners, in each year under
consideration, did not attach to their returns qualified summary
appraisal reports as required by the statute and the regulations.
In addition, it has not been shown that petitioners’ C.P.A. was a
qualified appraiser within the meaning of the regulatory
requirements. Moreover, certain of the reports that were
referenced on the returns were not shown to exist, and none of
the purported reports or documentation submitted met the time
requirements for their preparation and submission. The
contributed property interests were not fully or adequately
described so as to permit respondent to understand the valuation
methodology, and the documentation submitted was terse and did
not adequately explain the bases for the values claimed.
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Our review of the materials and information that petitioners
submitted to respondent with their returns reveals that important
information that would have enabled respondent to understand and
monitor the claimed contributions was not supplied. Congress
mandated the reporting information so that the Internal Revenue
Service (IRS) could monitor and address congressional concerns
about overvaluation and other aspects of claimed charitable
contribution deductions. The submission of the information is
prerequisite to petitioners’ entitlement to a charitable
contribution deduction. Petitioners’ failure to substantially
comply or otherwise provide respondent with sufficient
information to accomplish the statutory purpose compels our
conclusion that respondent properly disallowed petitioners’
claimed noncash charitable contribution deductions.4
Section 183 Activities
Rance and Zane each claimed losses that respondent
disallowed as being from activities not engaged in for profit
within the meaning of section 183. If an individual engages in
an activity but does not engage in that activity for profit, “no
deduction attributable to such activity shall be allowed under
this chapter except as provided in * * * [section 183].” Sec.
183(a). Section 183(b)(1) permits deductions which are otherwise
4
Our holding that petitioners are not entitled to the
noncash charitable contribution deduction renders it unnecessary
to decide the value of the contributed interests.
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allowable without regard to whether the activity is engaged in
for profit, and section 183(b)(2) permits deductions which would
be allowable if such activity were engaged in for profit, but
only to the extent the gross income derived from the activity
exceeds the deductions allowable by reason of section 183(b)(1).
Section 183(c) defines an “activity not engaged in for profit” as
“any activity other than one with respect to which deductions are
allowable for the taxable year under section 162 or under
paragraph (1) or (2) of section 212.”
In order for a deduction to be allowed under section 162 or
section 212(1) or (2), the taxpayer must establish that he
“engaged in the activity with ‘the predominant, primary or
principal objective’ of realizing an economic profit independent
of tax savings.” Giles v. Commissioner, T.C. Memo. 2006-15
(quoting Wolf v. Commissioner, 4 F.3d 709, 713 (9th Cir. 1993),
affg. T.C. Memo. 1991-212); see Patin v. Commissioner, 88 T.C.
1086 (1987), affd. sub nom. Skeen v. Commissioner, 864 F.2d 93,
94 (9th Cir. 1989).
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
actual and honest objective of making a profit. Keanini v.
Commissioner, 94 T.C. 41, 46 (1990); Dreicer v. Commissioner, 78
T.C. 642, 645 (1982), affd. without published opinion 702 F.2d
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1205 (D.C. Cir. 1983); sec. 1.183-2(a), Income Tax Regs. In
making this determination, more weight is accorded to objective
facts than to the taxpayer’s statement of intent. Engdahl v.
Commissioner, 72 T.C. 659, 666 (1979).
Factors to be considered in determining whether an activity
is engaged in for profit include: (1) The manner in which the
taxpayer carries on the activity; (2) the expertise of the
taxpayer or his advisers; (3) the time and effort expended by the
taxpayer in carrying on the activity; (4) the expectation that
assets used in the activity may appreciate in value; (5) the
success of the taxpayer in carrying on other similar or
dissimilar activities; (6) the taxpayer’s history of income or
losses with respect to the activity; (7) the amount of occasional
profits, if any, which are earned; (8) the financial status of
the taxpayer; and (9) the elements of personal pleasure or
recreation. All facts and circumstances are to be taken into
account and no single factor or group of factors is
determinative. Indep. Elec. Supply, Inc. v. Commissioner, 781
F.2d 724, 726-727 (9th Cir. 1986), affg. Lahr v. Commissioner,
T.C. Memo. 1984-472; Golanty v. Commissioner, 72 T.C. 411, 425-
426 (1979), affd. without published opinion 647 F.2d 170 (9th
Cir. 1981); sec. 1.183-2(b), Income Tax Regs.
We consider each of Rance’s and Zane’s activities
separately, beginning with petitioner Rance’s activity involving
cutting horses.
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Rance’s Cutting Horse Activity
Schedules F were attached to Rance’s 1998 through 2005
income tax returns with his activity described as “crop
livestock”. At trial the evidence offered was Rance’s testimony
about his activity, but no documentary evidence (i.e., records)
was offered in support of the income and deduction entries on the
Schedules F. Rance explained that his profit motivation was
based on his goal that one of his horses could turn out to be a
“Triple Crown winner” who could earn him income in excess of the
losses claimed from the activity.
Rance’s testimony about his cutting horse activity was, in
great part, lacking in specifics.5 He discussed horse bloodlines
but failed to indicate much about his horses, such as the year
and cost of purchase, the training regimen, the events entered,
purses and competitions won, breeding efforts, profit analyses,
business plans, necessity of expenses, sale price, and so forth.
Accordingly, we are left with the task of analyzing Rance’s
cutting horse activity using his testimony and the Schedules F
attached to his income tax returns.
Rance and LaRhea had purchased 70 acres of land in southern
Oregon in 1996 and moved to the property late in 1999 after
5
For example, Rance testified about a $17,000 breeding fee
and a mare he sold for $35,000. The tax returns in the record
(1998 through 2005) do not appear to reflect these events or
activity. In addition, Rance testified that he had as many as 20
horses. The Schedules F, likewise, do not reflect that level of
activity.
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constructing a house and other buildings. Beginning in 1998,
Rance and LaRhea claimed farm losses pertaining to the Oregon
property for an activity described as “crop livestock”. The
primary expenses claimed for 1998 were depreciation, repairs, and
plans; there was no income for that year. The specifics of the
claimed expenses for 1998 have not been detailed or adequately
explained.
In 1999, Rance purchased P.K., a driving horse; Popcorn, a
Royal Dartmoor pony mare in foal; and Leo, a western pleasure
mule. He subsequently acquired Jewels, which was later traded
for Mitzi and I Gotta Lotta; none of these horses were entered in
competitions. Mitzi was sold for $6,300 and I Gotta Lotta for
$6,000. No information was offered as to how these horses fit
into Rance’s business plan, which he stated involved cutting
horses.
Dual Docs was purchased in 2001 for $30,000 and was the
first horse entered into competition. During 2001 and 2002, Dual
Docs was in training in Medford, Oregon, with Bobby and Jolene
Nelson. He was sold at a loss in 2004. This generic information
is, in essence, all the record offers regarding Dual Docs.
The following is an analysis of Rance’s cutting horse
activity using the nine factors as a guide.
1. Manner in Which the Activity Is Conducted--The fact that
a taxpayer carries on the activity in a businesslike manner and
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maintains complete and accurate books and records may indicate a
profit objective. Sec. 1.183-2(b)(1), Income Tax Regs.
Essentially, Rance’s only record of his activity was a bank
account that, for early years, was not segregated from his
personal checking account. No other records were produced with
respect to his cutting horse activity. No records corroborating
his testimony were produced to show the horses purchased or their
progress and profitability. In particular, no formal business
plan, budgets, operating statements, or analysis was produced to
show the financial management or planning of the activity.
Although Rance testified that he had detailed written business
plans broken down by horse, such plans were not offered into
evidence, and little detail of the plans was described in the
testimony.6
At trial, Rance was unable to provide detail about the
collective deductions claimed on the Schedules F. The returns
were prepared by Mr. Kramer, who used the checkbook to prepare
the Schedules F. Someone with the intent to make a profit from
cutting horses could be expected to have adequate information
6
Petitioners attempted to address their failure to present
detailed evidence by contending that respondent did not question
the substantiation or underlying records during the audit
examination. That, however, does not relieve them of the burden
of showing that they met the requirements of sec. 183. They also
attempted to parlay that same contention into a situation where
the burden of proof would be shifted to respondent under sec.
7491(a). We found that attempt to be untimely and in other
respects ill conceived.
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from which to analyze the expenses and to project the progress of
the activity. The activity was for the most part undocumented
and there was little or no interest shown in the financial aspect
of the activity or its prospects. See, e.g., Rinehart v.
Commissioner, T.C. Memo. 2002-9.
In addition, no effort was made to explain how the expenses
claimed on the returns related to the activity. There was no
explanation regarding how the assets being depreciated or the
totality of expenses comported with the needs of the activity
conducted. Respondent also points out that the cutting horses
lived with trainers and that it was, therefore, less clear how
all the expenses associated with Rance and LaRhea’s Oregon
acreage pertain to this activity. One of the most important
indications of whether an activity is being performed in a
businesslike manner is whether the taxpayer implements some
method for controlling losses. Burger v. Commissioner, 809 F.2d
355, 359 (7th Cir. 1987), affg. T.C. Memo. 1985-523. No such
explanation was provided in this case.
This factor favors respondent and reflects that Rance did
not operate this activity in a businesslike manner.
2. Taxpayer’s Expertise--A taxpayer’s expertise, research,
and study of an activity, as well as his consultation with
experts, may be indicative of a profit motive. Sec. 1.183-
2(b)(2), Income Tax Regs.
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Rance was generally knowledgeable about cutting horses and
had experience in riding, breeding, and caring for these animals.
Rance consulted with numerous experts; however, he did not detail
the specific advice received or how he employed that advice in
the activity. He sought no professional advice on the economics
of the cutting horse activity. He did, however, seek advice
about the tax aspects and ways to avoid classification of the
activity as a hobby. Rance did seek guidance and advice from
others, but he failed to explain how the advice he obtained was
used or how it assisted in the attempt to seek profits from the
activity. However, this factor favors Rance and LaRhea.
3. Time and Effort Spent in Conducting the Activity--The
fact that the taxpayer devotes much of his personal time and
effort to carrying on 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.
Rance spent 8 to 10 hours a week on this activity. His
involvement with cutting horses provided a recreational benefit.
The record is sparse, however, on the specifics of Rance’s
involvement in this activity. Accordingly, this factor favors
respondent’s determination.
4. Expectation That the Assets Will Appreciate in Value--
The taxpayer’s expectation that the assets used in the activity
may appreciate in value may, under certain circumstances,
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indicate a profit motive. Sec. 1.183-2(b)(4), Income Tax Regs.
Clearly, it was Rance’s expectation that the value of his horses
would increase and, in two instances, the values did increase by
small amounts. In addition, he held approximately 75 acres of
pasture land which could appreciate. It is also necessary,
however, that the objective be to realize a profit on the entire
operation. Bessenyey v. Commissioner, 45 T.C. 261, 274 (1965),
affd. 379 F.2d 252 (2d Cir. 1967). In order for Rance to recoup
the losses claimed through the years in issue, future earnings
and/or appreciation would have to be considerable. A champion
horse could appreciate substantially, but the likelihood of
producing a champion is small. Overall, we find that this factor
favors respondent’s determination.
5. Taxpayer’s Success in Similar or Dissimilar Activities--
Even if an activity is unprofitable, the fact that a taxpayer has
previously converted similar activities from unprofitable to
profitable enterprises may be an indication of a profit motive
with respect to the current activity. Sec. 1.183-2(b)(5), Income
Tax Regs. Rance had experience from a previous cutting horse
activity but abandoned it because he could not afford it.
Rance testified that, in his previous cutting horse activity, one
of his horses won a championship. He did not testify or show
that the appreciation in the assets in the earlier activity
resulted in overall profits or the amount of losses recouped.
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In comparison to the cutting horse activity, Rance and
LaRhea have been highly successful in the operation of Beneco.
Rance did not explain or show how his business acumen and
experience were used in the cutting horse activity. See Smith v.
Commissioner, T.C. Memo. 1997-503, affd. without published
opinion 182 F.3d 927 (9th Cir. 1999). Accordingly, this factor
favors respondent’s determination.
6. The Activity’s History of Income and/or Losses--An
important consideration is the taxpayer’s history of income
and/or losses related to the activity. Losses continuing beyond
the period customarily required to make an activity profitable,
if not explained, may indicate that the activity is not engaged
in for profit. Sec. 1.183-2(b)(6), Income Tax Regs.
As of the end of 2001, Rance had incurred nearly $350,000 in
losses from his Schedule F activity. By the end of 2005, the
claimed losses totaled more than $568,000. These continuing
losses were used to offset Rance and LaRhea’s ample income from
other pursuits, including their involvement in Beneco. The
amount of income in relation to the increasing and accumulating
expenses or losses does not show that Rance had a profit motive
with respect to this activity other than the outside possibility
of his breeding or acquiring a champion. See Burger v.
Commissioner, 809 F.2d at 360. Accordingly, this factor is
unfavorable for Rance and LaRhea.
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7. Amount of Occasional Profits--The amount and frequency
of occasional profits earned from the activity may also be
indicative of a profit objective. Sec. 1.183-2(b)(7), Income Tax
Regs. Rance contends that he sold horses during the years in
issue where the price exceeded the original cost. The amounts of
gain from those sales, however, were minimal ($839 and $230).
Moreover, Rance did not report any overall profits from the
activity. In other words, there was no showing of profit when
considering the overhead, depreciation, etc. The record reflects
continual and overwhelming losses. Accordingly, this factor is
unfavorable for Rance and LaRhea.
8. Financial Status of the Taxpayer--Substantial income
from sources other than the activity, particularly if the
activity’s losses generate substantial tax benefits, may indicate
that the activity is not engaged in for profit. This is
especially true where there are personal or recreational elements
involved. Sec. 1.183-2(b)(8), Income Tax Regs.
Without counting any farm income Rance and LaRhea had
combined gross income (before taking into account a disputed and
conceded income issue involving offshore deferred compensation)
of $376,439, $421,563, $644,620, and $1,664,811 for the years
1998, 1999, 2000, and 2001. By 2005, Rance and LaRhea’s gross
income was $2,739,845, without considering the cutting horse
activity. They see this scenario as one that shows that they had
the resources to effectively operate the cutting horse activity
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which is admittedly capital intensive. Conversely, respondent
contends that the continued losses in the cutting horse activity
were intended and used for a tax benefit by means of an offset to
Rance and LaRhea’s income. Considering the record as a whole, it
appears that the potential for tax benefits attributable to the
claimed losses from the activity was substantial. Considering
the fact that this was also a recreational activity, this factor
favors respondent’s determination.
9. Elements of Personal Pleasure--The presence of personal
motives, particularly when there are recreational elements
involved, may indicate that the activity is not engaged in for
profit. Sec. 1.183-2(b)(9), Income Tax Regs. Respondent points
out that Rance has been riding horses most of his life and
enjoyed his involvement with his cutting horse activities. He
rode horses in some competitions and had reentered the activity
because he enjoyed it and could afford it.
Rance contends that he was interested in the business
challenges and derived no personal pleasure from his involvement
in the activity. Rance admits that he enjoyed the activity, but
that his focus was winning competitions and producing a champion.
Here, again, the continuing losses without any apparent effort to
cut costs would tend to indicate a focus on the recreational
nature of the activity. Overall, this factor is unfavorable to
Rance and LaRhea.
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Our analysis of the nine factors reveals that, overall,
Rance did not enter into or continue his cutting horse activity
with the requisite profit motive. We hold that respondent’s
determination disallowing the losses from that activity was not
in error.
Zane’s Staffordshire Bull Terrier Activity
Zane became interested in dogs when he was 12 years old,
after attending a dog show. Thereafter, his parents bought him
his first Staffordshire Bull Terrier.7 He became involved in dog
showing, breeding, and judging, and by 1985, at age 22, he served
as the youngest championship show judge in recent history.
During the years in issue he attended many dog shows and owned or
coowned as many as 30 to 40 dogs. Most of the dogs lived with
their handlers or with his coowners.
Zane believed that showing or judging dogs at shows did not
normally generate revenue, but breeding and selling puppies could
have potential for revenue. More revenue would result if his
dogs showed well and/or won medals at a show. Zane has semen
stored from two of his dogs. He testified that a breeding
typically requires two straws of semen and he could charge around
$2,000 per breeding. He estimated that the 80 straws he had at
7
Ultimately, Zane became a noted expert in American and
Staffordshire Bull Terriers.
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the time of trial would be worth $80,000.8 Zane was particular
about breeding his dogs, and he would breed his dogs only with
high-quality dogs.
At the time of trial, Zane was selling Terrier puppies for
amounts ranging from $1,500 to $2,000. No information was
provided, however, as to the selling price for puppies during the
years at issue. Zane believed that one of his dogs was worth
$50,000, although no evidence, other than his testimony, was
offered to support his belief.
1. Manner in Which the Activity Is Conducted--Zane did not
maintain a separate bank account for his dog activities, and no
other records of this activity were produced. For example, there
were no records showing: Purchase of dogs; financial analysis of
their potential for profitability; formal business plan, budgets,
operating statements, and analyses of cost control. Zane did not
calculate the amount of income he would need to recover the
losses incurred, and he did not predict when the activity might
become profitable. He did, however, invest a substantial amount
in the training and showing of Terriers worldwide in order to
document their quality.
8
Because multiple straws are needed for an insemination,
the number of possible inseminations would be reduced by some
mathematical factor. One report in the record indicated that
approximately 7.9 straws was the factor. If that were correct,
80 straws would result in approximately 10 inseminations for
total revenue of approximately $20,000.
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Beginning in 1998 and extending through 2003, Zane filed one
Schedule F each year designating the activity as “Cattle Crops--
Dog Breeding.” In 2004, he simply included the dog breeding
activity expenses in a Schedule F labeled “Cattle Crops--Dog
Breeding”, and a separate Schedule F was attached and designated
“Organic Dairy Farm”.
Zane’s lack of records and failure to address and/or be
particularly concerned about the financial aspects and the
potential for recouping losses show that he did not operate the
activity in a businesslike manner. Someone with the intent to
make a profit from dogs would be expected to have a substantial
file on each dog. See, e.g., Rinehart v. Commissioner, T.C.
Memo. 2002-9. The lack of detailed records as to which dogs were
profitable and which were not is an indication that the dog
breeding activity was not carried on for profit. See Smith v.
Commissioner, T.C. Memo. 1997-503.
Zane made no effort to reduce costs and control losses.
Although he contends that his coownership arrangements helped to
reduce expenses, any such reduction was insufficient to stem the
increasing overall amount of expenses and the increasing losses.
He did not earn any income from judging during the years at issue
and has earned relatively nominal amounts from showing dogs.
Zane’s income tax returns reflect no income from the dog breeding
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activity for 1997 through 2000 and only nominal amounts
thereafter. This factor is not favorable for Zane.
2. Taxpayer’s Expertise--Zane is a noted longtime expert in
judging, showing, and breeding American Staffordshire Terriers
and Staffordshire Bull Terriers. Accordingly, this factor favors
Zane.
3. Time and Effort Spent Conducting the Activity--Zane
testified that he spent an average of 10 to 12 hours per week on
the dog breeding activity. He also testified that he spent 20 to
30 hours per week on the dairy farming, along with working full
time (presumably at least 40 hours per week) at Beneco. Zane
also testified about spending time in charitable activities. It
appears that he was spread thin and that his estimates of hours
may be overstated. Overall, however, this factor favors Zane.
4. Expectation That the Assets Will Appreciate in Value--
Zane believed that one of the dogs was worth $50,000, but he
failed to corroborate his belief. In addition, he did not
specify whether the dog was solely owned or coowned. If we were
to assume that Zane’s belief was correct and that he was the sole
owner, the $50,000 would not be sufficient to recoup the $275,000
in losses already incurred by 2001. Zane also had potential to
earn revenue from insemination (breeding) and the sale of
puppies. The difficultly here is the lack of documentation
and/or corroboration supporting Zane’s contention. The income
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reported through the taxable years in question does not reflect
the potential to recoup the claimed losses as Zane contends.
Accordingly, we find this factor to be unfavorable for Zane.
5. Taxpayer’s Success in Similar or Dissimilar Activities--
In addition to his dog breeding activity, Zane operated a cattle
activity that had reported losses. On the other hand, Zane was
vice president of Beneco–-a very successful business operated by
Zane and his family. He did not show that the experience or
success from Beneco was carried over into his dog breeding
activity. For example, there were inadequate records of the
activity. There was no showing that his acquired business
techniques were used to cut costs or improve receipts.
Accordingly, this factor is not favorable to Zane.
6. The Activity’s History of Income and/or Losses--By the
end of 2001, Zane had accumulated losses in an amount approaching
$275,000. By 2004, his losses were approaching $340,000. These
losses were used to offset Zane and Shannon’s other substantial
income. The amount of losses in comparison with revenues does
not show, however, that Zane intended to cut losses or improve
the potential for gain. Although Zane contends that the
potential to recoup the losses and show gain existed, the record
does not support his contention. Accordingly, this factor is
unfavorable for Zane.
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7. Amount of Occasional Profits--No profits and only
limited receipts have been reported from Zane’s dog breeding
activity. This factor is unfavorable for Zane.
8. Financial Status of the Taxpayer--Zane and Shannon’s
gross income, without considering income adjustments they
conceded, was $382,020, $277,979, $320,569, and $718,466 for the
1998, 1999, 2000, and 2001 years. For each of the next 3 years,
their income exceeded $700,000 annually. The potential for tax
benefits from the claimed dog breeding activity losses was
substantial. This factor favors respondent’s determination.
9. Elements of Personal Pleasure--There is no question
about the pleasure Zane derived from his involvement in the dog
breeding activity. He has been involved with dogs since he was
12 years old and enjoyed judging shows and has had the
opportunity to travel all over the world. It is noted that his
judging was not compensated and that he traveled at his own
expense and that the travel expenses have been deducted. He was
an acknowledged expert concerning Staffordshire Bull Terriers and
American Staffordshire Terriers worldwide.
Considering all of the above-discussed factors and the
record as a whole, it appears that Zane’s dog breeding activity
was one of personal interest and more of a hobby than a business.
It was the participation in showing and judging terriers that
attracted him to the activity and not the profit objective. It
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is noted that expenses for travel, shows, and boarding dogs were
substantial.
Accordingly, we hold that Zane did not enter into or
continue the dog breeding activity with the requisite profit
motive for the years before the Court.
Zane’s Cow and Dairy Farm Activity
Zane and Shannon argued on brief that Zane’s dog breeding
and cow and dairy farm activities were one activity and that the
cow and dairy farm activity was an expansion or extension of the
dog breeding activity. That argument was made, to some extent,
to make the point that Zane went into the cow and dairy farm
activity to help remedy or recoup some of the losses experienced
in the dog breeding activity. It was also contended that some of
his expertise in breeding dogs carried over into the breeding of
cows.
Section 1.183-1(d), Income Tax Regs., provides the
appropriate legal standard for determining whether two or more
activities constitute one or two activities. A “facts and
circumstances” standard is prescribed to ascertain whether the
activities are separate. “Generally, the most significant facts
and circumstances in making this determination are the degree of
organizational and economic interrelationship of various
undertakings, the business purpose which is (or might be) served
by carrying on the various undertakings”. Sec. 1.183-1(d)(1),
Income Tax Regs.
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In this instance, there was no organizational or economic
interrelationship between the two activities. Other than the
reporting of the expenses of both on the same Schedule F, the
activities were geographically and financially independent. No
business purpose was expressed other than Zane’s ability to use
his knowledge of dog breeding in cow breeding. The use of that
experience and knowledge by Zane is not, per se, a business
purpose and did not result in any economy of scale or symbiosis
between the two activities.
The cow and dairy farm activity was a separate pursuit. We
treat the dog breeding activity and the cow and dairy farm
activity as separate for purposes of our section 183 analysis.
Beginning in 1998, Zane claimed losses on Schedule F from
his cow and dairy farm activity which he reported along with
those of his dog breeding activity and described as “cattle
crops--dog breeding”. Subsequently, in 2001 he described the
activity as “organic dairy farm” on his Schedule F.
Respondent contends that Zane did not effectively enter into
the cow and dairy farm activity until 2001, whereas Zane contends
that the early activity involving the cattle was preliminary to
and an integral part of the expansion of that activity in 2001.
In 1998, Zane purchased a 400-acre farm, (Goose Hill), in upstate
New York where he also built his home. His Schedule F for the
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1999 tax year reflects that other than depreciation and repairs
of the property, most of the expenditures were for the dog
breeding activity, including dog training and showing. No
expenses were claimed that appeared to relate directly to the cow
and dairy farm activity. Likewise, for the 2000 tax year most
were for the dog breeding activity, and only a relatively small
portion could have been connected with the cow and dairy farm
activity.
For 2001 two Schedules F were included, and the one labeled
“Cattle Crops--Dog Breeding” contained substantially increased
expenditures. Relatively large amounts were spent on items
relating to cows such as feed and trucking expenses. The second
Schedule F was labeled “Organic Dairy Farm” and contained claimed
expenditures and depreciation totaling $98,470. These
circumstances reflect that Zane did not begin to pursue the dairy
farm idea until 2001. Any expenditures nominally connected with
cows before 2001 would have, in any event, been considered
startup expenditures (which are to be capitalized) and were
incurred before the implementation of the plan to pursue the
dairy farm. See Toth v. Commissioner, 128 T.C. 1, 4-6 (2007).
Accordingly, we agree with respondent that Zane and Shannon are
not entitled to claim any losses in connection with his cow
activity before 2001.
With respect to 2001, Zane had studied and researched the
various types of cattle that could be bred. Zane recognized that
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family dairy farms were not doing well, and he decided that to be
profitable, he had to find for his farm a niche in the market
that would let it compete as to product and price. After much
research he decided to raise Normande cattle. The dairy farm
idea had materialized and was operational by the end of 2001 and
accordingly expenditures would not be considered to be startup
expenses.
During 2000, Zane purchased 225 additional acres of farmland
nearby and called it the Columbus Dairy. The Columbus Dairy
became the organic dairy farm. At the Columbus Dairy, Zane built
a milking parlor and other buildings for the milking operation.
Zane also reclaimed the pastureland and built miles of fencing
for the organic dairy operations on the Columbus Dairy property.
Milking started sometime in 2002.
Normande cows are good producers of milk in France but are
largely used for beef consumption in the United States. After
visiting many farmers and ranchers throughout the United States,
Zane acquired a herd of Normande cows that he believed would be
the best milk producers. He intended to further breed the
acquired herd so his activity could become competitive in the
dairy farming industry. Zane had a 7-year business plan
involving the importation of bull semen from France, as he could
not import Normande cows to breed with his cows to produce more
and better milk. At the same time, Zane was working to convert
his land from a conventional to a certified organic farm. Zane
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believed that if his farm could be certified as organic, he would
be able to sell the milk at a price three times that of
conventional milk.
By the time of trial, Zane’s animal breeding was
progressing, and the farm was certified organic in 2006. His
gross revenues exceeded $100,000 for 2004, 2005, and 2006. Zane
expects the revenue to triple in 2007 because of the organic
certification. In operating this activity, Zane has consulted
with experts, done marketing, maintained separate checking
account records, and focused on ways to maximize revenue.
The following is an analysis of the nine factors, more fully
described above, as applicable to this activity.
1. Manner in Which the Activity Is Conducted--Zane
physically segregated the cow activity from the dog breeding
activity and, as of 2001, maintained a separate bank account for
the cow activity. He had a formal 7-year business plan that he
pursued throughout the years in issue. He took steps to maximize
his revenues and continually worked to show a profit.
Although for years before 2001 Zane reported the dog
breeding activity and the cow and dairy farm activity on a single
Schedule F, the activities were separately pursued and had
differing operations. Beginning around 2001, Zane hired Mr.
Hughes to be his farm manager. He gave him a place to live, the
use of a truck, and cash wages of around $30,000 per year.
Although Zane did not keep many formal records, he did approach
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the operation of the cow activity in a businesslike manner.
Accordingly, this factor is favorable for Zane.
2. Taxpayer’s Expertise--Through study, Zane gained
expertise in the breeding of cows and in the use of Normande cows
for dairy purposes. He sought professional advice and
successfully used in the cow activity his animal husbandry
expertise gained from breeding dogs. Overall, this factor is
favorable for Zane.
3. Time and Effort Spent in Conducting the Activity--Zane
spent an average of 20 to 30 hours per week on his cow and dairy
farm activity. Certainly, 20 to 30 hours per week is
significant. Accordingly, this factor favors Zane.
4. Expectation That the Assets Will Appreciate in Value--
The term “profit” encompasses appreciation in the value of
assets, such as land, used in the activity. Sec. 1.183-2(b)(4),
Income Tax Regs. Respondent contends:
farming and the holding of land with the primary
intent to profit from an increase in its value
will be considered a single activity only if the
farming activity reduces the net cost of carrying
the land for its appreciation in value. That is,
they will be considered a single activity only if
the income derived from farming exceeds the
deductions attributable to the farming activity
which are not directly attributable to the
holding of the land.
Zane has two separate farms, one in Hamilton, New York
(Goose Hill), with approximately 400 acres purchased in 1998 for
$600 to $650 per acre and currently worth around $2,500 per acre
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on the basis of comparable sales of farm land, and another farm
with 225 acres (Columbus Dairy) which was purchased in 2000 for
$500 to $600 per acre and is currently worth around $1,200 to
$1,500 per acre on the basis of comparable land sales.
Although we do not consider the land appreciation and the
cow and dairy farm activity as a single activity, we recognize
that Zane’s investment in the land and buildings also has the
potential for appreciation and profit. On that basis, we find
this factor to be favorable to Zane.
5. Taxpayer’s Success in Similar or Dissimilar Activities--
Zane operated the dog breeding activity at a loss before entering
the cow and dairy farm activity. Although Zane was not
financially successful in the dog breeding activity, he was
successful in gaining expertise in animal husbandry and related
topics involving the care and breeding of animals. Beneco is a
successful business operated by Zane and his family. We discern
that Zane has employed some of the success of other endeavors in
his cow activity and, accordingly, this factor is favorable to
Zane.
6. The Activity’s History of Income and/or Losses--By the
end of 2001, Zane’s accumulated losses from the cow activity
approached $153,000. Although the total losses had increased to
approximately $307,000 by 2003, the last year for which a
Schedule F was available, the potential for increased revenues
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from the sale of organic milk could address the deficit.
Accordingly, we find this factor to be neutral.
7. Amount of Occasional Profits--Zane has not reported any
profits from the cow activity, and therefore this factor is
unfavorable for Zane.
8. Financial Status of the Taxpayer-–Without counting any
farm income Zane and Shannon’s gross income, before considering
income adjustments they conceded, was $382,020, $277,979,
$320,569, and $718,466 for the years 1998, 1999, 2000, and 2001.
For each of the next 3 years, their income exceeded $700,000.
That level of income provided the potential for substantial tax
benefits from the claimed losses from the cow and dairy farm
activity. Therefore, this factor is unfavorable for Zane and
Shannon.
9. Elements of Personal Pleasure--Although Zane has a keen
interest in cows, especially the Normande breed, his focus in
this activity has been to seek a profit from a dairy operation.
We note that the Normande breed was not traditionally used for
dairy purposes in the United States. However, Zane believed that
they had great potential for high quality and quantity
production. Unlike the dog breeding activity, we find that
Zane’s interest in the cow and dairy farm activity was more
business and less pleasure oriented.
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Overall, we hold that Zane has established that he entered
into the cow and dairy farm activity in 2001 with the requisite
profit motive within the meaning of section 183.
Whether Petitioners Are Liable for Penalties Under Section 6662
for Each Adjustment Considered by the Court for the Taxable Years
1998, 1999, 2000, and 2001
Section 6662(a) imposes a 20-percent penalty on any portion
of an underpayment of tax required to be shown on a return. The
penalty is applicable to the portion of any underpayment
attributable to one or more of the following: (1) Negligence or
disregard of rules or regulations; (2) any substantial
understatement of income tax, and (3) any substantial valuation
misstatement. Sec. 6662(b).
The term “negligence” includes any failure to make a
reasonable attempt to comply with the provisions of title 26, and
“disregard” includes any careless, reckless, or intentional
disregard. Sec. 6662(c). Negligence is the lack of due care or
failure to do what a reasonable and ordinarily prudent person
would do in a similar situation. Neely v. Commissioner, 85 T.C.
934, 947 (1985).
Negligence includes any failure to exercise ordinary and
reasonable care in the preparation of a tax return, but it does
not include a return position that has a reasonable basis. Sec.
1.6662-3(b)(1), Income Tax Regs. Reasonable basis is a
relatively high standard of tax reporting, significantly higher
than not frivolous or not patently improper. It is not satisfied
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by a return position that is merely arguable. Sec. 1.6662-
3(b)(3), Income Tax Regs.
Negligence may be indicated when a taxpayer fails to
ascertain the correctness of an item on the return that would
seem to a reasonable and prudent person to be “too good to be
true” under the circumstances. Sec. 1.6662-3(b)(1)(ii), Income
Tax Regs. A substantial understatement of income tax is defined
as an understatement of income tax that exceeds the greater of 10
percent of the tax required to be shown on the tax return or
$5,000. Sec. 6662(d)(1)(A).
As already discussed, the Commissioner bears the burden of
production in any court proceeding with respect to the penalty,
addition to tax, or additional amount imposed by title 26. Sec.
7491(c). The burden imposed on the Commissioner is to come
forward with sufficient evidence regarding the appropriateness of
applying a particular addition to tax or penalty against the
taxpayer. Wheeler v. Commissioner, 127 T.C. 200 (2006); Higbee
v. Commissioner, 116 T.C. 438 (2001). Section 7491(c) does not,
however, require the Commissioner to introduce evidence of
reasonable cause, substantial authority, or similar provisions.
Section 6664 provides an exception to the imposition of
accuracy-related penalties if the taxpayer shows that there was
reasonable cause for the underpayment and that the taxpayer acted
in good faith. Sec. 6664(c); United States v. Boyle, 469 U.S.
241 (1985). Whether a taxpayer acted with reasonable cause and
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in good faith is a factual question. Sec. 1.6664-4(b)(1), Income
Tax Regs. Generally, the most important factor in determining
whether a taxpayer acted with reasonable cause and in good faith
is the extent to which the taxpayer exercised ordinary business
care and prudence in attempting to assess his or her proper tax
liability. Id. Reasonable cause may, in some cases, be
established by reliance on the advice of a professional tax
adviser. Id. Sec. 1.6664-4(b), Income Tax Regs. In order for
the taxpayer to establish that he reasonably relied upon advice,
he must prove by a preponderance of the evidence that (1) the
adviser was a competent professional who had sufficient expertise
to justify reliance; (2) the taxpayer provided necessary and
accurate information to the adviser; and (3) the taxpayer
actually relied in good faith on the adviser’s judgment.
Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43, 99
(2000), affd. 299 F.3d 221 (3d Cir. 2002).
Although honest misunderstanding of fact or law could be
reasonable, petitioners are required to take reasonable steps to
determine the law and to comply with it. See Niedringhaus v.
Commissioner, 99 T.C. 202 (1992). In the end, the duty of filing
accurate returns lies with petitioners, who must bear the
ultimate responsibility for any negligent errors of their agent.
See Pritchett v. Commissioner, 63 T.C. 149, 174 (1974).
Petitioners generally contend that they had hired tax
professionals to advise them on their various activities,
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deductions, and return reporting and that they appropriately
followed the advice and return reporting positions of those
professionals. Respondent, however, sees petitioners as
sophisticated and successful business people who understand
complex legal concepts in connection their Beneco business.
Respondent contends that petitioners should have known that the
positions they took on their returns were incorrect.
Respondent also points out that petitioners have conceded
their offshore leasing issue and the penalties determined with
respect to it and that those transactions reflected that
petitioners had a high tolerance for risk in their tax reporting.
In essence, respondent argues that petitioners were willing to
take aggressive tax reporting positions and that we should
consider that in evaluating petitioners’ other deductions and
reporting positions.
Petitioners claim to have relied upon their accountants for
the contribution and section 183 loss issues. Mr. Kramer
prepared petitioners’ returns for the years 1998 through 2001.
Petitioners each testified that they relied upon Mr. Kramer to
properly prepare their returns.
Petitioners’ Accuracy-Related Penalties for Their Noncash
Charitable Contribution Adjustments for the 1998, 1999, 2000, and
2001 Tax Years
Each couple conceded that they are liable for the accuracy-
related penalties with respect to their offshore leasing
transactions, a matter which affected their liabilities for
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several taxable years. We must decide whether petitioners are
liable for the accuracy-related penalties with respect to the
noncash charitable contribution deductions.
Beginning in the mid-1990s and for various years through
2001, petitioners claimed deductions for noncash charitable
contributions. Respondent determined that they are not entitled
to the deductions because they failed to supply the information
required by the statute and regulations, and we have so held.9
Respondent contends that petitioners knew that they had not
supplied the required information--i.e., that the appraisals
valued Beneco stock rather than the limited partnership interests
and that the appraisals submitted were not timely as required by
the statute. Amongst other errors in reporting the noncash
charitable contributions, the percentages of ownership were
misstated, the C.P.A. signed the appraiser’s name, and reference
was made to an appraisal with a particular date which has not
been shown to exist. Respondent contends that no reasonably
prudent person would have allowed these errors to persist year
after year.
9
Respondent also questioned whether the values of the
limited partnership interests or the amounts of the claimed
contributions were overstated. We have not addressed the value
question because we have sustained respondent’s determination
that petitioners are not entitled to any deduction because they
failed to provide information required by the statute and the
regulations.
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Petitioners do not dispute the errors on their tax returns
with respect to the noncash charitable contributions. They
acknowledge that the appraisals of the donated property were not
“qualified appraisals” as required by the regulations; that none
of the appraisals was made within 60 days of the contribution of
the partnership interest; that Mr. Kramer (C.P.A.) and Rick
Brewster (Mr. Brewster) (C.P.A.) each decided not to value the
partnership interests (i.e., the property donated), but decided
to value the only asset of the partnerships (the Beneco stock).
Petitioners contend that these errors or omissions do not, ipso
facto, make them liable for penalties and that the issue is
simply whether they reasonably relied on the professionals they
hired–-Attorney Kelley, experienced in estate and tax planning;
Mr. Kramer, an experienced C.P.A. practicing in the tax field for
over 35 years; and Mr. Brewster, an experienced C.P.A. practicing
in the tax field for over 25 years--to provide them proper tax
advice and to properly prepare their tax returns.
The penalty under section 6662 is not imposed with respect
to any portion of any underpayment if it is shown that there was
reasonable cause for such portion and that the taxpayer acted in
good faith with respect to such portion. A taxpayer’s reliance
on the advice of an independent professional as to the tax
treatment of an item, if such reliance was reasonable and the
taxpayer acted in good faith, will establish that the taxpayer
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was not negligent and will satisfy the reasonable cause
exception. Sec. 6664(c); sec. 1.6664-4(b), Income Tax Regs.
The general rule is that a taxpayer has a duty to file a
complete and accurate tax return and cannot avoid that duty
merely by placing that responsibility with an agent. United
States v. Boyle, 469 U.S. at 252; Metra Chem Corp. v.
Commissioner, 88 T.C. 654, 662 (1987). In certain limited
situations, the good faith reliance on the advice of an
independent, competent professional in the preparation of the tax
return can satisfy the reasonable cause and good faith exception.
United States v. Boyle, supra at 250-251; Weis v. Commissioner,
94 T.C. 473, 487 (1990). Reliance on the advice of a
professional tax adviser, however, does not automatically
demonstrate reasonable cause and good faith. Sec. 1.6664-
4(b)(1), Income Tax Regs. All of the facts and circumstances
must be taken into account. Sec. 1.6664-4(c)(1), Income Tax
Regs. The advice must be based upon all pertinent facts and the
applicable law. Sec. 1.6664-4(c)(1)(i), Income Tax Regs. The
advice must not be based on unreasonable factual or legal
assumptions. Sec. 1.6664-4(c)(1)(ii), Income Tax Regs. The
advice cannot be based on an assumption that the taxpayer knows,
or has reason to know, is unlikely to be true. Id.
In order to show reasonable reliance the taxpayer must
prove: (1) The adviser was a competent professional who had
sufficient expertise to justify the taxpayer’s reliance on him;
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(2) the taxpayer provided necessary and accurate information to
the adviser; and (3) the taxpayer actually relied in good faith
on the adviser’s judgment. Weis v. Commissioner, supra at 487
(citing Pessin v. Commissioner, 59 T.C. 473, 489 (1972)).
The gist of the disallowance of petitioners’ noncash
charitable contribution deductions was their failure to comply
with certain statutorily specified procedural requirements that
were intended to enable respondent to monitor such deductions.
Petitioners relied on their tax professionals to properly report
the charitable contribution deductions. The Court’s holding on
this issue was based on these procedural failures.
Petitioners’ C.P.A., Mr. Kramer, has been licensed since
1967, and he prepared tax returns and gave tax advice for a
living. He prepared approximately 1,000 tax returns each year.
Mr. Kramer, in addition to preparing petitioners’ returns, also
provides tax and consulting advice for petitioners and their
corporation, Beneco. Mr. Kramer advised petitioners with respect
to the noncash charitable contributions that they may have made
in 1998, 1999, 2000 and 2001, and he was aware that they were
relying on his advice. He also prepared petitioners’ tax returns
for the years at issue, making certain necessary recommendations
as to obtaining an appraisal, when to get the appraisal, and what
type of appraisal to obtain. He was not instructed by any of
petitioners on how to do his job or how to value the partnership
interests that were donated. Mr. Kramer instructed petitioners
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regarding all of the requirements, and he was responsible to
properly report the contributions on their returns.
Mr. Kramer also made the appraisal for the early years at
issue by appraising the Beneco stock. Petitioners relied on Mr.
Kramer as their C.P.A. and for the necessary appraisals with
respect to the partnership interests contributed for their 1998
through 2001 tax years. Mr. Kramer testified that he believed
he was familiar with section 170 reporting requirements for
noncash charitable contributions and with the Form 8283 used to
report noncash charitable contributions. Mr. Kramer recognized
that it was his responsibility to make sure that the section 170
reporting requirements for the noncash charitable contributions
were met when he completed the tax returns for the years at
issue. Mr. Kramer stated that he made a good-faith effort to
comply with the section 170 reporting requirements. The record
reflects that his efforts fell far short of the requirements.
Around 1999 or 2000, Mr. Kramer advised petitioners to
obtain a certified appraisal, and he recommended that they hire
Mr. Koehl, a certified appraiser. Mr. Kramer hired Mr. Koehl, on
petitioners’ behalf, to appraise the partnership interests. Mr.
Koehl made the independent decision to value only the Beneco
stock.
Accordingly, petitioners have shown that they had every
reason to believe that their adviser was a competent professional
with sufficient expertise to justify their reliance on him.
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There is no question whether petitioners provided necessary and
accurate information to their tax professional. Finally, we find
that petitioners relied in good faith on the adviser’s judgment
and had good reason to do so. It was solely the actions of
petitioners’ tax professional that caused petitioners’ failure to
meet the procedural requisites for their noncash charitable
contributions.10 Under these circumstances, we hold that
petitioners had reasonable cause and are not liable for the
section 6662 penalty with respect to the disallowed noncash
charitable contribution deductions.
Whether Rance and LaRhea Are Liable for a Section 6662 Penalty
With Respect to Their Disallowed Schedule F Losses
Respondent argues that Rance and LaRhea were negligent in
claiming Schedule F losses in each of the taxable years before
the Court. In support of his argument, respondent points out
that Rance described the activity as “crop livestock” on the
Schedule F, whereas at trial it was described as a cutting horse
activity. Respondent also points to the failure to keep business
records, other than a commingled bank checking account. See sec.
1.6662-3(b)(1), Income Tax Regs.
10
We see a difference and a distinction between reliance
for procedural as opposed to substantive aspects or tax
reporting. Petitioners followed the advice and guidance of the
tax professional and provided him with the information needed to
document their contributions. Petitioners relied on the
professional’s ample experience and obligation to make sure that
the transactions were properly reported, which the professional
failed to do.
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The Court observed that Rance’s interest in the activity
focused upon the cutting horses and he was otherwise unfamiliar
with and could not identify many of the items claimed on the
Schedules F. There were only minimal amounts of revenue in any
of the years at issue, and the losses were unabated and
substantial. The size of the tax losses in relation to the
revenue from the activity, combined with Rance’s hobbylike
involvement in the activity, made the situation one that has been
described as “too good to be true” and can readily be construed
as a hobby as opposed to an activity where profit was intended.
Dodge v. Commissioner, T.C. Memo. 1998-89, affd. without
published opinion 188 F.3d 507 (6th Cir. 1999); sec. 1.6662-
3(b)(1)(ii), Income Tax Regs. We also note that Rance was
advised by Mr. Kramer that he needed more revenue to avoid hobby
loss characterization.
Rance’s principal argument on this issue is that he relied
on his tax professional. This Schedule F situation is unlike the
noncash charitable contribution where petitioners complied with
their tax professionals’ requests and the failures to properly
comply with the procedural requirements were the fault of the tax
professionals. Rance was engaged in the activity, and he is a
sophisticated and successful business professional. Rance was
aware of his activities, losses, etc., and his tax professional
merely prepared the returns (Schedules F) from the financial
information that Rance provided. The reliance argument is not
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available to Rance and LaRhea in this instance. Accordingly, we
hold that Rance and LaRhea were negligent, within the meaning of
section 6662, for failure to keep proper books and records and
generally for claiming losses from the cutting horse activity.
Whether Zane and Shannon Are Liable for a Section 6662 Penalty
With Respect to Their Disallowed Schedule F Losses Claimed With
Respect to Their Dog breeding activity and Pre-2001 Cow Activity
Zane and Shannon claimed Schedule F losses in connection
with a dog breeding and showing activity for their 1998, 1999,
2000, and 2001 tax years.11 Zane claimed substantial losses from
his dog showing, breeding, and judging activity even though
prospects for revenue were limited and/or remote. He produced no
formal books and records. The expenses were sometimes combined
with those involving the cow and dairy farm activity, making it
difficult to evaluate the success or progress of the business.
With no revenue from the dog breeding activity in any of the
years at issue, the size of the tax losses from the activity,
combined with the substantial enjoyment Zane derived from his
involvement with the dogs, resulted in a situation that has been
11
Because Zane was found to be involved in a profit-
motivated activity with respect to his 2001 cow and dairy farm
activity, no underpayment results and there is no need to
consider the parties’ arguments with respect to the sec. 6662
penalty regarding that activity. To the extent that an
underpayment is attributable to the cow and dairy farm activity
claimed on the Schedule F for 1998, 1999, or 2000, it is
considered in conjunction with the substantially dominant dog
breeding activity.
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described as “too good to be true.” Smith v. Commissioner, T.C.
Memo. 1997-503; sec. 1.6662-3(b)(1), Income Tax Regs.
Zane’s principal argument on this issue is that he relied on
his tax professional. This Schedule F situation is unlike the
one involving the noncash charitable contributions where
petitioners complied with their tax professionals’ requests and
the failure to properly comply with the procedural requirements
was the fault of the tax professionals. Zane was engaged in the
activity, and he is a sophisticated and successful business
professional. Zane was aware of his activities, losses, etc.,
and his tax professional merely prepared the returns (Schedules
F) from the financial information that Zane provided. The
reliance argument is not available to Zane and Shannon in this
instance.
Accordingly, we hold that Zane and Shannon were negligent,
within the meaning of section 6662, for failure to keep proper
books and records and generally for claiming Schedule F losses
for 1998, 1999, and 2000.
To reflect the foregoing and concessions by the parties,
Decisions will be entered
under Rule 155.