Holowinski v. Commissioner

T.C. Memo. 1997-168
UNITED STATES TAX COURT
B. ALBERT AND BETTY M. HOLOWINSKI, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 4726-96. Filed April 7, 1997.
Scott M. Estill, for petitioners.
Robert A. Varra, for respondent.
MEMORANDUM OPINION
POWELL, Special Trial Judge: This case was assigned
pursuant to the provisions of section 7443A(b)(3) and Rules 180,
181, and 182.1
1
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the years in issue, and all
Rule references are to the Tax Court Rules of Practice and
Procedure.
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Respondent determined deficiencies in petitioners' Federal
income taxes and accuracy-related penalties as follows:
Years Deficiencies Sec. 6662(a) Penalties
1992 $1,905 $381
1993 3,570 714
1994 2,029 406
The issues are: (1) Whether petitioners' antique glassware
sales activity was engaged in for profit within the meaning of
section 183, and (2) whether petitioners are liable for the
accuracy-related penalties pursuant to section 6662(a).
Background
Petitioners resided in Littleton, Colorado, at the time they
filed their petition. The facts may be summarized as follows.
Petitioner Betty M. Holowinski obtained a high school degree
and attended 2 years of college where she studied political
science. Petitioner B. Albert Holowinski served in the United
States military for many years and, after his military
retirement, worked in the aerospace industry. During his
military service he obtained a bachelor's degree in business and
a master's degree in urban affairs.
In 1992, both petitioners had retired. Early that year,
Mrs. Holowinski became interested in buying and selling Victorian
glassware. She thought they could make money and that they would
have fun traveling around to various antique shops and flea
markets looking for the glass. To gain some background knowledge
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Mrs. Holowinski read a book entitled "How to Make Money in
Antiques". Mr. Holowinski spoke with an accountant, Alan Myers
(Mr. Myers), about bookkeeping and tax matters.
In April 1992, petitioners began buying antique glassware.
Petitioners continued to purchase antique glassware throughout
the years in issue, focusing primarily on glass produced by a
company named Westmoreland Glass (Westmoreland) that conducted
business from 1875 to 1985. Petitioners traveled to antique
conventions and to antique shops throughout the central United
States in search of Westmoreland glassware. Petitioners' travels
took them to various States including Kansas, Ohio, Tennessee,
Iowa, Nebraska, Oklahoma, Texas, Arkansas, and Illinois.
Petitioners envisioned purchasing glassware for approximately 40
to 50 percent of its potential resale value. During the taxable
years 1992, 1993, and 1994 petitioners spent $7,173, $7,471, and
$4,144, respectively, for glassware. Petitioners stored the
glassware in their home, placing the inexpensive pieces in their
basement and the more valuable pieces upstairs where the
temperature remained constant. Some glassware was displayed on
the walls of various living areas of petitioners' home and in
china cabinets.
Mrs. Holowinski spent approximately 40 hours per week on the
antique glassware sales activity, which petitioners called Albe's
Antiques, and Mr. Holowinski spent 20 to 30 hours per week.
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Sales were generated by three methods: (1) Through
advertisements in antique newsletters (newsletter sales); (2) at
antique conventions, by selling out of their hotel room and at
auctions (convention sales); and (3) by renting a showcase at the
Colorado Antique Gallery (showcase sales). Sales were
approximately evenly divided between the three methods. While
the bulk of the glassware collection was located in their home,
for security reasons petitioners never gave out their home
telephone number or address. Rather, petitioners paid $50 a
month plus a commission equal to 10 percent of sales to rent the
showcase, which held approximately 100 pieces of merchandise.
For 1992, 1993, and 1994, petitioners' sales from the three
methods, before paying commissions on showcase sales, totaled
$264, $1,583, and $2,253, respectively.
Petitioners kept detailed inventory records and a mileage
log. They maintained a separate bank account for Albe's Antiques
in 1992 and part of 1993, but closed the account in 1993 to save
money on fees. Petitioners insured their inventory on their
homeowners' policy. Albe's Antiques was licensed to do business
and collect sales tax in Colorado.
Petitioners did not prepare any financial statements or
income projections for Albe's Antiques. At the end of each
taxable year, Mr. Myers prepared petitioners' tax returns based
on information petitioners provided to him. Petitioners have not
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prepared profit and loss statements for the years subsequent to
those before the Court.
Mrs. Holowinski summarized the antique glassware sales
activity as follows:
Very few people know that we deal in antiques. There's
no sign at the house -- first of all, because of where
we live, we couldn't have a business.
So * * * [the business is] very low-keyed, we keep
a low profile, and it's only through the mail or when
we go on these conventions * * *.
On their 1992, 1993, and 1994 Federal income tax returns,
petitioners reported losses from the antique glassware sales
activity in the amounts of $9,504, $12,734, and 11,664,
respectively. In summary, the losses were computed as follows:
1992 1993 1994
Sales $264 $1,583 $2,253
Cost of Goods Sold 170 973 1,453
Gross Profit 94 610 800
Expenses:
Commissions and fees2 63 165 110
Car, truck & travel 7,391 10,626 9,665
All other expenses 2,144 2,553 2,689
Net Loss (9,504) (12,734) (11,664)
In the notice of deficiency respondent determined that
petitioners were not entitled to deductions for the net losses
listed above because their antique glassware sales activity was
2
The commission expenses are listed in the amounts reported on
petitioners' tax returns for the years in issue. We recognize
that these numbers do not square with the reported sales figures
and the formula provided by petitioners for computing commissions
on showcase sales. We speculate that petitioners may have sold
some items and incurred commissions at auctions and at antique
conventions they attended.
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not engaged in for profit. Respondent further determined that
petitioners were liable for an accuracy-related penalty for each
year in issue pursuant to section 6662(a) for negligence or
disregard of rules or regulations. In addition, respondent made
certain computational adjustments as a result of the disallowance
of the Schedule C losses.3
Discussion
A. Activity for Profit
Section 162(a) allows deductions for ordinary and necessary
expenses in carrying on a trade or business. Section 183(a)
generally provides that an individual's deductions attributable
to an activity not engaged in for profit shall only be allowed to
the extent provided in section 183(b). Section 183(b) generally
limits the deductions from an activity not engaged in for profit
to the sum of (1) otherwise allowable deductions, and (2) any
other deductions attributable to the activity to the extent the
gross income from the activity exceeds the otherwise allowable
deductions. Section 183(c) defines an "activity not engaged in
for profit" as any activity other than one for which deductions
are allowable under section 162 or under paragraph (1) or (2) of
section 212. The test for determining whether an individual is
carrying on a trade or business under section 162, or whether an
3
The computational adjustments affect the amount of
petitioners' Social Security benefits that are taxable for
certain years, and petitioners' medical expense deduction for
1994.
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individual is engaged in an activity for the production or
collection of income or for the management, conservation, or
maintenance of property held for the production of income under
section 212, is whether the individual is engaged in the activity
with the predominant purpose and intention of making a profit.
Nickeson v. Commissioner, 962 F.2d 973, 976 (10th Cir. 1992),
affg. Brock v. Commissioner, T.C. Memo. 1989-641; Allen v.
Commissioner, 72 T.C. 28, 33 (1979). While the taxpayer's
expectation need not be reasonable, it must be a good-faith
expectation. Allen v. Commissioner, supra at 33. In resolving
the factual question of the taxpayer's intent, greater weight is
given to the objective facts than to the taxpayer's statements of
intention. Thomas v. Commissioner, 84 T.C. 1244, 1269 (1985),
affd. 792 F.2d 1256 (4th Cir. 1986).
Section 1.183-2(b), Income Tax Regs., sets forth a
nonexclusive list of nine factors to be used to determine whether
an activity is engaged in for profit. The factors are: (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 the 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
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financial status of the taxpayer; and (9) elements of personal
pleasure or recreation. No single factor, nor a simple numerical
majority of factors, is necessarily controlling. Cannon v.
Commissioner, 949 F.2d 345, 350 (10th Cir. 1991), affg. T.C.
Memo. 1990-148.
Several factors weigh slightly in petitioners' favor.
First, petitioners generally carried on the activity in a
businesslike manner. They maintained accurate inventory records,
obtained a Colorado business license, registered with the State
to collect sales tax, advertised in antique newsletters although
in a limited fashion, and rented a showcase at the Colorado
Antique Gallery.
On the other hand, some factors weigh heavily in favor of
respondent. Petitioners reported no profits, but rather
substantial losses for the years in issue. See Golanty v.
Commissioner, 72 T.C. 411, 427 (1979), affd. without published
opinion 647 F.2d 170 (9th Cir. 1981). While losses in the early
years of an activity may not be indicative of the absence of a
profit motive, several facts convince us otherwise in this case.
First, petitioners reported losses of more than eight times the
total sales reported for the years in issue (total sales).
Petitioners incurred traveling expenses in excess of six times
the total sales. Considering only cost of goods sold and direct
selling expenses (commission expenses and the $50 a month
showcase rental) petitioners posted a cumulative loss for the
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years in issue. Indeed, assuming petitioners liquidated all of
the inventory they purchased during the years in issue and that
they were able to purchase it at 40 percent of the hypothetical
sale value, the ensuing gross profit would not even cover the
cost of their traveling expenses. Stated more bluntly,
petitioners' traveling expenses were so grossly in excess of
their total sales that petitioners had no prospect of ever
turning a profit.4
Furthermore, we find it telling that for subsequent years
petitioners have not even prepared a profit and loss statement.
Surely, if a person were concerned with making a profit, she or
he would be interested in whether in fact there was or would be a
profit or loss from the activity.
Finally, petitioners admittedly derived personal pleasure
from antique hunting and possibly from displaying their more
valuable pieces of antique glassware in their home. We are
cognizant of the fact that there is no general prohibition on
pursuing a business that one enjoys. See Larson v. Commissioner,
T.C. Memo. 1991-99. We are also cognizant that the Federal fisc
should not help underwrite personal pursuits. See Stanley v.
Commissioner, T.C. Memo. 1980-217.
In sum, after considering all the relevant factors, we
conclude that, while petitioners may have intended to earn a
4
We note that petitioners' travel records showed that of the
34 days traveling in 1993, 10 were spent in the Dallas/Fort Worth
area where petitioners' daughter lived.
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profit on individual items of glassware, when the activity is
viewed in its entirety, petitioners did not engage in the antique
glassware sales activity for profit.
B. Penalties
Section 6662(a) and (b)(1) impose a penalty equal to 20
percent of any portion of an underpayment attributable to
negligence or disregard of rules or regulations. Negligence is
defined as the lack of due care or failure to do what a
reasonable and ordinarily prudent person would do under the
circumstances. Neely v. Commissioner, 85 T.C. 934, 947 (1985).
Section 6664(c)(1) provides that no penalty shall be imposed
under section 6662(a) with respect to any portion of an
underpayment if it is shown that there was a reasonable cause for
such portion and the taxpayer acted in good faith. Whether the
taxpayer acted with reasonable cause and in good faith is
determined on a case-by-case basis taking into account all of the
pertinent facts and circumstances. Remy v. Commissioner, T.C.
Memo. 1997-72. Relevant factors include the taxpayer's efforts
to assess his or her proper tax liability, the knowledge and
experience of the taxpayer, and reliance on the advice of a
professional, such as an accountant. Drummond v. Commissioner,
T.C. Memo. 1997-71. An honest misunderstanding of fact or law
that is reasonable in light of the experience, knowledge, and
education of the taxpayer may indicate reasonable cause and good
faith. Remy v. Commissioner, supra.
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The determination of whether petitioners engaged in their
antique glassware sales activity for profit involves a difficult
factual question. See, e.g., Cavalaris v. Commissioner, T.C.
Memo. 1996-308. Petitioners substantiated all of the claimed
expenses and employed an accountant to prepare their tax returns
and advise them. Nothing in the record suggests that their
reliance on Mr. Myers was less than reasonable, particularly
considering petitioners' lack of prior business experience and
educational backgrounds.5 Accordingly, we find that petitioners
acted with reasonable cause and in good faith, and, therefore,
the penalties do not apply.
Decision will be entered for
respondent with respect to the
deficiencies, and decision will
be entered for petitioners with
respect to the penalties under
section 6662(a).
5
While Mr. Holowinski did obtain his undergraduate degree in
business administration, he did so many years prior to those in
issue. His work experience did not focus on business or
financial skills, and he does not appear to have any special
training in accounting or tax matters.