DocketNumber: Docket No. 10292-89
Citation Numbers: 63 T.C.M. 2590, 1992 Tax Ct. Memo LEXIS 211, 1992 T.C. Memo. 188
Judges: COHEN
Filed Date: 3/30/1992
Status: Non-Precedential
Modified Date: 11/20/2020
*211 Decision will be entered under Rule 155.
MEMORANDUM FINDINGS OF FACT AND OPINION
COLVIN,
Sec. | Sec. | Sec. | Sec. | ||
Year | Deficiency | 6653(a)(1)1 | 6653(a)(2)2 | 6661 | 6651(a)(1) |
1984 | $ 3,408 | $ 170 | 3 | -- | $ 852 |
1985 | 6,751 | 338 | $ 1,688 | 1,619 | |
1986 | 734 | 37 | -- | -- |
After concessions, the issues for decision are:
(1) Whether petitioners' horse activity during 1984, 1985, and 1986 was engaged in for profit under
(2) whether petitioners' gross income includes payments received by petitioner Carlene Easter in 1985 and 1986 from a noncompete note awarded to her*212 in her divorce from her prior husband. We hold that it does;
(3) whether petitioners are liable for additions to tax under
The notice of deficiency for 1984 was issued only to petitioner Eddie J. Easter. Accordingly, references to petitioners for the year 1984 are only to him. References to petitioner in the singular are also to Mr. Easter. Section references are to the Internal Revenue Code in effect for the years at issue. Rule references are to the Tax Court Rules of Practice and Procedure.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
1.
Petitioners married in June 1985 and were married throughout 1986. They resided in Florence, Texas, when they filed their petition.
Petitioners were each married previously. Petitioner was married to Tonya Easter. He and Tonya Easter ceased living together in November 1984 and were divorced in June 1985. Petitioner Carlene Easter was married to Gerald Glenn McPherson until their divorce in*213 May 1985.
From 1982 through 1986, petitioner owned and operated E & E Hydraulic and Pump Service (E & E), which was located at petitioner's home. Petitioner maintained a separate bank account for the business in 1984. In 1982 and 1983, petitioner was also employed by River City Air & Hydraulic. In 1986, he was employed by Caliber Construction, Inc. In 1985, petitioner Carlene Easter was employed by Steger & Bizzell.
2.
Petitioner has worked with horses for many years. As a child, he showed horses and worked on a ranch riding horses. He has trained both western pleasure horses and working cow or ranch horses and has shown and fitted halter horses.
Petitioner acquired his horse training skills through practical experience. He has not attended seminars or courses to improve his training abilities or his knowledge of operating a horse business.
From 1982 through 1986, petitioner's horse activities included training, breeding, and reselling horses. Before 1982, petitioner conducted these activities on land which he rented. In 1982 or 1983, petitioner purchased a homestead with 8.5 acres of land. In 1987 and 1988, petitioner built arenas, *214 barns, round pens, and other facilities on the land for working with horses. Petitioner traded his services to get the material to build these things. For example, he rode a person's horse for a month or two in exchange for pipe.
The extent of petitioner's involvement with horses changed over the years. Petitioner sometimes conducted the horse activities while also working a day job. In 1984 he spent between 4 to 6 hours a day working with the horses, and about 8 hours a day running his hydraulic and pump business. Petitioner also trained and rode horses for other people in 1985.
In 1986 the horse market fell. That year petitioner began devoting more time toward working with his own horses. Petitioner trained and rode few, if any, horses for others that year.
Petitioner performed many tasks associated with the horses to save money. For example, he wormed the horses, trimmed their hooves, and sutured their cuts. Petitioner did not employ any trainers.
Petitioner did not have a business plan. He did not consult an accountant about what books and records he should keep. He did not consult with veterinary experts about how to make the horses more salable.
Petitioner had*215 documents which he used in his horse activities. He had business cards. He had stallion service contracts which he used when he bred one of his stallions to another's horse. Petitioner also had a breaking, training, and boarding agreement which he used when he performed services for others.
Petitioner had fliers printed announcing the availability of one of his stallions for stud.
During the years at issue, petitioner did not keep a record of the points awarded to his horses when he showed them. In 1978, he registered the brands he used to identify his horses. Petitioners did not maintain a separate bank account for their horse activity.
At the time of trial, petitioners owned two potentially valuable horses. The first was a stallion, which was the only male offspring of a horse which won over $ 7 million in races during 1990. Petitioners have advertised this horse. The other was a mare whose parents are both "AAA producers". 1 Petitioners were raising the mare's colt.
*216 3.
Before 1983, Carlene Easter and her former husband, Gerald Glenn McPherson, lived in Alaska where they owned a business. In 1983 they sold the business. As part of the sale, Carlene Easter and her former husband agreed not to compete with the buyer.
The divorce decree between Carlene Easter and Mr. McPherson awarded the noncompete contract to Mrs. Easter as follows: "A note in the amount of approximately $ 1,000.00 per month, payable to * * * [the parties] by Northwest Technical Services, Inc." This provision appears under the heading "Division of Marital Estate". Petitioners received $ 7,000 in 1985 and $ 12,000 in 1986 pursuant to this contract.
The divorce decree required Mr. McPherson to pay the following: child support of $ 200.00 per month, with the first payment being due and payable on August 15, 1985, and at the expiration of thirty-two months, the child support payment shall increase to $ 500.00 per month, with the first payment being due and payable on the [sic] January 15, 1988, and a like payment being due and payable on the same day of each month thereafter * * *
4.
Petitioner filed an individual income tax return for 1984 using rates for married filing separately on January 28, 1988. On the same date, petitioners filed joint returns for 1985 and 1986. Petitioners' income tax return for 1987 is not dated. Petitioners' 1988 return is dated September 22, 1989. The deficiency notices for 1984, 1985, and 1986 were issued to petitioners on February 15, 1989.
Petitioner first reported his horse activity on his 1982 income tax return. The following are the net profits and losses which petitioners reported for their horse activities on their 1982 through 1988 income tax returns:
11982 | 1983 | 1984 | 1985 | |
Income | 2 | <$ 4,386> | <$ 4,603> | $ 661 |
Deductions | <6,700> | <3,764> | <8,329> | <5,855> |
NET | <$ 6,700> | <$ 8,150> | <$ 12,932> | <$ 5,194> |
PROFIT/LOSS |
1986 | 1987 | 1988 | |
Income | <$ 2,259> | $ 4,153 | $ 3,250 |
Deductions | <5,580> | <2,391> | 3 <2,038> |
NET | <$ 7,839> | $ 1,762 | $ 1,212 |
PROFIT/LOSS |
*218 Petitioners reported the following income from sales of horses on Schedule F for 1982 through 1986:
1982 | 1983 | 1984 | 1985 | 1986 | |
Amount | 1 | $ 0 | $ 0 | $ 3,891 | $ 1,391 |
Cost or other basis | 4,386 | 4,603 | 3,230 | 3,650 | |
PROFIT OR LOSS | <$ 4,386> | <$ 4,603> | $ 661 | <$ 2,259> |
Petitioners reported the following income for their horse activities on Schedule C for 1987 and 1988:
1987 | 1988 | |
Gross receipts or sales | $ 4,153 | $ 3,250 |
Cost of goods sold | 1 | |
GROSS INCOME | $ 4,153 | $ 3,250 |
Petitioners deducted the following amounts for their horse activities:
11982 | 1983 | 1984 | 1985 | 1986 | 1987 | 1988 | |
Feed | $ 523 | $ 2,061 | $ 5,506 | $ 3,293 | $ 2,621 | $ 1,252 | $ 436 |
Veterinary | 436 | 777 | 488 | 312 | 312 | 83 | 390 |
Death loss | 4,000 | 0 | 0 | 0 | 0 | 0 | 0 |
Farrier | 0 | 25 | 275 | 336 | 166 | 0 | 0 |
Tack | 0 | 840 | 1,695 | 1,009 | 113 | 0 | 0 |
Advertising | 0 | 41 | 129 | 132 | 290 | 0 | 31 |
Depreciation | 0 | 0 | 0 | 0 | 500 | 1,000 | 1,000 |
Dues/fees/ | 0 | 20 | 236 | 51 | 320 | 56 | 60 |
subs./pubs. | |||||||
Other | 1,742 | 0 | 0 | 722 | 1,258 | 0 | 212 |
TOTAL | $ 6,701 | $ 3,764 | $ 8,329 | $ 5,855 | $ 5,580 | $ 2,391 | 2 $ 2,038 |
Petitioners concede, among other things, that their gross income for 1984, 1985, and 1986 included interest income of $ 637, $ 1,792, and $ 1,579, respectively, and net capital gains of $ 33,057, $ 29,521, and $ 8,669, respectively.
Petitioners reported wage income of $ 3,816 from Steger & Bizzell on their 1985 return and wage income of $ 13,263 from Caliber Construction, Inc., on their 1986 return.
OPINION
1.
The first issue for decision is whether petitioners' horse activity in 1984, 1985, and 1986 was for profit under
a.
In the 7 years from 1982 through 1988, petitioners reported profits in 2 years, 1987 and 1988. Thus, we must decide if petitioners are entitled to a rebuttable presumption that their horse activities were engaged in for profit.
While petitioners reported gross receipts or sales for horse activities in 1987 and 1988 of $ 4,153 and $ 3,250, respectively, they did not indicate whether the income was from sales of horses or from services performed.
To the extent that this income was attributable to the sale of horses, petitioners should have deducted amounts for basis, or cost of goods sold.
Alternatively, all or a portion of petitioner's horse income in 1987 and 1988 may have been from services performed. However, the record shows that petitioners had little, if any, income from services in 1987 and 1988.
Petitioner*221 testified that, because the horse market fell in 1986, he was less active with horses in 1987 and 1988. Petitioners' returns support this. The returns show that, between 1986 and 1987, petitioners' horse-related expenses were dramatically reduced. Petitioners deducted $ 2,621 for feed in 1986, $ 1,252 in 1987, and only $ 436 in 1988. In addition, petitioners deducted $ 166 and $ 113 for farrier and tack in 1986, but nothing for 1987 and 1988. Petitioners deducted $ 290 for advertising in 1986, none in 1987 and only $ 31 in 1988.
Accordingly, we conclude that very little or none of the income which petitioners reported from horse activities in 1987 and 1988 was due to petitioner's performance of horse-related services.
Finally, we question the credibility of the 1987 and 1988 returns on other grounds. As respondent argues, petitioners prepared the 1988 return after the notices of deficiency were issued in this case. It is unclear from the record when petitioners prepared their 1987 return. These same 2 years are the only years between 1982 and 1988 in which petitioners reported a profit. Considering this in conjunction with petitioners' failure to show the source of their*222 income for 1987 and 1988, we are not convinced that petitioners actually made a profit in those years.
For the reasons stated above, we do not believe that petitioners' 1987 and 1988 returns fairly reflect what petitioners earned in those years from the horse activity. Accordingly, we find that the presumption that petitioners engaged in the horse activity for profit is inapplicable.
b.
We next decide whether petitioners engaged in the horse activities for profit under
Petitioner argues that his goal and objective has always been to earn a profit and that he never has considered the work a hobby.
Whether petitioner had the requisite profit objective is an issue of fact to be resolved on the basis of all of the facts and circumstances.
The first factor is the manner in which the taxpayer carries on the activity.
Complete and accurate recordkeeping may indicate that an activity is engaged*224 in for profit.
Petitioner testified that he thought he received some stud fees during the years at issue, but he did not produce any evidence to corroborate his testimony.
Petitioners deducted a total of $ 551 for advertising in the years at issue. At trial, petitioners produced a copy of a flyer which they had printed to advertise one of their stallions for stud. They did not, however, introduce evidence indicating how these fliers were distributed or if they advertised any of petitioner's other services.
Petitioner kept ribbons and trophies which his horses won at *225 shows. He registered the brands he used to identify his horses. He did so, however, in 1978 (4 years before he reported his horse activity on his returns), and he has not shown that the registration was related to a profit objective.
Petitioner had business cards, stallion service contracts, and breaking, training, and boarding agreements. At trial, however, he presented copies of only one service contract and two breaking, training, and boarding agreements to show that he contracted and was paid for services he performed for others.
During the years at issue, petitioners did not maintain a separate bank account for their horse activity, even though they maintained a separate bank account for petitioner's other business, E & E, during at least one of the years at issue. Petitioner did not consult an accountant about what types of books or records he should keep for the business. Petitioner did not convince us that he had a business plan or show that he seriously sought customers. He failed to show how he got customers, or how he expected to become profitable.
A change of operating methods or abandonment of unprofitable methods in a manner consistent with an intent to improve*226 profitability may indicate a profit objective.
On balance, we think this first factor suggests that petitioners did not conduct their horse activities in a businesslike manner.
The second factor is the expertise of the taxpayer or his advisers.
Petitioner was experienced in some aspects of raising horses. He knew how to perform various tasks associated with the activity himself and did so in order to save money. However, there is little or no indication that he studied the business aspects of the activity (e.g., how to operate for profit) and we are not convinced that he was knowledgeable about these things. Furthermore, petitioner's testimony that he talked to people in the horse training and sales business about how to make the business profitable was vague and unconvincing.
The third factor is the time and effort expended by the taxpayer in carrying on the activity.
Between 1984 and 1986, petitioner worked at least one other job in addition to conducting his horse activities. During each of these years, he owned and operated E & E. In 1984, petitioner spent about 8 hours each day running E & E and between 4 to 6 hours working with the horses. It is unclear how much time petitioner spent working with horses during 1985. In 1986, however, petitioner trained and rode few, if any, horses for others. He was employed by Caliber Construction, Inc., during that year.
We think that petitioner's involvement with his business, E & E, along with his job with Caliber Construction, Inc., indicate that petitioner's horse activity was generally a secondary focus.
Petitioner testified about how hard he worked at the horse activity, even when he also worked a day job. He testified that, at times, he drove at night to another State to purchase horses and bring them back to Texas over the weekend. He would then sell them all day Sunday and on Monday evening after working his regular job. Petitioner, however, *229 did not indicate how often he did this or whether he did so during the years at issue, and he did not produce records to corroborate the testimony. Petitioner has not persuaded us that he expended substantial amounts of time and effort in business-related horse activities during the years at issue.
The fourth factor is the expectation that the assets used in the activity may appreciate in value.
Petitioner has not convinced us that he expected that his horses would appreciate in value. For 1983, 1984, and 1986, petitioner's basis in horses that he sold substantially exceeded his sales price for the horses. For 1987 and 1988, although petitioner reported gross receipts or sales, he did not deduct from that the cost of goods sold or basis. Because the horses petitioner*230 sold between 1983 and 1988 appreciated little in value, if at all, we do not believe that petitioners could have reasonably expected to rely on the appreciation in value of the horses to make a profit.
The fifth factor is the success of the taxpayer in carrying on other similar or dissimilar activities.
The record does not contain evidence of past efforts on the part of petitioner to convert an unprofitable business to one that is profitable. Accordingly, we have not considered this factor in our determination of petitioner's profit objective in his horse activities.
The sixth factor is the taxpayer's history of income or loss with respect to the activity.
Petitioner reported losses for his horse activities for 1982 through 1986 in the following amounts: 1982 -- $ 6,699; 1983 -- $ 8,150; 1984 -- $ 12,932; 1985 -- $ 5,194; and 1986 -- $ 7,839. Petitioners did report gains of $ 1,762 and $ 1,212 in 1987 and 1988. However, as discussed previously, we are not convinced that petitioners actually realized gains in these years. We believe that this record of losses indicates that petitioner did not have the objective*232 to make a profit.
Petitioner argues that, but for certain circumstances, he would have made a profit in a few of these years. For example, he asserts that the decline of the horse market adversely affected his ability to make a profit. In addition, petitioner argues that, if one of his stud horses had not died in 1982, he may have made a profit that year. Petitioner also argues that his profit prospects have improved because two racetracks opened near petitioners, apparently after the years at issue. We find petitioner's arguments speculative and unconvincing. We believe that petitioners' history of losses shows that their horse activity was not engaged in for profit.
The seventh factor is the amount of occasional profit, if any, which is earned.
The eighth factor is the financial status of the taxpayer.
Petitioners have income from other sources, against which to deduct these losses, but it is not "substantial" income. Accordingly, we give this factor little weight in our determination of whether petitioner engaged in his horse activities for profit.
The ninth factor is whether elements of personal pleasure or recreation are involved.
Petitioner enjoyed working with horses. He has done so since he was a child. Petitioner testified that his children sometimes rode the horses. We conclude that petitioner's enjoyment of horses weighs against the finding that he engaged in the horse activities for profit.
There is some evidence which indicates*234 that petitioners may have engaged in the horse activity for profit, but it is outweighed by evidence showing that they did not. Many of petitioner's claims, such as time spent, number of customers, proportional efforts, business plan, and business records, are vague and uncorroborated. Petitioners have failed to show that they possessed the required profit objective concerning their horse activities for 1984 through 1986. Accordingly, we find that they did not engage in the horse activities for profit.
2.
The second issue for decision is whether petitioners' gross income includes payments received by petitioner Carlene Easter in 1985 and 1986 from a noncompete note awarded to her in her divorce from her former husband. Petitioners bear the burden of showing that they are not liable for tax on these payments.
Petitioners argue that petitioner Carlene Easter did not report these payments as income because there was a clear understanding between her and her former husband that the payments were in lieu of child support.
Gross income does not include the receipt of payments which*235 are in the nature of child support.
We do not agree with petitioners' position that the payments in question are child support. The divorce decree did not "fix" this money as child support. The decree labels the payments a division of marital property. The decree "fixes" other money as child support, namely $ 200 for 32 months and then $ 500 per month.
Thus, we find that the payments in question are not child support. Accordingly, they are taxable as income to petitioners.
3.
The next issue for decision is whether petitioners are liable for additions to tax for negligence for 1984, 1985, and 1986 under
Negligence is defined as a lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances.
As a general rule, taxpayers are charged with knowledge of the law.
Respondent's determination of a taxpayer's negligence or intentional disregard of rules and regulations is prima facie correct, and the taxpayer bears the burden of proving that he acted *238 reasonably, prudently, and with due care in preparing and filing his Federal income tax returns.
Petitioners failed to report several thousand dollars in interest income and capital gains for the years at issue. In addition, they did not report as income the payments petitioner Carlene Easter received in 1985 and 1986 pursuant to the noncompete note awarded to her in her divorce from her former husband.
Petitioners have not presented evidence to show that they exercised care in preparing their returns for the years at issue, nor have they given any persuasive reason why they should not be liable for the negligence addition. Accordingly, we conclude that they have not met their burden of proof and are liable for additions to tax for 1984, 1985, and 1986 under
4.
The next issue for decision is whether petitioners are liable for additions to tax for substantial understatement of income*239 tax for 1985 under
If the taxpayer has substantial authority for his tax treatment of any item on the return, the understatement is reduced by the amount attributable thereto.
The taxpayer bears the burden of proving that he is not liable for the addition to tax for substantial understatement of income tax.
Petitioners have offered no evidence to show why they are not liable for the
5.
The final issue for decision is whether petitioners are liable for additions to tax for 1984 and 1985 under
In order to prove "reasonable cause", a taxpayer must show that he exercised ordinary business care and prudence and was*241 nevertheless unable to file the return within the prescribed time.
A taxpayer may establish reasonable cause for failing to file a timely return by proving that he reasonably relied on the advice of an accountant or attorney and later found that such advice was erroneous or mistaken. See
Petitioners were late in filing their income tax returns for 1984 and 1985. They filed each of these returns on January 28, 1988. They have not explained why they did not file timely. Accordingly, they have not sustained their burden of proving that the*242 failure was due to reasonable cause. We hold they are liable for additions to tax for 1984 and 1985 under
To reflect the foregoing,
1. For taxable year 1986,
2. For taxable year 1986,
3. Fifty percent of the interest due on the portion of the underpayment attributable to negligence.↩
1. Petitioners did not indicate what an "AAA producer" is.↩
1. Numbers for 1982 have been rounded. ↩
2. Petitioners left this section blank on returns. ↩
3. This is the number shown on return. Correct amount is $ 2,129↩
1. Petitioners left this section blank on returns.↩
1. Petitioners left this section blank on returns.↩
1. Numbers for 1982 have been rounded. ↩
2. This is the number shown on return. The correct amount is $ 2,129.↩
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