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Parties Involved:
Charla Gates Cannon
Appellant
Commissioner of Internal Revenue
Appellee

Document Text:

( 

PUBLISH 

UNITED STATES COURT OF APPEALS 

TENTH CIRCUIT 

CHARLA GATES CANNON, 

Petitioner-Appellant, 

FIL.ED 

United St.ates Coprt (?f Appeals Tenth C1rcu1t 

,mv 15 1991 

ROBERT L. HOECKER 

Clerk 

) 

) 

) 

) 

) 

) 

) 

) 

) 

No. 90-9017 

v. 

COMMISSIONER OF INTERNAL REVENUE 

Respondent-Appellee. 

Appeal from the United States Tax Court 

No. 9671-82 

Towner Leeper of Leeper & Leeper, El Paso, Texas (Arthur Bosworth 

of Denver, Colorado with him on the brief) for 

Petitioner-Appellant. 

Sally J. Schornstheimer of the United States Department of 

Justice, Tax Division, Washington, D.C •. (Gary R. Allen, Richard 

Farber, and Shirley D. Peterson with her on the brief) for 

Respondent-Appellee. 

Before MOORE and EBEL, Circuit Judges, and ANDERSON, District 

Judge*. 

EBEL, Circuit Judge. 

* The Honorable Aldon J. Anderson, District Judge, United 

States District Court for the District of Utah, sitting by designation. 

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Appellate Case: 90-9017 Document: 010110097314 Date Filed: 11/15/1991 Page: 1 
This case concerns a taxpayer who became involved in an 

unprofitable mining venture and deducted her distributive share of 

certain partnership losses on her income tax returns. The 

Commissioner of Internal Revenue disallowed these deductions, and 

the Tax Court upheld the Commissioner's determinations. The 

taxpayer appeals, raising two issues. First, did the Tax Court 

correctly resolve the case on a theory not considered by either 

party, namely, section 183 losses? Second, did the Tax Court 

correctly conclude that the limited partnership did not incur the 

expenses at issue with the requisite profit motive? We conclude 

that the Tax Court's reliance on section 183 was proper and that 

the court's findings regarding partnership motives were not 

clearly erroneous. Accordingly, we affirm. 

I. BACKGROUND 

The facts in this case are fully set forth in the Tax Court's 

opinion. See Cannon v. Commissioner, 59 T.C.M. (CCH) 164 (1990). 

For purposes of this appeal, they may be summarized as follows: 

This case involves a taxpayer's treatment of losses incurred 

in connection with a Mexican gold and silver mining venture. In 

1973, the taxpayer, Charla Cannon, joined a limited partnership 

("Vemco") that was formed "to engage in the business of land 

development, exploration, mining and ore processing both in the 

United States and foreign countries." Id. at 165 (citation 

omitted). The taxpayer, who had a large annual income from trusts 

and her deceased husband's estate and employment benefits, 

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provided Vemco with the funds necessary to conduct its business 

operations. In return, she was to receive a higher percentage 

than her partners of the profits or the proceeds in the event of a 

sale or disposition of the partnership assets. In addition, the 

annual expenses and losses of the partnership were allocated to 

the taxpayer insofar as her capital account permitted. 

Vemco decided to invest in the Mexican venture at issue in 

this case in reliance upon the findings of an experienced miner 

who explored the sites and an engineer who analyzed and reported 

on the mining properties. Because Mexican law prohibits nonMexican nationals or corporations from acquiring a majority 

interest in Mexican mining concessions, Compania Minera San Jose 

de Manzanillas, S.A. ("Manzanillas"), a Mexican corporation, held 

the mining concessions, and Vemco became a forty-nine percent 

shareholder in that corporation. 1 In 1978, however, Vemco 

discovered that the president of Manzanillas had been embezzling, 

and the mining concessions were transferred to Memco, a different 

Mexican corporation. Although the taxpayer, through Vemco, 

expended over $800,000 for exploration and development of the 

mines, Memco never operated at a profit. Vemco did not report any 

income from mining for the years involved in this lawsuit, nor did 

it receive any dividends. 

The taxpayer deducted her distributive share of the 

partnership losses claimed by Vemco on her federal income tax 

returns for 1976, 1977, 1978, and 1979. The Commissioner of 

1 The taxpayer claimed that Vemco was in a joint venture with 

this Mexican corporation, but the Tax Court rejected this 

argument. 59 T.C.M. at 171. 

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Appellate Case: 90-9017 Document: 010110097314 Date Filed: 11/15/1991 Page: 3 
Internal Revenue ("Commissioner") disallowed these deductions on 

the grounds that the taxpayer did not establish that these amounts 

constituted ordinary and necessary business expenses or were for 

an activity entered into for profit or for the production of 

income. Alternatively, the Commissioner asserted that these 

amounts were nondeductible capital contributions to the Mexican 

corporation that the parties formed to hold title to the mines. 

The Tax Court agreed with the Commissioner's decision to 

disallow the deductions, but found the expenditures to be 

nondeductible under section 183 of the Internal Revenue Code. 

Because the Tax Court decided the case on the basis of a section 

that neither party raised explicitly, the taxpayer filed a motion 

for reconsideration, which was denied. The taxpayer appeals. 

This court has jurisdiction to review the Tax Court's decision 

pursuant to 26 u.s.c. § 7482(a). 

We first discuss whether the Tax Court erred in resolving 

this case on the basis of section 183. We then discuss whether 

the expenses at issue were incurred with the requisite profit 

motive. 

II. DISCUSSION 

A. The Propriety of Resolving the Case Under Section 183 

In Commissioner v. Transport Manufacturing & Equipment Co., 

478 F.2d 731, 735 (8th Cir. 1973), the Eighth Circuit stated that 

the Commissioner should notify the taxpayer of the particular Code 

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Appellate Case: 90-9017 Document: 010110097314 Date Filed: 11/15/1991 Page: 4 
section, regulation, or theory involved in a case to avoid 

prejudice to the taxpayer. The court reasoned that "[t]he 

taxpayer works at an extreme disadvantage in trying to invalidate 

deficiency assessments if he does not specifically know why the 

Commissioner is challenging the taxpayer." Id. (footnote 

omitted). The court recognized, however, that prejudice does not 

always result: "Of course, if a certain Code section, regulation 

or theory has not been specifically raised in the notice of 

deficiency, in the pleadings, or at trial and if there is an 

absence of surprise on the taxpayer's part, the taxpayer has no 

reason to complain." Id. n.8 (citation omitted). 

Here, the taxpayer contends that the Tax Court erroneously 

decided this case on the basis of a theory and Code provision 

(lack of profit motive and section 183) that neither party 

considered or raised, thereby surprising and prejudicing the 

taxpayer. According to the taxpayer,· only three Code sections 

were at issue: sections 162, 212, and 616. 2 We disagree. 

Section 183 is interrelated to sections 162 and 212, profit motive 

being the common underlying theme. Indeed, as discussed infra, 

these provisions even reference each other. Accordingly, we find 

2 Section 162 allows for the deduction of "all the ordinary and 

necessary expenses paid or incurred during the taxable year in 

carrying on any trade or business .... " I.R.C. § 162(a). 

Section 212 allows for the deduction of "all the ordinary and 

necessary expenses paid or incurred during the taxable year -- (1) 

for the production or collection of income; [or] (2) for the 

management, conservation, or maintenance of property held for the 

production of income .••• " I.R.C. § 212. 

Section 616 allows for the deduction of development 

expenditures for mines and other natural deposits "if paid or 

incurred after the existence of ores or minerals in commercially 

marketable quantities has been disclosed." I.R.C. § 616(a). 

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that the taxpayer in this case was adequately put on notice, was 

not prejudiced, and should not have been surprised. 

The taxpayer asserts that neither party ever considered the 

Tax Court's position that a profit motive was not present. Yet, 

the evidence reveals that profit motive was indeed a critical 

issue in this case and that the Commissioner was unwilling to 

concede the presence of a profit motive. For example, the 

statutory notices of deficiency that the Commissioner issued to 

the taxpayer expressly stated that she had not established that 

she entered into the transaction in pursuit of economic profit and 

that this lack of profit motive was one of the bases for the 

disallowance of the claimed partnership deductions. Record, 

vol. I, doc. 3, Deficiency Notice, Explanation of Adjustments, 

Exhibit A. In addition, the Commissioner's opening statement 

explicitly noted that the taxpayer had to prove a profit motive. 

Record, vol. II, Transcript, Nov. 19, 1986, at 26. Indeed, the 

taxpayer attempted to do this, see infra Part II.B, and 

acknowledged that "(t]o obtain a deduction under Section 162 for a 

trade or business expense or under Section 212 for an expenditure 

for the production of income requires a profit motive." Brief for 

Appellant at 37. 3 

In determining whether the mining activity met the 

requirements of sections 162 or 212, the court naturally applied 

section 183. Section 183 is often used in analyzing "for profit" 

issues, both in the context of hobby losses and in the context of 

3 Thomas v. Commissioner, 792 F.2d 1256, 1259 (4th Cir. 1986), 

establishes that section 616 also requires a profit motive. 

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trade or business expenses. Numerous courts have used the 

regulations accompanying section 183 to determine profit motive 

under other sections. See, e.g., Independent Elec. Supply, Inc. 

v. Commissioner, 781 F.2d 724, 726-27 (9th Cir. 1986) ("the courts 

have relied on the section 183 factors in conducting the profit 

motive analysis under section 162"); Brannen v. Commissioner, 722 

F.2d 695, 704-06 (11th Cir. 1984) (applying factors listed in 

section 183 regulations to determine whether taxpayer's activities 

were engaged in for profit under section 162); Faulconer v. 

Commissioner, 748 F.2d 890, 893 (4th Cir. 1984) (referring to 

section 183 to determine whether a taxpayer was entitled to 

deductions under sections 162 or 212, noting that the profit 

motive is the same under all three statutory sections, and 

concluding that "[t]he regulations under section 183, therefore, 

explicate the profit-motive requirements of sections 162 and 212, 

and courts have properly relied on the section 183 factors in 

making the profit-motive analysis under sections 162 and 212"); 

Carter v. Commissioner, 645 F.2d 784, 786 (9th Cir. 1981) 

("[section] 183(c) must be read in conjunction with [section] 

162") (footnote omitted); Dreicer v. Commissioner, 665 F.2d 1292, 

1294 (D.C. Cir. 1981) ("a taxpayer claiming a deduction under 

Sections 162 or 212 for an expense, or under Section 165 for a 

loss, must be prepared to demonstrate an associated profit motive 

in order to avoid the ban of Section 183") (footnote omitted). 

Thus, the Tax Court's application of section 183 was routine and 

predictable, not extraordinary. 

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In fact, the regulations accompanying section 212, on which 

the taxpayer relied, expressly refer to section 183. They specify 

that the inquiry as to profit motive under section 212 is 

determined by reference to section 183 and the accompanying 

regulations: "For provisions relating to activities not engaged 

in for profit applicable to taxable years beginning after December 

31, 1969, see section 183 and the regulations thereunder." Treas. 

Reg.§ 1.212-l(c). Section 183 similarly references sections 162 

and 212 when it defines "activity not engaged in for profit" as 

"any activity other than one with respect to which deductions are 

allowable ... under section 162 or under paragraph (1) or (2) 

of section 212." I.R.C. § 183(c). 

In summary, the Tax Court did not err in resolving this case 

on the basis of Internal Revenue Code section 183. Given the 

importance of profit motive, the Tax Court's reliance on section 

183 was both predictable and nonprejudicial. 

B. Applying Section 183 

Having determined that it was proper to utilize section 183 

in this case, we next address whether the Tax Court correctly 

applied the factors enumerated in the Treasury Regulations 

accompanying that section. 

Whether Vemco and the taxpayer were in pursuit of economic 

profit is a question of fact. The applicable standard of review 

is a stringent one: a finding of fact should not be disturbed 

unless it is clearly erroneous. Fed. R. Civ. P. 52(a). "A 

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finding is 'clearly erroneous' when although there is evidence to 

support it, the reviewing court on the entire evidence is left 

with a definite and firm conviction that a mistake has been 

committed." United States v. United States Gypsum Co., 333 U.S. 

364, 395 ( 1948). 

The taxpayer makes a persuasive argument that might well have 

convinced us if we were examining the record de novo. However, as 

the Supreme Court stated in Anderson v. Bessemer City, 470 U.S. 

564 (1985): 

This [clearly erroneous] standard plainly does not 

entitle a reviewing court to reverse the finding of the 

trier of fact simply because it is convinced that it 

would have decided the case differently •..• If the 

district court's account of the evidence is plausible in 

light of the record viewed in its entirety, the court of 

appeals may not reverse it even though convinced that 

had it been sitting as the trier of fact, it would have 

weighed the evidence differently. 

Id. at 573-74. Given the Tax Court's "plausible" account of the 

evidence, we cannot say as a reviewing court that its decision was 

clearly erroneous. After a thorough examination of the facts and 

circumstances of this case, we therefore affirm the Tax Court's 

determination that neither the taxpayer nor Vemco possessed the 

requisite profit motive. 

The Tax Court appropriately delineated the proper procedures 

to follow in determining whether an activity is engaged in for 

profit. Where a partnership is involved, as it is in this case, 

the dominant economic motive of the partnership, not that of the 

individual investors, is determinative. Polakof v. Commissioner, 

820 F.2d 321, 323 (9th Cir. 1987), cert. denied, 484 U.S. 1025 

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(1988); Tallal v. Commissioner, 778 F.2d 275, 276 (5th Cir. 

1985); Brannen, 722 F.2d at 703-04. 

The taxpayer bears the burden of proving the required profit 

objective. Tax Ct. R. 142(a); Welch v. Helverinq, 290 U.S. 111, 

115 (1933). The test is whether profit was the dominant or 

primary objective of the venture. See, e.g., Polakof, 820 F.2d 

at 323-24 ("dominant economic motive," "primary purpose"); Thomas 

v. Commissioner, 792 F. 2d 1256, 1259 ( 4th Cir. 1986) ( "primary 

objective"); Snyder v. United States, 674 F.2d 1359, 1364 (10th 

Cir. 1982) ("primarily motivated"); Eastman v. United States, 635 

F.2d 833, 837 (Ct. Cl. 1980) ("primary purpose," "overriding 

profit motivation"). 

The regulations under section 183 set forth nine nonexclusive 

factors to be considered in determining whether a taxpayer's 

activities are engaged in with the objective of realizing a 

profit: (1) the extent to which the taxpayer carries on the 

activity in a businesslike manner; (2) the taxpayer's expertise 

or his reliance on the advice of experts; (3) the time and effort 

the taxpayer expends in carrying on the activity; (4) the 

expectation that assets used in the activity may appreciate in 

value; (5) the taxpayer's success in similar activities; (6) the 

taxpayer's history of income or loss in the activity; (7) the 

amount of occasional profits, if any; (8) the taxpayer's 

financial status; and (9) the elements of personal pleasure or 

recreation. Treas. Reg.§ 1.183-2(b). 

The Treasury Regulations provide insight regarding how to 

apply these objective factors to determine subjective intent. The 

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ultimate inquiry entails examining the facts and circumstances of 

each case: 

Id. 

No one factor is determinative in making this 

determination. In addition, it is not intended that 

only the factors described in this paragraph are to be 

taken into account in making the determination, or that 

a determination is to be made on the basis that the 

number of factors (whether or not listed in this 

paragraph) indicating a lack of profit objective exceeds 

the number of factors indicating a profit objective, or 

vice versa. 

The Tax Court applied the relevant factors and concluded that 

the partnership was not motivated by profit on the following 

bases: (1) The $50,172.32 projected net monthly profit that lured 

the taxpayer and Vemco into this mining activity, predicted in the 

expert's report, was unattainable as it was erroneously based upon 

projected ore grades that were contrary to actual test results. 

(2) Vemco failed to increase the milling capacity of the mines as 

recommended in the same expert report. 4 (3) Vemco continued to 

fund projects relating to the mines even though they had an 

unbroken record of substantial losses ($2,205,045.10), they were 

unlikely to recoup those losses, and the Mexican corporations 

never paid a dividend to Vemco. (4) Despite these losses, Vemco 

took few steps to increase production. (5) The taxpayer received 

substantial income from other sources, which enabled her to 

4 Treas. Reg.§ 1.183-2(b)(2) provides: "Where a taxpayer 

• procures ••• expert advice, but does not carry on the 

activity in accordance with such practices, a lack of intent to 

derive profit may be indicated unless it appears that the taxpayer 

is attempting to develop new or superior techniques which may 

result in profits from the activity." 

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provide large amounts of capital. 5 (6) Vemco maintained 

incomplete books and records. 

In support of the taxpayer's position, the Tax Court 

acknowledged that some of the limited partners contributed time 

and effort to the mining operations6 and that one limited partner 

had operated profitable mines in the past7 . We add several other 

factors to this short list, namely the taxpayer's repeated 

statements regarding profit motive during the proceedings below, 

the taxpayer's reliance upon expert advice, and the lack of an 

alternative non-profit-making explanation for the venture. 

The taxpayer stated during the proceedings before the Tax 

Court that she was indeed motivated by a desire to profit: 

Counsel: What was your motive in -- why did you want to 

spend -- make an investment down there? Do 

you enjoy mining? 

Cannon: Well, I had heard a great deal about mining 

all my life, but also, over and above that, I 

obviously was down there to make money. 

I have invested in several things throughout 

my lifetime and this one looked very good .• 

I had no intention to do anything except make 

money. 

5 Although we agree with the Tax Court's assessment of the 

other Treasury Regulation factors, we find the factor focusing 

upon the financial status of the taxpayer to be a wash. See 

Treas. Reg.§ 1.183-2(b)(8). 

6 See Treas. Reg.§ 1.183-2(b)(3). 

7 See Treas. Reg.§ 1.183-2(b)(5). The taxpayer's own previous 

businesses included a profitable aeronautical business, an 

unprofitable sheep-raising operation, a profitable woman's 

exercise and health spa, and a helicopter sales business for which 

success or lack of success was not established. Record, vol. II, 

Transcript, Nov. 20, 1986, at 297-300. 

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Record, vol. II, Transcript, Nov. 20, 1986, at 289-90. She also 

discussed the profitability of her former ventures and the 

anticipated profits of this venture. 8 Id. at 285, 293, 296-300. 

Vemco's solicitation of expert advice further supports the 

taxpayer's contention that the mining activity was engaged in for 

profit. See Treas. Reg.§ 1.183-2(b)(2). Carl Weaver, an 

experienced miner since 1939 in Arizona, Colorado, Utah, and 

Mexico and a limited partner in Vemco, explored the mines and 

prepared a report on their histories and capabilities. Henry 

Ehrlinger, a professor of mining and engineering at the University 

of Texas at El Paso, also analyzed and reported on the mines. 

Ehrlinger had considerable experience in Mexican mining and had 

operated a company similar to Vemco on his own. Ralph Wilcox, 

Jr., a graduate geology student at the University of Texas, 

analyzed ore samples taken from the mines. The taxpayer relied 

upon this expertise. Record, vol. 2,· Transcript, Nov. 20, 1986, 

at 283-89. 

Finally, the ninth factor, "Elements of personal pleasure or 

recreation," deserves more attention than it was given by the Tax 

Court. Treas. Reg. § l.183-2(b)(9) clearly indicates that "a 

profit motivation may be indicated where an activity lacks any 

appeal other than profit." Here, the absence of any suggestion of 

an alternative motive in the record is a powerful factor in 

8 We note, however, that a taxpayer's statement of intent is 

given less weight than objective factors in determining such 

intent. Treas. Reg.§ 1.183-2(a); Engdahl v. Commissioner, 72 

T.C. 659, 666 (1979);see also Brodrick v. Derby, 236 F.2d 35, 38 

(10th Cir. 1956) (circumstances may indicate motive contrary to 

that stated). 

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support of the taxpayer's position. 9 

Although it is unclear what besides profit might have 

prompted Vemco to expend substantial amounts of money on this 

venture, we cannot declare the court's findings clearly erroneous. 

The Tax Court carefully applied the appropriate factors and 

provided a solid basis for its decision. 

With respect to the experts' reports, the Tax Court 

emphasized that Ehrlinger's monthly profit projection of 

$50,172.32 was erroneously based upon inconsistent data regarding 

the ore grades that could be realized per ton of ore mined. 59 

T.C.M. at 169. The actual assay work on the ore veins showed a 

decidedly poorer ore body in general than was assumed in the 

expert's report. Id. In addition, Vemco did not implement the 

critical aspects of the experts' advice, upon which any prospect 

of profits depended. Id. at 170. See Treas. Reg.§ 1.183-2(b)(2) 

(where a taxpayer procures but does not follow expert advice, "a 

lack of intent to derive profit may be indicated"). Specifically, 

Weaver and Ehrlinger recommended that Vemco install a higher 

9 Courts that fail to discern a profit motive often specify an 

alternative explanation for a party's actions. See, e.g., 

Polakof, 820 F.2d at 324 (limited partnership that bought film 

properties was motivated by a desire to create tax shelters rather 

than to profit); Thomas, 792 F.2d at 1258 (primary objective of 

coal mining program was to secure tax benefits rather than to earn 

an economic profit); Estate of Power v. Commissioner, 736 F.2d 

826, 831 (1st Cir. 1984) (taxpayer's horse-breeding activity was 

engaged in for personal satisfaction, not profit); Eastman, 635 

F.2d at 841 (family engaged in horse-breeding in order to utilize 

the losses from that operation to offset other income). But see 

Antonides v. Commissioner, 893 F.2d 656, 660 (4th Cir. 1990) 

(suggesting that the court does not need to pinpoint the likely 

motivation, as long as it determines on the basis of the Treasury 

Regulation factors that the activity was not engaged in for 

profit). 

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capacity mill in order to enhance the efficiency and profitability 

of the mines; indeed, their profit projections depended upon this 

mill. Vemco never installed it, however, thereby precluding any 

chances of transforming this mining venture into a profitable 

operation. 59 T.C.M. at 170. 

The Tax Court also emphasized that Vemco did not receive any 

profits from this mining venture for an entire eleven-year-period. 

In fact, the mines had an unbroken record of substantial losses 

totalling $2,205,045.10. Id. at 169. A record of such persistent 

and substantial losses is persuasive evidence that Vemco did not 

possess the requisite profit motive. See Treas. Reg.§ 1.183-

2(b)(6) ("[W]here losses continue to be sustained beyond the 

period which customarily is necessary to bring the operation to 

profitable status such continued losses, if not explainable, .•. 

may be indicative that the activity is not being engaged in for 

profit."). Furthermore, Vemco took few steps to increase 

production in the face of these overwhelming losses, and the 

record reveals that Vemco was unlikely to recoup the losses. 

Finally, Vemco maintained incomplete books and records, as it 

was unable to verify many claimed payments by tracing them back to 

a source document. See Treas. Reg.§ 1.183-(2)(b)(l). 

In summary, the record reveals that several of the factors 

set forth in Treas. Reg.§ 1.183-2(b) support the taxpayer's 

position, whereas others support the government's position. 

Taking all facts and circumstances into account, we cannot say 

that the Tax Court's application of the Treasury Regulations 

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,, , 1 V 

accompanying section 183 was clearly erroneous. Accordingly, we 

AFFIRM the findings of the Tax Court. 

In light of this ruling, we need not address the alternative 

basis that the Tax Court provided for its decision, namely that 

the deductions that the petitioner claimed through Vemco "are 

disallowed by virtue of their being the expenses of another 

taxpayer." 59 T.C.M. at 170. 

AFFIRMED. 

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