United States Court of Appeals

FOR THE EIGHTH CIRCUIT

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Nos. 11-2526/2529

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DKD Enterprises, also known as *

DKD Enterprises, Inc., *

*

Appellant, *

*

v. *

*

Commissioner of Internal Revenue, *

*

Appellee. *

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Appeals from the United States

Nos. 11-2528/2530 Tax Court.

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Debra K. Dursky, *

*

Appellant, *

*

v. *

*

Commissioner of Internal Revenue, *

*

Appellee. *

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Submitted: February 14, 2012

Filed: July 17, 2012

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Before RILEY, Chief Judge, WOLLMAN and SMITH, Circuit Judges.

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RILEY, Chief Judge.

The United States Tax Court assessed income tax deficiencies and penalties

against DKD Enterprises, Inc. (DKD) and Debra K. Dursky for the years 2003 to

2005. DKD and Dursky appeal. We affirm in part, reverse in part, and remand for

further consideration.

I. BACKGROUND

A. Facts

DKD is an Iowa corporation wholly owned and managed by Dursky. At all

relevant times, Dursky operated DKD out of her personal residence in West Des

Moines, Iowa. DKD’s principal source of income was information technology

consulting. Dursky was DKD’s only employee engaged in the consulting business.

DKD also operated a “cattery” to breed, show, and sell pedigree show kittens. 

Before 2003, Dursky and Elizabeth Watkins operated the cattery as an informal,

unincorporated venture. When Dursky and Watkins decided to expand the cattery

operation, ostensibly to enhance its national reputation and to increase profits, DKD

assumed responsibility for the cattery. Dursky and Watkins continued to manage the

cattery from Dursky’s home.

To enhance the cattery’s national reputation, DKD entered its kittens in 

national competitions. Dursky and Watkins anticipated breeding national champions

would increase the value of DKD’s premium show-quality kittens to between $1,000

and $5,000 per kitten. Between 2003 and 2005, DKD’s cattery won four national

championships. 

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For the tax years 2003, 2004, and 2005, DKD reported a total income of

$198,257, $234,556, and $213,970, respectively. DKD paid Dursky an annual salary

of $80,400 plus other compensation, including healthcare benefits and a profit sharing

pension plan. DKD paid Dursky $1,000 per month to rent office space in Dursky’s

residence for DKD’s consulting and cattery operations.1

During each year of this period, DKD reimbursed $60,968, $66,734, and

$68,329, respectively, to Watkins and Dursky for out-of-pocket expenses associated

with the cattery, such as travel and competition costs, veterinary bills, cat food,

grooming, and supplies. DKD also paid Watkins an annual salary of $7,700 for the

approximately 1,700 hours Watkins purportedly devoted to the cattery’s operation

each year. The cattery produced no revenue in 2003, $250 in 2004 from the sale of

three cats, and $1,525 in 2005 from the sale of eight cats. 

Due to the substantial costs associated with competing on the national circuit,

unexpected expenses and market forces, breeding problems, and inadequate revenues

from kitten sales, DKD could not afford to continue operating the cattery. In 2006,

DKD abandoned the operation, and Dursky and Watkins resumed managing the

cattery as a separate, unincorporated venture. 

B. Procedural History

The Commissioner of Internal Revenue (Commissioner) audited DKD’s and

Dursky’s tax returns from 2003 to 2005 and found substantial tax deficiencies. DKD

and Dursky appealed the Commissioner’s ruling, and the tax court held a hearing at

which both Dursky and Watkins testified. The tax court found much of their

testimony to be “questionable, implausible, unpersuasive, uncorroborated, vague,

and/or conclusory.” 

1

The parties agreed the total monthly fair rental value of Dursky’s residence was

$1,600. 

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As relevant on appeal, the tax court disallowed DKD’s claimed deductions for

(1) operational expenses of the cattery, finding the activity was a personal hobby of

Dursky rather than a genuine trade or business of DKD; (2) payments toward a profitsharing pension plan that benefitted Dursky, deciding the plan was ineligible for

deductions because it discriminated in favor of Dursky, a highly paid employee; and

(3) medical benefits paid by DKD for Dursky’s benefit, determining the payments

were not made pursuant to a qualifying “plan.” With respect to Dursky’s returns, the

Commissioner found DKD’s payments in support of the cattery and to fund the

pension plan were constructive dividends to Dursky and therefore constituted taxable

income for Dursky, and Dursky was liable for income taxes on the medical benefits

payments made by DKD on Dursky’s behalf. 

The tax court assessed deficiencies against DKD for tax year 2003 in the

amount of $22,734 with a $1,965.80 penalty; for tax year 2004 in the amount of

$35,064 with a $10,211.60 penalty; and for tax year 2005 in the amount of $30,668

with a $6,133 penalty. The tax court assessed tax deficiencies against Dursky in the

amount of $17,476 for tax year 2003; $16,403 with a $3,280.60 penalty for tax year

2004; and $12,604 with a $2,520.80 penalty for tax year 2005.

II. DISCUSSION

A. Standard of Review

We review decisions of the tax court “in the same manner and to the same

extent as decisions of the District Court in civil actions without a jury.” Comm’r v.

Riss, 374 F.2d 161, 166 (8th Cir. 1967); see also 26 U.S.C. § 7482. We therefore

review the court’s legal conclusions de novo and its factual conclusions for clear error. 

See Chakales v. Comm’r, 79 F.3d 726, 728 (8th Cir. 1996). “[A]ll deductions,

whether with respect to individuals, or corporations, are matters of legislative grace,

and unless the claimed deductions come clearly within the scope of the statute, they

are not to be allowed. The burden to make that showing rests upon the taxpayer.” 

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Five Lakes Outing Club v. United States, 468 F.2d 443, 444 (8th Cir. 1972) (quoting

Int’l Trading Co. v. Comm’r, 275 F.2d 578, 584 (7th Cir. 1960)). 

B. Trade or Business

DKD asserts the tax court erred in denying DKD’s claimed deductions for the

cattery’s operational expenses. Under 26 U.S.C. § 162(a), a corporation may deduct

from its taxable income “ordinary and necessary expenses paid or incurred . . . in

carrying on any trade or business.” To qualify as a trade or business under § 162(a),

“the taxpayer must be involved in the activity with continuity and regularity” for the

“primary purpose” of “income or profit.” Comm’r v. Groetzinger, 480 U.S. 23, 35

(1987). “A sporadic activity, a hobby, or an amusement diversion does not qualify.” 

Id. Whether an activity qualifies as a “trade or business” is a question of fact the

taxpayer must prove. See Int’l Trading Co., 275 F.2d at 584. 

“The existence of a genuine profit motive is the most important criterion

for . . . a trade or business.” Am. Acad. of Family Physicians v. United States, 91 F.3d

1155, 1158 (8th Cir. 1996) (quoting Prof. Ins. Agents of Mich. v. Comm’r, 726 F.2d

1097, 1102 (6th Cir. 1984)) (internal marks omitted). In Transport Mfg. & Equip. Co.

v. Comm’r, 434 F.2d 373, at 375, 377 (8th Cir. 1970), the tax court found a closely

held corporation that was principally in the trucking and freight business lacked a

“genuine profit motive” for certain real estate activities. The corporation purchased

a luxury estate, ostensibly with the intention of selling the property at a profit, and

attempted to deduct the property’s operating expenses as “ordinary and necessary

business expenses.” Id. However, for ten years the corporation made minimal efforts

to market the property, which was frequently used by members of the principal

shareholder’s family for personal use. Id. The tax court found, as a matter of fact, the

primary motive of the real estate venture was not “business or investment purposes

but rather for the personal benefit” of the taxpayer’s family, and was therefore not a

deductible trade or business expense. Id. We affirmed. Id.

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In the instant case, the tax court found DKD’s cattery was Dursky’s personal

hobby rather than a trade or business. The primary evidence offered by DKD was

Dursky’s and Watkins’ testimony that they intended to operate the cattery for profit. 

The tax court rejected this testimony. Because “the trial court is not conclusively

bound by the taxpayer’s stated intention” with respect to the profit motive, Transport

Mfg., 434 F.2d at 377, it was not clear error for the tax court to assess witness

credibility and weigh the evidence accordingly.

We do not agree with the tax court that “there is no reliable evidence in the

record . . . that during each of the years at issue DKD intended to make a profit from

DKD’s cattery activity.” The testimony of Dursky and Watkins was corroborated to

some extent because DKD (1) operated a website marketing its kittens,

(2) successfully raised four national champion kittens, and (3) earned some income

in 2004 and 2005 from kitten sales. The mere fact DKD’s cattery expenses vastly

exceeded its income is not sufficient to disprove the existence of a genuine profit

motive. It also would not be correct for the tax court to disallow a “trade or business”

deduction merely because, in the court’s view, the business venture was unlikely to

produce the desired profits. The rule is clear—the tax court should find the trade or

business venture lacked a genuine profit motive only if the court finds, as a factual

matter, the taxpayer lacked a good-faith, subjective intention to make a profit and was

engaged in the activity for wholly different reasons. See Groetzinger, 480 U.S. at 35

(clarifying “if one’s . . . activity is pursued full time, in good faith, and with regularity,

to the production of income for a livelihood, and is not a mere hobby, it is a trade or

business within the meaning of” 26 U.S.C. § 162(a)); Int’l Trading Co., 275 F.2d at

584 (deciding the taxpayer “need not have a reasonable expectation of a profit” but

must have a “good faith . . . intention of making a profit or of producing income”).

Here, the tax court concluded “DKD expended substantial amounts in DKD’s

cattery activity for the personal pleasure of Ms. Dursky, its sole stockholder, and with

the expectation that it would be able to deduct those substantial amounts for each of

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those years.” Although we disagree with some of the tax court’s reasoning, we cannot

say the tax court clearly erred in finding “DKD has failed to carry its burden of

establishing that for each of the years at issue DKD’s cattery activity constituted a

trade or business of DKD within the meaning of section 162(a).” We therefore affirm

on this issue.

C. Constructive Dividend

Dursky challenges the tax court’s finding that DKD’s expenditures to finance

the cattery were taxable as a constructive dividend to Dursky. A constructive

dividend is a payment or economic benefit conferred by a corporation on one of its

shareholders. See Riss, 374 F.2d at 167; Sachs v. Comm’r, 277 F.2d 879, 882-83 (8th

Cir. 1960); see generally United States v. Ellefsen, 655 F.3d 769, 779 (8th Cir. 2011)

(“Where controlling shareholders divert corporate income to themselves, such

diverted funds should be treated as constructive dividends.” (quoting Simon v.

Comm’r, 248 F.2d 869, 873 (8th Cir. 1957)) (internal marks omitted). A constructive

dividend is measured in terms of the benefit conferred on the shareholder, not the cost

to the corporation. See Sachs, 277 F.2d at 883. Whether corporate expenditures

constitute a constructive dividend is a question of fact which we review for clear error. 

Id. at 881, 883.

The tax court found that “during each of the years at issue DKD expended

substantial amounts in DKD’s cattery activity for the personal pleasure of Ms. Dursky,

its sole stockholder, and that during each of those years that activity was incident to

the personal hobby of Ms. Dursky.” Dursky argues the tax court applied the wrong

test in determining whether DKD’s cattery expenditures constituted a constructive

dividend. Rather than focusing on the economic benefit the corporation conferred on

Dursky, if any, Dursky argues the tax court focused merely on the “personal pleasure”

she derived from the cattery. Dursky concludes she was wrongfully assessed a tax

penalty merely because DKD engaged in a business activity from which she derived

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personal pleasure and satisfaction, even though this activity conferred no tangible

economic benefit on Dursky.

We agree with Dursky that a shareholder does not receive a constructive

dividend merely because she derives personal pleasure or satisfaction from the

operation of her business. However, we disagree with Dursky’s interpretation of the

tax court’s findings. The tax court’s constructive dividend finding must be considered

in light of its determination DKD lacked a genuine profit motive to operate the cattery. 

Because DKD lacked a legitimate business purpose to operate the cattery, the tax court

reasonably inferred DKD operated the cattery for no other reason than to finance

Dursky’s personal hobby.

Dursky also argues the tax court erred by calculating the constructive dividend

in terms of the cost to DKD rather than explicitly determining the financial benefit to

Dursky. Dursky fails to recognize that, in certain circumstances, the value of a

constructive dividend may be measured by the cost to the corporation. See Walker

v. Comm’r, 362 F.2d 140, 142-43 (7th Cir. 1966) (“The tax court properly upheld the

Commissioner’s use of the actual out-of-pocket amounts expended by the corporation

. . . as the measure of the constructive dividend” where a closely held corporation

made a vacation house available for shareholders’ personal use without a sufficient

business reason). DKD financed the cattery solely for the personal benefit of Dursky,

thereby relieving Dursky of the substantial hobby costs associated with the cattery’s

operation. It was not clear error for the tax court to find, as a matter of fact, the

economic benefit conferred on Dursky was equal to the costs incurred by the

corporation. We affirm on this issue.

D. Profit-Sharing Pension Plan

In 2003, DKD contributed $10,000 to a profit-sharing pension fund established

by DKD and managed by Fidelity Brokerage Service, LLC. In 2004, DKD

contributed $20,000 to the plan. DKD claimed deductions under 26 U.S.C. §§ 401

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and 501(a) for these contributions. The notices of deficiency provided to DKD

asserted these payments were not an “ordinary and necessary business expense” and

the deductions were therefore improper. At the hearing, the Commissioner raised a

different argument, alleging the pension plan discriminated in favor of Dursky, a

“highly compensated” employee, because Watkins was not included in the plan. See

26 U.S.C. § 401(a)(4). The tax court agreed with the Commissioner, and denied

DKD’s claimed deductions and included the contributions in Dursky’s taxable income

as constructive dividends.

The United States Tax Court Rules provide the Commissioner has the burden

to prove “any new matter” raised for the first time before the tax court. See Tax Court

Rule 142(a). Proving the new discrimination argument required evidence not

necessary under the Commissioner’s original theory; therefore, the Commissioner had

the burden to prove DKD was ineligible for the deductions under the Commissioner’s

new position. See Blodgett v. Comm’r, 394 F.3d 1030, 1040 (8th Cir. 2005) (“A new

position taken by the Commissioner is not necessarily a ‘new matter’ if it merely

clarifies or develops the Commissioner’s original determination without requiring the

presentation of different evidence, being inconsistent with the Commissioner’s

original determination, or increasing the amount of deficiency.”).2

To prove the plan discriminated against Watkins, the Commissioner produced

a document executed by Dursky on behalf of DKD establishing that, as of December

2

Rule 142(a) on its face applies to issues raised for the first time “in the

answer.” It is unclear on the record before us whether the Commissioner raised this

argument in its pretrial briefing, or for the first time in the evidentiary hearing before

the tax court. It appears the tax court applies Rule 142(a) to other matters raised for

the first time before the tax court. See Tabrezi v. Comm’r, 91 T.C.M. (CCH) 953 at

*3 (2006) (applying Rule 142(a) to an argument raised for the first time by the

Commissioner in a post-trial brief). The Commissioner has not challenged Dursky’s

argument that the Commissioner has the burden of proof with respect to this issue, and

we conclude Rule 142(a) applies.

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2001, Dursky was the only DKD employee enrolled in the pension plan. The

Commissioner argues this 2001 document satisfied its burden to prove Watkins was

excluded from the plan from 2003 to 2004. We differ. Watkins testified she was not

employed by DKD until 2002 or 2003. The Commissioner has offered no evidence

to the contrary. The 2001 document, from when Watkins was not an employee,

simply has no bearing on the dispositive question of whether Watkins was enrolled

in the plan in 2003 or 2004. 

The Commissioner asserts, without support, that producing evidence regarding

the plan’s 2001 enrollment shifted the burden to DKD to prove, in 2003 and 2004, the

plan did not discriminate in favor of Dursky. The Commissioner cannot satisfy its

burden of proof by presenting wholly irrelevant evidence. Nor can the Commissioner

meet its burden of proof by showing DKD did not refute the Commissioner’s

irrelevant evidence. The Commissioner clearly failed to establish DKD’s pension

plan discriminated in favor of Dursky. 

Furthermore, because funds properly allocated to a qualifying pension plan

under § 401(a) are taxable to the beneficiary only when they are actually distributed,

see 26 U.S.C. § 402(a), DKD’s contributions to the pension plan did not constitute

taxable income to Dursky during the tax years 2003 or 2004. DKD is entitled to

deduct contributions to the plan under 26 U.S.C. §§ 401(a) and 501, and those

contributions are not taxable to Dursky as a constructive dividend.

DKD and Dursky also argue DKD was entitled to deduct a $5,000 contribution

made to the pension fund in 2006, which DKD attempted to deduct from its 2005 tax

return. The tax court found DKD bore the burden of proof on this matter, because

DKD raised the issue for the first time before the tax court. DKD and Dursky do not

challenge the tax court’s conclusion with respect to the burden of proof.

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The tax court decided DKD and Dursky were not entitled to favorable tax

treatment with respect to the 2006 payment for the same reason it disallowed the

claimed deductions and exclusions in 2003 and 2004. The court’s reasoning on this

point is murky, potentially relying on the irrelevant 2001 document and not explaining

the support for its allocation of the burden of proof and persuasion. We cannot

decipher this from the record. We therefore remand to the tax court for further

consideration consistent with this opinion. See, e.g., Montin v. Estate of Johnson, 636

F.3d 409, 413 (8th Cir. 2011) (remanding to the district court because “a reasonable

finder of fact could infer” the appellant’s position was meritorious based upon

evidence that was overlooked).

E. Health Benefits Plan

Finally, DKD and Dursky assert the tax court erred in deciding payments made

by DKD to provide health insurance for Dursky were neither an “ordinary and

necessary business expense” that DKD could deduct under 26 U.S.C. § 162(a) nor an

“accident or health plan” excludable from Dursky’s income under 26 U.S.C. § 106(a). 

Because the tax court permissibly found DKD failed to prove the payments were made

pursuant to a pre-determined plan for the benefit of employees, we affirm.

Payments made according to a qualifying accident or health plan for the benefit

of employees are a deductible business expense for the employer under 26 U.S.C.

§ 162(a). See 26 C.F.R. § 1.162-10(a). Such payments are not taxable income to the

beneficiary. See 26 U.S.C. § 106(a). Internal Revenue Service regulations adopt an

expansive definition of a “plan”—a plan may cover a single employee or limited class

of employees; need not be in writing; and need not be enforceable by the employee. 

See 26 C.F.R. § 1.105-5. However, there must be an actual plan of which the

employee has actual knowledge, in order for medical benefits to qualify for the

§ 106(a) exclusion and the 162(a) deduction. See 26 U.S.C. § 106(a); 26 C.F.R.

§ 1.162-10(a); cf. Larkin v. Comm’r, 394 F.2d 494, 495 (1st Cir. 1968) (deciding for

the employer or the employee to claim a deduction for accident or health plan

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expenditures under 26 U.S.C. § 105(a), the expenditures must have been made

according to an actual plan); Am. Foundary v. Comm’r, 536 F.2d 289, 292-93 (9th

Cir. 1976) (same). 

We have no difficulty concluding Dursky and DKD failed to prove the health

benefit payments were made according to a qualifying “plan.” At the hearing, Dursky

testified DKD “paid [her] quarterly medical insurance,” paying approximately the

same amount for her insurance in 2003, 2004, and 2005. Dursky did not testify these

payments were made according to a pre-determined “plan” intended to benefit

employees. Nor do we find evidence in the record to compel such a conclusion. The

tax court’s disallowance of DKD’s deductions for these payments and requirement

that Dursky include them in her income were not clear error.

For the first time at oral argument, Dursky and DKD cited Rev. Rul. 61-146 in

support of their claims. According to Dursky and DKD, this ruling compels the

conclusion Dursky and DKD are entitled to deduct the medical payments at issue here. 

We disagree. In Rev. Rul. 61-146, the Commissioner considered whether employees

could exclude from their taxable income reimbursements they received from their

employer for obtaining private health insurance. There was no question that the

payments were made according to a pre-determined plan, or that the plan was known

by and intended to benefit employees. Contrary to DKD’s and Dursky’s assertion,

Rev. Rul. 61-146 does not stand for the proposition that any payments made by the

employer in payment of an employee’s health insurance premiums are necessarily

deductible under 26 U.S.C. § 162(a) and excludable under 26 U.S.C. § 106(a). The

Ruling provides no basis to overturn the tax court’s factual findings. With respect to

the health insurance payments, the tax court is affirmed.

III. CONCLUSION

We affirm in part, reverse in part, and remand. We affirm the tax court’s

decisions that (1) DKD’s cattery operations costs were not legitimate trade or business

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expenses under 26 U.S.C. § 162(a); (2) funds spent by DKD to operate the cattery

were taxable to Dursky as a constructive dividend; and (3) funds spent by DKD in

payment of Dursky’s health insurance plan were not a deductible “accident or health

plan” under 26 U.S.C. § 106(a) nor an excludable “ordinary and necessary business

expense” under 26 U.S.C. § 162(a). We reverse the tax court’s decisions that DKD’s

contributions to the profit-sharing pension plan for 2003 and 2004 did not qualify for

the 26 U.S.C. §§ 401 and 501 deduction as they discriminated in favor of Dursky, a

highly paid employee, because, on this record, we conclude these payments were

deductible by DKD and not a constructive dividend or otherwise income for Dursky. 

We remand to the tax court for further consideration as to (1) whether DKD’s 2006

contribution to the profit-sharing pension plan qualified for the §§ 401 and 501

deduction in tax year 2005; and (2) whether that distribution is taxable to Dursky as

a constructive dividend.

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