T.C. M em o . 2 0 1 8 -1 4 7

UNITED STATES TAX COURT

J EFFREY B. YAPP AND TAM ARA A. YAPP, Pet i t i o n ers v . COM M ISSIONER OF INTERNAL REVENUE, Res po n d en t

Do ck etNo . 1 3 8 05 -1 4
. Fi l edSep t em b er 1 0 , 2 0 1 8
. Bert ram Pau l Hu s b an d , Ri ch ardW arren Crai g o , an d J effreyM . W o n g , fo r p et i t i o n ers . Pau l m i k el l A. Fab i an , M arkA. Nel s o n , Sarah A. Hers o n , an dAm y B. Ul m er, fo r res p o n d en t .

M EM ORANDUM FINDINGS OF FACT AND OPINION COHEN, Ju d g e: Res p o nd en t d et erm i n eda $ 47 5 ,1 3 5 d efi ci en cy an da $ 9 5 ,0 2 7 s ect i o n 6 6 6 2(a) accu racy -rel at edp en al ty wi t h res p ectt o p et i t io n ers ’ Fed eral i nco m e t ax fo r 2 0 1 0 . Aft er co n ces s i o n s , th e i s s u es fo r d eci s i o n are:- 2
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[* 2 ] (1 ) wh et h er p aym en t s m ad e fo r l eg al an dp ro fes s io n al s erv i ces an d wag e p aym en t s are d edu ct i b l e as ex p en s es o f a b u s i n es s o p erat ed b y J effreyB. Yap p (J
. Yap p), (2 ) wh et h er p aym en t s an do t h er rep o rt edex pen s es are d edu ct ib l e as
ex p en s es o f a b u s in es s o p erat edb y Tam ara A. Yap p (T. Yap p, an dt o g et h er wi t h J
. Yap p, p et i t i o n ers ), an d(3 ) wh et h er p et i t i o n ers are l i ab le fo r th e s ect i o n 6 6 62 (a)
accu racy -rel at edp en al ty . Al l s ect i o n referen ces are t o t h e In tern al Rev en u e Co d e i n effect fo r 2 0 1 0 , an dal l Ru l e referen ces are t o th e Tax Co u rt Ru l es o f Pract i ce
an d Pro cedu re. FINDINGS OF FACT So m e o f t h e fact s h av e b een s ti p u lat ed , an dth e s t i p u l at edfact s are i n co rp o rat edi n o u r fi n d in g s b y th i s referen ce. Pet i t i o n ers res i d edi n Oreg o n wh en t h ey fi l edth ei r p et i t i o n . NXTM , LLC J . Yap p was an em

p l oy ee o f M TV Netwo rk s (M TV) fro m 2 0 0 4 u n t i l 2 0 0 9
. Du ri n g h i s em

p l o y m en tatM T V, h e was i nv o l v edi n the d ev el op m en t o f a web
b as edp ro m o t i o nal p lat fo rm fo r m u s i c art i s t s (p l at fo rm ). Ats o m e p o i n t i n 2 0 0 9 , M TV d eci dedn o tt o p u rs u e fu rt h er d ev el o p m en to f t h e p l at fo rm , an dJ . Yap p
as k edM T V t o al l o w h i m t o co n t i n u e d ev el op i n g th e p l at fo rm o n h i s o wn .- 3
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[* 3 ] OnJ u ly

1 6 , 2 0 09 , J . Yap p fo rm edNXTM USIC, LLC, as a s in g l e-m em b er Del aware l i m i t ed l i ab il i ty co m pan y . Th e co m

p an y ’ s n am e was ch an g edt o NXTM , LLC (NXTM ), o n Au gu s t5 , 2 0 09 . On t h ats am e d at e J
. Yap p ex ecu t ed NXTM ’ s fi rs to perat in g ag reem en t . OnAu g u s t3 1 , 2 0 0 9, NXTM en tered i n t o an
as s i g n m en tag reem en t (as s i g n m en t ) wi t h M TV und er wh i ch NXTM recei v edth e ri gh t s t o th e p l at fo rm

i n ex ch an g e fo r rep ay i n g M T V’ s p ri o r i n v es t m en tan d d ev el o p m en tco st s an dp ay i n g M TV ro y al t i es fro m fu tu re s al es . Fo l l o wi n g th i s
as s i g n m en tM TV em

p l o y ees as s o ci at edwi th th e p l at fo rm wo rk ed fo r NXTM
. NXTM u s edth e p l at fo rm t o o p erat e as a m

u s i cal art is t p ro m o ti on al
co m p an y . Tay l or Swi ftwas th e p ri n ci p al m u s ical art i s tp ro m o t edo n th e p l at fo rm . To fu ndfu rth er d ev el o p m en to f t h e p l at fo rm NXTM p u rs u eda t wo -p h as e i n v es t m en ts t rat eg y . Th e fi rs tp h as e i n cl u d edrai s i n g fu n d s fro m fri en d s an d fam i l y ; th e s eco n d ph as e was t o p u rs u e i n s t i tu t i on al i n ves t o rs . As J . Yap p carri edo u th is i n v es t m en t s t rat eg y fo r NXTM , h e am en d edi t s LLC o p erat i n g ag reem en t s ev eral t i m es . J . Yap p ex ecu t edan ag reem en td at ed J an u ary 1 , 2 0 1 0 , th atam en d edan dres t at edNXTM ’ s fi rs t o p erat i n g ag reem en ti n p rep arat i o n fo r t h e co m

p an y t o s t artth e i n s t i tu t i o n al i n v es tm en tp h as e. No ad d it i o n al m em

b ers were ad d edt o NXTM th ro ug h th i s ag reem en t . InFeb ru ary 2 0 1 0 J . Yap p n eg o t i at edat to rn ey ’ s fees NXTM o wedt o a redu cedam o u ntt o t al i n g- 4
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[* 4 ] $ 1 2 0 ,0 0 0 fo r wo rkp rev i o us l y p erfo rm edfo r NXTM , an dh e p ai dth e fees o ut
o f NXTM ’ s b an k acco u n t . OnM arch 1 8 , 2 0 1 0 , NXTM ’ s o p erat i n g ag reem en twas fu rt her am en dedt o ad d 2 “ Cl as s A Co m m o n M em

b ers ” an d1 7 “ Seri es A Preferred M em bers ”. Th e n ew m em

b ers i n cl u d edi nd i v i du al s wh o co n t ri b u t ed fu n d i n g du ri n g th e fri en ds an dfam i ly i n v es t m en tp h as e. On Sep t em ber 1 6 , 2 0 1 0 , NXTM ’ s
o p erat i n g ag reem en twas am en d edt o ad di t s i n st i tu t i o n al i n v es t o rs as m em b ers . Real Fo o dReal Li fe, LLC Du ri n g 2 0 0 9 an d2 0 1 0 T. Yap p wo rk edt o es t ab l is h h er o wn h eal th fo o d b u s i n es s . T. Yap p h adb een i n t ro du ced t o p ro b i ot i c s up p l em en t s du ri ng h er effo rt s t o fi n dtreat m en t s fo r m ed i cal co n di t i o n s s uffered b y p et i t i o ners ’ s o n . T. Yap p b eg anwo rk i ng wi t h anAu st ral i an co m p an y cal l edA.G.M . Fo o d s Pt y . Lt d ., d o i n g b u s i n es s as Grai n fi el d s (AGM ), wh o s e ferm en tedp ro b i ot i c s up p l em en t s s h e h ad
u s ed prev i o u s l y . T. Yap p b el i ev edth at , i f s h e i n co rp orat edAGM ’ s u np l eas an t t as t i n g s up p l em en t s i n t o b et t er t as t i ng p ro duct s , th ere was an o p p o rtu n i t y t o
m ark etan ds el l p ro b i o ti c s up p l em en t s i n th e Un i t ed St at es . OnJ an uary 1 , 2 0 0 9, T. Yap p en t ered i n t o a d is t ri b u t i o n ag reem en t(d i s t ri bu t i o n ag reem en t ) wi th AGM
. Un d er i t s t erm s AGM wo u l d h el p T. Yap p d ev el o p h er o wnl i n e o f p ro b io t i c p ro duct s i n ex ch an ge fo r T. Yap p ’ s m ark et i n g an ds el l i n g AGM ’ s s up p l em en t s i n t h e Un i t edSt at es . InOct o b er 2 0 0 9 T. Yap p fo rm edReal Fo o dReal Li fe, LLC- 5
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[* 5 ] (RFRL), as a s i ng le-m em b er Cal ifo rn i a l im it ed l iab i li t y co m pan y t o p urs u e t h i s o p p o rtu n i ty . Th ro u g h o u t2 0 0 9 an d2 0 1 0 T. Yap p wo rk ed t o d ev el o p RFRL’ s p ro du ct l i ne. Sh e wo rk ed t o fo rm u l at e n ew reci p es th at i nco rp o rat ed AGM ’ s s up p lem en t s t o ach i ev e p ro du ct s wi t h b et t er t as t e, t ex tu re, an ds h el f l i fe. Wh en T. Yap p d ev el o p ed a wo rk ab l e reci p e, s h e s en ti t t o AGM , an d AGM wo u l d u s e h er reci p e t o p ro du ce a co m

m erci al -l ev el p ro du cttri al ru n. AGM th ens en ts am p l es o f t h e t ri al ru n p ro du ct s t o T. Yap p . T. Yap p u s edth e p ro ducts am p l es t o refi n e fu rt h er RFRL’ s p ro du ct s b y

co n du ct in g fo cu s g ro up s an dg iv i ng th e s am p l es away i n
ex ch an g e fo r feedb ack . Sh e al so wro te an dp o s t edart i cl es o n RFRL’ s web s i t e,
reco rd eda v i d eo p res en tat i o n fo r Wh o l e Fo o d s , an dm etwi t h n u m ero u s d o ct o rs
an d ex p ert s t o p ro m o t e RFRL. T. Yap p t o o ks t ep s t o l au n ch RFRL’ s p ro du ctl i n e co m m erci al ly . Sh e h i red d es i g n ers t o creat e RFRL’ s l o g o , s l o g an , an d p ro du ctl ab el s . To g et h er wi t h h er d au gh t er an db ro t h er-i n -l aw, s h e res earch edo pt i o n s fo r s h i p p in g RFRL’ s p ro duct s . T. Yap p al so res t ru ctu redRFRL i n o rd er t o s ep arat e RFRL-b ran d ed p ro duct s fro m

h er an t i ci p at edn o n -h eal t h fo o d p ro du ctl i n es . InM ay 2 0 1 0 s h e fo rm edFerm act i v e, LLC, as a s i n g l e-m em b er Del aware l i m i t edl i ab i l i t y co m p an y- 6
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[* 6 ] th atwo u l ds erv e as a p aren tco m p an y wi t h s ep arat e d iv i s i o ns fo r RFRL an d
o t h er p ro du ct s . In No v em

b er 2 0 1 0 AGM o b t ai n edcert i fi cat io n s thatth e RFRL-b ran d ed p ro duct s i tp ro duced were Ko s h er, Parev e, an do rg an i c. Du ri n g th e m o n t h o f Decem b er 2 0 1 0 , T. Yap p s o l i ci t edan d recei v edp re-o rd ers o f RFRL p ro du ct s . Th e fi rs t s h i p m en to f fi n i s h edRFRL-b ran d edp ro du ct s arri v edi n t h e Un i t edSt at es i n l at e Decem

b er 2 0 1 0 . Th e p ro du ct s s us t ai n edd am ag e duri n g s h i p m en t t h at d el ay edth ei r u l t i m at e d el i v ery t o RFRL. RFRL o ffi ci al l y l au n ch edi ts p ro du ct s at a p art y h o s t edb y

NXTM o n Feb ru ary

2 5 , 2 0 1 1
. Tax Rep o rt i n g fo r 2 0 0 9 an d2 0 1 0 Pet i t i o ners u s edth e s am e cert i fi edp ub l i c acco u nt an t(C.P.A.) t o p rep are an d jo i n t ly fi le t h ei r Fo rm s 1 0 4 0 , U.S. In d i v i du al In co m e Tax Retu rn , fo r 2 00 9 an d 2 0 1 0 . Pet i t i o n ers p ro v i d edth ei r C.P.A. wi t h o n l y th e g en eral l ed g ers t h ei r b o o kk eep er k ep tt o reco rdi n co m e an dex p en s es fo r NXTM , RFRL, an dth ei r h o u s eh o l d . Fo r b o th y ears p et i t i o ners treat edth ei r res p ect i v e b us i n es s es , NXTM
an d RFRL, as d i s reg ard eden ti t i es fo r t ax p u rp o ses an di n cl u d ed Sch edu les C, Pro fi to r Lo s s Fro m

Bu s i n es s , wi t h th ei r jo i n t l y fi l ed Fo rm s 1 0 40 . Th o u g h NXTM k ep t i t s b o o k s u s i n g th e accru al m et h o d o f acco u n t i ng , p et i t i o n ers fi l edth ei r 2 0 0 9 i n co m e t ax retu rn u si n g t h e cas h m et h o do n th e Sch edu l e C p rep ared fo r NXTM
.- 7
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[* 7 ] Fo r 2 0 0 9 p et it i o n ers rep o rt edn etn eg at i v e i n co m e o f $ 5 5 9 ,1 7 9. Fo r 2 0 1 0 t h ey cl ai m eda n eto p erat in g l os s (NOL) carry o ver o f $ 55 7 ,4 2 3 fro m 2 00 9
. Pet i t io n ers ’ 2 0 1 0 retu rn i n cl u d edp ers o n al ex p en s es as p arto f RFRL’ s b u si n es s d educt i o n s an dfai l edt o co n ti n u e t o t ak e d ep reci at i on d edu ct i o ns cl ai m edfo r 2 0 0 9
. Th e In t ern al Rev en u e Serv i ce (IRS) co n du ct edan ex am i nat i o n o f p et i t i o n ers ’ retu rn s fo r 2 0 0 9 an d2 0 1 0 . As a res u l t , the IRS d et erm in ed ad ju s t m en t s t o p et i t i o n ers ’ 2 00 9 g ro s s i n co m e t h at i ncreas edi t fro m ! $ 5 5 9 ,1 7 9 t o $ 2 8 4 ,7 8 5 . Th es e ad

ju s t m en t s i n cl ud edth e d i s al l o wan ce o f $ 1 2 2 ,7 3 7 cl ai m edas p arto f a d edu ct io n fo r NXTM ’ s wag e ex p en s es p ai dfo r 2 0 0 9 . Th e IRS al s o d i s al lo wed$ 1 20 ,0 0 0 cl ai m edas p arto f a d edu ct i on fo r l eg al an dp ro fes si o n al
s erv i ces ex p en s es fo r NXTM . Th es e ex p en s es were act u al l y p ai d i n 2 0 1 0
. Th e IRS al s o d i s al l o wed al l d edu ct i o n s cl ai m edfo r RFRL-rel at edex p en d itu res . Th e IRS ad

j us t m en ts d i dn o tres u lti n a d efi ci en cy fo r p et i t i o n ers ’ 2 0 0 9 t ax ab l e y ear. Th e IRS d i s al l owedi n fu l l p et i t i o n ers ’ $ 55 7 ,4 2 3 NOL carry fo rward fo r 2 0 1 0 . OnM arch 2 8 , 2 0 13 , th e g ro up m an ag er fo r t h e IRS ex am i n er ex ecu t eda Ci v il Pen al t y

Ap p ro v al Fo rm

(p en al ty ap p ro v al fo rm ) ap p ro v i n g th e s ect i o n 6 6 6 2 (a) an d (b )(2 ) u n derp aym en tp en al t y fo r a s ub s t an t ial u n d ers t at em en to f i n co m e t ax th atwas d et erm i n edi n th e n o t i ce o f d efi ci en cy d at ed M arch 1 7, 2 0 1 4
.- 8
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[* 8 ] OPINION I. Bu s i n es s Ex p en s e Dedu ct i o ns Tax p ay ers are req u i redt o m ai n t ai n s u ffi ci en treco rd s t o es t ab l i s h the
am ou n tan dp u rp o s e o f an y d edu ct i o n . Sec. 6 00 1 ; Hi g b ee v . Co m m i s s i o n er, 1 1 6 T.C. 4 3 8 , 4 4 0 (2 0 0 1 ); s ec. 1 .6 0 0 1 -1 (a), (e), In co m e Tax Reg s. Th e t ax p ay er h as t h e b u rd en o f p ro v i n g en t it l em en t t o h i s o r h er d edu ct i o n s cl ai m ed . See New Co l on i al Ice Co
. v . Hel v eri ng , 2 9 2 U.S. 4 3 5 , 4 4 0 (1 9 3 4 ); Ro ckw el l v . Co m m i s s i o n er, 5 1 2 F.2 d8 8 2 , 8 8 6 (9 t h Ci r. 1 9 7 5 ), aff’ g T.C. M em o . 1 9 7 2 -1 3 3
. Th i s i n cl u d es th e b u rd en o f s ubs t an t i at i o n . Hrad es ky v . Co m m is s i o n er, 6 5 T.C. 8 7 , 9 0 (1 9 7 5 ), aff’ dp er cu ri am , 5 4 0 F.2 d8 2 1 (5 t h Ci r. 1 9 7 6 ). Sect io n 1 6 2 (a) al l o ws as a d edu ct i o n “ al l t h e o rd i n ary an dn eces s ary
ex p en s es p ai d o r i n cu rreddu ri n g the t ax ab l e y ear i n carry in g o n an y trad e o r b u s i n es s ”. Anex p en s e i s o rd i n ary i f i ti s n o rm al , u su al , o r cu s t o m ary i n th e t ax p ay er’ s trad e o r b u s i n es s , an di ti s n eces s ary i f ap pro p ri at e o r h el p fu l fo r s u ch b u s i n es s . See Dep u t y

v . duPo n t , 3 08 U.S. 4 8 8 , 4 9 5 (1 9 4 0 ); s ee al s o Li n g ren v . Co m m i s s i o n er, T.C. M em o 2 0 1 6 -2 13
. A t ax p ay er i s n o tcarry i n g o n a t rad e o r b u si nes s fo r s ect i o n 1 6 2 (a) p u rp o s es
u n t i l t h e b u s i n es s i s fu n ct i o ni n g as a g o i n g co n cern an dp erfo rm i n g th e act i v i t i es fo r wh i ch i twas o rg an i zed
. Ri ch m o n d Tel ev i s i o n Co rp . v . Un i tedSt at es , 3 4 5 F.2 d- 9
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[* 9 ] 9 0 1 , 9 0 7 (4 t h Ci r. 1 9 6 5 ), v acat edan drem an d edo n o t h er g ro u n d s, 3 82 U.S. 6 8 (1 96 5 ); s ee al s o Gl o t o v v . Co m m i ss i on er, T.C. M em o . 2 00 7 -1 4 7 . Bu s i n es s
o p erat i o n s wi t h res p ectt o th e act i v it y m u s t h av e act ual l y

co m m en ced . See M cKel v ey

v . Co m m i s s i o n er, T.C. M em o . 2 0 0 2 -6 3 , aff’ d , 7 6 F. Ap p ’ x 8 0 6 (9 t h Ci r. 2 0 03 ). “ Un t i l th att i m e, ex p en ses rel at edt o th at act i v i t y are n ot‘ o rd i n ary

an d
n eces s ary ’ ex p en s es cu rren tl y d edu ct ib l e u n d er s ect i o n 1 6 2 * * * b u trat h er are

‘ st art -up’ o r ‘ p re-o p en i n g’ ex p en s es .” See W o o dy v . Co m m i s s i o n er, T.C. M em o . 2 0 0 9 -9 3 , s l i p o p . at9 -1 0 (ci t i n g Hard y v . Co m m i s si o n er, 9 3 T.C. 6 84 , 6 87 -6 8 8 (1 9 8 9), aff’ di n p art , rem an d edi n p art , 1 9 9 0 U.S. Ap p . Lex i s 1 9 6 7 0 (1 0 t h Ci r. Oct . 2 9 , 1 9 9 0 )), aff’ d , 4 03 F. Ap p ’ x 5 1 9 (D.C. Ci r. 2 0 1 0 ). St artup ex p en s es , al t h o u g h n o td edu ct i bl e duri ng th e p re-o p en i n g p h as e, m ay g en eral l y b e d edu ct ed
o r cap i t al i zedan dd edu ct ed o v er t i m e up o n a t ax p ay er’ s b eco m i n g act i vel y
en g ag edi n b us i nes s p u rs u an t t o s ect i o n 1 9 5 . Sec. 1 .1 95 -1 T, Tem p o rary In co m e Tax Reg s ., 7 3 Fed . Reg . 3 8 9 1 0 (J u l y 8 , 2 0 0 8 ). A. NXTM 1
. Leg al an dPro fes s i o n al Serv i ces Pet i t i o ners co n ced e t h atres p o n d en tp ro p erl y d i s al l o wedth e NXTM Sch edu l e C d edu ct i o n s cl ai m edfo r l eg al an d p ro fes s i o n al s erv ices fo r 2 00 9 . Th ey
n o n et h el es s arg u e t h at l eg al fees o f $ 1 2 0 , 0 0 0 p ai d b y NXTM i n Feb ru ary

2 0 1 0 are- 1 0 -

[* 1 0 ] d edu ct i b le fro m

th ei r 2 0 1 0 g ro s s i nco m e. Res p o n den t ’ s p os i t i o n i s th at
s i nce NXTM b ecam e a m u lt i m em b er LLC i n 2 0 1 0 i ts h o u l db e t reat edas a p art n ers hi p fo r t ax p urp os es . Acco rd i n g t o res p o n den t , J . Yap p fai l edt o
s ub s t an t i at e t h ath i s o u t s i de b as i s i n h i s NXTM p artn ers h ip i n t eres twas s u ffi ci en t t o al l o wh i m

t o d edu ctth e fu l l am ou n t o f t h e l eg al fees p ai d
. J . Yap p t es t i fi edattri al th at wh en NXTM p ai dthe l eg al fees i n Feb ru ary 2 0 1 0 i t was s t i ll a s i n g l e-m em b er LLC. He fu rt h er t es t i fi edthatNXTM d idn o t ad m i tn ew m em

b ers u n t i l M arch 2 0 1 0 . Th e NXTM o p erat i n g ag reem en tan d
s ub s equ en tam en d m en t s i n ev i d en ce s up po rtJ . Yap p ’ s t es t i m on y th atNXTM
rem ai n eda s i n gl e-m em

b er LLC u n t i l th e s eco n dam en d m en tt o t h e o p erat i ng ag reem en twas ex ecu t edi n M arch 2 0 1 0 . A s i n gl e-m em ber LLC i s d i s reg ard edas
an en ti t y s ep arat e fro m

i t s o wn er fo r Fed eral i n co m e t ax p u rp o s es u n les s i t el ect s
o t h erwi s e. See s ecs . 3 0 1.7 7 0 1 -2 (a), 3 0 1 .7 70 1 -3 (b )(i ) an d(i i ), Pro ced
. & Ad m i n . Reg s. Pet i t i on ers al so p ro v id edev i d en ce t h atNXTM p ai d$ 12 0 ,0 0 0 fo r l eg al fees i n 2 0 1 0, i n cl u d i n g co m

pan y em ai l s n eg o t iat i n g th e redu ct i o n an dp aym en to f l eg al fees o wed , b an ks t at em en t s s ho wi n g wi re t ran s fers fro m NXTM ’ s acco u n t, an da
co p y o f a cl eared el ect ro n i c ch eckdrawn o n NXTM ’ s acco u n t . Th es e d o cu m en t s , co upl ed wi t h J . Yap p ’ s t es t i m o n y , are cred i b l e ev i den ce t h atNXTM p ai d l eg al fees o f $ 1 2 0 ,0 00 du ri n g Feb ru ary 2 0 1 0 an d t h atatth e t i m e o f p aym en t NXTM- 1 1 -

[* 1 1 ] was a s i n g l e-m em

b er LLC an dth erefo re a d i s reg ard eden t i ty . Si n ce NXTM
was n ota p art n ers h i p atth e t im e t h e l eg al fees were p ai d, J . Yap p i s n o treq u i red t o s ub s t an t i at e h i s o u t s i d e b as i s i n h i s NXTM p artn ers h i p i n t eres ti n o rd er t o d eductth e fu l l am o u n t o f t h e l eg al fees p ai d
. Cf. s ec. 7 0 4 (d ). W e co n cl u d e t h at p et i t i o n ers are en t i t l ed t o a d edu ct i o n o f $ 1 2 0 ,0 0 0 fo r t h es e ex p en s es .

2
. W ag es Pet i t i o ners co n t en dth atres p o n d en ti m p ro perl y d i sal l owed$ 1 2 2 ,7 3 7 o f a d educt i o n fo r wag es cl ai m edo n t h ei r 2 0 09 retu rn fo r NXTM , wh i ch was p arto f t h e NOL carry o ver cl ai m edfo r 2 0 1 0 . Res p on d en td i s al l o w edth i s p ort i on o f t h e wag e d edu ct i o n cl ai m ed fo r NXTM fo r l acko f s ubs t an ti at io n . Whi l e 2 0 0 9 i s n o ta y ear i n i s s u e i n th is cas e, we m ay d et erm i n e t h e co rrect am o u n t o f NOL fo r a y ear
n o ti n i s s u e as a p rel im i n ary s t ep i n d et erm i n i n g t he co rrect am o u n to f an NOL carry o ver t o a t ax ab l e y ear i n i s s u e. Sec. 6 2 1 4 (b ); Cal u m etIn du s ., In c. v . Co m m i s s i o n er, 9 5 T.C. 2 57 , 2 7 4 -2 7 5 (1 9 9 0 ). Dedu ct i o n s m ay i ncl u d e a
reas on ab l e al l o wan ce fo r s al ari es o r o t h er co m p en s at i o n fo r s erv i ces actu al l y
ren d ered . Co m

p en sat i on i s d edu ct i b l e u n d er s ect io n 1 62 (a)(1 ) o n l y i f i ti s (1 )
reas on ab l e i n am o u n t, (2 ) b as edo n s erv i ces actu al l y ren dered , an d(3 ) p ai do r i n cu rred . El l er v . Co m

m i ss i o n er, 7 7 T.C. 9 3 4 , 9 6 2 (1 9 8 1 ).- 1 2 -

[* 1 2 ] In s up p o rto f t h ei r co n t en t i o n p et it i on ers o ffered ev i d en ce i n th e fo rm o f a g en eral l ed g er l i s t i n g n u m ero u s p aym en t s t o s ev eral i n d i v idu al s u n d er t h e h ead i n g

“ p ayro l l ” an db an ks t at em en t s s h o wi n g el ect ro n i c t ran s fers fro m NXTM ’ s
acco u n t . Attri al J . Yap p b ri efl y t es t i fi edth atwh en M TV as s i g ned t h e p l at fo rm t o NXTM th e M TV em

p l o y ees as s o ci at edwi t h th e p l at fo rm ’ s d ev el o p m en tcam e t o
wo rkfo r NXTM . Pet i t i o n ers p ro du cedn o co rro b o rat i n g wi t n es s es o r o t h er
co n tem p o ran eo u s em

p l oym en t -rel at edd o cu m en ts s u ch as em p l o ym en tco n t ract s , Fo rm s W -2 , W ag e an dTax St at em en t , o r Fo rm s 1 0 9 9 -M ISC, M is cel l an eo u s In co m e, t o s ub s tan t i at e th ei r cl ai m . Pet i t i on ers fai l edt o p ro vi d edan y d et ai l s reg ard i n g th e n u m

b er o f NXTM ’ s em

p l o y ees , th ei r jo b d es cri p t i o n s , o r t he
am ou n t s th at NXTM was o b l i g at edt o p ay th em . Pet i ti o n ers th u s fai l edt o m eet t h ei r b urd en t o s ub s t an t iat e en ti t l em en tt o a d edu ct i o n fo r wag es p ai d g reat er t h an t h atal lo wed b y

res po n d en t . B. RFRL Ex pen d i tures Pet i t i o ners co n t en dth atth ei r ex p en d i tures rel at edt o d ev el o p i ng RFRL’ s p ro ductl i n e qu al i fy

as d edu ct i b l e b u s i n es s ex pen ses u n d er s ect i o n 1 6 2. Res po n d en tco n t en d s th atev en th o u g h p et i t i o n ers p ai d t h es e ex pen s es t h ey are
s t artup ex p en d itu res s ub

jectt o th e l i m i t at i o n s o f s ect i o n 1 9 5 as o p p o s edt o s ect i o n 1 6 2 b u s i n es s ex pen s es . Res p o n d en tfu rth er arg u es t h atev en i f RFRL q u al i fi edas- 1 3 -

[* 1 3 ] an act i v e t rad e o r b us i n es s , p et i t io n ers fai l ed t o s ub st an t i at e t h e ex p en s es t h atth ey d edu ct edfo r RFRL. Sect io n 1 9 5 (a) p ro v i d es th e g en eral ru l e t h atn o cu rren t d edu ct i o n s h al l b e al l o wed fo r s t artup o r p re-o p en i n g ex p en s es . Sect i o n 1 9 5(c) d efi n es “ s t art -up
ex p en d i tu res ” t o i n cl u d e an y am o u n t : (A) p ai do r i n cu rredi n co n n ect i o n wi th
-- (i ) i n v es t i g at i n g th e creat i o n o r acq u i s it i o n o f an act i v e t rad e o r b u si n es s , o r (i i ) creat i ng an act i v e t rad e o r b u s i n es s , o r (i i i ) an y act iv i t y en g ag edi n fo r p ro fi t an dfo r t he p ro du ct i o n o f i n co m e b efo re t h e d ay o n wh i ch th e act i v e t rad e o r b u s i n es s b eg i n s , i n an ti ci pat i o n o f s uch act i v i t y b eco m i n g an act i v e t rad e o r b u si n es s, an d (B) wh i ch , i f p ai do r i n cu rredi n co n n ect i o n wi t h t h e o p erat i o n o f an ex is t in g act iv e t rad e o r b us i n es s * * * wo u ldb e al l o wab l e as a d edu ct i o n fo r t h e t ax ab l e y ear i n wh i ch p ai do r i n cu rred
. St artup ex p en s es , al t h o u g h n otd edu ct i b le du ri n g the p re-o p en i ng p h as e, m ay g en eral l y b e d edu ct edo r cap i t al i zedan dd edu ct edo v er t i m e up o n a t ax p ay er’ s b eco m i n g act i v el y

en g ag ed i n a t rad e o r b u s i nes s p u rs u an tt o s ect i o n 1 9 5 . Sec. 1 .1 95 -1 T, Tem

p o raryIn co m e Tax Reg s . , s upra; s ee W oo dy v . Co m m i s si o n er, s l i p
o p . at1 0
.- 1 4 -

[* 1 4 ] Wh et h er a t ax pay er’ s act i v i t i es co n s t i tu t e th e carry i n g o n o f a t rad e o r b u s i n es s req u i res an ex am i n at i o n o f t h e fact s an dci rcu m s tan ces o f each cas e. See Co m m i s s i o n er v . Gro et zi n g er, 4 8 0 U.S. 2 3 , 3 6 (1 9 8 7 ); s ee al so W o o dy v . Co m m i s s i o n er, s l ip o p . at 9 -1 0 . Wh en d et erm i n i n g wh eth er a t rad e o r b u s in es s
ex i s t s t h e Co urt fo cu s es o n th ree fact o rs : (1 ) wh et h er t h e t ax p ay er u n dert o o kth e act i vi t y i nt en d in g t o earn a p ro fi t , (2 ) wh ether t h e t ax p ay er i s reg u larl y an d act i vel y i n v o l v edi n th e act i v it y , an d(3 ) wh ether t h e t ax p ay er’ s act i v i t y h as actu al l y co m m en ced . See W o o dy

v . Co m m i s s io n er, s l ip o p . at1 1
. Wh en , as a t h res h ol dm at t er, d i dT. Yap p co m p l et e RFRL’ s s t artup p h as e
an d b eco m e act i v el y

en gag edi n b us i nes s ? Pet i t i on ers b o t h t es t i fi edattri al ab o u t T. Yap p ’ s effo rt s t o res earch an d d ev el o p an RFRL-b ran dedp ro du ct l i n e. Gen eral l y , th ei r t es t i m o ny s u g g es t edth atRFRL’ s b u si nes s was s t i l l i n d ev el o p m en tan d h adn o t b eg u n o p erat i n g i n 2 0 1 0 . T. Yap p t es t i fi edab ou tt es t i n g
an d ex p eri m en t i n g wi t h d ifferen tRFRL p ro du ctreci p es ; l earn i n g ab o utth e p o t en t i al h eal t h b en efi ts o f u s i ng p ro bi o ti c p ro du ct s; an dcreat i n g RFRL’ s p ro du ct l i ne t h ro u g h tri al an derro r. Nu m ero u s em ai l co n v ers at i o n s , co s t an al y s es , o n l i n e edu cat i o n al art i cl es , b an k reco rd s , cred i t cards t at em en t s , an dcan cel edch eck s i n
ev i d en ce al s o d em o n s t rat e t h atRFRL rem ai n edi n th e s t artup p h as e t h ro u g h o u t 2 0 1 0 . Si g n i fi can tl y , th e fi rs t d el i v ery o f m ark et -read y RFRL p ro du ct s d i dn o t- 1 5 -

[* 1 5 ] arri v e i n th e Un i t ed St at es u n t i l l at e Decem b er 2 01 0 , an ds h ip p i n g -rel at ed d am ag e d el ay edth e p ro du ct s ’ d el i v ery t o RFRL ev en fu rt h er. Pet i t i on ers l au n ch edRFRL’ s p ro du ct s atan o ffi ci al l au n ch p art y i n Feb ru ary

2 0 1 1. T. Yap p ' s d es cri p ti o n o f h er act i v it i es du ri n g 2 0 1 0 an dthe co rro b o rat i n g d o cu m en t at i o n p ers u ad e u s th atth e d efi n i t i o n o f s t artup ex pen s es i n s ect i o n 1 9 5 (c) i s ap p l i cab l e t o th o s e act i v i t ies . Th e p rep o n d eran ce o f t h e ev i d en ce l ead s t o th e
co n cl u s i o n th atp et i t i o n ers ’ RFRL-rel at edact i v i t i es d idn o t ri s e t o th e l ev el o f a t rad e o r b u si n es s u n t il th e co m p an y ’ s o ffi ci al l au n ch i n Feb ru ary 2 0 1 1 atth e earl ies t . Itwas atth i s p o i n tthatRFRL act ual l y co m m en cedo fferi ng p ro b i o t i c h eal t h fo o dfo r s al e. See, e.g
. , Ko en i g v . Co m m i s s i o n er, T.C. M em o . 1 9 9 8 -2 1 5 , s l ip o p . at1 3 -1 4 (ci t i n g Ken n ed y v . Co m m i s s io n er, T.C. M em o . 1 9 73 -1 5 ), aff’ d , 2 2 1 F.3 d1 3 48 (9 t h Ci r. 2 0 00 ). Si n ce al l th e ex p en ses ati s s ue i n th i s cas e were p ai do r i n cu rred b efo re t h e Feb ru ary 2 0 1 1 l au n ch , we co n cl u d e t h at t h ey qu al i fy as
s t artup ex p en d itu res . As s u ch t h e RFRL-rel at edex p en s es are s ub ject t o the p ro v is i o n s o f s ect i o n 1 9 5 an dcan n o t cu rren t ly b e d edu ct edu n d er s ect i o n 1 6 2 . See Hard y v. Co m

m i s s io ner, 9 3 T.C. 6 8 4 . W e s u s t ai n res p o n d en t’ s d et erm i n at i o n i n t h e n o ti ce t o d i s al l o w d edu ct io n s fo r t h es e ex p en s es .- 1 6 -

[* 1 6 ] II. Accu racy -Rel at edPen al t y Sect io n 6 6 6 2 (a) an d(b )(2 ) i m p o s es a 2 0 % accu racy -rel at ed p en al t y o n an y
u n d erp aym en t o f Fed eral i n co m e t ax at t ri bu t ab le t o a s ub s tan t i al u n d ers t at em en to f i n co m e t ax . Anu n ders tat em en to f i n co m e t ax i s s ub st an t i al i f i tex ceed s t h e g reat er o f 1 0 % o f t h e t ax req u i redt o b e s h o wno n th e ret u rn o r $ 5 ,0 00 . Sec. 6 6 6 2 (d )(1 )(A). As d et erm i n edi n th e n o t i ce o f d efi ci en cy p et i t i o n ers ’
u n d ers t at em en to f i n co m e t ax fo r 2 0 1 0 was s ub s t an t i al , an dres p o n d en td et erm i n ed t h e p en al t y

u n d er s ect io n 6 6 6 2 (a) an d(b )(2 ) fo r t haty ear. Un d er s ect i o n 7 49 1 (c) res p o n d en th as th e b u rd en o f p ro du ct io n wi t h res p ect t o the accu racy -rel at edp en al t y . See Hi g b ee v . Co m m i s s i o n er, 1 1 6 T.C. 4 3 8 , 4 4 6 (2 0 0 1). To s at i s fy

res po n d en t ’ s b u rd en o f p ro du ct io n u n d er s ect i o n 7 4 9 1 (c),
res p o n d en t m

u s tp ro du ce ev i d en ce s h o wi ng , i n t er al i a, th atres po n d en t ’ s rep res en t at i v es co m

p l iedwi t h s ect i o n 6 7 5 1 (b )(1 ). See Graev v . Co m m is s i o n er, 1 4 9 T.C. _

_ _ , _

_ _ (s l i p o p . at1 4 ) (Dec. 2 0, 2 0 17 ), s up pl em en t i n g an do v erru l i ng i n p art 1 4 7 T.C. 4 6 0 (2 0 1 6 ). Th e reco rdco n tai n s a p en al t y ap p ro val fo rm t h at
s h o ws th atres p o n d en t ’ s rep res en t at i v es co m p li ed wi t h s ect io n 6 7 5 1 (b )(1 ). Res po n d edh as m etth e b u rd en o f p ro du ct i o n i n th i s cas e. See i d. at

_ __ , s l i p o p . at2 2 . As res po n d en th as d on e s o , i ti s p et i t i o n ers ’ b u rd en t o es t ab li s h t h atth e- 1 7 -

[* 1 7 ] i m p o s i ti on o f t he p en al t y

i s n o tap p ro p ri at e. See Hi gb ee v . Co m m i s s i o n er, 1 1 6 T.C. at4 47
. Sect io n 6 6 6 4 (c)(1 ) p ro v i d es an ex cep t i on t o t he s ect io n 6 66 2 (a) p en al t y i f i t i s s ho wnth atthere was reas o n ab le cau s e fo r an y p o rt i o n o f th e u nd erp aym en tan d t h e t ax p ay er act edi n g o odfai t h . Th e d et erm in at i o n o f wh et her a t ax p ay er act ed wi t h reas o n ab l e cau s e an di n g o o dfai t h i s m ad e o n a cas e-b y -cas e b as i s , t ak i n g i n t o acco u n tal l th e p ert i n en tfact s an dci rcu m s t an ces . Sec. 1 .6 6 6 4 -4 (b )(1 ), In co m e Tax Reg s . Th e m o sti m p o rt an t fact o r i s th e ex t en to f t h e t ax p ay er’ s effo rt t o as s es s h i s o r h er p ro p er t ax l i ab i l i t y . Id . Ci rcu m s t an ces th at m ay i n di cat e
reas on ab l e cau s e an dg o o d fai t h i n cl u d e an h on es t m i s un d ers tan d i n g o f fact o r l aw t h ati s reas on ab le i n v i ew o f th e t ax p ay er’ s ex p eri en ce, kn o wl ed g e, an d edu cat i o n . Id
. Acco rd i ng t o p et it i on ers , th e p en al t i es are n otap p l icab l e b ecau s e t h ey rel i ed
up o n thei r C.P.A. t o rep o rtth e Fed eral i n co m e t ax l i ab i l it i es s h o wno n th ei r jo i n t retu rn s . Un d er cert ai n ci rcu m st an ces a t ax pay er’ s rel i an ce up o n p ro fes s io n al ad v ice m ay

es t ab l i s h t h e t ax p ay er’ s reas o nab l e cau s e an d g o o dfai th wi t h res p ect t o an u nd erp aym en to f t ax . To es t ab li s h reas o n ab l e cau se t h ro ug h rel i an ce o n p ro fes s i on al ad v i ce t h e t ax p ay er m u s tp ro v e t h at(1 ) t he ad v is er was a co m p et en t p ro fes s i on al wh o h ads u ffi ci en tex p ert i s e t o ju s t i fy rel i an ce, (2 ) t h e t ax p ay er- 1 8 -

[* 1 8 ] p ro v i d edn eces s ary an d accu rat e i n fo rm at io n t o th e ad v i s er, an d(3 ) t h e t ax p ay er act u al l y

rel i edi n g o o dfai t h o n th e ad vi s er’ s ju d g m en t . Neo n at o l og y As s ocs ., P.A. v
. Co m

m i ss i o n er, 1 1 5 T.C. 4 3 , 9 9 (2 0 0 0 ), aff’ d, 2 9 9 F.3 d 2 2 1 (3 d Ci r. 2 0 02 ). Rel i an ce o n a ret u rnp rep arer i s n o treas o nab l e wh ere “ ev ena cu rs o ry
rev i ew” o f t h e t ax retu rn wo u l drev eal erro rs . M et ra Ch em . Co rp . v . Co m m i s s i o n er, 8 8 T.C. 6 54 , 6 6 2 (1 9 8 7 ). Pet i t i o ners h av e n o tes t ab l i s hedth atth ey p ro v i d edth ei r C.P.A. wi t h
co m p l et e an daccu rat e i n fo rm at i o n . T. Yap p t es t i fi edattri al th atth ey p ro v i d ed t h ei r C.P.A. wi t h o n l y t h e g en eral l ed g ers thatth ei r b o o kk eep er k ep t t o reco rd i n co m e an d ex pen s es fo r NXTM , RFRL, an d t h e Yap p h o us eh o l d
. Fu rt herm o re, J . Yap p ad m i t t edattri al th at h e ap p ro vedth e fi l in g o f t h e retu rn s wi t h ou t fu l l y

rev i ewi n g th em . Hadp et i t i o n ers rev i ewedth e ret u rn s , th ey
wo u l dh av e n o t i cedthe n um ero u s m i s t ak es th atth ey cl ai m th ei r C.P.A. m ad e, s u ch
as s el ect in g the wro n g acco u nt i n g m et h o dfo r rep o rt i n g NXTM ’ s t ax ab l e i n co m e i n 2 0 0 9, i n cl u d i n g p ers o n al ex p en s es as p arto f RFRL’ s b us i n es s d edu ct i o n s , an d fai l i n g t o co n t i n ue t o cl ai m o n th e 2 01 0 retu rn d ep reci at i o n d educt i on s cl ai m edfo r 2 0 0 9 . Th e i d en t i fi edm i s t ak es u n d erm i n e an y as su m p t i o n t h atth e p rep arer was a
co m p et en tp ro fes s i o n al m erel y b ecau s e h e was a C.P.A. Pet it i on ers ’ p u rp o rt ed rel i an ce o n th ei r C.P.A. d o es n otes t ab l i s h th at t hey act edwi t h reas o n ab l e cau s e- 1 9 -

[* 1 9 ] an d i n g o o d fai t h . Th erefo re, th e Co u rts u s tai n s res po n den t ’ s d et erm i n at i o n t h atp et i t i o n ers are l i ab l e fo r t h e s ect io n 6 6 6 2 (a) accu racy -rel at ed p en al t y fo r 2 0 1 0
. W e h av e co n s id eredal l o f t h e p art i es ’ arg u m en t s , an d , t o th e ex t en tn o t ad dres s edab o v e, we co n cl ud e t h atth ey are m o o t, i rrel ev an t , o r wi t h o u t m eri t . To refl ectth e fo reg o in g, Deci s i o n wi ll b e en t ered
u n der Ru l e 1 5 5
.