T.C. M em o . 2 0 1 9 -1 0 8

UNITED STATES TAX COURT

DENISE CELESTE M CM ILLAN, Pet i t i on er v . COM M ISSIONER OF INTERNAL REVENUE, Res po n d en t

Do ck etNo . 1 6 2 03 -1 3
. Fi l edAu gu s t 2 6 , 2 0 1 9
.

Den i s e Cel es t e M cM il l an , p ro s e. M i ch ael K. Park , Lau ra J . M u l l i n , Pri s ci l l a A. Parret t , an dVan es s a M
. Ho p p e, fo r res p o n d en t .

M EM ORANDUM FINDINGS OF FACT AND OPINION
HOLM ES, J u d g e: Th i s i s Den i s e M cM i l l an ’ s s i xt h Tax Co u rtcas e i n wh i ch th e Co m m i s s i o n er ch al l en g es d educt i o ns s h e cl ai m edfo r a h o rs e b u s in es s . Her l as th o rs e d i edi n 2 00 8 , an ds h e h as n otrep l aced h i m . Bu tb ei ng h o rs el es s h as n ’ t- 2
-

[* 2 ] s t op p edh er fro m

cl ai m i n g d edu ct i o n s fo r a h o rs e b u s in es s . Onh er 2 0 1 0 retu rn s h e rep o rt edth ats h e h adtwo b u s in es s es : o n e fo r “ h o rs e b reed i n g / s h o wi n g ,” wh i ch p ro du cedo n l y ex p en ses ; an d o n e t h ats o l d “ IT an d d at ab as e m an ag em en ts erv i ces ,” wh i ch p ro du cedi nco m e. Th e Co m m is si o n er d i s al lo wedal l th e d edu ct i o n s th ats h e cl ai m edfo r t h e h o rs e b u si n es s , an d d i s al lo wedd edu ct i o n s fo r l eg al fees an d a h o m e o ffi ce fo r h er IT b u s i n es s as wel l
. He al s o arg u es thatM s . M cM i l l an s ho u l d ’ v e rep o rt ed a $ 7 0 , 0 00 s et t l em en t fro m h er h o m eo wn ers as s o ci at i o n (HOA) as t ax ab l e i n co m e. Sh e s ay s t h e s et t l em en t
was fo r p ai n an ds u fferi n g an dth ath er h ors e act i v i ty real l y was a t rad e o r b u s i n es s . FINDINGS OF FACT I. Back g ro u n d M s . M cM i l l an i s s el f-em

p l o y ed . Sh e d es cri b es h ers el f as “ an ad m i ni s trat or,
a co rp o rat e o ffi cer an dd i rect o r, a[] s o ft ware p ro g ramm er, a p ro fes s i o n al l y
s ch o ol edeques tri an , an dan i n tern at i o n al l ev el dres s ag e co m p et i t o r an d trai n er.” Sh e co n du ct s t h es e act i v i t i es fro m the l i v i n g ro o m

o f h er o n e-b ed ro o m

ap art m en t . A. Ho rs e Breed in g / Sh o wi n g M s . M cM i l l an h as b een i n v o l v edwi th h o rs es s i n ce t h e 1 9 70 s . Her
ex p eri en ce i s p ri m ari ly

i n dres sag e, a t y

p e o f eq ues tri anco m

p et it i o n wh ere a ri d er- 3
-

[* 3 ] i n a t o p h at an dt ai l co atg u i d es a h o rs e t h ro u g h a s eri es o f p reci s e
m o vem en t s . M s . M cM i ll an ap t l y co m p ares i t t o “ s k il l edg ym

n as t ics .” Du ri n g th e 1 9 8 0 s an d1 9 9 0 s s h e o wn eds ev eral h o rs es an dp art i ci p at edi n dres sag e
co m p et i t i o ns . Sh e g radu al ly

s o l d o ff h er h o rs es , an db y 1 9 97 s h e h ado n l y

o n e l eft --Go l dru s h
. Bet ween 1 9 9 2 an d1 9 9 7 s h e b red Go l dru s h fi v e t i m es , each t i m e ch arg i n g a $ 1 ,5 0 0 s tu dfee. In 2 0 0 0 Go ld ru s h d ev el o p edan u n ev en s t ep an dh ad t o s t o p
co m p et i n g . M s . M cM i l l an tri edt o reh ab i l i t at e h i m , b u twi th ou ts u cces s. Sh e
co n ti n u edt o try t o breed h i m , al s o wi th o u ts u cces s . In 2 0 0 7 M s . M cM i l l ans en tGo l dru s h t o Au s tral ia, wh ere s h e t h ou g h ts h e’ d h av e b et ter l u ck
. Al th o u gh s he h ad n ’ trecei veda s tu dfee fo r Go l dru s h s i n ce 1 9 9 7 , s h e h o p edth ati n Au s tral i a s h e co ul db reedh i m twi ce a m o n th an dg eta $ 1 ,5 0 0 s tu dfee each t i m e. Sh e u s edl i nes o f cred i tt o p ay fo r h i s tran s p o rt at i o n , an d s he t o l dth e p eo p l e b o ard i n g h i m they co u l d b reedth ei r m ares t o h i m i n
ex ch an g e fo r h i s upk eep . Bu ti n J an u ary 2 0 08 , o n l y

a few m o n ths aft er arri v i n g i n Au s tral i a, Go l dru s h d ied
. By th e en d o f 2 0 1 0--t h e t ax y ear at i s s u e i n th i s cas e--M s . M cM i l l an s t i l l h ad n o tb o u g htan o th er h ors e. Sh e s ay s , h o wev er, t h atth i s d o es n ’ t m ean s h e i s o u t
o f t h e h o rs e b u s i n es s . Acco rd i n g t o h er, h er “ b u s i n es s m o d el * * * i s t o fi n da- 4
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[* 4 ] t al en t edh o rs e wi th p ot en t i al fo r t h e ri g h t p ri ce, trai n the h o rs e t o i n t ern at i o n al l ev el , an dth ens el l th e h o rs e ata p ro fi t .” To fi n d a h o rs e, s h e s ay s s h e “ l eti tb e kn o wn b y wo rdo f m o ut h that[s h e] was i n th e m ark etfo r a s u i tab l e i n t ern at i o n al l ev el dres s ag e h ors e p ro sp ect ,” an d o ccas i o n al ly p eo p l e wo u l dt el l h er ab o u t
av ai l ab l e h o rs es . As p art o f h er s earch s h e “ v is i tedp ri v at e t rai ni n g b arn s , n et wo rk ed wi th b u s i n es s co n t act s , [an d ] rev i ewedv id eo t ap es o f h o rs es fo r s al e.” In 2 0 10 s h e al s o at ten d ed --b u td i dn otp art i ci p at e i n --fi v e dres s ag e co m p et i t i o n s . Sh e al s o wen t reg u l arl y

t o a l o cal “b arn ”, h er t erm fo r a “p ro fes s i on al dres s ag e t rai n i ng faci l it y .” Atth e b arn s he ro d e an acq u ai nt an ce’ s h o rs e an dg av e
s o m e free ri d i n g l es s o n s . Sh e al s o “ l u n g ed ” ab o u t a d o zen h ors es , wh i ch i s a fo rm
o f p ret rai n i n g wh ere t h e h o rs e ru ns aro u n dth e t rai n er i n a ci rcl e wh i l e at t ach edt o a l on g ro p e. Al th o ug h l u ng i n g u s u al l y l as ts o n ly

4 5 m i nu t es , M s . M cM i l l an s ai d
s h e al s o p rep aredth e h o rs es fo r t h ei r ex erci s e, co ol edth em d own aft erward , an d
was hedthem . Al l th i s co u l d t ak e up t o 3 h o u rs t o t al --m ean i n g th ats h e s p en tab o u t 3 6 h o u rs p erfo rm in g thes e t as k s i n 2 0 1 0 . Her t es t i m o n y o n th e co m

p en s at io n s h e
earn edfo r t h i s was i nco n s i s t en t : Sh e t es t i fi edfi rs t th ath er rat e fo r t h is wo rkwas $ 3 0 an h o u r, b u tthen s ai ds h e recei v edo n l y p erm i s s i o n t o s t o re h er h o rs e t ackan d dres s ag e cl o th es at th e b arn . Wh et h er t h is was cas h o r b art er i n co m e, s he d i dn o t rep o rti t .- 5
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[* 5 ] Al th ou g h M s . M cM i l l an ’ s i n v o l v em en twi th h o rs es s p an s fi v e d ecad es , s h e’ s h ado n l y

three p ro fi t ab l e y ears --n o n e aft er 1 9 8 8 . To h er, h o w ev er, 1 9 9 7 was th e tu rn i n g p o i n t. In th at y ear s h e t es t i fi edag ai n s t a fo rm er b us i n es s p art n er i n an
an i m al -cru el ty

cas e an d t ri edt o s t o p h i m fro m k eep i ng a h o rs e s h e’ ds o ld . Sh e
s ay s that as a res u lto f t h att es t i m o n y s h e “ l os tal l o f h er b us i n es s wi th i n th e dres s ag e co m

m u n i ty . ” Th e l o ss es s h e’ s rep o rt edfro m h er h o rs e act iv i ty

are q u i t e l arg e. Here are h er rep o rt ed i n co m e an dex pen s es fo r 2 0 0 4 -1 0 :

Year Gro s s i n co m e

fro m h o rs e act i v i ty E x pen ses fro m

h o rs e act i v i ty Net p ro fi to r

(l o s s) fro m

h o rs e act i v i ty 2 0 0 4 $5 8 8 $ 3 6,4 5 3 ($ 3 5,8 6 5 ) 2 0 0 5 -0
- 2 2 ,2 7 7 (2 2 ,2 7 7 ) 2 0 0 6 -0
- 3 3 ,1 2 8 (3 3 ,1 2 8 ) 2 0 0 7 -0
- 5 1 ,6 9 7 (5 1 ,6 9 7 ) 2 0 0 8 -0
- 4 ,2 0 3 (4 ,2 0 3 ) 2 0 0 9 -0
- 7 ,4 8 6 (7 ,4 8 6 ) 2 0 1 0 -0
- 5 ,2 3 8 (5 ,2 3 8 ) To t al 5 8 8 1 6 0,4 8 2 (1 5 9,8 9 4 )- 6
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[* 6 ] B. IT an dDat ab as e M an ag em en tServ ices Fo rtun at el y

fo r M s. M cM i l l an , “ h ors e b reed i n g /s h o wi n g ” i s n o th er o n l y
s o u rce o f i nco m e. St art i n g i n 2 0 0 0 s h e d i dd at ab as e s oft ware p ro g ramm i n g fo r a d i rect m ark et er cal l edTo n y Ho ffm an Pro du ct i o n s. Sh e fi rs two rk edi n t h at
co m p an y ’ s o ffi ce, b u t i n 2 0 0 3 s h e co n v in cedh er b o s s t o l eth er wo rkfro m h o m e. In 2 0 08 s h e s t art edd o in g s i m i l ar wo rkfo r a co m p an y cal l edQ.X. Tel eco m , al s o
wo rk i n g fro m

h o m e. In 2 01 0 s h e wo rk ed 5 -6 h o u rs a d ay fo r Q.X. Tel eco m , b u t h er s ch edu l e was i rreg ul ar an dth o s e h o u rs were s p readth ro u g h ou tth e d ay . In 2 0 1 0 Q.X. Tel eco m

p ai dh er $ 6 5 ,0 0 0 an d rep ort edi to n a Fo rm 1 09 9 -M ISC, M i s cel lan eo u s In co m e. Th e reco rds h o ws th ats h e’ s earn edaro u n d$ 6 0 ,0 0 0 a y ear fro m h er IT wo rk s in ce atl eas t2 0 0 4
. C. Ho m e Offi ce M s . M cM i l l an h ad s ev en co m p u t ers , al l o f wh i ch s h e k ep tal on g a s i n g l e wal l o f h er ro u g hl y

8 00 -s quare-fo o t , o n e-b ed ro om ap art m en t ’ s l i v i n g ro o m . Sh e
u s ed on e co m

p u t er fo r h er IT jo b , o n e fo r h er h o rs e-rel at edact iv i ty , o n e t o ad m i n is t er h er web s i t e, o n e t o wat ch h o rs e DVDs , two as b ackups , an do n e as a fi le s erv er. Al th ou g h the l i v i n g ro o m t o o kup ab o u th al f o f h er ap art m en t , M s . M cM i l l an s ai ds h e n ev er u s ed i tfo r an yth i n g b u two rk . In ad d i t i o n t o h er IT- 7
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[* 7 ] wo rk , s h e s ay s s h e “ co n du ct edev ery as p ecto f [h er] dres sag e h o rs e b u s i n es s fro m th ato ffi ce, ex cep tg ro o m i n g , s ad d l i n g , an dri d i n g .” Sh e t es t i fi ed th ati n al l
o f 2 0 10 s h e n ev er en t ert ai n edath o m e. Sh e al s o cl ai m s th ats h e at e al l o f h er
m eal s i n h er k i t ch en ’ s d i n i n g area, k ep th er t el ev i s io n an d s t ereo i n h er b ed ro o m , an d k ep tm o s to f h er b o o k s i n a wal k -i n cl os et . D. Laws u i t s Bu tM s. M cM i l l an al s o wo rk edo n s o m et h i n g el se i n h er l iv i n g ro o m -- l aws u i t s . Sh e’ s b een i nv o l v ed i n s ev eral , i n cl u d i n g s o m e s m al l -cl ai m s cas es an da
s u i tag ai n s tm ov ers s h e u s edi n 2 0 11 . On e o f t h es e cas es b eg ani n 2 0 0 5 wh en s h e fi led a co m

p l ai n tag ai n s th er HOA fo r b reach o f co v en an t s , b reach o f fi du ci ary du ty , an dn u i s an ce. Sh e s ai dthe HOA h adi g n o redh er “ freq u en tco m p lai n t s o f
o ff-l eas h d o gs b ark in g , fi gh t i n g , b i t i n g an dd efecat in g th ro u g ho u tthe As s oci at i o n ’ s co m

m o n areas ;” “ the p res en ce o f m o l di n h er b at h ro o m , g ro wi n g b et ween th e t i les th em s el v es an db et ween th e wal l an dth e tub ri m ;” an d “ s ev ere
n o i s e i n tru s i o n s t emm i n g fro m al l eg edi m

p ro p er s tru ctu ral co n s tru ct i o n an d/ o r rep ai rs th ereo f.” Th e Cas e In fo rm at i o n Sh eet s he fi l edatth e s t arto f t he cas e h ada
s p ace fo r h er t o “ [l ] i s tal l g en eral an ds p eci fi c d am ag es cl ai m ed , i n cl u d i ng b u tn o t l i m i ted t o , m ed i cal ex p en s e (p as tan dfu tu re), l o s s o f earn i n g s , p ro p erty d am ag es ,- 8
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[* 8 ] an d an y

o th er s p eci fi c m o n et ary

d am ag es th atap p l y

i n y o u r p art i cu lar cas e,” b u ts h e l efti tb l an k
. Sh e wen tth ro ug h s ev eral at t o rn ey s an dev ens u edh er fi rs t at t o rn ey s fo r
m al p ract i ce aft er t h ey --i n h er wo rd s --“ at t em p t [ed ] t o s et t l e [h er] l aws u i t wi th o u t [h er] p erm i s s i o n .” Th o s e at t orn ey s en d ed up fi li ng a l i en i n an at t em p tt o co l l ect
u np ai dfees . An d wh i l e t h atcas e was o n g o in g , th e Ven tura Co u nt y Di s tri ct At t o rn ey ’ s Offi ce p ro s ecu t edh er fo r m is d em ean o r v i ol at io n s o f Cal i fo rn i a’ s p eep in g -t o m

s t atu t e. Acco rd i n g t o a l et t er fro m o n e o f h er at t orn ey s , th e ch arg es
aro s e fro m h er at t em

p t“ t o g at h er s o u n d s am

p l es fro m th e u n i tab o v e h er ata t i m e wh en th e u n i t w as u n o ccup i edan dwas b ei n g rem o del edb y n um ero u s wo rkm en .” Th e HOA s et t l edi n J u n e 2 0 1 0 fo r $ 7 0 ,0 00 . M u ch o f i twen tt o p ay M s . M cM i l l an ’ s n ew at t orn ey an ds at i s fy

th e o l dat t o rn ey s ’ l i en . Th e n am ed d efen d an twas Sh ad o w Ri d g e atOak ParkHo m eo wn ers As s o ci at i o n, an d i n th e
s et t l em en tM s. M cM i l l an ag reedt o t ak e d o wn a web s it e s h e h adm ad e cal l ed

“ www.b ewareo fs h ad owri d ge.co m ” t h atu s edth e n am es o f th e HOA’ s p res i d en t
an d b o ardm em

b ers . Th e s et t l em en td o cu m en t s d es cri b e t he cas e as a d i s pu t e o v er “ al l eg ed
n u i s an ces , cl ai m s o f em o ti o n al d i s tres s , l i b el , s l an d er, i n v as i o n o f p ri v acy an d
co n st ru ct i o n d efect .” Attri al , h o wev er, M s . M cM i l l an cl ai m edth atei th er t h e- 9
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[* 9 ] m o ldo r t h e s tres s h adm ad e h er n au seo u s, th ats h e’ dd ev el op eda ras h , an d th ati n 2 0 0 6 s h e s p en t aro u n d$ 1 9 ,0 0 0 t o s t ay i n a h o t el rat her t h an rem ai n i n h er ap art m en t . In2 0 0 4 s h e’ d s een a p s y ch i at ri s t , wh o s e n am e s he rem em b eredattri al , b u ts h e co u l dn ’ t rem em

b er t h e n am e o f a g en eral p ract i t i o n er wh o s h e s ay s p res cri bed ras h cream

fo r h er aro u n dth e s am e t i m e. Nei th er co u l d s h e rem em b er th e n am e o f a d o ct or s h e s ai dh er at t o rn ey s p l an nedt o cal l as an ex p ertwi tn es s , th o u g h s h e d i drem em

ber t h e n am es o f h er m o ld , co n s tru ct i o n -d efect , an d n o i s e
ex p ert s . M s . M cM i l l an ’ s l i t i g at i o n ex p eri en ce al s o i n cl ud es fi v e p rev i ou s cas es i n th e Tax Co u rt . Sh e an d th e Co m m i s s io n er s et t ledth ree o f t h o s e cas es , b u tth e
o th er t w o wen t t o tri al wi th o n e g o i n g t o ap p eal an dth ent o t h e Suprem e Co u rt . See M cM i l l an v . Co m

m i s si o ner (M cM i l l an II), T.C. M em o . 2 0 15 -1 0 9 (fi nd i n g n o trad e o r b u si n es s i n h o rs e act i v i ty i n wh i ch p et i t i o n er’ s o n e h ors e h add i ed ); M cM i l lan v . Co m

m i ss i o n er (M cM i l l an I), T.C. M em o . 2 0 1 3 -4 0 (fi n d i n g n o t rad e
o r b u si n es s i n h o rs e act i v i ty i n wh ich p et i ti o n er’ s o n e h o rs e h adn ei ther b een b red
n o r co m p et edi n ei g h t y ears ), aff’ d , 6 9 7 F. Ap p ’ x 4 8 9 (9 th Ci r. 2 0 1 7 ), cert . d en i ed , 1 3 8 S. Ct . 1 0 1 0 (2 0 1 8 ).- 1 0 -

[* 1 0 ] II. 2 01 0 Tax Retu rn M s . M cM i l l an p rep aredh er 2 0 1 0 t ax retu rn h ers el f. Sh e d i dn ’ trep o rtth e $ 7 0 ,0 0 0 fro m

h er s et t l em en to f t h e HOA s u i t . At tri al s h e ch aract eri zedi tas an awardfo r p ai n an ds u fferi n g an ds ai dth ats h e’ dl earn edi n 1 99 8 thats u ch award s
aren ’ tt ax ab l e aft er s h e h ad s et t l eda d i fferen tl aws u i t . Sh e al s o s ai d thata CPA
s h e’ d u s edi n th e 1 9 90 s t o l dh er t h atth e ex cl u s io n i s n ow m o re “ n arro wl y d efi n ed ”
an d i s ap p ro p ri at e o n ly

wh ens o m eo n e i s “p hy s i cal l y i ll .” Sh e d i dn o tas kan y o f h er at to rn ey s ab o u ti t . Sh e i n cl u d edtwo Sch edu l es C wi th h er retu rn : o n e fo r “ h o rs e b reed i n g / s h o wi n g ” an do n e fo r “ IT an dd at ab as e m an ag em en ts erv i ces .” Onh er Sch edu l e C fo r “ h o rs e b reed i n g / s h o wi ng ,” s h e rep o rt edzero i n co m e an d t h e fo l l o w i n g ex p en s es , fo r a t o t al l o s s o f $ 5 , 2 3 8 :

Ex p en s e Am o u n t Car an dtru ck $ 2 5 0 In t eres t (o th er) 3 , 9 3 8 Ren t(o th er b u si n es s p ro p ert y ) 9 6 0 Ot h er 9 0 To t al l o s s 5 , 2 3 8- 1 1 -

[* 1 1 ] Th e “ car an d t ru ckex p en s es ” are fo r 5 0 0 m i l es dri v en . Th e “ o th er
ex p en s es ” are fo r “ m ag azi n es an ds ub s cri p t i o n s .” M s . M cM i ll an d i dn ’ tex p l ai n o n h er ret u rn o r attri al wh at th e “ i n t eres t ” was fo r. 1 W e d o n ’ tkn o w wh atth e “ o th er b u s i n es s p ro p ert y ” was
. Onh er Sch edu l e C fo r t h e IT an dd at ab as e m an ag em en tb u s in es s M s . M cM i l l an al s o cl ai m edd edu ct i o n s fo r h o m e-o ffi ce ex pen ses . Th es e t o t al ed $ 8 ,0 4 5 an dco n s i s t edo f $ 2 ,2 46 i n d ep reci at i o n p l u s h al f o f th e fo l l o w i n g
ex p en s es : Ex p en s e Am o u n t In s u ran ce $2 ,3 0 5 Ut i li t i es 5 ,3 9 2 Ot

h er ex p en s es 3 ,9 0 0

1 Du ri n g th e t ri al ari s i n g fro m h er 2 0 0 9 t ax y ear, s h e arg u ed thatth e $ 5 ,6 9 0 i n i nt eres ts h e d edu ct edo n h er h o rs e-rel at edSch edu l e C fo r t h at y ear was fo r m o ney s h e b o rro wedi n 2 0 0 7 t o s en dGo ld ru s h t o Au s tral i a. Th e t ran s cri p to f t h at tri al i s i n th e reco rdh ere--M s. M cM i l l an p ro ffered i t ; an dal th o u g h th e Co m m i s s i o n er i ni t i al l y

o bject edt o i t , h e l at er wi th drew h i s o b j ect i o n . Th e reco rd i s s il en t , h o wev er, reg ard in g t h e o ri g i n o f t h e $ 3 , 9 38 i n teres tex pen s e o n M s . M cM i l l an ’ s 2 0 1 0 “ h ors e b reed i n g /s ho wi ng ” Sch edu l e C. W e wi l l n o t ju s t as s u m e th ati tal s o was rel at edt o m o v i n g Go l dru s h t o Au st ral i a; i n an y ev en t , M s . M cM i l l an i n tro du cedn o ev i d en ce atal l th ats h e actu al l y p ai dthatam ou n ti n i n t eres ti n 2 0 10
.- 1 2 -

[* 1 2 ] Th e reco rdd o es n ’ tt el l u s wh atth e “ ot h er ex p en s es ” were o r wh et her t h ey were act u al l y

p ai d . M s . M cM il l an d edu ct ed h al f t h es e ex p en s es b ecau s e s h e cl ai m eds h e u s edh al f h er ap art m en tas a h o m e o ffi ce. Sh e al s o d educt ed$ 1 1 ,9 9 8 fo r l eg al an dp ro fes s i o n al s erv i ces , wh i ch i n cl u d edam o u n ts s h e p ai dt o b o th th e at t o rn ey rep res en t i n g h er i n h er s u i tag ai n s t h er HOA an d t h e at t o rn ey wh o d efen d edh er ag ai n s t th e m i s d em ean o r ch arg es . III. Pet i t i o n an d Tri al Th e Co m m is s i o n er i s s u edM s . M cM i l l an a n o t i ce o f d efi ci en cy th at d i s al lo wedd edu ct i o n s fo r l eg al an dp ro fes s i o n al s erv i ces , an d fo r b u si nes s u s e o f h er h o m e--d edu ct i o n s s he’ dt ak en o n h er Sch edu l e C fo r h er “ IT an dd at ab as e
m an ag em en ts erv ices .” Th e n o t i ce al so as s ert eda s ect i o n 6 6 6 2 (a) 2 p en al ty o n th e al t ern at e g ro u n d s o f n eg li g en ce o r d i s reg ardo f ru l es o r reg u l at i o n s , a s ub st an t i al
u n d ers t at em en to f i n co m e t ax , an d a s ub s tan t i al -v al uat i on m i s s tat em en t . M s . M cM i l l an t i m el y

fi l eda p et i t i o n , an di n h i s an s wer t h e Co m m is si o n er rai s ed two n ew i s s u es --t h atM s . M cM i l l an was n o t en ti t ledt o an y d educt i o n s fo r h er h o rs el es s “ h o rs e b reed i n g / sh o wi n g” b u s i n es s an dth atth e $ 7 0 ,0 00 s h e’ drecei v ed i n the HOA s et t lem en twas t ax ab l e. He al s o as s ert edan i n creas eds ect i o n 6 6 6 2 (a)

2 Al l s ect i o n referen ces are t o th e In t ern al Rev enu e Co de i n effect fo r t h e y ear at i s s u e, an d al l Ru l e referen ces are t o th e Tax Co u rtRu les o f Pract i ce an d Pro cedure, u n les s we s ay o th erwi s e.- 1 3 -

[* 1 3 ] p en al ty

o n th es e d efi ci en ci es , al th o u g h o n ly o n the g ro un d s o f n eg l i g en ce o r d i s reg ardo f ru l es o r reg u l at i on s . W e t ri edth e cas e i n Lo s An g el es . 3 Attri al th e Co m m i s s i o n er d i dn ’ t i n tro du ce an y

ev i d en ce t h ath e’ dco m

p l iedwi th s ect i on 6 7 5 1(b )(1 ), ev entho u g h h e’ das s ert edp en al t i es . See Graev v . Co m m i ss i o ner, 1 49 T.C. 4 8 5, 4 9 3 n .1 4 (2 0 1 7) (ci t i n g Ch ai v . Co m m i s s i o ner, 8 5 1 F.3 d1 9 0 , 2 2 1 (2 dCi r. 2 0 1 7 ), aff’ g i n p art , rev ’ g i n p art T.C. M em o . 2 0 1 5 -4 2 ), s up pl em en t i n g an do verru l i ng i n p art1 4 7 T.C. 4 6 0 (2 0 1 6 )). Aft er t ri al p ro g res s s l o wedco n s i derab l y wh en M s . M cM i l l an
m o vedt o m ak e 9 5 co rrect i o n s t o th e t ran s cri p t . So m e o f h er p ro p o s ed co rrect i o n s were fo r m i s s i ng t es t i m on y ; o th ers were fo r m is t ak es s u ch as m is s p el l i n g “ l i b el ” as

“ l i ab l e” an d“ m an e” as “ m ai n ”; an ds t i l l o th ers were fo r m i s s p el li n g p ro p er n am es . Her l i sto f p ro p o s edco rrect i o n s co n t ai nedco m m en tary , s u ch as wh en s h e wro t e

“ s h o u l db e ‘breedi ng ,’ n o t ‘ b read in g ’ -- was Sp el l ch eckb ro k en ? ” Th e Co m m i s s i o n er d i dn ’ t o b

jectt o M s . M cM i l l an ’ s m o t io n , an dth e Co u rtad o p t ed

3 Th e Co m

m i s si o ner l o d g edo b

j ect i on s t o s ev eral s tat em en t s i n t h e s t ip u l at i o n o f fact s an dth e fi rs ts up p l em en t al s t i p u l at i o n o f fact s , as wel l as t o m an y ex h i b i t s at t ach edt o tho s e s t i p u l at i o n s . Attri al we ex p l ai n edth atth e p art y wh o wan t edan ex h i b i t ad m i t t edo v er an o b j ect i o n was res p o n s i b le fo r i n tro du ci n g i t du ri n g t es t i m o n y , atwh ich p oi n twe wo u l dru l e o n an y o b ject i o n th atwas ren ewed . M o s ts u ch ex h i bi t s were n otad dres s ed attri al . Th e ex h ib i t s th atwere ad m i t t edi n th ei r en t i ret y

are 1 -J , 4 -J , 5 -J , 6 -J , 1 6 -J th ro u g h 2 1 -J , 2 6 -J , 2 8-J th ro u g h 3 0 -J , 4 3 -J , 4 6 -J th ro u g h 4 8 -J , 5 0 -J th ro u g h 5 6 -J , 5 8 -J , an d6 0 -J . W e al s o ad m i t t edp ag es 3 4 8 3 -3 4 8 5 o f ex h i bi t6 8 -P.- 1 4 -

[* 1 4 ] m an y

o f M s . M cM il l an ’ s p ro p o s edco rrect i o n s an do rd eredth ata co rrect ed tran s cri p tb e fi l ed
. M s . M cM i l l an l i v edi n Cal i fo rn i a atal l rel ev an tt i m es , s o ab s en ta
s t ip u l at i o n t o th e co n traryth i s cas e i s ap peal ab l e t o th e Ni n th Ci rcu i t . See s ec. 7 4 8 2 (b )(1 )(A). OPINION Th ere are fi v e qu es t i o ns fo r u s t o an swer:

• Sh o u l dM s . M cM i l l an h av e rep o rt ed th e HOA s et tl em en t p ro ceed s as i n co m e?

• Can M s . M cM i l l an d edu ct th e ex p en s es s h e l i s t edo n h er Sch edu l e C fo r “ h o rs e b reed i n g / s h o wi n g ”?

• Can M s . M cM i l l an d edu ct h al f t h e co st o f h er ap art m en t as a h om e-o ffi ce ex p en s e?

• Can M s . M cM i l l an d edu ct o n h er Sch edul e C fo r “ IT an d d at ab as e m an ag em en t s erv ices ” the at t o rn ey ’ s fees s h e p ai d t o p ro s ecu t e h er HOA s u i tan dd efen dag ai n s tth e cri m in al cas e?

• Is M s . M cM il l an l i ab l e fo r a s ect i o n 6 6 6 2 (a) p en al ty ? W e b eg i n wi th s om e g en eral p o i n t s . Th e fi rs ti s th e b u rd en o f p ro o f. Tax pay ers u s u al ly

b ear t h atb u rd en i n o u r Co u rt . Ru l e 1 4 2 (a); W el ch v . Hel v eri n g , 2 9 0 U.S. 1 1 1 , 1 15 (1 9 33 ). Th e Co m m i s s io ner b ears th e b u rd en o n l y fo r n ew m at t ers , i n creas es i n d efi ci en ci es , o r affi rm at i v e d efen ses th ath e rai s es i n- 1 5 -

[* 1 5 ] h i s an s w er. Ru l e 1 4 2 (a). It ’ s th erefo re up t o M s . M cM il lan t o s h o w th at
s h e’ s en t it l edt o the l eg al -fee an dh o m e-o ffi ce d edu ct i o ns th atth e Co m m i s s i o n er d i s al lo wedi n th e n o t i ce. Bu ti t’ s up t o th e Co m m i s s io n er t o s h ow t h at M s . M cM i l l an can ’ t ex cl u d e h er s et t l em en t p ro ceed s o r d edu cth er h o rs e-rel at ed
ex p en s es , b ecau s e h e rai s edth os e i s s u es fo r t h e fi rs tt im e i n h i s an s wer. W e al s o n o t e t h atth e o u t co m es o f M s . M cM i l l an ’ s p ri o r au d i t s an d Tax Co u rtcas es d o n ’ taffect th i s cas e. Each t ax y ear s t an ds o n i ts o wn , an d the Co m m i s s i o n er d o es n ’ th av e t o al lo w d educt i o n s n o wju s tb ecau se h e d i dn ’ t d i s al lo w s i m i l ar d educt i o n s i n th e p as t . See, e.g ., Pek ar v . Co m m i s s i o ner, 1 1 3 T.C. 1 5 8 , 1 6 6 (1 9 9 9 ). 4 Th i s m ak es s en s e b ecau s e fact s th at d et erm i n e wh et h er a d educt i o n i s p ro p er can ch an g e fro m y ear t o y ear. Fo r ex am pl e, a t ax pay er m i g h t
u s e a h om e o ffi ce ex cl u s i v el y fo r b u s i n es s i n y ear 1 , wh ich wo u ldm ak e a d educt i o n p ro p er, b u tm ig h tu s e t h e s am e o ffi ce fo r b o th b u s i n es s an dn on b u s i n es s p u rp os es i n y ear 2 , wh ich wo u ldm ean n o d edu ct i o n. See s ec. 2 8 0 A(a), (c)(1 ). Treat i n g each t ax y ear s ep arat el y al s o p rev en ts d edu ct io ns th at were m i s t ak en l y al l o wed fro m

b eco m i n g p eren n i al wi n d fal l s t o u n d es erv in g t ax p ay ers . See Pek ar, 1 1 3 T.C. at1 66
.

4 Nei th er p art y

h as arg u edth atco l l at eral es t o p p el ap p li es t o an y i s su e i n th i s cas e.- 1 6 -

[* 1 6 ] In h er am en d edp et it i o n M s . M cM i l l an s ai dthatth e d edu ct i b i l i ty o f h er l eg al fees was “

ju di ci al ly es t o p p ed ” b y

h er s et t l em en twi th th e IRS fo r h er 2 0 0 4 t ax y ear. Bu tth ats t i p u l at edd eci s i o n was n ’ t a ju d i ci al d et erm in at io n --i twas ju s t
an ag reem en tb etween the p art i es . See Un i t edSt at es v . In t ’ l Bl d g . Co ., 3 4 5 U.S. 5 0 2 , 5 0 5 (1 9 5 3). An d th e factth atth e Co m m i s s i on er s et t ledd o es n ’ tn eces s ari l y
m ean th ath e b el i ev edM s . M cM i l l an ’ s p os i t i o n was co rrect ; h e co u l d ’ v e fo l d ed as
a res u l to f t h e l i t i g at i o n ri s k s , n o tth e u n derl y i ng fact s . See i d . (s et t l em en tco u l d b e b as edo n m eri t s o r co l l at eral co n s i d erat i o n s ). In co n s i s t en ttreat m en to v er t h e y ears d o es n ’ ti ts el f m ean s o m eth i n g ’ s am i s s , an da s t ip u l at edd eci s i o n d o es n ’ tb i n d th e Co u rti n a s ub s equ en t cas e ab o u t a d i fferen tt ax y ear. See i d . at 5 0 5-0 6 ; s ee al s o Ru l e 9 1 (e) (s t ip ul at i o n b i n d i n g i n p res en tcas e o n l y ). M s . M cM i l l an ci t es Tai tv . W . M d . Ry . Co ., 2 8 9 U.S. 6 20 , 6 21 -2 4 (1 9 3 3 ), a
cas e wh i ch d i di n vo l v e co l l at eral es t o p p el . Inth atcas e t he Sup rem e Co u rt ack n owl ed gedth at“ th e s ch em e o f t h e rev enu e act s i s an i m p o si t io n o f t ax fo r
an n ual p eri o d s , an dth e ex act i o n fo r o n e y ear i s d i s ti n ctfro m th atfo r an y

o th er,” b u twen to n t o s ay

th atthi s facts h o u l dn ’ t“ d ep ri ve t he g o v ern m en tan dth e t ax p ay er o f rel ief fro m

redu n d an tl i t i g at io n o f th e i d en t i cal qu es t i o n o f t h e
s t atu te’ s ap p l i cat i o n t o the t ax p ay er’ s s tatu s .” Id . at6 2 4. In th at cas e, t h e qu es t i o n
was wh et h er a co rp orat i o n co u l dam o rt i ze th e o ri g i n al i s s u e d is co u nt(OID) o n- 1 7 -

[* 1 7 ] s p eci fi c b o n d s t h atp red eces s o r co rp orat i on s h adi ss u edi n 1 9 0 2 -0 8 an d 1 9 1 1 . Id . at6 21 -2 2 . Ina cas e i n v ol v i n g t ax y ears 1 9 1 8 an d 1 9 1 9 , th e Fo urt h Ci rcu i th ads ai di t co u ld , b u tthe Co m m i s s i o n er n ev ert h el es s wen to n t o d i s al l o w th e am o rt i zat io n d edu ct io n f o r th e s a me exa ct

b o n d s fo r t ax y ears 1 9 2 0-2 5 . Id . at 6 2 2 . Th e Sup rem e Co u rts ai dth atth e s ub s equ en tcas es were es t o p p edb ecau s e

“ th e fact s wi th res p ectt o t h e s al e o f b o n d s an d t h e s u cces s iv e o wn ers hi p * * * were t h e s am e atth e t i m e o f b o th tri al s .” Id . at6 2 5 . In o th er wo rd s , n o th i n g ab o u t th e i s s uan ce o f t h e b o n d s i n 1 9 0 2 -0 8 an d1 91 1 h adch an g ed --o r co u l dh av e ch an ged --b et ween th e 1 9 1 8-1 9 cas e an dth e 1 9 2 0 -2 5 cas e. Un l i ke t h e qu es t i o n o f h o w t o treat a s p eci fi c d eb ti n s tru m en t ’ s OID, wh et h er l eg al fees p ai d du ri n g a s i n g le y ear are o rd in ary an dn eces s ary

b u s i n es s
ex p en s es d ep en d s o n fact s an dci rcu m s t an ces s peci fi c t o th at y ear--i td o es n ’ t
m at t er wh et h er d i fferen tfees p ai di n d i fferen ty ears were d edu ct i b l e o r n o t . As wi th o ur h o m e-o ffi ce ex am p l e ab o v e, i ti s en t i rel y

p o s s ib l e t hatth e fees M s . M cM i l lan p ai di n o n e y ear m etth e d edu ct i bi l i ty req ui rem en t s b u t th at th e fees s h e p ai di n an o th er d i dn o t --as we d i s cu s s b el o w, i td ep en d s o n wh atex act l y th o s e fees were fo r. So , W . M d . Ry . Co . d o es n ’ th el p M s . M cM i l lan . Ital s o d oes n ’ th u rt h er--fo r th e s am e reas o n s , o u r o p i n i o n s d i s al l o wi n g d educt i o n s fo r fees s h e p ai d i n- 1 8 -

[* 1 8 ] 2 0 0 7 an d2 00 8 , M cM i l l an I, at* 2 5 , an dal l o wi ng ju s t5 0 % o f t he d edu ct i o n
s h e cl ai m edfo r 2 0 0 9 , M cM i l l an II, at* 11 , are al s o i rrel ev an t. It ’ s n o t s u rp ri si n g th atn ei th er p art y as k edu s t o rel y o n o u r o p i n io n s i n M s . M cM i l l an ’ s o th er t wo cas es b ecau s e each o f t h o se reach eda d ifferen tres u l t -- p o s s i b l y b ecau s e t h e p art i es ’ b u rd en s were d i fferen t i n each
. 5 Co m pare M cM i l lan I, at* 8 -* 9 , wi th M cM i l l an II, at* 3 . Inth e cas e i n v ol v i n g h er 2 0 0 7 an d 2 0 0 8 t ax y ears M s . M cM i l l an h adth e b u rd en o f p ro o f o n al l i s s ues ; an d i n ad d it i o n t o fi n d in g t hatl eg al fees rel at edt o h er HOA s u i tweren ’ t d edu ct i bl e, we h el dth ath er h ors e act i v i ty was n o ta t rad e o r b us i n es s an dth ati n t eres to n t h e l o an
s h e t o o ko utt o s en dGo ld ru s h t o Au s tral ia was n ’ t d edu ct i b l e. 6 M cM i l l an I, at* 8
-
* 9 , * 2 2 , * 2 5 . Th e Co m

m is s i o n er h adthe b u rd en o f p ro o f o n ev ery i s s u e i n th e
cas e i nv o l v i n g h er 2 0 0 9 t ax y ear, an dh e fai l edt o ch al l en g e t h e as s ert i o n s h e m ad e
o n h er ret u rnthath er ap art m en twas 5 0 % o ffi ce, s o we al l o w edh er t o d edu ct5 0 %
o f h er l eg al fees fro m

th e HOA s u i t . M cM i l l an II, at* 3 , * 1 1 . Th ere we al s o al l o wed Ms . M cM i l l an t o d edu ct i n t eres tex p en s es rel at edt o Go l dru s h ’ s

5 M s . M cM i ll an s p eci fi cal l y s ai ds h e was n’ trai s i n g co l l at eral es to p p el o r r es j u di ca ta , th o u g h s h e d i darg u e t h ath er p ri o r retu rn s an d th e Co m m i s s i on er’ s treat m en to f t h em

were rel ev an t . 6 In th ato p i n i on we al s o h el dth at Go l dru sh ’ s d eat h d i dn o tco n s t itu t e a cas u al ty l o s s . See M cM i l lan I, at* 2 3 -* 25
.- 1 9 -

[* 1 9 ] tran s p o rt at i on b ecau s e t he Co m m i s s i o n er d i dn ’ ts h ow t h ath er h o rs e act i v i t y
was n’ ta t rad e o r b u s i n es s i n 2 0 0 7 wh en s h e t oo ko u tth e l o an . Id
. at* 2 6-* 2 8 . Bu t
we s t i l l fo u n dth ath er h o rs e act i v i ty was n ’ ta t rad e o r b u s i n es s i n 2 0 0 9 --t h o u g h M s . M cM i l l an was th e Co m m i s s i o n er’ s o n l y

wi tn es s. Id . at * 2 5 . Ev eni f we h ada
reas on t o fo l l o w thes e cas es , we co u l dn ’ trel y o n th e i n co n s i s t en tres u l t s . M s . M cM i l l an al s o co m

pl ai n s th at s he g et s au d it eda l ot , s h e d o es n ’ tl i k e h o w the au d i t s are d o n e, an d th e Co m m i s s i o ner s om et i m es al l ows an ds o m et i m es d o es n’ tal l o w h er h om e-o ffi ce, at t orn ey ’ s -fees , an dh o rs e-b us i n es s d edu ct i o n s . Bu t , as we’ v e ex p l ai ned , i tm ak es s en s e fo r d ifferen t y ears t o co m e o utd i fferen t l y b ecau s e th e fact s an dci rcu m s t an ces th atd et erm i ne wh et h er t h es e t y p es o f d educt i o n s are ap p ro p ri at e are s p eci fi c t o i n d iv i du al t ax y ears . Un l es s th ere’ s

“ s ub s t an t i al ev i d en ce o f un co n s t i tu t i o n al co n duct ” b y the Co m m i s si on er--an dwe fi ndn o n e i n th e reco rdh ere--we d on ’ t l o okb eh i n dn o t i ces o f d efi ci en cy . See Green b erg ’ s Ex p res s , In c. v . Co m m i s s i o n er, 6 2 T.C. 3 2 4 , 3 27 -2 8 (1 9 74 ); b u ts ee Graev v . Co m

m i s si o ner, 1 4 9 T.C. at5 1 4 (Ho lm es , J ., co n cu rri n g). Th at ’ s b ecau s e Tax Co u rtp ro ceed i n g s are de n o vo rev i ews o f th e t ax pay er’ s t ax l i ab i l it y . Green b erg ’ s Ex p res s , In c., 6 2 T.C. at3 2 8 . Fo r ex am pl e, we d i dn ’ t l o o k b eh i n dth e
n o t i ce o f d efi ci en cy

i n Green b erg ’ s Ex p res s , In c., wh ere t he t ax p ay ers co m p l ai n ed- 2 0 -

[* 2 0 ] th atth ey

were s ub j ect edt o m

u lt i p l e au d i t s o n l y

b ecau s e o f t h ei r affi l i at i o n wi th th e Gam

b i n o cri m e fam i l y . W e wo n ’ t l o okb eh i n d i t h ere, ei th er. Th i s cas e s t an ds o n i t s o wn . I. Set t l em en tPro ceed s W e’ l l s tartwi th t h e o n e i n co m e i s s u e i n the cas e. Th e Co m m i s s i o n er s ay s M s . M cM i l l an s ho u l d ’ v e rep o rt ed as i n co m e t h e $ 7 0 ,0 0 0 s et t l em en t o f h er HOA
s u i t --aft er al l, g ro ss i n co m e i s al l i n co m e “ fro m wh at ev er s o u rce d eri ved .” Sec. 6 1 (a); s ee al s o Co m

m i s si o ner v . Gl en s h aw Gl as s Co ., 3 4 8 U.S. 4 2 6 , 4 2 9-3 1 (1 9 5 5). M s . M cM i l l an m ak es two arg u m en t s fo r wh y s h e d i dn’ th av e t o : Sh e fi rs t arg u es th atth e $ 7 0,0 0 0 was an awardfo r p ai n an ds u fferi n g , ev en th o u g h th e
s et t l em en td o cu m en ts d on ’ ts ay s o ; an ds eco n d, s h e d id n ’ tactual l y recei v e al l o f th e s et tl em en tm o n ey

b ecau s e s o m e wen tt o p ay h er cu rren tat t o rn ey

an d s at i s fy h er p ri o r at t o rn ey s’ l i en . W e l oo kateach
. A. Pai n an dSu fferi n g Sect io n 1 0 4 (a)(2 ) ex cl ud es fro m g ro s s i n co m e d am ag es recei v ed“b y s u i t o r ag reem en t* * * o n acco u nto f p ers o n al p h y s i cal i nju ri es o r p h y s i cal s i ckn es s .” To qu al i fy fo r t h i s ex cl u s i o n , a t ax p ay er m us ts h o w th at“ th e d am ag es were recei v ed
o n ‘ acco u n to f p ers on al i n juri es o r s i ckn es s .’ ” Co m m i s s io n er v . Sch l ei er, 5 1 5 U.S.- 2 1 -

[* 2 1 ] 3 2 3 , 3 37 (1 9 95 ) (qu o t i n g s ect i o n 1 0 4 ); 7 s ee al s o Green v . Co m m i s s i o n er, T.C. M em o . 2 00 7 -3 9 , 2 0 0 7 W L 5 1 8 9 0 8 , at* 3 , aff’ di n p art , rem an d edo n o th er g ro u nd s , 3 1 2 F. Ap p ’ x 9 2 9 (9 th Ci r. 2 0 0 9); Al l u m v . Co m m i s si o n er, T.C. M em o . 2 0 0 5 -1 7 7 , 2 0 0 5 W L 1 6 92 4 8 8 , at* 4 , aff’ d , 2 3 1 F. Ap p ’ x 5 5 0 (9 th Ci r. 2 0 07 ). Bu t

“ em o t i o n al d i st res s s h al l n o t b e t reat edas a p h y s i cal i n jury o r p h y s i cal s ickn es s ,”
s ec. 1 0 4(a) (fl u s h l an g uag e), n o r s h al l th i n g s l i k e i n s o m n i a, h ead ach es , o r s t o m ach p ro b lem s th atres u l tfro m s u ch d i s tres s , s ee Pet t i tv . Co m m is si o n er, T.C. M em o . 2 0 0 8 -8 7 , 2 0 0 8 W L 9 2 8 09 0 , at* 4 ; s ee al s o H.R. Co n f. Rep t . No . 1 0 4 -7 3 7 , at3 0 1
n .5 6 (1 9 9 6 ), 1 9 9 6 -3 C.B. 7 4 1 , 1 0 4 1
. To d eci d e wh et h er s et t l em en tp ro ceed s qu al i fy fo r t h i s ex cl u si o n , “ we l o o k t o the wri t t en t erm s o f t h e s et t l em en t.” Pet t i t , 2 0 0 8 W L 9 28 0 9 0, at* 3; s ee al s o Al l u m , 2 0 0 5 W L 1 69 2 4 8 8, at* 4 . In Pet t i t , 2 0 0 8 W L 9 2 8 09 0 , at* 1 , * 4 , fo r
ex am p l e, we fo u n d th atan awardfo r ag e d i s cri m in at i o n was i n cl u d ab l e--ev en th o u g h th e t ax p ay er t o l du s h e’ ds uffered fro m i rri t ab l e b o wel s yn dro m e an d h ead ach es --b ecau s e t h e s et t l em en tag reem en tn ei th er “ co n t ai n[ed ] l an g u ag e

7 In Sch l ei er, 5 1 5 U.S. at3 3 7 , th e Sup rem e Co u rtal s o s ai dth e u n d erl y i n g cau s e o f act i o n m

u stb e “ b as edup o n t o rto r t o rtty p e ri g h t s ,” b u tthe Co m

m i s s i o n er h as s i n ce rem o v edth atp h ras e fro m h i s reg u lat i o n s . See Perez v
. Co m m i s s i o n er, 1 4 4 T.C. 5 1 , 5 9 -6 2 (2 0 1 5 ).- 2 2 -

[* 2 2 ] i n d i cat i n g * * * ev i d en ce o f p h y s i cal i n juri es o r p h y s i cal s i ckn es s ” n o r m ad e
an y “ al lu s i on t o co m

pen s at i o n fo r a p h y s i cal i n jury o r p hy si cal s i ckn es s . ” Th e s et t l em en td o cu m en th ere s ay s th e $ 7 0 ,0 0 0 was co n s i d erat io n fo r M s . M cM i l l an ’ s d i s m i ss i n g h er s u i t , wh i ch i td es cri b es as b ei ng “ in co n n ect i o n wi th th e co n s tru ct i o n , m ai n t en an ce, up k eep , en fo rcem en to f CC&Rs , an d
co n di t i o n s [o f M s . M cM i l l an ’ s res i d en ce] , i n cl u d in g al l eg edn u i s an ces , cl ai m s o f
em ot i o n al d i s tres s , l i bel , s l an d er, i n v as i o n o f p ri v acy an dco n s tru ct i o n d efect .” Un l ik e t h e s et t l em en t i n Pet t i t , i td o es n ’ tap p o rt i o n fu n d s am o ng d i fferen t ty p es o f d am ag es . See i d. at* 1 . Bu tl i ke t h e Pet ti ts et t l em en ti tal s o d oes n ’ t“ co nt ai n l an g u ag e i n d i cat i n g th at[M s . M cM i l l an ] p res en tedan y ev i d en ce o f p hy s i cal i n juri es o r p h y s i cal s i cknes s,” n o r d o es i tm ak e an y “ al l u s i o n t o co m

p en sat i o n fo r a p h y s i cal i n

jury o r p h y s i cal s ickn es s .” See i d . at* 4 . Th e s et t lem en tag reem en t th erefo re d o es n’ ts h o w th atan y o f t h e $ 70 ,0 0 0 was p ai d“ o n acco u n t o f p ers o n al p h y s i cal i n

juri es o r p h y s i cal s i ckn es s . ” See s ec. 1 0 4(a). Ev en i f th e s et t l em en tag reem en twere am b ig u o u s ab o u twh atth e $ 7 0 ,0 0 0
was fo r, we’ ds t i l l fi n d th at th e en t i re am o u n t was i n cl ud ab le. If a s et t l em en t d o cu m en ti s n ’ tcl ear, “ w e l o o k t o th e i n t en to f t h e p ay o r, b as edo n al l th e fact s an d ci rcu m s t an ces o f t h e cas e, i n cl u d i n g th e co m p l ai n tth atwas fi l edan d th e d et ai l s
s u rro u n d i n g th e l i t i g at i o n.” Al l u m , 2 0 0 5 W L 1 6 9 2 4 88 , at* 4 . An dg en eral- 2 3 -

[* 2 3 ] al l eg at i o ns o f p h y si cal i n jury o r p h y s ical s i cknes s i n a co m p l ai ntare n o t
en o ug h --t h ey

h av e t o b e s p eci fi c. See i d . Th e s et t l em en td o cu m en th ere s p eci fi es th atth e HOA p ai dM s . M cM i l lan t o dro p h er s u i tan d t ak e d o wn h er web s i t e--t h at i s , i t was n’ tco m

p en s at i ng h er fo r p h y s i cal i n juri es o r s i ckn es s . An dM s. M cM i l lan ’ s p l ead i n g s m ad e cl ear t h ats h e fi l edth e s u i tb ecau s e t h e HOA i g n o red h er co m pl ai n ts ab o u t d o g s , m o l d , an dn o i s e--n o tb ecau s e s h e was i n j u redo r i l l
. Sh e ev en l eftth e d am ag es s ect i o n o f t h e Cas e In fo rm at i o n Sh eetb l an k. Th e o n l y ev i d en ce i n th e reco rdo f th i s cas e t h ats u g g es ts th e s et t l em en twas fo r p h y s i cal i n

j u ry is M s . M cM i l l an ’ s o wnt es t i m o n y , an d ev en th en s h e s ai di t
co u ld ’ v e res ul tedfro m

s tres s --wh ich wo u ldm ak e i ta s y m p t o m o f em o t i o n al d i s tres s an dm ean thatthe s et t l em en tp ro ceed s wo u lds t i l l b e i ncl u d ab l e i n h er i n co m e. See Pet t i t , 2 0 0 8 W L 9 2 8 0 9 0 , at* 4
. An dwe d o n’ tb el i ev e h er t es ti m o n y ab o utth es e s y

m p t o m s t o b eg i n wi th --al th o u g h s he co u ldrem em b er th e n am e o f h er m o l dex pert , co n s tru ct i o n -d efect ex p ert , an dn o i s e ex pert wh o m s h e’ d p l an n ed t o cal l if t h e HOA s u i t wen tt o t ri al , s h e co u l dn ’ t rem em b er th e n am e o f ei th er t h e d o ct o r s h e s ai ds h e wo u l d cal l o r t h e d oct o r t hats h e s ai d h adtreat ed h er. Th e ev i d en ce we h av e ab o u tth e HOA s u i ts h o ws th atn o p arto f t he
s et t l em en tp ro ceed s was p ai d“ o n acco u n to f p ers o n al p h y s i cal i n juri es o r p h y s i cal- 2 4 -

[* 2 4 ] s i ckn es s .” See s ec. 1 0 4 (a)(2 ). Th o se p ro ceed s are t h erefo re n o t ex cl u ab l e
u n d er s ect i o n 1 0 4 (a)(2 ). B. At t o rn ey ’ s Fees Th i s b ri ng s u s t o M s . M cM i ll an ’ s arg u m en t th at th e $ 7 0 ,0 0 0 was n ’ ti n co m e t o h er b ecau s e i t wen tt o p ay h er at t o rn ey s . Th e ap p l icab l e ru le h ere i s s i m p l e-- wh en s et tl em en t p ro ceed s are i n co m e, s o i s wh at ev er p o rt io n o f t h em g o es t o at t o rn ey ’ s fees
. 8 Co m

m i s s i o n er v . Ban k s , 5 4 3 U.S. 4 2 6 , 4 3 6 -3 7 (2 0 0 5 ). Th at ’ s tru e ev en i f wh atth e at t o rn ey g et s i s a co n t i n g en cy

fee o r m o n ey

award edb y

a fee-s h i ft i n g p ro v i si o n. See Si n y ard , 2 6 8 F.3 d at7 5 9 ; Green , 2 0 0 7 W L W L5 1 89 0 8 , at* 3. In Ban k s , 5 4 3 U.S. at4 3 3-3 4 , th e Sup rem e Co u rtp o i n t edo u t th atth e al t ern at iv e--al lo wi n g s u cces s fu l p l ai n t iffs t o ex cl u de fro m th ei r i n co m e
am ou n t s th ey

p ai di n at t o rn ey s ’ fees --wo u l dp erm i t an t i ci pat o ry as si g n m en t s o f p o t en t i al i n co m e, s o m et h in g co u rt s h av e l o n g fo rb i d d en . Th e Co u rt al s o reject ed th e arg u m en t th at a p lai n t i ff an dh i s at t o rn ey were jo i n tv en tu rers s eek i ng i n co m e t o g et h er, i n s t eadfi n d i n g th atth ey were p ri n ci p al an dag en t . Id . at4 3 5 -3 6 . It
ex p lai n edth at b ecau s e an “ at t orn ey i s an ag en t wh o i s dut y

b o u n dt o acto n l y

i n th e

8 Bu tat t o rn ey s ’ fees m i g h tb e d ed u ct i b l e . See, e.g ., Ban ks , 5 4 3 U.S. at4 3 3 ; Si n y ardv . Co m

m i s s i on er, 2 6 8 F.3 d7 56 , 7 5 9 (9 th Ci r. 2 0 0 1 ), aff’ g T.C. M em o . 1 9 9 8 -3 6 4
.- 2 5 -

[* 2 5 ] i n t eres t s o f th e p ri n ci p al , * * * i ti s ap p ro pri at e t o treat th e fu l l am ou n to f [a]
reco v ery as i n co m e t o t h e p ri n ci p al .” Id . at 4 3 6
. Becau s e t he $ 70 ,0 0 0 s et t l em en t M s . M cM i ll an recei v edfro m h er HOA was i n co m e t o h er, i td o es n ’ tm at ter i f p arto r al l o f i t wen tt o p ay h er at t orn ey s --s h e h ad t o rep o rt i tal l
. 9 W e t h erefo re fi n dfo r t h e Co m m is s i o n er o n th i s i s s u e. II. Ho rs e Breed in g / Sh o wi n g W i th i n co m e o u to f t he way , we can co rral th e d edu ct io n ques t i o n s . Th e fi rs ti s M s . M cM i ll an ’ s cl ai m ed$ 5 ,2 3 8 l o s s o n h er “ h ors e b reed i n g /s h o wi n g ” Sch edu l e C. Onth ats ch edul e s h e rep o rt edn o i n co m e an dd edu ct edth e fo l l o wi ng
ex p en s es : $ 2 5 0 fo r m i l eag e, $ 9 0 fo r “ m ag azi n es an ds ub s cri p t i on s , ” $ 3 ,9 3 8 i n i n t eres t , an d$ 9 6 0 fo r ren t i n g o r l eas i n g “ ot her b u si nes s p ro p ert y .” In h i s an s wer th e Co m m i s s i o n er s ai d s h e was n ’ t en t i t l edt o thes e d edu ct i o n s b ecau s e h er “ h o rs e b reed i n g / s h o wi n g ” act i v i ty was n ’ t a t rad e o r b u s i n es s . Tax p ay ers can d edu ctth e o rd in ary an dn eces s ary

ex p en s es o f carry i n g o n a trad e o r b u si n es s . Sec. 1 6 2 (a). Wh eth er an act i v i ty i s a t rad e o r b us i n es s d ep en d s
o n th e fact s an dci rcu m s tan ces , b u t th ree fact o rs h av e t o b e p res en t: Th e t ax p ay er

9 W e al s o n o t e t h at th e reco rdd o es n ’ ts h o wex act ly h ow m u ch o f t h e s et t l em en twen t t o at t o rn ey ’ s fees o r t o s at i s fy th e l i en . M s . M cM i l l an s ay s i n h er b ri ef t h at$ 1 7 ,0 0 0 wen tt o th e p ers o n wh o was h er at t o rn ey atth e en d o f t h e s u i t , th at$ 3 5 ,0 0 0 wen tt o s at i s fy th e l i en , an dth atp ri o r y ears ’ ex p en s es m ad e t h e l aws u i ta n etl o ss t o h er; b u tth o s e fact s aren ’ ti n ev i d en ce.- 2 6 -

[* 2 6 ] m us tb e reg u larl y

an dact i v el y

i n v o l v edi n the act i v i ty ; th e act i v i ty m u s t h av e b eg u n ; an dthe t ax p ay er m u s ti n t en d t o m ak e a p ro fi t . See Co m m is s io n er v . Gro et zi n g er, 4 80 U.S. 2 3 , 3 5 (1 9 8 7 ); M cM an u s v . Co m m i ss i on er, T.C. M em o . 1 9 8 7 -4 5 7 , 1 9 8 7 Tax Ct . M em o LEXIS 4 5 4 , at * 19 -* 2 1 , aff’ dwi tho u t p ub l i s h ed
o p i n i o n , 8 6 5 F.2 d2 5 5 (4 th Ci r. 1 9 8 8 ). A. Reg u l ar an dAct i ve Fo r an act i vi ty

t o b e a t rad e o r b us i n es s , th e t ax p ay er h as t o reg u l arl y an d act i vel y b e i n v o l v edwi th i t --“ [a] s po rad i c act i v i ty , a h o b by , o r an am u s em en t d i v ers i o n d o es n o tqual i fy .” Gro et zi n g er, 4 8 0 U.S. at3 5 ; s ee al s o, e.g ., M cM an u s , 1 9 8 7 Tax Ct . M em o LEXIS 4 5 4 , at* 2 0
. InGro et zi ng er, 4 8 0 U.S. at2 4 , 3 6 , fo r
ex am p l e, t h e Suprem e Co urt h el dth atg am b l i n g was th e t rad e o r b u s in es s o f a t ax p ay er wh o fo r n earl y an en t i re y ear wen tt o a g reyh o u n d tracks i x t i m es a week
an d s pen t6 0 -8 0 h ou rs each weeko n g am b l in g -rel at edact i v i t i es s u ch as p laci n g b et s an ds tu dy i n g raci n g fo rm s . InBark er v . Co m m i s s io n er, T.C. M em o . 2 0 1 2 -7 7 , 2 0 1 2 W L 9 4 7 1 3 4 , at * 8 , h o wev er, we fo u n d a t ax p ay er d i dn ’ tact iv el y an d reg u l arl y en g ag e i n th e d ev el o p m en t o f rad i o equi p m en t fo r as tro n au ts i n a y ear wh en h i s o nl y

rel at edact i v i ty

was g o i n g t o two co n feren ces ab o u t M ars . M s . M cM i l l an ’ s s i tuat i o n i n 2 0 1 0 was cl o s er t o Bark er t h an Gro et zi n g er. W e d o b el i ev e t hats h e atl eas t co nt em p l at eda b u si n es s --s h e cred i b l y t es t i fi edth at- 2 7 -

[* 2 7 ] du ri n g th aty ear s he “ l eti tb e kn o wnb y wo rdo f m ou th” t hats h e was i n th e
m ark etfo r a h ors e. W e al s o b el i ev e t h ats h e t al k edt o p eo p l e ab o ut h o rs es an d wat ch edv i d eo s o f h o rs es th atwere fo r s al e. W e ev en b el i ev e t hats h e wat ch ed fi ve d res s ag e co m

p et it i o n s --b utth es e are t h e s o rt s o f t h i ng s s o m eo n e i nt eres t edi n g et t i n g i n t o (o r, as wi th M s . M cM i l l an , res um i n g ) a b u s i n es s m i gh td o. Th e o n l y th i n g we can qu an t i fy

i s th e 3 6 h o u rs o f l un g in g s he d i di n ex ch an ge fo r th e b art er i n co m e s h e d i dn ’ t rep o rt . W e can al s o i n fer t h at s he d i dn ’ t en g ag e i n h er h o rs e-rel at edact i v i ty

fu l l -t i m e b ecau s e s h e al s o s p en t 5 -6 h o u rs a d ay wo rk i n g fo r Q.X. Tel eco m

as w el l as wh atm

u s t ’ v e b een s i g ni fi can t t i m e o n l i t i g at i o n . Th e Co m m i s s i o n er co rrect l y

cal l s th i s act i v it y

“ l i m i t ed ” an d p o i n t s o u t th at M s . M cM i l l an d i dn ’ tcal l an y wi tn es s es t o co rro b o rat e th ats h e act ual l y en g ag edi n i t . Th atarg u m en td o es n ’ th el p h i m , th ou g h , b ecau s e h e h as th e b u rd en o f s h o wi n g th atM s . M cM i l l an was n ’ ten ti t l edt o th e d edu ct i o n s s h e’ dl i s tedo n h er “ h o rs e b reed i n g / s h o wi n g ” Sch edu le C--m ean in g i twas up t o h i m t o p res en t ev id en ce t h at M s . M cM i l l an d i d n o t

act i v el y an dreg ul arl y

en g ag e i n h er h o rs e-rel at edact i v i ty , n o tup t o h er t o s h o w thats h e di d
. M s . M cM i l l an , h o wev er, l o s es b ecau s e o f h er t es t i m o n y . Sh e n ei th er o wn ed a h o rs e n o r p art ici p at ed i n an y dres s ag e co m

pet i t i on s i n 2 0 10 , an dth is l ead s u s t o- 2 8 -

[* 2 8 ] fi n di tm o re l i k el y th an n o tth ats h e was n o tact i v el y an d reg u l arl y

i n v o l v ed i n “ h o rs e b reed i n g / s h o wi n g” t h aty ear. B. Actu al Co m

m en cem en t To b e a t rad e o r b u si n es s , an act iv i ty m us tal s o h av e act ual l y

co m m en ced

-- wh i ch m ean s i t h as t o h av e “beg u n t o fu n ct i o n as a g o i n g co n cern an dp erfo rm ed th o s 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 dTel ev i si o n Co rp . v . Un i t ed St at es , 3 4 5 F.2 d9 0 1 , 9 0 7 (4 th Ci r. 1 9 6 5 ), v acat edan drem an d edo n o th er g ro u n d s , 3 8 2 U.S. 6 8 (1 9 65 ); acco rd Hei nb o ck el v . Co m m i s s i o n er, T.C. M em o . 2 0 1 3 -1 2 5 , at* 4 2 -* 4 4 ; M cM an us , 1 9 8 7 Tax Ct . M em o LEXIS 4 5 4 , at* 2 1 . Deci d i n g t o s t art a b u s in es s an ds p en d i n g m o n ey o n i t --ev en o v er a co ns i d erab le l en gt h o f t i m e-- i s n’ t en o u g h . M cM an u s, 1 9 8 7 Tax Ct
. M em o LEXIS 4 5 4 , at* 2 1 . Th at ’ s b ecau s e
an act i v e t rad e o r b u si n es s i s “ m o re t h an i n i t i al res earch i n t o o r i n v es t i g at io n o f b u s i n es s p o t en t i al .” Hei nb o ck el , at* 42 ; s ee al s o Dean v . Co m m i s s i o n er, 5 6 T.C. 8 9 5 , 9 0 2 -0 3 (1 9 7 1) (co s to f t rav el i n g t o v i ew an dp o t en ti al l y p u rch as e eq u i p m en t fo r fu tu re b u s in es s n otd edu ct i b l e u n d er s ect i o n 1 6 2 o r s ect io n 2 1 2 ). Th e co s to f dri v i ng aro u n dl o o ki ng fo r n ews p ap ers o r rad i o s tat i o n s t o b u y , fo r ex am p l e, i s n ’ t d educt i b l e. Fran kv . Co m m i ss i o n er, 2 0 T.C. 5 11 , 5 1 3 (1 9 5 3 ). Anact i v i ty

d o es n ’ th av e t o b e g en erat i n g rev enu e y ett o b e act i v el y an d reg u l arl y en g ag edi n , s ee, e.g ., Bark er, 2 0 1 2 W L 9 47 1 3 4 , at* 8 , b u ti td o es h av e t o- 2 9 -

[* 2 9 ] b e up an dru n n i n g . Th at ’ s wh y i n Hei nbo ck el , at* 4 4 , we fo un dthata t ax p ay er wh o s ai dh e was ru n ni n g a v i ney ardb u th adn ’ ty etp l an t edan y g rap e
v i n es was n ’ ten t i t l edt o s ect i on 1 6 2 d edu ct i o n s . In M cKel v ey v . Co m m i ss i o n er, T.C. M em o . 2 00 2 -6 3 , 2 0 0 2 W L 3 4 1 0 4 4 , at* 3 -* 4 , aff’ d , 7 6 F. Ap p’ x 8 0 6 (9 th Ci r. 2 0 0 3 ), we d i s al l o wedd edu ct io n s b y a t ax p ay er wh o b o u g htl an dfo r a t ree farm b u td i dn ’ ty etfarm

an y trees . Bu y i n g l an dan d p lan n i n g t o d ev el o p i ti s n ’ t en o u g h t o m ak e an act i v i ty a t rad e o r b u s i nes s , s ee Ch ri s t i an v . Co m m i s s i o ner, T.C. M em o. 1 9 9 5 -1 2 , 1 9 9 5 W L 9 15 1 , at* 4-* 5 , an d n ei th er i s i s s u i n g s t o ck , s i g n i n g
co n tract s, an db u y i n g co m p o n en t s i f act u al m an u factu ri n g h as n ’ ty etb eg un , s ee M cM an u s , 1 9 87 Tax Ct
. M em o LEXIS 4 5 4, at * 24 -* 2 6
. 1 0 Th atM s . M cM i l l an d i dn’ to wn , b reed , o r s ho w an y h o rs es i n 2 0 1 0 m ak es i t i m p o s s ib l e fo r M s . M cM i l l ant o d o wh ata “ h o rs e b reed i n g /s ho wi ng ” b u s i n es s d o es --b reed i n g an ds h owi ng h ors es . Th e th i n g s M s . M cM i ll an s ay s s h e d i d

-- t al k i n g ab o u t , wat ch in g , an dth i n k i n g ab o u t h o rs es an d o ccas i o n al ly trai ni n g o t h er p eo pl e’ s h o rs es --are at b es ti ni t i al res earch i n t o a p o t en t i al “ h o rs e b reed i n g / s h o wi n g ” b u s i n es s . See Dean , 5 6 T.C. at9 0 2 -0 3 ; Fran k , 2 0 T.C. at5 1 3
.

1 0 Th e co s t s o f m an y o f t h es e act i v i t i es m ay , h o wev er, qu al i fy as “ s t artup ” o r “p re-o pen i n g ” ex p en s es , wh i ch b eco m e d edu ct ib l e o v er t i m e o n l y aft er t h e act i ve trad e o r b u si n es s co m

m en ces . Hei nb o ck el , T.C. M em o. 2 0 1 3 -1 2 5 , at* 4 3 (ci t i n g Hard y v. Co m

m i s s io ner, 9 3 T.C. 6 8 4 , 6 8 7 (1 9 8 9 ), an ds ect i o n 1 9 5).- 3 0 -

[* 3 0 ] W i th o ut a h o rs e, M s. M cM i l l an was l i k e t h e v i nel es s v i n tn er i n Hei nb o ck el , at* 4 4 ; th e t reel es s t ree farm er i n M cKel v ey , 2 0 02 W L 3 4 10 4 4, at* 3 -* 4 ; th e d ev el o p m en t l es s d ev el o per i n Ch ri s ti an , 1 9 9 5 W L 9 1 5 1 , at* 4 -* 5 ; an d the
m an u fact u rer wh o d i dn ’ t do an y m an u fact u ri n g i n M cM an us , 1 9 8 7 Tax Ct
. M em o LEXIS 4 5 4 , at* 2 4-* 26 --s h e m ay h av e b een g et ti n g read y

t o s t art o r res u m e a b u s i n es s , b u tthatb us i n es s h adn ’ tb eg u n . W e b el i ev e M s . M cM il l anwh en s h e s ay s th ats h e’ s b een co n t i n u o us l y i n v o l v ed wi th h ors es s i n ce t h e 1 9 7 0 s . Bu t h er l as th ors e d i edi n 2 0 0 8 , atwh i ch p o i n ts h e h ad n ’ t s ho wno r b redh i m i n a d ecad e. W e t h erefo re fi n dth ati f h er h o rs e act i v i ty

was ev er a t rad e o r b u s i n es s , th at trad e o r b u s i n es s en d edb efo re 2 0 1 0 , an di n th aty ear s h e was atm o s t l o o k i n g i n t o s t art i ng an ew. M s . M cM i l l an ’ s

“ h o rs e b reed i n g /s h owi n g” b u s i n es s h ad n ’ t actu al l y co m m en cedo r res u m edb y

th e
en d o f 2 0 1 0. C. Pro fi tM o t i ve Th e t h ird al t ern at i v e g ro u n dfo r d is al lo wan ce h ere i s th atan act i vi ty i s a trad e o r b u si n es s th atqu al i fi es fo r s ect i on 1 6 2 d edu ct i o n s o n l y i f th e t ax pay er’ s

“p red o m in an t , p ri m ary

o r p ri n ci p al o b

ject i ve” fo r en g ag i n g i n i ti s t o m ak e an
eco n om i c p ro fi t i n d ep en d en t o f t ax s av i n g s . See W o l f v . Co m m i ss i o n er, 4 F.3 d 7 0 9 , 7 1 3 (9 th Ci r. 1 9 9 3 ), aff’ g T.C. M em o. 1 9 9 1 -2 1 2 ; s ee al s o s ec. 1 8 3 (a), (c);- 3 1 -

[* 3 1 ] Gro et zi n g er, 4 8 0 U.S. at3 5 ; Dro b ny v . Co m m i s s i o n er, 8 6 T.C. 1 3 2 6, 1 3 4 0- 4 1 (1 98 6 ). A p ro fi tm o t iv e i s al s o req u i redfo r s ect i o n 2 1 2 d edu ct i o n s, wh i ch are fo r ex p en s es i n cu rredi n th e p ro du ct i o n o f i n co m e wh enth ere i sn ’ ta t rad e o r b u s i n es s . See Bo l ari s v . Co m m i s s i o n er, 7 7 6 F.2 d1 4 2 8 , 1 4 3 2 (9 th Ci r. 1 9 8 5 ), aff’ g i n p art , rev ’ g in p art8 1 T.C. 8 4 0 (1 98 3 ); Al l en v . Co m m i s s io n er, 7 2 T.C. 2 8 , 3 3 (1 98 2 ); s ee al s o s ec. 1 8 3 (a), (c). A t ax p ay er’ s p ro fi tex p ect at i o n d o es n ’ th av e t o b e reas o nab l e, b u t i tm u s tb e g en u i n e. See Drei cer v . Co m m i s s i o ner, 7 8 T.C. 6 4 2 , 6 4 5 (1 9 8 2), aff’ dwi th ou tp ub l i s h edo p in i o n , 7 0 2 F.2 d1 2 05 (D.C. Ci r. 1 9 8 3 );
s ec. 1 .1 8 3-2 (a), In co m e Tax Reg s . Th e reg u l at i o n s t el l u s t o co n s i d er “ o b ject i v e s t an dard s , t ak i n g i n t o acco u n t al l o f t h e fact s an d ci rcu m s t an ces ” wh en d et erm i n in g wh eth er a t ax p ay er i n t en d ed t o m ak e a p ro fi t . Sec. 1 .1 8 3 -2 (a), In co m e Tax Reg s . Th ey al s o l i s tn i n e fact o rs fo r u s t o co n s i d er, al th o ug h “ [n ] o o n e fact o r i s d et erm in at iv e,” we can co n s i d er ad d it i o n al fact o rs , an d we’ re n o ts up p o s edt o s i m p ly co m p are t h e n u m

b er o f fact ors th ats ug g es ta p ro fi tm o t i v e t o th e num b er o f fact o rs th atd o n ’ t. See s ec. 1 .1 83 -2 (b ), In co m e Tax Reg s . Th e Sev en th Ci rcu i t s ay s th is i s “ a g o o fy reg u l at i o n ” an dth i n k s we s h ou l dt ak e a m ore h ol i s t i c ap p ro ach t o t h e qu es t i o n o f wh et h er a t ax p ay er i n t en d edt o tu rna p ro fi t . Ro b ert s v . Co m m i s s io n er, 8 2 0 F.3 d 2 4 7 , 2 5 0 , 2 5 4 (7 th Ci r. 2 0 1 6 ), rev ’ g T.C. M em o . 2 0 1 4 -7 4 . Itd i ds o i t s el f i n an- 3 2 -

[* 3 2 ] o p i n i o n th atd eal t wi th h o rs e b reed i n g. See Es t at e o f Stu l l er v . Un i t ed St at es , 8 1 1 F.3 d8 9 0 , 8 9 6 -9 8 (7 th Ci r. 2 0 1 6 ). Th is cas e i s ap p eal ab l e t o th e Ni n t h Ci rcu i t , th o u g h , s o we’ l l co n si d er al l n i n e fact o rs .

1
. M an n er i n Wh i ch th e Act i v i ty Is Co ndu ct ed Th e fi rs tfact o r t el l s u s t o l o okath o w th e t ax p ay er co ndu ct s th e act i v i ty . It
s ay s “ [t ] h e fact th atth e t ax p ay er carri es o n the act i vi ty i n a b u s in es s l i k e m an n er
* * * m ay i n d i cat e t h atth e act iv i t y

i s en g ag ed i n fo r p ro fi t .” Sec. 1
. 1 8 3 -2 (b )(1 ), In co m e Tax Reg s . M ai n t ai ni n g “ co m p l et e an daccu rat e b o o k s an dreco rd s ,” h av in g a b us i n es s p l an , carry i n g o n an act i v i ty “ i n a m an n er s ub s t an ti al l y s i m i l ar t o o th er act i v i t i es o f t h e s am e n atu re wh ich are p ro fi t ab l e,” an d ch an g i n g

“ o p erat i n g m et h o d s , ad op t[i n g ] * * * n ew t ech n i qu es o r ab an d on [i n g ] * * *
u np ro fi t ab l e m et h o d s i n a m an ner co n s i s t en twi th an i n t en tt o i m p ro ve p ro fi tab il i ty ” s h o wth ata t ax pay er co n du ct edan act iv i ty i n a b u s in es s l i k e m an n er. See i d
. a. Bo o k s an dReco rd s Co m p l et e an daccu rat e b o o ks an dreco rd s can s u g g es tth atan act i v it y i s
co n du ct ed i n a b u si n es s l i k e m an n er. See i d. It ’ s n o tth e acto f k eep i n g reco rd s th atm ak es th i s tru e, b u ti n s t eadth e reco rd s ’ h el p fu l n es s t o a t ax p ay er i n
ev al u at i ng an act i v it y ’ s p erfo rm an ce, cu t ti n g ex pen s es , an di n creas i ng p ro fi t s . See- 3 3 -

[* 3 3 ] Go l an ty

v . Co m m i s si o ner, 7 2 T.C. 4 11 , 4 3 0 (1 9 79 ), aff’ dwi th o u tp ub l i s h ed
o p i n i o n , 6 4 7 F.2 d1 7 0 (9 th Ci r. 1 9 8 1 ). M s . M cM i l l an t es t i fi edth ats h e k ep t
reco rd s u s i n g M i cro s o ftM on ey , b u t th atm ov ers s h e u s edi n 2 0 1 1 l o s tth em an d th e h arddri v e wh ere s h e k ep t el ect ro n i c co p ies was acci d en t al l y eras ed . Th e Co m m i s s i o n er s u g g es ts we d i s b el i ev e t h is t es ti m o n y , es p eci al l y b ecau s e M s . M cM i l lan was ab le t o tu rn o ver s o m e v ery o l d t ax retu rn s . Bu tev en i f we as s u m e th atM s . M cM i l l an d i dk eep th es e reco rd s , th ey ap p aren t ly

d i dn ’ ten ab le h er t o
av o idl arg e s us t ai n edl o s s es s i n ce atl eas t2 0 0 4 , an dan y p ro fi ts i n ce 1 9 8 8
. Inl i g h t
o f t h i s d ecad es -l o n g l acko f i m p ro v em en t , we fi n dth atth e m ere act o f
reco rd k eep i n g d o es n ’ t s u gg es tth atM s . M cM i ll an co n du ct edh er h o rs e act i v i ty i n a b u s in es s l i k e m an n er.

b
. Bu s i n es s Pl an s A b u s in es s p lan al s o s ug g es t s th atan act iv i ty i s co ndu ct edi n a b u s i n es s l i k e
m an n er. See Ph i l l i p s v . Co m m i s s i o n er, T.C. M em o . 1 9 9 7 -1 28 , 1 9 9 7 W L 1 0 5 0 1 5 , at* 6 ; s ec. 1 .1 8 3 -2 (b )(1 ), In co m e Tax Reg s . Bu s i n es s p l an s d o n ’ th av e t o b e i n wri t in g --we al s o co n s i der u n wri t t en p l an s ev i d en cedb y t ax p ay ers ’ act io n s . See Ph i l l ip s , 1 9 9 7 W L 1 05 0 1 5 , at *6 (p l an s h own b y b u i l d i n g b arn an dt acks h o p an d b reed i n g an dreg is t eri n g h o rs es ). M s . M cM il l ant es t i fi edth at h er b u s i n es s p l an
was t o “ fi n da t al en t edh o rs e wi th p o t en t i al fo r t h e ri g htp ri ce, t rai n th e h o rs e t o- 3 4 -

[* 3 4 ] i n t ern at i o n al l ev el , an dthen s el l the h o rs e ata p ro fi t .” Attri al s h e t es t i fi ed ab o utam o u n t s s h e’ d b o u gh tan ds o l dh o rs es fo r i n th e 1 98 0 s an d earl y 1 9 9 0 s , b u t th e p l an s h e d es cri b edfo r 2 0 1 0 l ack eds o m e i m p o rt an td et ai l s --a b u d g etfo r b u y i n g an db o ard i n g a h o rs e, a t i m el i n e fo r i t s trai ni n g an d s al e, an d an es t i m at e o f
ex p ect edreturn o n i n v es t m en t . Her act i on s i n 2 0 1 0 g iv e n o s ub st an ce t o h er
v ag ue t es t i m o n y --i n t h aty ear, t h e o n l y s t ep s s h e t o o k t o wardp u rch as in g , trai n i n g , o r s el l in g a h o rs e were s p o rad i c, wo rd -o f-m ou th i nqu iri es ab o u tav ai l ab le h o rs es . Th i s l acko f a co h eren tb u s in es s p l an al s o s ug g es t s an u nb u s i n es s l ik e m an n er.

c. In du s try

St an dard s Th e fact th atan act i v i ty i s co n du ct edi n the s am e way th ats i m i lar, p ro fi t ab l e act i vi t i es are can al s o s u g g es ta b u s i n es s l i k e m an n er. See s ec. 1 .1 8 3 -2 (b )(1 ), In co m e Tax Reg s . Here t he Co m m i s s i o n er i n tro du ced n o ev i d en ce o f wh ata p ro fi tab le “ h o rs e b reed i n g / s h o wi n g” b us i n es s wo u l dl o o kl i k e, s o th ere’ s n o th i n g fo r u s t o co m

p are M s . M cM i ll an ’ s act i v i ty t o . Th i s fact or fav o rs M s . M cM i l l an . d
. Ad ju s t i n g Ap p ro ach Ch an g i ng “ o perat i n g m et h o d s , ad op t [i n g ] * * * n ew t ech n i qu es o r ab an do n [i n g ] * * * u np ro fi t ab l e m et h o d s i n a m an n er co n si st en twi th an i n t en tt o i m p ro v e p ro fi t ab i l i ty ” are al s o i n d icat i o n s th at a t ax p ay er co n du ct ed an act i v i ty i n a b u s in es s l i k e m an n er. See s ec. 1 .1 8 3 -2 (b )(1 ), In co m e Tax Reg s . M s. M cM i l l an ’ s- 3 5 -

[* 3 5 ] l as tp ro fi t ab l e y ear was 1 9 8 8 , an dth e reco rds h ows th ats h e’ s s u s t ai n ed
co n si d erab l e l os s es ev ery y ear s i n ce 2 0 0 4 . M s . M cM il lan ’ s d eci s i o n t o s en d Go l dru s h t o Au s tral i a i n 2 0 0 7 s eem s l i k e an at t em p t ed n ew ap p ro ach t o i m

p ro v e p ro fi tab il i ty , b u tg i v en h er p l an o f ch arg i n g a $ 1 ,5 0 0 s tu dfee, s h e wo u l d ’ v e h adt o b reedGo l dru s h o v er 1 0 0 t i m es ju s tt o co ver t h e l o s s es o n th e reco rd . Th e p l an d o es n’ ts eem

real is t i c i n l i g h to f t h e fact th ats h e was ab le t o b reedh i m an av erag e
o f o n ly o n ce a y ear b ackwh en h e was co m p et i n g . Th e d ecad es o f l o s s es M s . M cM i l lan s u s t ai n edan dth e i n feas i b i l i ty o f h er o n ly

at t em p t t o i n creas e p ro fi tab il i ty

t o get h er s u g g es t an u nb u s i n es s l i k e m an ner. Onb al an ce, we fi ndth atM s . M cM i ll an d i dn o tco n du cth er h o rs e act i v i t y i n a b u s in es s l i k e m an n er. Th i s fact o r wei g h s ag ai n s th er.

2
. Ex p ert i s e o f Tax p ay er o r Ad v i s ers Co n su lt i n g wi th i n du s try

ex p ert s an d s tu dy i ng accep t edb u s in es s p ract i ces wh en p rep ari n g fo r an act i v i ty can s u g ges ta p ro fi t m o t i v e. See s ec. 1 .1 8 3 -2 (b )(2 ), In co m e Tax Reg s . Th e Co m m i s s i o ner d i dn ’ tp ro du ce an y ev i den ce th at M s . M cM i l l an di d

n ’t co n s u l twi t h an y

ex p ert s , s o thi s fact o r can ’ tfav o r h i m . Wh atab o u tM s . M cM i l lan ’ s o wnex p eri en ce? Wh at ’ s rel ev an t h ere i s ex p ert i s e
s h e h adi n th e h o rs e b u s i n es s , n o tju s tex p eri en ce wi th h o rs es . See M cKeev er v . Co m m i s s i o n er, T.C. M em o . 2 0 0 0 -2 8 8 , 2 0 00 W L 1 2 9 7 7 10 , at* 1 2 . M s . M cM i l l an- 3 6 -

[* 3 6 ] t es t i fi ed th ats h e’ s o p erat eda h o rs e b us i n es s s in ce t h e m id -1 9 70 s , b u tb y h er
o wnacco u n ts h e’ s h ado n l y three p ro fi t ab l e y ears --an d n o n e s i n ce 1 9 8 8 . W e can ’ t fi ndth ats o m eo n e wh o s u ffered o v er 2 0 co n s ecu ti v e y ears o f l o s s es was an ex p ert , s o we wo n ’ tfi n d t h atM s . M cM i l l an ’ s p res um edrel i an ce o n h er o wn ex p eri en ce
co u nt s i n h er fav o r. Th is fact o r i s n eu tral
.

3
. Ti m e an d Effo rtEx p en d edo n th e Act i v i ty

“ Th e fact th atth e t ax p ay er d ev o tes m uch o f h i s p ers o n al t i m e an deffo rtt o carry i n g o n an act i v i ty , p art i cu l arl y i f t h e act i vi ty

d o es n o th av e s ub s tan t ial p ers o n al o r recreat i o n al as p ect s, m ay i n d i cat e an i n t en ti o n t o d eri v e a p ro fi t .” Sec. 1 .1 83 -2 (b )(3 ), In co m e Tax Reg s . Th e Co m m i s s i o n er s ay s M s . M cM il l an d i dn ’ t
s p en d a s i g n i fi can tam ou n to f t i m e o n “ h o rs e b reed i ng / s ho wi n g ” b ecau s e th e o n l y rel at ed p u rs u i t s s h e rep o rt edwere t al k i n g t o p eo p l e, wat ch i n g v i d eo s o f h o rs es fo r
s al e, at ten d i n g dres s ag e co m p et i t i o n s , ri di n g at the b arn , g i v i n g ri d i n g l es s o n s , an d l u n g i n g h o rs es . Bu t ex cep tfo r t h e l u n g i n g th e reco rdi s s i l en tab o u t h o w m u ch t i m e s h e s p en t o n th es e v ari o u s p u rs u it s . W e th erefo re can ’ tfi n d t h at M s . M cM i l l an ’ s t i m e co m m i t m en twas ex ten s i v e. Wh atwe d o kn o w i s th atm an y o f th es e p u rs u i ts --i n cl u d i n g v i s i t i n g t h e b arn , ri di n g h o rs es , an d at t en di n g dres s ag e co m pet i t i on s --are recreat i o nal . Th at ’ s
es p eci al ly tru e fo r M s . M cM il l an , wh o h as a g en ui n e l o v e o f h ors es . Becau s e we- 3 7 -

[* 3 7 ] d o n ’ tkn o w h o w m

u ch t i m e M s . M cM i l l an s p en to n h er h o rs e act i v i ty , b u t we d o kn o w th atth e act i v i ty h ads ub s t an t i al “ recreat i o nal as p ect s ,” we fi n dth at th i s fact o r i s n eu tral
.

4
. Ex p ect at i on Th atAs s et s M ay Ap p reci at e Anex p ect at i o n th atas s et s wi l l ap preci at e can s u g g es t a p ro fi tm o t i v e. See
s ec. 1 .1 8 3-2 (b )(4 ), In co m e Tax Reg s . M s . M cM i l l an t es t i fi edthats h e h o p edt o b u y a h o rs e an d s el l i t fo r a p ro fi t , b u ti n 2 0 1 0 s h e d i dn ’ to wno n e--o r an y o th er
as s et l ik el y

t o ap p reci at e. Th e o n l y

h o rs e-rel at edp ro p erty

s h e o wn edwas th e t ack
an d ri d i n g o u t fi t s s h e s t o red atth e b arn , an d we s ee n o way s he co u ld ’ v e ex p ect ed th o s e t o ap p reci at e. Th i s fact o r wei gh s ag ai ns tfi n d i n g a p ro fi tm o t i v e.

5
. Su cces s i n Si m i l ar Act i v i t i es

“ Th e fact th atth e t ax p ay er h as en g ag edi n s i m i l ar act i v i t ies i n the p as tan d
co n vert edth em

fro m u npro fi t ab l e t o p ro fi t ab l e en t erp ri ses m ay i n di cat e t h ath e i s
en g ag edi n th e p res en tact i v i ty fo r p ro fi t .” Sec. 1 .1 83 -2 (b )(5 ), In co m e Tax Reg s. Th e Co m m i ss i o n er h as s h o wnth atal tho u g h M s . M cM i ll an h as b een i n v o l vedwi t h h o rs es fo r s ev eral d ecad es , s he’ s h adv ery l i t tl e fi n an ci al s u cces s wi th th em . Sh e’ s h ad o n l y th ree p ro fi t ab l e y ears , n o n e s i n ce 1 9 8 8 , an dh as s u fferedo v er $ 1 5 0 ,0 0 0 i n l os s es s i n ce 2 0 04 . Th i s fact or wei g h s ag ai n s tfi nd i n g a p ro fi t m o t i v e.- 3 8 -

[* 3 8 ] 6
. Hi s t o ry o f In co m e o r Lo s s es Lo n g p eri o ds o f l o s s es fo l l o wi n g th e i n it i al s tart up p h as e can i n d i cat e t h e l acko f a p ro fi tm o t i v e. See s ec. 1 .1 8 2 -2 (b )(6 ), In co m e Tax Reg s.; s ee al s o Go l an ty , 7 2 T.C. at 4 2 7
. By 2 01 0 , M s . M cM i l l an h ad n ’ tm ad e a p ro fi to n h er h o rs e act i v i ty

i n o v er 2 0 y ears , h er l o s s es i n th e p reced i n g 6 y ears were
co n si d erab l e, an ds h e h ad n’ trep o rt edan y h o rs e-rel at edi n co m e wh at s o ev er s i n ce 2 0 0 4 . Th i s fact o r s tro n g l y s u g g es t s th atM s. M cM i l l an ’ s h ors e act i v it y was n o t
en g ag edi n fo r p ro fi t .

7
. Am o u n t o f Occas i o n al Pro fi t s , If An y Occas i o nal p ro fi t s can s ho w a p ro fi tm o ti v e, b u tth e s i ze an dfreq u en cy o f p ro fi ts rel at i v e t o l o s ses are wh atm at ter m o st . See s ec. 1 .1 8 3 -2 (b )(7 ), In co m e Tax Reg s. “ [S] ub s tan t i al p ro fi t , th ou g h o n l y o ccas io n al ” i s th erefo re a b et t er i nd i cat o r
o f a p ro fi tm o t i v e t h an “ o ccas i o n al s m al l p ro fi t fro m an act i v i ty

g en erat i n g l arg e l o s s es ,” an d ev en th e o p po rtu n i ty t o m ak e a s ubs t an ti al p ro fi ti n a s p ecu l at iv e
v en tu re can t i p t h i s fact o r i n a t ax p ay er’ s fav o r. Id . M s . M cM i l l an l as ttu rn eda p ro fi t i n 1 9 8 8 , an dd id n ’ ts u cces s fu l l y s h o w o r b reeda h o rs e du ri ng th e d ecad e p reced i n g th e t ax y ear ati ss u e. W i th o u ta h o rs e i n 2 0 1 0 , s h e h adn o way t o m ak e a p ro fi ti n th aty ear, ei th er. Rat h er t h an a h i g h ly s p ecu l at i v e v en tu re t h at
o ccas i o n al l y

m ak es l arg e p ro fi t s --wh i ch m an y h o rs e-rel at edb u s in es s es are--- 3 9 -

[* 3 9 ] M s . M cM i l l an ’ s h o rs e act i v i ty was a co ns i s ten t s ou rce o f p red i ct ab l e l o s ses , an d i n 20 1 0 th ere was n o i nd icat i o n th ati t co u l db eco m e o th erwi s e. Th i s s tro n g l y
s u g g es t s th atM s. M cM i l l an d i dn o ten g ag e i n h er h o rs e-rel at ed act i v i t ies wi th the i n t en to f m ak i n g a p ro fi t .

8
. Fi n an ci al St atu s

“ Sub s t an t i al i n co m e fro m s o u rces o th er th an th e act i v it y (p art i cu l arl y i f t h e l o s s es fro m

th e act i v i ty

g en erat e s ub s t an t i al t ax b en efi t s ) m ay i nd i cat e t h atth e act i vi ty i s n o t en g ag edi n fo r p ro fi t.” Sec. 1
. 1 8 3 -2 (b )(8 ), In co m e Tax Reg s. M s . M cM i l l an earn s a res p ect ab l e i n co m e fro m h er wo rkas an IT p ro fes s i on al , an d h as d o ne s o s i n ce at l eas t2 0 0 4
. Her “ h o rs e b reed i n g / s h owi n g” ex p en s es -- wh i ch s h e i n cu rs in an act i v i ty wi th s ub st an t i al recreat io n al as p ect s --s i g n i fi can t ly redu ce t h e t ax ab l e p o rt i on o f t hati n co m e. Th i s fact o r wei g h s ag ai n s t fi n d i n g a p ro fi t m o t i v e.

9
. El em en t s o f Pers on al Pl eas u re o r Recreat i o n

“ Th e p res en ce o f p ers o n al m o t i v es i n carry i n g o n o f anact i vi ty m ay i n d i cat e th atth e act i v it y

i s n o ten g ag ed i n fo r p ro fi t , es p eci al l y wh ere t h ere are recreat i o nal
o r p ers o n al el em en t s i n v o l v ed .” Sec. 1 .1 8 3 -2 (b )(9 ), In co m e Tax Reg s . Th at d o es n’ tm ean th at a b u s in es s b eco m es a h o b by ju s tb ecau s e t h e t ax p ay er en jo y s i t -- as we’ v e s ai d , “ su fferi ng h as n ev er b een m ad e a p rereq u is i te t o d edu ct ib i l i ty .”- 4 0 -

[* 4 0 ] J ack s o n v . Co m

m i s s i on er, 5 9 T.C. 3 1 2 , 3 1 7 (1 9 7 2 ). Atth e s am e t i m e,

“ wh ere t h e p o s s i b il i ty

fo r p ro fi ti s s m al l (g iv en al l th e o th er fact ors ) an dth e p o s s i b i l i ty

fo r g rat i fi cat i o n i s s ub s t an t i al , i ti s cl ear t h atth e l at t er p o s s i b i l i ty
co n st i tu t es th e p ri m ary

m o ti v at i o n fo r t h e act i v i ty .” Do d g e v . Co m m i s s i on er, T.C. M em o. 1 9 9 8 -8 9 , 1 9 9 8 W L 8 81 7 5 , at* 7 (qu o t i n g Bu rg er v . Co m m i s s i o n er, T.C. M em o. 1 9 8 5 -5 2 3 , aff’ d , 8 0 9 F.2 d3 5 5 (7 th Ci r. 1 9 87 )), aff’ d wi th o u tp ub l i s h ed
o p i n i o n , 1 8 8 F.3 d5 0 7 (6 th Ci r. 1 9 9 9 ). In 2 0 1 0 th e p o ss i b i l i ty

o f M s . M cM il l an p ro fi t in g fro m h er h o rs e act i v i ty
was n il . Bu tth e g rat ifi cat i o n M s . M cM i l l an recei v ed fro m trai n in g , ri d i n g , an d cari ng fo r h o rs es w as cl ear, an dh er d ecad es o f i nv o l v em en twi th dres s ag e i s an
u n m i s t ak ab l e an di m

po rt an tp arto f h er i d en t i ty . No p ro fi tp o t en t i al p l u s
s ub s t an t i al p ers o n al s at i sfact i o n eq u al s a h eav y wei gh tag ai n s t o u r fi nd i n g a p ro fi t
m o ti v e. Th e “ g o o fy ” reg ul at i o n’ s n i n e fact ors l eadu s t o th e s am e co n cl u s i o n th ata
m o re “ h o l i st i c” ap p ro ach wo u ldh av e: M s . M cM i l l an s upp o rt edh ers el f wi th h er IT wo rkan den g ag edi n “ h ors e b reed i n g / s h o wi n g ” fo r p ers o n al reas o n s an dd i d
n o tex pect t o m ak e a p ro fi t . Sh e t h erefo re can ’ tu s e h er h o rs e-rel at edex p en d i tu res t o o ffs eto th er i n co m e. An dev en i f s h e d i dg en u i nel y i n t en d t o turn a p ro fi tat
s o m e p o i n t , i n 2 0 1 0 s h e was atm o s t i n th e i n i t ial p h as es o f i n v es t ig at i n g p o t en t i al- 4 1 -

[* 4 1 ] o p p o rtu n i t i es an dh adn ’ t actu al l y co m m en cedan y

“ h o rs e b reed i n g / s h o wi n g ” b u s i n es s . Th i s t oo wo u ldp recl u d e h er fro m d educt i ng an y

ex p en s es . W e t h erefo re d i s al l o w an y d edu ct i o n s fo r t h e ex p en s es o n h er “ h o rs e b reed i n g / s h o wi n g ” Sch edu le C. III. IT an dDat ab as e M an ag em en tServ ices A. Ho m e Offi ce Onh er Sch edu l e C fo r “ IT an dd at ab as e m an ag em en ts erv i ces ” M s . M cM i l l an d educt eda t o tal o f $ 8,0 4 5 fo r i n s u ran ce, u t i l i t i es , d ep reci at io n , an d
o th er ex p en s es rel at edt o h er h om e o ffi ce, wh i ch s h e cl ai m ed t o o k up 5 0 % o f h er ap art m en t . Th e co st s o f a h o m e o ffi ce t hata t ax p ay er u s es ex cl u s i v el y o n a reg u l ar b as i s as th e “ p ri n ci pal p l ace o f b u s in es s fo r an y trad e o r b u s i n es s ” are d educt i b l e. Sec. 2 8 0 A(c)(1 )(A); s ee al s o Ham ach er v . Co m m i s s i on er, 9 4 T.C. 3 4 8 , 3 5 3 (1 9 9 0); Hei nb o ck el , at* 6 2 -* 63 . Bu t th e “ ex cl u si ve u s e” req u i rem en t
m ak es s ect i o n 2 8 0 A an al l -o r-n o t h i n g s t atu te--i f t h e t ax p ay er u ses th e h o m e o ffi ce
m o st l y fo r b us in es s b u tal s o u s es i tfo r an y o th er reas o n , th ere’ s n o d edu ct i o n . See Ham ach er, 9 4 T.C. at3 5 6 -5 7 . A t ax p ay er can , h owev er, co m b i n e m o re t h an o n e trad e o r b u si n es s t o m eetth e ex cl u s i v e u s e req u irem en ti f each trad e o r b u s i n es s al s o s at i s fi es th e res t o f t h e t es t . See i d . at3 5 6
.- 4 2 -

[* 4 2 ] W e b el i ev e t h atM s . M cM i l l an ’ s l i v i n g ro o m was h er p ri n ci p al p l ace o f b u s i n es s fo r h er “ IT an d d at ab as e m an ag em en ts erv i ces ,” b u t h er o wn t es t i m o n y
s h o ws th ats h e al s o u s edi tfo r o th er t h i n g s . Th e m o s to bv i o u s o f th es e was h er h o rs e act i v i ty , wh i ch we’ ve fo u n dwas n o ta t rad e o r b u s in es s i n 2 0 1 0 . Th atal o n e d efeat s the s ect i on 2 80 A “ ex cl u s i v e u s e” req u i rem en t , an dm ean s we can s u s t ai n th e Co m m i s s i o n er’ s d is al l o w an ce o f M s . M cM i l l an ’ s h o m e-o ffi ce d edu ct i o n s . Bu tev en i f h er h o rs e act i v it y h adb een a t rad e o r b u s in es s i n 2 0 1 0 an dh er l i vi n g ro o m

was i t s p ri n ci p al p l ace o f b us i n es s , M s . M cM i ll an s t i l l wo u l dn ’ th av e
m eth er b u rd en o f s h o wi n g ex cl u s i v e u s e. Sh e t es t i fi edth ati n ad di ti o n t o
co n du ct in g h er IT b u s i n es s an dn earl y “ ev ery as pect o f [h er] dres s ag e h o rs e b u s i n es s ” fro m

h er h o m e o ffi ce, s h e al so u s edi t wh en wo rk in g o n h er v ari ou s l aws u i t s an dfo r web s i t e ad m i n i s trat i o n --an di n 2 0 1 0 s he h ad b ot h a web s it e rel at ed t o h er h o rs e b u si n es s an dth e s i t e s h e ag reedt o t ak e d o wnas p arto f th e HOA s et t l em en t . Ev en i f h er l aws u i t s an dweb s it es were s o m eh o w trad es o r b u s i n es s es --an d we fi n dth atth ey weren ’ t --s h e s t i l l co u ld n ’ tt ak e th e d edu ct i o n i f
s h e u sedh er l i vi n g ro o m

fo r an yth i n g el se, an dh er t es t im o n y th ats h e n ev er u s ed
an y p arto f i tfo r an yth i ng o th er t h an b u s in es s i s s i m p ly i m p os s ib l e fo r u s t o b el i ev e. W e fi n d i tm o re l i k el y th an n o tth ats h e d i datl eas ts o m et i m es u s e h er- 4 3 -

[* 4 3 ] l i v i n g ro o m

as a l i v i n g ro o m , an dwe d en y h er s ect i o n 2 8 0 A d edu ct i on fo r th atreas on as w el l
. Fi n al l y , ev en i f M s . M cM i ll an h ads h o wn thats h e was en t i t l ed t o d edu ctth e
co s to f h er l i v i ng ro o m , s h e fai l edt o s ubs t an ti at e i t . Tax p ay ers wh o h av e t h e b u rd eno f p ro vi ng en ti t l em en t t o a d edu ct io n o f an y k i n dm u s t h av e reco rd s th at
s ub s t an t i at e t h ei r ex p en s es . See s ec. 6 0 01 ; s ec. 1 .6 00 1 -1 (a), In co m e Tax Reg s . If th ey d o n ’ t , we can es t i m at e s om e ex p en s es , b uto n ly i f t h ere’ s en o u g h ev i den ce t o
s up p ortan es t i m at e. See Co h an v . Co m m is s i o n er, 3 9 F.2 d5 40 , 5 4 3 -4 4 (2 dCi r. 1 9 3 0 ); Van i cekv . Co m

m is s i o n er, 8 5 T.C. 7 3 1 , 7 4 2 -4 3 (1 9 8 5 ). Th ere are n o
reco rd s i n ev i den ce t hats h o w M s . M cM i l l anactu al l y i ncu rredth e co s t s s he cl ai m edfo r i n su ran ce, u ti l i t i es , an d“ o th er ex p en s es ” o r t h atwo u l d al lo w u s t o p ro p erl y es t i m at e s u ch co st s . Th is l acko f reco rd s al so l ead s u s t o s u s t ai n th e Co m m i s s i o n er’ s d i s al l owan ce o f M s . M cM i l l an ’ s h o m e o ffi ce d edu ct i o ns . B. At t o rn ey ’ s Fees , Ag ai n Onh er Sch edu l e C fo r t h e IT an dd at ab as e m an ag em en tb u s in es s M s . M cM i l l an d educt edthe $ 1 1 ,9 9 8 s h e p ai dat t o rn ey s t o h an d l e th e HOA s u i t
an d d efen dh er ag ai n s tcri m i n al ch arg es . Tax p ay ers can d edu ctthe o rd i n ary an d
n eces s ary ex p en ses o f carry i n g o n a t rad e o r b u s i n es s o r o th erwi s e p ro du ci n g i n co m e, s ecs . 1 62 (a), 2 1 2 (1 ), b u tn o tp ers o n al , l i v i ng , o r fam i l y ex pen s es , s ec.- 4 4 -

[* 4 4 ] 2 6 2 (a). Wh et h er l i t i g at i on co s t s are d edu ct ib l e b u si n es s ex pen s es o r
n o n d edu ct i b l e p ers o nal ex p en s es d ep en d s o n “ th e o ri g i n an dch aract er o f t he cl ai m wi th res p ect t o wh i ch an ex p en s e was i ncu rred .” Un i t edSt at es v . Gi l m o re, 3 7 2 U.S. 3 9 , 4 9 (1 96 3 ). If t h e cl ai m aro s e “ i n co n n ect i o n wi th th e t ax pay er’ s p ro fi t-s eek i n g act i v i ti es ,” t he fees are d edu ct i b l e. Id . at4 8 . If n o t, th en th ey aren ’ t d educt i b l e, reg ard l es s o f “ th e co n s equ en ces th atm i g h tres u l t t o a t ax p ay er’ s i n co m e-p ro du ci n g p ro p ert y ” fro m l o s i n g t h e cas e. Id . Th e Sup rem e Co urt fo rm u l at edth i s t es ti n Gi l m o re, 3 7 2 U.S. at 4 1 -4 2 , 5 1 -5 2 , wh ere i tfo u n dth atth e l eg al fees a h u s b an di n cu rreddu ri n g h i s d i v orce t ry i n g t o p rev en th i s wi fe fro m t ak i n g h i s co n tro l l i n g i n t eres t s i n th ree car d eal ers h i p s were p ers o n al b ecau s e t h e
o ri g i n o f t h e wi fe’ s cl ai m was th e m ari t al rel at i o n s h ip , n o t an i n co m e-p ro du ci n g act i vi ty . Onb ri ef M s . M cM i l lan co n ced es th ats h e can ’ td edu ctth e en t i re $ 1 1 ,9 9 8
-- i n s t ead , s h e s ay s s h e’ s en ti t l edt o d edu cth al f o f i t b ecau s e t h at ’ s wh at we al l o wed h er t o d o i n the cas e i n v o lv i n g h er 2 0 0 9 t ax y ear. See M cM i l l an II, at* 1 0 -* 1 1
. Th ath o l di n g res u l t edfro m th e Co m m i s s io n er’ s fai l ure t o s h o w th atth e fees
weren ’ td edu ct i b l e o r ch al l en g e M s . M cM i l l an ’ s cl ai m th at5 0 % o f h er ap art m en t
was a h o m e o ffi ce. Id
. Here, h o wev er, M s . M cM il l an h as th e b u rd en , an ds h e
can ’ tju s trel y

o n th atp ri o r d eci s i o n .- 4 5 -

[* 4 5 ] In M s . M cM i l l an ’ s s ui tag ai n s th er HOA n ei th er h er co m p l ai n tn o r t he
s et t l em en ts h e s i g n edm en t i o n s an y i n t erferen ce wi th h er wo rk . Sh e n ei th er
s o u g htn o r recei vedd am ag es fo r l o s tearn i n gs , an d s he d i dn ott es t i fy th ats h e
s u ffered an y . Her cl ai m s --b reach o f fi du ci ary du ty , b reach o f co v en an t s , an d
n u i s an ce--o ri g i n at edfro m h er s t atu s as a h o m eo wn er an d an HOA m em b er, n o t fro m h er b u s i n es s act i v i t i es . See Gi l m o re, 3 7 2 U.S. at4 9 . Th e am o un t s s h e s p en t p u rs u i n g th o s e cl ai m s th erefo re aren ’ td educt i b l e. W e ap pl y th e Gi l m o re t es twi th reg ardt o cri m i n al cas es , t o o . Cri m i n al

d efen s e fees are d edu ct i b le i f “ th e cri m e i s d i rect l y co n n ect edt o th e t ax p ay er’ s b u s i n es s ,” HIE Ho l d i n g s, In c. v . Co m m is si o n er, T.C. M em o . 2 0 0 9-1 3 0 , 2 00 9 W L 1 5 8 6 0 4 4 , at* 9 7 (ci ti n g Co m m i s s io n er v . Tel l i er, 3 8 3 U.S. 6 87 (1 9 6 6 ) (s ecu ri t i es d eal er d efen di ng ag ai n s ts ecu ri t i es frau d )), aff’ d, 5 2 1 F. Ap p ’ x 6 0 2 (9 th Ci r. 2 0 1 3 ), b u t n o t i f “ the cri m e aro s e o u to f t he s h areh o l der’ s act i v i ti es an dn o to u to f th e co rp o rat io n’ s p ro fi t-m ak i n g act i v i t ies ,” i d . (ci t i n g , am o n g o th er cas es , Pet ers , Gam m , W es t& Vi n cen t , In c. v . Co m m i s s io n er, T.C. M em o . 1 99 6 -1 8 6 (s ecu ri t i es fi rm d efen di n g ag ai n s ti n si d er t rad i n g ch arg es th atd i dn ’ to ri g i n at e i n fi rm ’ s b u s i n es s )). Th e ch arg es M s . M cM i l l an faced res u l t edfro m h er at t em

p tt o i n fi l t rat e th e ap art m en t ab o ve h ers t o co l l ectev i d en ce fo r th e HOA s u i t , wh i ch , as we’ v e- 4 6 -

[* 4 6 ] fo u n d , l ack edan y co n n ect i o n t o h er b us i n es s . Su ch b eh av i o r was n o t req u i redb y , o r rel at edt o , an y b u s i n es s s h e was en gag edi n . W e t h erefo re fi nd th at th e fees M s. M cM i l lan p ai dfo r h er cri m i n al d efen s e
were n o n d educt i b l e p ers o nal ex p en s es . IV. Pen al ty Th e Co m m is s i o n er s ay s M s . M cM i l l an i s l i ab l e fo r a s ect io n 6 66 2 (a) p en al ty . Sect i o n 6 6 6 2 (a) i m p os es a 2 0 % p en al ty

o n t ax u n d ers tat em en t s thatare
s ub s t an t i al , s ee s ec. 6 6 6 2 (b )(2 ), (d ), o r t h at are du e t o n eg l i g en ce o r d i s reg ardo f
ru l es an dreg u l at i o n s , s ee s ec. 6 6 6 2 (b )(1 ), (c). Bu ta t ax p ay er wh o h adreas o n ab l e
cau s e fo r an u n d erp aym en tan dact edi n g o o d fai th i s n o t l i ab le fo r t he p en al ty . See s ec. 6 6 6 4 (c)(1 ); s ec. 1 .6 6 6 4 -4 (a), In co m e Tax Reg s . Wh en th e t ax p ay er i s an i n d i v i du al , the Co m m i s s i o n er al way s h as th e i n it i al b u rd eno f p ro du ct i o n o n p en al t i es , m ean i n g h e m u s tp res en tev id en ce t h at i m p o s i n g th e p en al ty

i s ap p ro p ri at e. Sec. 7 49 1 (c); Hi g b ee v . Co m m i s si o n er, 1 1 6 T.C. 4 3 8 , 4 4 6 -4 7 (2 0 0 1 ). He m eet s th is i n it i al b u rd en fo r t h e s ubs t an ti al
u n d ers t at em en tp en al ty

h e as sert edi n h i s n o t i ce h ere b ecau s e M s . M cM i l l an ’ s d efi ci en cy

i s m o re t h an $ 5,0 0 0 an dm o re t h an 1 0 % o f th e t ax s h e s h o u l d ’ v e rep o rt ed . See s ec. 6 6 6 2 (d )(1 )(A). He s ay s h e m eet s h i s i n it ial b u rd en o n
n eg li g en ce t o o b ecau s e h e’ s s ho wnth atM s . M cM il l and i dn ’ trep ortth e $ 7 0 ,0 0 0- 4 7 -

[* 4 7 ] HOA s et t l em en tev en th ou g h s he kn ew h o w n arro w th e l i m i t at i o ns o n
ex cl u d ab i l i ty

were; th at th e HOA s u i t an dh er cri m i nal cas e o bv i ou s l y weren ’ t rel at ed t o h er IT b u s in es s ; thats h e d edu ct edh al f t he co s to f h er ap art m en tev en th o u g h s h e d i dn ’ tu s e h er h o m e o ffi ce ex cl u si vel y fo r b u s i n es s; an dth at h er h o rs e act i vi ty cl earl y was n o t a trad e o r b u s i n es s b ecau s e s he d i dn ’ t o wna h ors e i n 2 0 1 0
an d h ad n ’ ts h o wno r b redo n e i n aro u n da d ecad e. See s ec. 1 .6 6 6 2 -3 (b )(1 )(i i ), In co m e Tax Reg s . 1 1 W e ag ree. Wh i ch b ri n g s u s t o th e b u rd en o f p ers u as i o n . Fo r p en al t i es d et erm i n edi n th e n o ti ce o f d efi ci en cy , thatb urd en i s o n the t ax p ay er--wh ich m ean s th ato n ce t h e Co m m i s s i o n er p res en t s pr i m a f a ci e ev id en ce t h ata p en al ty i s ap p ro p ri at e, i t ’ s up t o the t ax p ay er t o s h ow reas o n ab l e cau s e an d g oo dfai th . See Hi g b ee, 1 16 T.C. at 4 4 6 -4 7 ; San d erl i n g , In c. v . Co m m is s i o n er, 6 6 T.C. 7 4 3 , 7 57 (1 9 7 6 ), aff’ d i n p art , rev ’ d i n p arto n o th er g ro un d s , 5 7 1 F.2 d1 7 4 (3 dCi r. 1 9 78 ). M s. M cM i l l an d o es n’ targ u e th ats h e h adreas o n ab l e cau s e t o d edu cth er l eg al fees an d h o m e-o ffi ce ex p en ses o r thats h e d i ds o i n g oo dfai th --m i s u n d ers t an d i n g h er b u rd enwi th reg ard t o th e p en al ty d et erm i n edi n t h e n o t i ce, s h e s ay s o n l y th atth e

1 1 Al th ou g h h e l is t ed “ s ub s t an t i al v al u at i o n o v ers t at em en t ” as a g ro u n dfo r th e s ect i o n 6 6 6 2 (a) p en al ty i n th e n o t i ce, h e d i dn ’ targ u e i to n b ri ef.- 4 8 -

[* 4 8 ] Co m

m i s si o n er d i dn ’ t s ho w th ats h e di d n ’t actwi th reas o n ab l e cau s e an d g o o dfai th . Sh e t h erefo re h as n ’ tm ad e an y s h o wi n g o f reas o n ab l e cau s e o r g o o d fai th an dcan ’ t u s e t h o se d efen s es t o es cap e t h e p en al ty rel at edt o h er h o m e-o ffi ce
an d l eg al -fees d edu ct i on s . M s . M cM i l l an ’ s arg u m en ti s ap p ro pri at e, h o wev er, wi th res p ectt o the p en al ty the Co m

m i s s i o n er as s ert edfo r t h e fi rs tt i m e i n h i s an s wer--n am el y , th e p o rt i on s rel at edt o M s. M cM i l l an ’ s u n rep o rt eds et t l em en ti n co m e an d h o rs e-act i v i ty

d edu ct i o n s. Th o s e are n ew m at t ers , s o th e Co m m i s s i o n er h as th e b u rd eno f p ers u as i o n an dm u s t s h o w th atM s . M cM i l l an di dn ’t h av e reas o n ab l e
cau s e, acti n g o o dfai th , o r rel y o n s ub st an t i al au th o ri ty . See Ru l e 1 4 2(a); San derl i n g , In c., 6 6 T.C. at7 5 7 ; M cM i l lan II, at* 2 9 ; Sn y d er v . Co m m i s s i on er, T.C. M em o . 2 00 6 -9 2 , 2 0 0 6 W L 1 1 5 7 8 7 4, at* 6. Wh i l e cro ss -ex am i n in g M s . M cM i l l an th e Co m m i s s i o n er’ s at to rn ey
es t ab l i s h edth ats h e d i dn ’ tco n s u l tan y o f h er at t o rn ey s ab o u th er ret u rn p o s i t i o n . Sh e d id , h o wev er, ad m i t th ats h e as k eda CPA s h e’ d ret ai n edi n th e 1 99 0 s wh et h er th e ex cl u s i o n fo r p ai n an ds u fferi n g award s was s t i l l i n p lace, an d h e t o l dh er t h at i t ’ s n o wm o re “ n arro w l y

d efi n ed ” an dap p l i es o n ly wh ens o m eo n e i s “p h y s i cal l y i l l.” Rat her t h an s u g ges t reas o n ab l e rel i an ce t h atm i g h tex cu s e a s ect i o n 6 6 6 2 (a) p en al ty , s ee s ec. 6 6 64 (c)(1 ); Neo n at o l o g y As s o cs ., P.A. v
. Co m

m i s s io n er, 1 1 5- 4 9 -

[* 4 9 ] T.C. 4 3 , 9 8 (2 0 0 0 ), aff’ d , 2 9 9 F.3 d 2 2 1 (3 dCi r. 2 0 0 2 ); s ec. 1 .6 6 6 4 -4 (b )(1 ), In co m e Tax Reg s ., th i s t es t im o n y s h o ws th at M s . M cM i l l an kn ew t h atth e
ex cl u s i o n s h e was rel y i n g o n was l i m i t ed , th ats h e h adreas on t o qu es t i o n wh et h er
s h e qual i fi edfo r i t, an dth ats h e d i dn ’ tfo l lo w up t o m ak e s u re h er p o s it i on was
reas on ab l e. It ’ s al s o an o th er reas o n t o qu es t i o n h er t es t i m o n y ab o u t h er p h y s i cal
s ym p to m s --o f wh ich there’ s n o co n t em p o ran eo u s ev i d en ce an d the t reat m en tfo r wh i ch s h e co u l dn o trem em b er. Th e Co m

m i s s i o n er t h erefo re m et h i s b u rd en o f
s h o wi n g th atM s . M cM il l and i d n otreas o n ab l y rel y i n g o o d fai th o n p ro fes s i o n al ad v ice, an dth ats h e h ad n ei ther reas o n ab l e cau s e n or g o o dfai th i n fai l i n g t o rep o rt h er s et t l em en twi th th e HOA. Th e ev i d en ce al s o s h o ws th atwh en M s . M cM i l l anfi l edh er 2 01 0 retu rn h er h o rs e act i v i ty

h ad n ’ tm ad e a p ro fi t s in ce 1 9 8 8 an dl ack edan y way t o d o s o . W e th erefo re fi n d t h atth e Co m m i s s i o n er al s o m eth i s b u rd en o f s ho wi n g th at M s . M cM i l l an l ack edreas o n ab l e cau s e o r g o o d fai th i n cl ai m i n g d edu ct i o n s fo r

“ h o rs e/breed i n g s h owi n g.” Bu tM s. M cM i l l an wi l l l u cko u t aft er al l . An o th er p arto f th e Co m m i s s i o n er’ s b u rd en o f p ro du ct i o n o n p en al t i es i s s h o wi n g th atth ey were

“p ers o n al l y

ap p ro v ed(i n wri ti n g ) b y th e i m m ed i at e s up erv i s o r o f t h e i n d i v i du al
m ak i n g s u ch d et erm i n at io n .” See s ec. 6 75 1 (b )(1 ); Graev , 1 4 9 T.C. at4 92 -9 4
.- 5 0 -

[* 5 0 ] M s . M cM i l l an p u t th e accu racy -rel at edp en al ty ati ss u e i n h er p l ead in g s an d
co n tes t edi to n i t s m eri t s i n h er b ri efs , b ut the Co m m i ss i on er d id n ’ ti n tro du ce an y
ev i d en ce o f s u ch ap p ro v al attri al . See Wh eel er v . Co m m is s i o n er, 1 2 7 T.C. 2 0 0 , 2 0 8 , 2 1 0 , 2 1 2 (2 0 06 ), aff’ d , 5 2 1 F.3 d1 28 9 (1 0t h Ci r. 2 0 0 8 ). So , d es p i t e h er
s ub s t an t i al u n ders t at em en tan dn eg l i g en ce, we d o n’ ts u s t ai n an y s ect i o n 6 6 6 2 (a) p en al ty ag ai n s tM s . M cM i l lan fo r 2 0 1 0 . See Fo rdv . Co m m is si o n er, T.C. M em o . 2 0 1 8 -8 , at* 6, aff’ d , 7 5 1 F. Ap p ’ x 8 4 3 (6 th Ci r. 2 0 1 8 ).
Deci s i o n wi ll b e en t eredu n d er Ru l e 1 5 5
.