T.C. Mem o. 2 01 3- 23 9

UNITED STAT ES TAX COURT

PATRICK SC HLIEVERT AND SHIRLEY M. SCHLIEVERT, Pet it io ne rs v. COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No . 16 11 3- 12 . Fil edOcto be r 22 , 20 13 .
Patric k S ch li ev ertan d S hi rle y M. Sch li ev ert , pro se. St ep he n A. Hal le r, fo r res po nd en t.

MEMORANDUM FINDINGS OF FACT AND OPINION KROUPA, Ju dg e: Res po nd en t d et erm in edan$1 1,3 02 de fic ie nc y in 1 pe ti ti on ers ’ Fed eral in co m e ta x fo r 20 10 . Res po nd en t al so de te rm in edth at

All do ll ar am ou nt s ar e ro un de d t o t he ne ares t wh ol e num be r. 1-2
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[* 2] pe ti ti on ers were l iabl e fo r th e acc ur acy-rela te d p en al ty und er s ect io n 6 66 2( a) 2 fo r 20 10 . W e are ask edto de ci de whet he r pe ti ti on ers , a un iv ers it y pro fes so r an d a ho m em ak er, en ga ge d i n t he ir r eco rdlab el act iv it y forpro fitun de r se ct io n 1 83 du rin g 2 01 0. We ho ldth atth ey di d n oten ga ge inth ei r rec or d l ab el act iv it y with a bo nafid e p ro fitob

jecti ve an d are the refo re n oten ti tl edto de du ctlo ss es fro m th e act iv ity . W e are als o a sk edto de ci de whet he r pe ti ti on ers are l iabl e fo r th e accu racy-rela te d p en al ty und er s ect io n 6 66 2( a) fo r 20 10 . W e h ol d t ha t the y are. FINDINGS OF FACT The pa rti es ha ve st ip ul at edso m e fac ts . W e in co rp or at e th e st ip ul at io n o f fact s an d t he acco m

pa nyin g e xh ib it s b y

th is refe ren ce. Pet it io ne rs res id edinIowa whe n the y

fil edth e p et it io n. I. Pet it io ne rs Dr. Sch li ev ertis a pr of

es so r an d the he adof t he Mi cro bi ol og y Depa rtment atth e Uni ve rs ity

of I owa , Carv er Co ll eg e o f Med ic in e (Un iv ers it y ). Befo re be co min g apro fes so r, Dr. Sch li ev ertwork edas age ol og is t an d p ur su eda Mas te r’s Deg ree i n S ci en ce Educ at io n. Dr. Sch li ev ertearn eda $2 18 ,03 4 s al ary du rin g All sec ti on refe ren ces are t o t he Int ern al Rev enue Co de (Co de ) in effe ctfor 2 20 10 , andall Ru le refe ren ces are t o t he Tax C ou rt Rul es of P ract ic e an d Pro cedur e, un le ss ot he rwis e in di cat ed .-3
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[* 3] 20 10 fro m

th e Uni ve rs ity . Mrs . Sch li ev ertis a ho m em ak er. Tog ethe r pe ti ti on ers ha ve a ne t wo rth of $ 1.8 m il li on . Dr. Sch li ev ertcrea te d a ndco -fo un de d two b io te ch no lo gy com pa ni es . Thes e co m pa ni es de ve lo p dru gs to pre ve ntan d t reatin fect io us di se as es . One co m pa ny is or ga ni zedas a n LLC wh il e th e o th er i s i nc or po rat ed . Each c om

pa ny em pl oys an at to rn ey , at l eas t o ne Ph .D. sci en ti stan d aCEO. The co m pa ni es are b ui lton Dr. Sch li ev ert ’s exp ert is e in imm un ol og y an d i nf ect io us di se as es . The co m pani es ha ve a bu si ne ss pl anan d ati m el in e to wardpro fit ab il ity bu t ar e n oty etpro fit ab le . Befo re 2 01 0, p et it io ne rs ha d n o e xp eri en ce wi th th e m us ic in du st ry

or reco rdlab el s. II. SaraSch li ev ertan d t he Ban d SaraSch li ev ert , pet it io ne rs ’ on ly chi ld , att en de d t he Uni ve rs it y of S ou th ern Cal ifo rn iato stud y

an d m ajorinMu si c In du st ry . Sara i nt ern edat At la nt ic Reco rd s as anacqui si ti on s an d re pe rto ire sp eci al is t. Whi le in te rn in g, Sa ra d is co ve redth e 3
ro ckba ndThe Gal le ry

(ba nd ). The b an d, o rig in al ly from Mas sa ch us et ts , m ov edto Cal ifo rn iainho pe s o f m ak in g i t b ig . The b an d was un ab le to si gn with At la nt ic Rec or ds . Sara s ub se qu en tl y be ga n m an ag in g t he ba ndso m et im e in 20 09 . A y ear
An ac qu is it io ns an d re pe rto ire sp eci al is t’s p rin ci pa l dut ie s ar e to fin d a nd 3 recrui t m us ic al tal en t fo r a rec or d c om pa ny.-4
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[* 4] lat er, Sar a p it ch edth e id ea o f pr oduc in g t he ba nd ’s reco rdto pe ti ti on ers . Pet it io ne rs ag reed . Pet it io ne rs en te redin to anora l ag reem en t (a gr eem en t) wi th th e b an d t o fu nd th e b an d’s ex pe ns es . The ag reem en t p ro vi de d t ha t p et it io ne rs wou ldbe rep ai d fo r al l ex pe ns es fro m

an y m on ey th e b an d re cei ve d fr om

a fu tu re re co rdlab el adva nc e or50 % of the m on ey

fro m reco rdsal es . Peti ti on ers wou ldals o re cei ve 10 % of t he am ou ntov er $ 20 0,0 00 th atth e b an d e arn ed . The ag reem en t al so requi redth at Saraco nt in ue to serve as t he ba nd ’s m an ag er fo r a 1 5% fe e. III. SURF Pet it io ne rs na m edth ei r rec or d l ab el act iv it y “ Sch li ev ert ’s Ult im at e Rec or d Faci li ty” or “ SURF” be cau se Dr. Sch li ev erten joy s s ur fin g. Pe ti ti on ers ha ve no t reg is te redSURF as a tr ad em arkno r adve rti se d a s SURF. Add it io na ll y , pet it io ne rs ha ve no t i nc or

po rat edSURF n ororg an iz edSURF as anLLC. Peti ti on ers ’ reco rd labe l ac ti vi ty has ne ve r ha d aba nkacco un t o r an y em pl oyees. No r ha s p et it io ne rs ’ reco rdlab el act iv ity

in ve st edinor s ou gh t o utot he r ba nd s. Pet it io ne rs ha ve , ho wev er, rea d abo okto in fo rm th em se lv es ho w th e m

us ic bu si ne ss op erat es . 4

Pet it io ne rs tes ti fie d t o re ad in g Al l Yo u Nee d t o Kn ow Ab ou t the Mu si c 4 Bu si ne ss by D on al d S . Pas sm an .-5 -

[* 5] Pet it io ne rs als o d is cu ss edth ei r reco rdlab el act iv it y with Un iv ers it y

of Cal ifo rn iapro fes so rs . IV. Rec or d Lab el Acti vi ty The ag reem en t p ro vi de d fo r Sara ’s fro nt in g t he ba nd ’s exp en se s fr om he r pe rs on al ch eck in g a cco un t o r with h er p ers on al cred itcard . Peti ti on ers wou ldth en rei m bu rs e Sar a. Pet it io ne rs pa idfun ds ne it he r di rect ly to the bandno r fo r th e b an d vi a a s ep arat e b an k a cco un t. At tria l, p et it io ne rs pre se nt eda li stof i te m iz ed ex pe ns es bu t s ho wedno rece ip ts or i nv oi ces . Peti ti on ers ’ reco rdlab el act iv it y su st ai ne d l os se s o f $4 4,4 45 in20 10 , $1 1,6 81 in20 11 , and$1 ,00 0- $2 ,00 0 i n 2 01 2. The ba ndrel eas edanalb um in20 10 , an e xt en de d p la y CD. W arre n Hu art pr oduc edth e CD, an d the bandco pyrig ht edit s co nt en t. In si de th e jack etco ve r th e ba ndgi ve s “ th an ks ” to pe ti ti on ers , alo ng with 3 2 o th er p eo pl e. Pet it io ne rs di d, ho wev er, ret ai n the m as te r rec or di ng s. Si nc e 2 01 0, p et it io ne rs ha ve in ve st edles s an d l es s i n t he ba ndan d l ik ewis e in th ei r rec or d l ab el act iv ity . Peti ti on ers ha ve no t p ur su edothe r ta le ntor a ny oth er rel at edact iv ity

asi de fro m

in ve st in g m on ey

inth e b an d. In20 13 , pet it io ne rs refr ai ne d e nt ire ly from

in ve st in g i n t he ba ndor t he ir r eco rdlab el act iv it y . Pet it io ne rs pre se nt edno ev id en ce o f gr os s re cei pt s o r sa le s o f an y ki ndex cep t wi th-6
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[* 6] res pe ctto th e fi rs t qua rte r of 20 13 . Pet it io ne rs co nc ed e th atth ey are wai ti ng 5 to m ak e an y

furth er i nv es tm en ts un ti l the y cande du ctex pe ns es rel at in g t o t he ir reco rdlab el act iv ity . The b an d, o n t he ot he r ha nd , has co nt inue d t o t ou r an d t o pr oduc e m

us ic . V. In co m e Tax Returns Pet it io ne rs fil eda Fo rm

10 40 for20 10 an d re po rte d a$4 4,4 45 ne t l os s o n th e at ta ch edSch edul e C. The Sch edul e C d es cri be d p et it io ne rs ’ bu si ne ss as

“ Rec or d Lab el (Rec or di ng Indus try).” Peti ti on ers cla im ed$4 ,85 0 o f adve rti si ng ex pe ns es , $6 17 of c omm is si on s an d fe es , $2 4,8 25 of l eg al an d p ro fes si on al se rv ic es , $2 ,63 3 o f supp li es an d $ 11 ,79 0 o f tr av el ex pe ns es . Peti ti on ers rep orte d no gro ss rece ip ts or s al es on th e Sch edul e C an d l ik ewis e rep orte d n o g ro ss in co m e. Pet it io ne rs rep orte d a$1 1,6 81 ne t l os s o n t he Sch edul e C fo r th e fo ll owi ng y ear. Th e Sch edul e C fo r 20 11 de sc rib edpe ti ti on ers ’ bu si ne ss as “ Mu si c In du stry .” Res po nd en t d is al lo wedth e Sch edul e C l os se s fo r 20 10 , det erm in eda de fic ie nc y

forth aty ear a ndde te rm in edth atpe ti ti on ers were l iabl e fo r an accu racy-rela te d p en al ty. Pet it io ne rs ti m el y fil eda pe ti ti on . Pet it io ne rs ha d a$2 ,00 0 n etpro fitforth e fi rs t qua rte r of 20 13 . 5-7 -

[* 7] OPINION W e m us t d eci de whethe r pe ti ti on ers en ga ge d i n t he ir r eco rdlab el act iv ity fo r pr of itun de r se ct io n 1 83 du rin g 2 01 0. Re sp on de ntass ert s tha t p et it io ne rs ’ reco rdlab el act iv ity

was n ot hi ng m or e th ana m ean s t o s up po rt andhe lp Sara , pe ti ti on ers ’ daug ht er, b reakin to th e m us ic in du st ry . Peti ti on ers , onth e o th er ha nd , con te ndth ei r rec or d l ab el act iv it y was c on du ct edwith abo nafid e p ro fit ob jecti ve . W e are als o a sk edto de ci de whet he r pe ti ti on ers are l iabl e fo r th e accu racy-rela te d p en al ty. W e ad dr es s ea chof t he se is su es inturn . I. Exp en se Dedu ct io ns W e fi rs t ad dr es s the bu rd enof p ro of . Gener al ly, th e Co m

m is si on er’s de fic ie nc y

de te rm in at io n i s p res um edco rrec t, an d t he tax pa y er b ears th e b ur de n o f pr ov in g t he de te rm in at io n i s i m pr op er. See Ru le 14 2( a)(1 ); Welc h v . Helv eri ng , 29 0 U.S. 1 11 , 11 5 (1 93 3) ; Ev an s v . Commis si on er, 9 08 F.2d36 9 (8 th Cir . 19 90 ), rev ’g T.C. Mem o. 1 98 8- 46 8. An ap pe al inth is cas e wou ldli e to th e U.S. Co urt o f App eal s fo r th e Eig ht h Ci rcu it(Eig ht h C irc ui t) abs en t a s ti pu la ti on to th e co ntrary. Whe re the Co urt o f App eal s t o wh ic h app eal li es ha s d eci de d a n i ss ue th atis squa rel y inpo in t, we wi ll fo ll ow the de ci si on of t ha t co urt. Go ls env. Co m m is si on er, 5 4 T.C. 7 42 , 75 7-8
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[* 8] (19 70 ), aff’d, 4 45 F.2d98 5 (1 0t h C ir. 1 97 1) . The Eig ht h C irc ui t re qu ire s tha t a ta xp ay er h av e a b on a fi de ob jecti ve of r eal iz in g p ro fitfro m anact iv it y

to de du ct ex pe ns es rel at in g t o t ha t ac ti vi ty. Evan s v . Comm is si on er, 9 08 F.2dat 3 73 ; s ee al so Taub e v . Commis si on er, 8 8 T.C. 4 64 (19 87 ). Acco rd in gl y , pet it io ne rs m us t pr ov e th ey

en ga ge d i n t he ir r eco rdlab el act iv ity with abo nafid e p ro fitob jecti ve to be en ti tl edto de du ctex pe ns es rel at in g t o t he ir r eco rdlab el act iv it y . See Ev an s v. Co m m is si on er, 9 08 F.2dat 3 73 . W e n ow turn t o wh ethe r pe ti ti on ers m ay de du ctex pe ns es rel at edto th ei r reco rdlab el act iv ity . Dedu ct io ns are al lo wedforall ord in ary an d n eces sary ex pe ns es pa idor i nc urreddu rin g t he tax y ear i n c arrying on a tr ad e o r bu si ne ss or fo r th e p ro du ct io n o f in co m e. Secs . 16 2( a), 2 12 (1 ). W e lo okto sec ti on 18 3 i n co nju nc ti on with s ect io n 1 62 to de te rm in e whe th er an act iv it y is en ga ge d i n fo r pr of it . This Co urt co ns id ers whet he r anact iv it y is en ga ge d i n fo r pr of

iton a cas eby-cas e b as is , tak in g i nt o a cco un t the fact s an d c irc um st an ces in vo lv ed . See Gol an ty v. Comm is si on er, 7 2 T.C. 4 11 , 42 6 (1 97 9) , aff’d wit ho utpubl is he d op in io n, 6 47 F.2d17 0 (9 th Cir . 19 81 ). W e st ru ctur e o uran al y si s o f whe th er an act iv ity is en ga ge d i n fo r pr of

itaro un d n in e n on ex cl us iv e fac to rs . Sec. 1 .18 3- 2( b) , In co m e Tax Reg s.-9
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[* 9] The n in e fac to rs are: (1) th e m an ne r in whi chth e ta xp ay er ca rri edon th e act iv ity , (2) th e ex pe rti se of t he tax pa y er o r hi s o r he r advi se rs , (3) th e ti m e an d effo rt the tax pa y er ex pe nd edincarry in g o n t he act iv it y , (4) th e expe ct at io n t ha t th e as se ts us edinth e act iv ity m ay ap pr eci at e inva lu e, (5 ) th e ta xp ay er’s s uc ces s i n carry in g o n o th er s im il ar o r di ss im il ar ac ti vi ti es , (6) th e ta xp ay er’s h is to ry of in co m e o r lo ss with re sp ectto th e act iv it y , (7) th e am ou ntof o ccas io na l p ro fit s, i f an y , whi chare ea rn ed , (8) th e ta xp ay er’s fi na nc ia l s ta tu s an d (9 ) whe th er el em en ts of pe rs on al pl eas ur e o r rec reat io n a re i nv ol ve d. Id . No s in gl e fac to r orsetof f act or s i s d et erm in at iv e, no r is th e ex is te nc e o f a
m ajor it y of f act or s fa vo rin g o r di sf

av or in g apro fitob

jecti ve co nt ro ll in g. Verr et t v. Co m m is si on er, T.C. Mem o. 2 01 2- 22 3; see Evan s v . Comm is si on er, 9 08 F.2dat 37 3; sec . 1.1 83 -2 (b ), In co m e Tax Reg s. Ce rta in fact or s m ay be gi ve n m or e wei gh t th anot he rs be cau se th ey

are m or e rel ev an t t o t he fact s. See Vit al e v . Co m m is si on er, T.C. Mem o. 1 99 9- 13 1, af f’d witho utpubl is he d o pi ni on , 21 7 F .3d 84 3 (4 thCir . 20 00 ). Notall fact or s m ay ap pl y inan y cas e. See Gre env. Co m m is si on er, T.C. Mem o. 1 98 9- 43 6; see als o Ak el is v. Co m m is si on er, T.C. Mem o. 1 98 9- 18 2. Grea te r wei gh t i s g iv ento ob jecti ve fact s o ve r th e ta xp ay er’s subjec ti ve in te nt . See En gd ah l v . Comm is si on er, 7 2 T.C. 6 59 , 66 6 (1 97 9) ; s ec.-1 0-

[* 10 ] 1.1 83 -2 (a) and(b) , Inc om e Tax Reg s. We focu s n ow o n e achof the ni ne fact or s, i n turn. 1. Man ne r in Whi chth e Tax pa y er Co nduc ts th e Act iv it y W e b eg in by con si de rin g wh ethe r pe ti ti on ers carr ie d o n t he ir r eco rdlab el act iv ity ina bu si ne ss li ke m anne r. See s ec. 1 .18 3.-2 (b )(1 ), In co m e Tax Reg s. We co ns id er wh ethe r th e ta xp ay er co nduc te d t he act iv ity ina m an ne r subs ta nt ia ll y si mil ar t o o th er ac ti vi ti es of t he same natur e th atwere p ro fit ab le an d wh ethe r th e ta xp ay er k ep t ac cu rat e b oo ks an d re co rd s. En gd ah l v . Commis si on er, 7 2 T.C. at 66 6- 66 7; Jo hn so n v . Comm is si on er, T.C. Mem o. 2 01 2- 23 1; W il m otv. Co m m is si on er, T.C. Mem o. 2 01 1- 29 3; Sm it h v . Comm is si on er, T.C. Mem o. 2 00 7- 36 8, af f’d, 36 4 F ed . App x. 3 17 (9t h C ir. 2 00 9) ; s ec. 1 .18 3- 2( b) (1 ), In co m e Tax Reg s. Pet it io ne rs co nt en d t ha t the y carri edon th ei r rec or d l ab el act iv it y ina bu si ne ss li ke m an ne r by adv ert is in g, educ at in g t he m se lv es an d re lying on ex pe rts in th e m us ic in du st ry . Res po nd en t co nt en ds th atpe ti ti on ers di d n otop erat e th ei r reco rdlab el act iv ity

li ke a bu si ne ss . The tri al reco rddo es no t re fle ctth atpe ti ti on ers ranth ei r rec or d l ab el act iv ity li ke a bu si ne ss . Spe ci fic al ly, th e tr ia l re co rddo es no t re fle ctth at pe ti ti on ers form edanen ti ty (as the y were ad vi se d t o d o) or p rep areda bu si ne ss-1 1-

[* 11 ] pl an , a pr of

itor l os s s ta te m en t, a b al an ce s he etor afin an ci al bre ak -ev en an al y si s fo r th ei r rec or d l ab el act iv it y . Whi le a so ph is ti cat edbu si ne ss pl anis no t ne ces sa ry , a tax pa y er s ho ul d k eep reco rd s tha t en ab le th e ta xp ay er t o m ak e in fo rm edbu si ne ss de ci si on s. Bu rg er v . Comm is si on er, 8 09 F.2d35 5, 3 59 (7t h Ci r. 19 87 ), aff’g T.C. Me m o. 1 98 5- 52 3; Dod ge v. Co m m is si on er, T.C. Mem o. 19 98 -8 9, af

f’d witho utpubl is he d o pi ni on , 18 8 F .3d50 7 (6 th Cir . 19 99 ). The or et ic al ly, a b us in es s p lan a ndreco rd s ar e u se d t o d ev el op a pr of it ab le bu si ne ss . Fail ur e to m ai nt ai n a de qu at e rec or ds , ho wev er, i nd ic at es a la ckof ne ces sa ry pro fitin te nt . Mon ta gn e v . Commis si on er, 1 66 Fed . App x. 2 65 (8t h C ir. 20 06 ), aff’g T.C. Me m o. 2 00 4- 25 2; Zid ar v . Commis si on er, T.C. Mem o. 2 00 1- 20 0. Furth er, Sar a p ai d a ll of t he ba nd ’s exp en se s thr ou gh he r pe rs on al ch eck in g acco un t o r he r pe rs on al cred itcard . Peti ti on ers wou ldth enrei m bu rs e Sar a. Pet it io ne rs pro vi de d ali stof i te m iz edex pe ns es bu t p ro vi de d n o e vi de nc e o f Sara ’s gi vi ng pe ti ti on ers rece ip ts or i nv oi ces of t he ba nd ’s exp en se s. Su chco m m in gl in g of fun ds in di cat es th atanact iv ity is m or e cl os el y

rel at edto a ho bb y

th ana bu si ne ss . See Bu sh v. Co m m is si on er, T.C. Mem o. 2 00 2- 33 , aff’d, 5 1 F ed . App x. 42 2 (4 thCir . 20 02 ); Lu nd qu is t v . Comm is si on er, T.C. Mem o. 1 99 9- 83 , aff’d witho utpubl is he d o pi ni on , 21 1 F .3d60 0 (1 1t h C ir. 2 00 0) .-1 2-

[* 12 ] Nor d idpe ti ti on ers pu rs ue an d p ro du ce m us ic ina bu si ne ss li ke m an ne r. Pet it io ne rs rep res en t o nl y on e b an d a ndha ve m ad e n o e ffo rt t o d ev el op or f in d ot he r ta le nt . Peti ti on ers ha ve no Int ern etpre se nc e fo r th ei r m us ic act iv it y , no act iv e p res en ce i n t he reco rd in g o r pr oduc in g i ndus try andha ve no t s ou gh t m etho ds to in crea se th ei r ex po su re t o the in du st ry . Unl ik e o th ers inth e m us ic in du st ry , pet it io ne rs do no t re pr es en t an y ot he r ba nd s, n or

do th ey ha ve any em pl oyees. Du e to th e ri sky na tu re o f th e m

us ic in du st ry , itis im

prud en t t o wo rk with o nl y on e b an d. Pet it io ne rs ne ve r adve rti se d a s a r eco rdlab el . Peti ti on ers ’ act iv it y is no t ev enreco gn iz edas areco rdlab el on th e o nl y alb um th ey pu rp orte dl y

pro du ced . Sav e fo r pe ti ti on ers ’ be in g “ th an ke d” onth e CD jack etalo ng with 3 2 o th er p eo pl e, no whe re o n t he ba nd ’s reco rdis th e labe l SURF o r an yth in g i nd ic at in g p et it io ne rs ’ pr of es si on al rel at io ns hi p wi th th e b an d. Ra th er, the co pyrig hton th e CD b el on gs to th e b an d, an d t he pro du ct io n c red it s g o t o Warren Huart. W e are no t que st io ni ng whet he r th e b an d m em be rs are b on a fi de m

us ic ia ns . W e are , ho wev er, que st io ni ng whet he r pe ti ti on ers ’ rel at io ns hi p t o t he ba ndwas carr ie d o n i n abu si ne ss li ke m an ne r. Becaus e p et it io ne rs do no t i nv es t i n a ny oth er ba nd , th ei r rec or d l ab el act iv ity is in ex tri cab ly tiedto th e b an d’s ac ti vi ty. Here,-1 3-

[* 13 ] pe ti ti on ers are co nf la ti ng th ei r reco rdlab el act iv it y with t he leg it im acy of th e b an d. W e h ol d t ha t p et it io ne rs di d n otco nduc t the ir r eco rdlab el act iv it y ina bu si ne ss li ke m an ne r. Thi s fa ct orfav or s re sp on de nt . 2. The Exp ert is e o f th e Tax pa y er o r His or He r Adv is ers W e n ow turn t o t he sec on d fa ct or , th e ex pe rti se of p et it io ne rs an d t he ir advi se rs . Exte ns iv e stud y of a ccep te d b us in es s p rin ci pl es or c on su lt at io n wi th ex pe rts inth e g iv enfie ldm ay de m on st rat e a p ro fitm ot iv e. Sec. 1 .18 3- 2( b) (2 ), In co m e Tax Reg s. Ad di ti on al ly, a ta xp ay er s ho ul d u nd ert ak e a b on a fi de in ve st ig at io n o f fac to rs th atwou ldaffec t the act iv it y ’s pro fit ab il it y . Bur ge r v. Co m m is si on er, 8 09 F.2dat 3 59 ; Go la nty v. Co m mis si on er, 7 2 T.C. at43 2; Mi tc he ll v. Co m

m is si on er, T.C. Mem o. 2 00 1- 26 9; Und erwo odv. Co m m is si on er, T.C. Mem o. 1 98 9- 62 5. Pet it io ne rs arg ue th atth ey to okst ep s t o e du cat e th em se lv es an d c on su lt ed ex pe rts ab ou t the m

us ic in du stry . Peti ti on ers tal ke d t o Un iv ers it y of C al ifo rn ia pr of es so rs , reada bo okan d re li edhe av il y on th ei r daug ht er b ecau se th ey th em se lv es ha ve no ex pe rie nc e o r ba ck gr ou ndinth e m us ic in du st ry .-1 4-

[* 14 ] Pet it io ne rs tes ti fie d t o h av in g c on su lt edUni ve rs ity of C al ifo rn iapro fes so rs who to ldth em

th atitis co m

m on pra ct ic e to ha ve anora l co nt ractwith aba nd . The tri al reco rddo es no t re fle ct , ho wev er, the na tu re o f th e p ro fes so rs ’ ex pe rti se . Nordo es th e tr ia l re co rdpro vi de a ba si s fo r us to be li ev e th atth e p ro fes so rs pe ti ti on ers co ns ul te d a t the Uni ve rs ity of C al ifo rn iawere ex pe rts inth e m us ic in du st ry . Furt he r, in ve st in g l arg e su m s o f m on ey , as p et it io ne rs he re d id , ov er an ex te nd edpe rio d a ndwitho uta writ te n c on tra ctis po orbu si ne ss pra ct ic e, ev enif do ne purs ua ntto advi ce. Pet it io ne rs were al so en co ur ag edto form anLLC for li ab il it y purp os es , y etth ey

ap pe ar t o h av e ig no redth atadvi ce. Pet it io ne rs als o re ada bo okab ou t the m us ic bu si ne ss . W e are no t co nv in ced , ho wev er, tha t p et it io ne rs he ed edth e advi ce i n the bo okth ey read . Mo reo ve r, on e b oo k d oe s n otanex pe rt m ak e. Fi na ll y , pet it io ne rs co nt en d t he y rel ie d o n S ara’s ex pe rti se . Sara m ajor edin Mu si c In du st ry , in te rn edinth e in du st ry an d m an ag edth e b an d fo r a y ear b efo re pe ti ti on ers be ga n fu nd in g t he ba nd . W e d o n otqu es ti on Sara ’s ent hu si as m forth e m us ic in du st ry . W e d o, h owe ve r, qu es ti on he r ex pe rti se . Sara h adno ex pe rie nc e m an ag in g a ny oth er b an d. An d ade gr ee co up le d wi th anin te rn sh ip inany fie ld fal ls sh ort o f qu al ifyin g a nyon e as anex pe rt. We gi ve li tt le weig htto pe ti ti on ers ’ rel ia nc e o n S ara a s an ex pe rt.-1 5-

[* 15 ] The tria l re co rddo es no t s ho w th atpe ti ti on ers so ug htrel iabl e advi ce o n ho w to op erat e a rec or d l ab el . Thi s fa ct orfav or s re sp on de nt . 3. The Taxp ay er’s Tim e an d Eff ort The am ou ntof t im e an d e ffo rt p et it io ne rs ex pe nd edincarry in g o n t he act iv ity is th e th irdfact or . See s ec 1 .18 3- 2( b) (3 ), In co m e Tax Reg s. A ta xp ay er who de di cat es a subs ta nt ia l am ou ntof p ers on al ti m e an d e ffo rt t o the act iv it y m ay ha ve a pr of

itob jecti ve , esp eci al ly whe re the act iv ity do es no t i nv ol ve subs ta nt ia l pe rs on al or r ecre at io na l as pe ct s. Gil es v. Co m m is si on er, T.C. Mem o. 2 00 5- 28 . If, ho wev er, a t ax pa y er s pe nd s l ittl e ti m e an d e ffo rt o n the act iv it y bu t h ire s a co m pe te ntan d qua li fie d p ers on to carry onth e act iv it y , a pr of

itm ot iv e m ay

st il l b e in di cat ed . Burru s v . Comm is si on er, T.C. Mem o. 2 00 3- 28 5. Dr. Sch li ev ertpu rp orte dl y de vo te d asubs ta nt ia l am ou ntof t im e an d e ffo rt to th ei r rec or d l ab el act iv ity . The o bjec ti ve fact s, h owe ve r, co nt rad ic t h is as se rti on . Dr. Schl ie ve rt i s a f ul l-t im e p ro fes so r, th e h eadof t he Mi cro bi ol og y Dep artm en t atth e Uni ve rs ity an d aco -fo un de r of

two ot he r co m

pa ni es inth at fie ld . Mrs . Sch li ev ertdi d n ottes ti fy to co nt rib ut in g a ny am ou ntof t im e to th ei r reco rdlab el act iv ity . Alth ou gha ta xp ay er m ay en ga ge inm or e th anon e tr ad e o r bu si ne ss at a ny on e ti m e, itis un li ke ly pet it io ne rs were ab le to de vo te a subs ta nt ia l-1 6-

[* 16 ] am ou ntof t im e an d e ffo rt t o t he ir r eco rdlab el act iv it y . See Ges tri chv. Co m m is si on er, 7 4 T.C. 5 25 , 52 9 (1 98 0) , aff’d wit ho utpubl is he d o pi ni on , 68 1 F.2 d 8 05 (3dCir . 19 82 ); S to rey v. Co m m is si on er, T.C. Mem o. 2 01 3- 59 ; Vi ta le v. Co m m is si on er, T.C. Mem o. 1 99 9- 13 1. Pet it io ne rs em

ph as iz e th atth ey

fin an cedW arre n Hu art , a pr om in en t re co rd pr oduc er, t o p ro du ce the ba nd ’s CD. Mr. Huart, h owe ve r, was n otanem pl oyee of pe ti ti on ers ’ reco rdlab el act iv ity . Here, ag ai n, p et it io ne rs are co nf la ti ng th e act iv it ie s o f th e b an d (p ay in g s om eo ne to pro du ce the band ’s reco rd ) with t he act iv ity of p ro vi di ng fun ds to th e b an d. Pe ti ti on ers adm itth atth ei r rec or d l ab el act iv ity ha d n o e m

pl oyees. Pet it io ne rs fai le d t o h ire a qu al ifi edan d c om pe te ntpe rs on to carry

on th ei r reco rdlab el act iv ity . Thu s, thi s fa ct orfav or s re sp on de ntbe cau se pe ti ti on ers di d no t h av e an y

em pl oyees a nddi d n otsp en d asubs ta nt ia l am ou ntof t im e o n t he act iv ity . 4. Exp ect at io n Th atPro pe rty W il l Ap pr eci at e in Valu e Nex t, we turn t o wh ethe r th ere i s an ex pe ct at io n t ha t the ass et s u se d i n t he act iv ity wil l i nc reas e in va lu e. A tax pa y er m ay in te ndto reap a pr of

itno t o nl y fro m th e o pe rat io n o f anact iv ity bu t al so fro m

th e ap pr eci at io n o f as se ts us edin th e act iv it y . Sec. 1 .18 3- 2( b) (4 ), In co m e Tax Reg s. Th e te stis whet he r th ere was a-1 7-

[* 17 ] bo nafid e ex pe ct at io n t ha t the ass et s u se d i n t he act iv ity wou ldin crea se in va lu e. Eng da hl v. Co m

m is si on er, 7 2 T.C. at66 9. Al th ou gh anap pr eci at io n ex pe ct at io n m ay

in di cat e a p ro fitob

jecti ve , exp ect at io n a lo ne is no t s uf fic ie ntto de m on st rat e th e act iv ity

was e ng ag edinfor

pro fit . San de rs v. Co m

m is si on er, T.C. Mem o. 1 99 9- 20 8; Lujanv. Co m m is si on er, T.C. Mem o. 1 99 2- 41 7; Bel tra n v . Co m m is si on er, T.C. Mem o. 1 98 2- 15 3. Pet it io ne rs ownth e m as te r rec or di ng of t he so ng s u se d t o p ro du ce the ba nd ’s CD. If th e b an d wer e to be su cces sf ul , pet it io ne rs m ig htexpe ctth e m as te r reco rd in g t o i nc reas e in va lu e. Nowh ere i n t he tri al reco rd , ho wev er, i s the va lu e of th e m as te r rec or di ng , m

uc h l es s the am ou ntpe ti ti on ers ex pe ctth e rec or di ng to be wort h i n t he futur e. The re co rd in g m ay , infact , gre at ly app reci at e. The c ha nc e of gre atap pr eci at io n, h owe ve r, is lo w. Thi s fa ct oris ne ut ral . 5. Tax pa y er’s Su cces s i n Othe r Si m il ar o r Dis si m il ar Act iv it ie s W e n ow l oo k t o p et it io ne rs ’ su cces s i n o th er ac ti vi ti es . Fin di ng th ata ta xp ay er h as su cces sf

ul ly eng ag edinm ak in g o th er ac ti vi ti es pro fit ab le m ay sh ow th atth e ta xp ay er h as a pr of itob jecti ve ev enth ou gh th e cu rren t ac ti vi ty is unpr of it ab le . Sec. 1 .18 3- 2( b) (5 ), In co m e Tax Reg s. Pet it io ne rs arg ue th atth ei r ba ck gr ou ndan d e xp eri en ce co -fo un di ng two bi ot ech no lo gy com pa ni es len ds-1 8-

[* 18 ] cred en ce t o qua li fy in g t he ir r eco rdlab el act iv it y as atra de or b us in es s. Res po nd en t ar gu es th atpe ti ti on ers ’ la ckof e xp eri en ce o r su cces s i n t he m us ic in du st ry is inli ne with alac k o f pr of itm ot iv e. W e ag ree wi th res po nd en t. Dr. Sch li ev ertest ab li sh edtwo bi ot ech no lo gy com pa ni es . The bi ot ech no lo gy com

pa ni es have a ti m el in e to wardpro fit ab il it y an d a re b ui lton Dr. Sch li ev ert ’s exp ert is e in imm un ol og y an d i nf ect io us di se as es . Neithe r co m pa ny is , ho wev er, p ro fit ab le . Peti ti on ers ’ reco rdlab el act iv it y , onth e o th er h an d, h as no em pl oyees, n o app aren t b us in es s p la n a ndno ti m el in e to wardpro fit ab il it y . Furth erm or e, Dr. Sch li ev ert ’s on ly con ne ct io n t o t he m us ic in du st ry

is th ro ug h h is daug ht er. The m an ne r in whi chth e b io te ch no lo gy com pani es are ru n i s v as tl y di ffer en t fr om

th atof p et it io ne rs ’ reco rdlab el act iv it y . For e xa m pl e, eac h bi ot ech no lo gy com

pa ny em pl oys pr of

es si on al s an d h as a bu si ne ss pl an . Thei r reco rdlab el act iv ity , inco nt ras t, h adne it he r em pl oyees n ora bu si ne ss pl an . The
m an ne r in whi chpe ti ti on ers carr ie d o n t he ir r eco rdlab el act iv it y m ak es itles s li ke ly tha t the y

en te redin to th ei r rec or d l ab el act iv it y with abo nafid e p ro fit
m ot iv e. Thi s fa ct orfav or s re sp on de nt .-1 9-

[* 19 ] 6. Tax pa y er’s His to ry of I nc om e o r Los s an d Am ou ntof P ro fit s W e n ex t ex am in e th e si xt h a ndsev en th fact or s, p et it io ne rs ’ hi st ory of in co m e o r lo ss es an d a ny am ou ntof p ro fit s, i n t an de m . Sec. 1 .18 3- 2( b) (6 ) an d (7 ), In co m e Tax Reg s. Lo ss es du rin g t he st artup st ag e o f anact iv it y m ay or m ay no t si gn al th atth e act iv ity

is en ga ge d i n fo r pr of

it . Sec. 1 .18 3- 2( b) (6 ), In co m e Tax Reg s. Subs ta nt ia l l os se s m ay , ho wev er, i nd ic at e th atth e ta xp ay er d idno t co nduc t th e act iv it y

forpro fit . Gol an ty v. Comm is si on er,7 2 T.C. at42 7; sec . 1.1 83
- 2( b) (6 ), In co m e Tax Reg s. We als o c on si de r th e am ou ntof o ccas io na l p ro fit s, i f an y , fro m th e act iv ity . Sec. 1 .18 3- 2( b) (7 ), In co m e Tax Reg s. Ab se ntactua l pr of it s, a s ho win g o f po te nt ia ll y subs ta nt ia l re tu rn s co ul d i nd ic at e a p ro fitm ot iv e. See Gi le s v . Comm is si on er, T.C. Mem o. 2 00 5- 28 ; Daws on v. Co m m is si on er, T.C. Mem o. 1 99 6- 41 7. Pet it io ne rs ha d n o g ro ss rece ip ts or s al es in20 10 . Accor di ng ly, pe ti ti on ers rep orte d n o i nc om e fro m th ei r rec or d l ab el act iv it y for20 10 . For t he two y ears aft er 2 01 0, p et it io ne rs cla im edlo ss es . The o nl y in co m e p et it io ne rs rep ort i s $2 ,00 0 fo r th e fi rs t qua rte r of 20 13 . Sin ce 2 01 0, p et it io ne rs have sp en t subs ta nt ia ll y

les s o n the bandeach y ear a ndha ve no t s pe ntan yth in g o n the ba ndin 20 13 .-2 0-

[* 20 ] Ourex am in at io n o f th e ag reem en t i nd ic at es th at , th eo ret ic al ly, pe ti ti on ers sh ou ldha ve rece iv ed50 % of the ba nd ’s in co m e fro m sal es be gi nn in g i n 2 01 0. The tri al reco rdsh ows th e b an d re le as edit s C D andwas s el li ng ti ck et s t o s ho ws du rin g 2 01 0. Pe ti ti on ers di d n otrece iv e an y pro ceed s u nt il th ree years l at er, ho wev er. Altho ug h the band ’s pro fit s wer e m in im al , if the ag reem en t h adbe en res pe ct ed , pet it io ne rs wou ldha ve rece iv eda po rti on of t he ba nd ’s sal es in co m e. It th eref or e ap pe ars as t ho ug h p ro fitwas n otpe ti ti on ers ’ pr im ary m ot iv e b ecau se th ey fai le d t o c ol le ctrev enue in20 10 . Pet it io ne rs co nc ed e th atth ey are re frai ni ng fro m

an y furth er i nv es ti ng un ti l th ey are ab le to de du ctex pe ns es rel at edto th ei r rec or d l ab el act iv it y . This co nc es si on is pa rti cu la rly detrimenta l t o p et it io ne rs ’ arg um en t b ecau se pro fitm us t be th e p rimary

ob jecti ve forex pe ns es to be de du ct ib le an d p ro fitm ean s ec on om ic pr of it , in de pe nd en t o f ta x s av in gs . See Su rlo ff v . Comm is si on er, 8 1 T.C. 2 10 , 23 3 (1 98 3) ; Sh ap iro v. Co m

mis si on er, 4 0 T.C. 3 4 (1 96 3) . Pet it io ne rs ha ve di sc on ti nu edin ve st in g i n t he bandev enth ou gh th e b an d ha s co nt in ue d t o t ou r an d p ro du ce m us ic . W e are unpe rs ua de d b y pe ti ti on ers ’ rel ia nc e o n t he ba nd ’s act iv it ie s t o l eg it im iz e th ei r own att em ptto de du ctexpe ns es rel at in g t o t he ir r eco rdlab el act iv it y . The se fact or s fa vo r res po nd en t.-2 1-

[* 21 ] 7. Fi na nc ia l St atus of t he Taxp ay er W e n ow l oo k t o p et it io ne rs ’ fin an ci al st atus . Sub st an ti al in co m e fro m so ur ces ot he r th anth e act iv ity m ay in di cat e th atth e act iv it y

is no t en ga ge d i n fo r pr of it . This is esp eci al ly true wher e th ere a re p ers on al or r ecre at io na l el em en ts in vo lv ed . Sec. 1 .18 3- 2( b) (8 ), In co m e Tax Reg s. Subs ta nt ia l i nc om e fro m ot he r so ur ces m ay

in di cat e th e act iv ity

is no t en ga ge d i n fo r pr of it , as l os se s fr om

th e act iv ity wou ldge ne rat e subs ta nt ia l t ax be ne fit s. Id .; s ee Di rk se v. Co m m is si on er, T.C. Mem o. 2 00 0- 35 6; Kahl a v . Comm is si on er, T.C. Mem o. 2 00 0- 12 7, af f’d, 27 3 F.3 d 1 09 6 (5 th Cir . 20 01 ). Res po nd en t ar gu es th atpe ti ti on ers ’ subs ta nt ia l wea lt h andin co m e en ab le d th em to fun d t he ir d au gh te r’s ba ndpro m ot io n wi th ou t af fect in g t he ir l iv in g st an da rd s. Pet it io ne rs ne ve rth el es s ar gu e th at , as am at te r of publ ic po li cy , th is Co urt s ho ul d re co gn iz e th e le gi ti m acy of th ei r rec or d l ab el act iv it y to en co ur ag e eco no m ic de ve lo pm en t. Pet it io ne rs ’ co un te rarg um en t tha t we s ho ul d e nc ou rag e en tre pr en eu rs hi p i s b ot h c reat iv e an d l ack in g i n m eri t. Dr. Sch li ev ertha s ea rn eda subs tant ia l i nc om e as a su cces sf ul
m ic ro bi ol og is t an d a cad em ic . Andwith ane t wo rth of a t l eas t $ 1.8 m il li on , pe ti ti on ers ha d s uf

fic ie ntweal than d i nc om e to fun d the ba ndwhi le si m ul ta ne ou sl y

ass is ti ng th ei r daug ht er t o p ur su e h er ch os encare er. Fu rth erm or e,-2 2-

[* 22 ] th e la ckof p ro fit ab il ity als o b en efi te d p et it io ne rs be cau se th ey wou ldha ve pa idm or e ta x b utforth e d educ ti on of t he ex pe ns es . Thi s fa ct orfav or s re sp on de nt . 8. Elem en ts of P ers on al Ple as ur e Fi na ll y , we weig h e le m en ts of p ers on al pl eas ur e in carry in g o n t he act iv ity . Pers on al or r ecre at io na l m ot iv es inco nduc ti ng anact iv it y m ay in di cat e a l ackof pr of itob jecti ve . Sec. 1 .18 3- 2( b) (9 ), In co m e Tax Reg s. Re sp on de ntarg ue s tha t pe ti ti on ers de riv edpe rs on al pl eas ur e in watc hi ng th ei r daug ht er s uc ceedinhe r fie ldof c ho ic e. Pet it io ne rs arg ue th atth ei r rec or d l ab el act iv ity is no t a h ob by and th atth ey de riv edno recr eat io na l b en efi t fr om carry in g o n t he ir r eco rdlab el act iv ity . Thi s ca se is no t s ig ni fic an tl y di ffer en t fr om

an y ot he r cas e whe re thi s C ou rt ha s d en ie d apa ren t’s at te m ptto de du ctin ve stm en ts inhi s o r he r ch il d’s ca reer . See B ern ard o v . Comm is si on er, T.C. Mem o. 2 00 4- 19 9 (t ax pa y er l ack edrequi si te pr of itm ot iv e fo r de du ct in g e xp en di tu res sh e m ad e to furth er d au gh te r’s si ng in g care er); Bu sh v. Co m

m is si on er, T.C. Mem o. 2 00 2- 33 (ta xp ay er d idno t en ga ge in
m an ag in g h is daug ht er’s b al le t ca reerwith apro fitm ot iv e); McC arthy v. Co m m is si on er, T.C. Mem o. 2 00 0- 13 5 (t axpa y er d idno t en ga ge inm an ag in g h is so n’s m ot oc ro ss raci ng with i nt en t t o m ak e a p ro fit ); DeM at ti a v . Comm is si on er,-2 3-

[* 23 ] T.C. Mem o. 1 99 8- 87 (ta xp ay er’s g ol f sp on so rs hi p a gr eem en t wi th hi s s on was no t en te redin to with a n h on es t o bjec ti ve of m ak in g apro fit ); No vav. Co m m is si on er, T.C. Mem o. 1 99 3- 56 3 (s am e). Pet it io ne rs ha d n o c on ne ct io n t o t he m us ic in du st ry

or t he ba ndun ti l Sa ra faci li ta te d t he ag reem en t b etweenth e two pa rti es . Peti ti on ers en te redin to th e ag reem en t wi th th e b an d a t an im po rtantti m e in Sara ’s li fe. Sarawas n oty et em pl oyed fu ll ti m e, an d p et it io ne rs were s ti ll supp orti ng he r by paying he r li vi ng ex pe ns es . By

requi rin g t he ba ndto ke ep Saraon as t he ir m an ag er fo r a 1 5% fe e, pe ti ti on ers so ug htto pro vi de Sarawith v al uabl e ex pe rie nc e as well as a n i nc om e. Sarais no w ful ly em

pl oyed an d i s p ro gr es si ng inhe r car eer. In st eadof f in di ng ne w ban ds an d e xp an di ng th ei r op po rtu ni ti es , pet it io ne rs ha ve di sc on ti nu ed in ve st in g i n t he ir r eco rdlab el act iv it y . Sup po rti ng Sara , th ou gh lau dabl e, is no t de du ct ib le . Afte r co ns id eri ng all th e fac to rs as app li edto th e uni qu e fac ts an d ci rcu m st an ces of thi s ca se an d a ll othe r fact s we c on si de r rel ev an t, we co nc lu de th atpe ti ti on ers di d n oten ga ge inth ei r reco rdlab el act iv it y forpro fitwithi n t he
m ean in g o f se ct io n 1 83 . There fo re, p et it io ne rs are n oten ti tl edto de du ctex pe ns es in ex ces s o f gr os s i nc om e fro m th e act iv it y .-2 4-

[* 24 ] II. Accu racy-Rel at edPen al ty W e n ow fo cu s o n wh ethe r pe ti ti on ers are l iabl e fo r anaccu racy-rela te d pe na lty un de r se ct io n 6 66 2( a) fo r 20 10 . A tax pa y er i s l iabl e fo r anaccu racyrel at edpe na lty

on an y pa rt o f anun de rp aym en t at tri bu tabl e to eit he r a s ub st an ti al un de rs ta te m en t o f in co m e ta x o r ne gl ig en ce o r di sr eg ardof rul es or r eg ul at io ns . Sec. 6 66 2( b) (1 ) an d (2 ). A “ subs ta nt ia l u nd ers ta te m en t” in cl ud es an un de rs ta te m en t o f in co m e ta x t ha t ex ceed s the gre at er o f 10 % of t he tax requi red to be sh ownon th e return o r $5 ,00 0. Se c. 66 62 (a), (b )(2 ), (d )(1 )(A); sec . 1.6 66 2- 4( a), In co m e Tax Reg s. “Neg li ge nc e” i nc lu de s an y fai lu re t o m ak e a rea so nabl e at te m ptto co m pl y with t he Co de or t o e xe rci se ord in ary an d re as on ab le care in pr ep ari ng a ta x re tu rn . Sec. 6 66 2( c); sec . 1.6 66 2- 3( b) (1 ), In co m e Tax Reg s. A ta xp ay er fa il s t o m ak e a rea so nabl e at te m ptto asc ert ai n t he co rrec tn es s o f a de du ct io n o n areturn t ha t wo ul d s eem to a reas on ab le an d p ru de ntpe rs on to be

“ to o g oo d t o b e true ” und er the cir cu m st an ces . Sec. 1 .66 62 -3 (b )(1 )(i i), In co m e Tax Reg s. The Co m m is si on er h as th e b ur de n o f pr oduc ti on an d m us t co m e fo rward with s uf fic ie ntev id en ce s ho win g t ha t i t i s ap pr op ria te to im po se a pe na lt y . Sec. 74 91 (c); see Hig be e v . Comm is si on er, 1 16 T.C. 43 8, 4 46 -4 47 (20 01 ). The ta xp ay er b ears th e b ur de n o f pr oo f as to an y de fen se to th e acc ur acy-relate d-2 5-

[* 25 ] pe na lty , su chas r eas on ab le cau se . Sec. 7 49 1( c); Ru le 14 2( a); Hig be e v . Co m m is si on er, 1 16 T.C. at 4 46 . Res po nd en t h as m ethi s b ur de n o f pr oduc ti onwith re sp ectto pe ti ti on ers ’ subs ta nt ia l u nd ers ta te m en t o f in co m e ta x. Se e se c. 66 62 (b )(2 ). The re co rd in di cat es th atpe ti ti on ers rep orte d i nc om e ta x o f $3 1,7 78 for20 10 . As ex pl ai ne d ab ov e, pe ti ti on ers un de rs ta te d t he ir i nc om e ta x l iabi li ty for 2 01 0 b y $1 1,3 02 . The ta x re qu ire d t o b e sh own on th e return, fo r pu rp os es of d et erm in in g wh ethe r th ere was a subs tant ia l u nd ers tate m en t o f in co m e ta x h ere, i s the su m of t he se two am ou nt s, $ 43 ,08 0. Tenpe rcen t o f th e ta x re qu ire d t o b e sh own on th e return i s $4 ,30 8. Th e und ers ta te m en t o f $1 1,3 02 is gre at er tha n $ 5,0 00 , whi chis gre at er th an10 % of t he tax requi redto be sh own onth e return. Re sp on de ntth eref or e m et hi s b ur de n o f pr oduc ti on . Pet it io ne rs do no t ad dr es s the pe na lt y is su e in th ei r br ie f. Nor d id pe ti ti on ers pre se ntev id en ce tha t the y ha d re as on ab le cau se foran y po rti on of a ny un de rp aym en t. We the refo re fi ndth atpe ti ti on ers are l iabl e fo r th e p en al ty. W e h av e co ns id eredall rem ai ni ng arg um en ts th e p art ie s m ad e an d, t o t he ex te ntno t ad dr es se d, we fi ndth em to be irr el ev an t, m oo t o r m eri tl es s.-2 6-

[* 26 ] To ref

le ctth e fo reg oi ng , Deci si on wil l b e en te red fo r res po nd en t.