United States Court of Appeals

for the Fifth Circuit

No. 20-60004

Ames D. Ray, 

Petitioner—Appellant,

versus

Commissioner of Internal Revenue, 

Respondent—Appellee.

Appeal from the United States Tax Court

USTC No. 14052-16

Before Dennis, Higginson, and Willett, Circuit Judges.

Stephen A. Higginson, Circuit Judge:

Appellant Ames D. Ray claimed a deduction for certain legal expenses 

on his 2014 federal income tax return. The Internal Revenue Service 

disallowed this deduction and issued a notice of deficiency to Ray. The IRS

imposed an accuracy-related penalty in addition to the deficiency amount. 

Ray filed a petition with the U.S. Tax Court challenging the deficiency 

determination and the imposition of the accuracy-related penalty. Following 

a one-day trial, the Tax Court issued a decision upholding in part the IRS’s 

deficiency determination and imposition of the accuracy-related penalty. Ray 

timely appealed the Tax Court’s decision. We affirm in part and reverse and

remand in part.

United States Court of Appeals

Fifth Circuit

FILED

September 14, 2021

Lyle W. Cayce

Clerk

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I.

This case concerns deductions appellant Ames Ray claimed on his 

2014 federal income tax return for legal expenses incurred in litigation against 

his ex-wife, Christina Ray, and her attorneys. This litigation has been ongoing 

for over twenty years, involves four separate lawsuits, and implicates facts 

dating back several decades.

A.

Ames and Christina Ray met while they were undergraduate students 

at Michigan State University, where both obtained advanced degrees in 

physics. They married in 1972 and moved to New York City in 1976. 

Christina developed a career in the finance industry, eventually serving as an 

officer at multiple financial institutions. She developed mathematical models 

for commodities trading and authored several books on risk management and 

options trading. In 1990, she founded a consulting firm to advise finance 

industry clients. Ames also worked for several financial institutions during 

the early stages of his career, but was never a commodities trader. In 1979, he 

developed a computer program that could analyze Securities and Exchange 

Commission filings, search for company information, and print financial 

statements, which he named “Firm Decisions.” Ames licensed this software 

to Citibank and received income from Citibank for the software until 1986. 

Ames and Christina divorced in 1977, though they continued to live

together off and on until 1992, when Ames moved to Florida. During the time 

that they lived together after their divorce, the couple continued to maintain 

joint banking and credit-card accounts and own shared assets. The Rays used 

a ledger system to track their joint and separate expenses, as well as financial 

transactions between them. 

Over time, Christina incurred various debts to Ames, which the 

couple formalized in several written documents. In 1981, Ames and Christina 

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jointly purchased land in Sagaponack, New York with the intent of building 

a vacation home on the land. Due to disagreements over construction, in 1984 

Ames sold his share of the property to Christina for $350,000. Ames lent this 

amount to Christina in exchange for her agreement to make regular payments 

to him. The Rays memorialized this agreement in a written document, which 

they notarized and accounted for in their ledger system.

A second real-estate transaction followed. The Rays lived in an 

apartment on East 87th Street in Manhattan from the time they moved to New 

York City in 1976. When that apartment was converted to a co-op around 

1987, the Rays purchased shares in the co-op. In November 1991, Ames sold 

his interest in the co-op shares to Christina, memorialized by a document 

they each signed. Christina executed a note to Ames for $432,427, dated 

November 25, 1991. According to Ames, this note covered the amounts 

Christina owed him for both the Sagaponack property and the Manhattan 

apartment.

Also in November 1991, Ames and Christina signed a document 

stating that Christina was solely liable for six different credit-card accounts 

in Ames’s name due to her charges to those accounts. The document further 

stated that Christina would either close out or remove Ames’s name from 

each account. Until Christina did so, the agreement would require her to 

spend no more than $1,800 per month on living and non-reimbursed business 

expenses. 

In April 1993, Christina signed a $532,288.10 “judgment by 

confession” in favor of Ames. The judgment by confession stated that it 

represented amounts due from Christina to Ames for (1) Christina’s default 

on the November 25, 1991 promissory note, (2) $99,860.43 in additional 

credit-card debt that Ames had paid or would pay on Christina’s behalf, 

(3) “legal and associated expenses incurred in connection with the 

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enforcement of the note,” and (4) interest due on these amounts through 

March 22, 1993. The judgment by confession was never entered in any court. 

In September 1993, Christina signed a letter to Ames stating that she 

would provide him with notarized financial statements on a semiannual basis 

until the judgment-by-confession amount was paid in full. Christina would be 

liable for a $50 penalty for each day she was late in providing her financial 

statements to Ames. 

On August 10, 1994, Christina signed another letter to Ames, this one

summarizing her debts to him, which then totaled $590,222.79. This amount 

covered (1) the $532,288.10 represented by the judgment by confession, 

(2) $18,774.24 for late financial statements plus interest, (3) additional 

credit-card debt and related interest, and (4) a reduction for a rent 

adjustment of $48,625. 

In early 1993, Christina approached Ames with a proposal to use a 

trading method she had developed to “mak[e] money trading futures and 

options.” On May 24, 1993, the Rays formalized the terms of their 

arrangement in a written document (the “trading agreement”). The 

document stipulated that Christina would manage the trading of Ames’s

commodities brokerage account in her “sole discretion.” Christina was to 

provide monthly reports to Ames with the “analysis, rationale, and logic of 

trades and positions.” Ames would pay Christina a 7 percent commission on 

the increase in value of the account on a monthly basis. The trading 

agreement further provided that “[Christina] and [Ames] may advertise the 

accurate results of [Christina’s] trading [of Ames’s] account.” The trading 

agreement stated that it would automatically terminate as of November 1993, 

and that because Christina was to trade Ames’s account “for hire,” Ames 

would be “permitted to terminate [the trading agreement] at any time.” 

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Ames deposited $500,000 into his commodities brokerage account so that 

Christina could trade his account pursuant to the trading agreement. 

On June 14, 1993, Ames proposed an amendment to the trading 

agreement that provided: “You’ll pay to me the amount of money that my 

account falls below $350[,000] . . . . Otherwise, trade my account to liquidate 

positions when my account’s value falls below $350[,000].” Christina signed 

the amendment on September 4, 1993. However, by the time Christina signed 

the amendment, the account’s value had already declined to $1,285, and she 

had thus stopped trading on the account due to insufficient capital. In August 

1994, Christina signed a letter to Ames confirming that she owed him 

$384,388 for the losses to the commodities account plus interest. 

Ames deducted his trading agreement losses as a Schedule C business 

loss on his 1993 tax return. The Internal Revenue Service (IRS) disallowed 

the deduction and sent Ames a notice of deficiency. Ames disputed the IRS’s 

deficiency determination in the U.S. Tax Court, and he and the IRS 

eventually reached a settlement, which was entered by the Tax Court on 

December 16, 1997 as a stipulated decision “[p]ursuant to the agreement of 

the parties.” Under the stipulated decision, Ames was charged a deficiency 

of $88,926.42 for the 1993 tax year and was still allowed to deduct 

$374,102.00 as a Schedule C business loss labeled “Futures Trader.” 

Then came litigation. On September 9, 1998, Ames filed a lawsuit 

against Christina in the New York Supreme Court for New York County (Ray 

v. Ray, Index No. 604381/98) (“Ray I”). Ames alleged two causes of action 

arising from (1) Christina’s failure to pay any part of the indebtedness 

amount summarized by the August 10, 1994 letter (representing her debts 

resulting from the two real estate purchase loans, the credit-card debt, and 

the late financials) and (2) Ames’s losses under the trading agreement. The 

New York Supreme Court dismissed the complaint on January 11, 2008. 

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Ames appealed, and on April 7, 2009, the Appellate Division of the Supreme 

Court of New York overturned the dismissal. As of June 2020, the case 

remained pending. See Ray v. Ray, 149 N.E.3d 443 (N.Y. 2020). In 2014, 

Ames incurred $77,724 in legal expenses for Ray I. 

On October 20, 2010, Ames again sued Christina in the New York 

Supreme Court for New York County (Ray v. Ray, Index No. 652314/2010) 

(“Ray II”). Ames alleged that Christina owed him at least $970,000, and that 

she had fraudulently conveyed property to avoid paying Ames. The New 

York Supreme Court dismissed the complaint on July 12, 2011, and the 

Appellate Division affirmed on July 9, 2013. Ames did not incur any legal 

expenses for Ray II in 2014. 

Ames filed another fraudulent conveyance lawsuit against Christina 

and her business, Guarnerius Management, LLC, in the New York Supreme 

Court on April 24, 2014 (Ray v. Ray et al., Index No. 153945/2014) (“Ray 

III”). Ames alleged that Christina mortgaged the Manhattan co-op for 

$500,000 and then fraudulently conveyed that amount—$80,000 to pay for 

legal fees and the remaining $420,000 to Guarnerius. The New York 

Supreme Court dismissed the complaint on December 22, 2014. Ames spent 

$151,500 on legal expenses for Ray III in 2014. 

On January 22, 2016, Ames sued Christina’s Ray I attorneys in the 

United States District Court for the Southern District of New York, alleging 

that they had made deceitful statements and representations to the trial and 

appellate courts in Ray I in order to obtain an advantage in the litigation (Case 

No. 1:15-cv-10176-JSR) (“Ray IV”). The district court dismissed the 

complaint on April 26, 2016, and the United States Court of Appeals for the 

Second Circuit affirmed the dismissal on April 14, 2017. Although Ames did 

not file his complaint in Ray IV until 2016, he incurred $38,000 in legal 

expenses for the case in 2014. 

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That brings us to the tax deductions at issue on appeal. On his 2014 

federal income tax return, Ames reported a negative amount of $238,937 as 

“[o]ther income” with the label “legal fees, costs.” Ames did not file a 

Schedule C (Profit or Loss from Business) with his 2014 tax return. 

The IRS issued a notice of deficiency to Ames, informing him that the 

IRS had disallowed the legal expense deduction and imposed a 20 percent

accuracy-related penalty pursuant to Internal Revenue Code § 6662(a). 

B.

Ames filed a petition with the U.S. Tax Court challenging the 

deficiency determination and the imposition of the accuracy-related penalty. 

He claimed that the IRS had erred in disallowing the deduction for his legal 

expenses, arguing that they were “deductible either under [26 U.S.C.] § 162, 

[26 U.S.C.] § 212 or as a capital loss in connection with a hedge fund of which 

[Ames] was founder, and an officer and director.” The Tax Court held a oneday trial on May 3, 2017, and issued an opinion on April 15, 2019.

Applying the preponderance of the credible evidence standard, the 

Tax Court found that none of Ames’s legal expenses was eligible for a 

deduction as an expense of carrying on a trade or business under § 162(a) of 

the Internal Revenue Code. The Tax Court next held that the portion of 

Ames’s legal expenses related to the trading agreement losses (those legal 

expenses attributable to the second cause of action in Ray I and part of Ray 

III)—but not the portion of his legal expenses related to his efforts to recover 

on his ex-wife’s indebtedness for the Sagaponack property purchase, the 

Manhattan apartment purchase, the credit-card debt, and the late financial 

statements (those legal expenses attributable to the first cause of action in 

Ray I, part of Ray III, and all of Ray IV)—could be deducted under Internal 

Revenue Code § 212. The Tax Court applied the “Cohan rule” (from Cohan 

v. Commissioner, 39 F.2d 540 (2d Cir. 1930)), using the ratio of damages 

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attributed to each Ray I cause of action, to determine that Ames could deduct 

39.5 percent of the Ray I and Ray III legal expenses he paid in 2014 under 

§ 212. 

The Tax Court found Ames liable for an accuracy-related penalty 

under Internal Revenue Code § 6662(a), (b)(1) and (2). The Tax Court 

further found that Ames had failed to carry his burden of proof in establishing 

an affirmative defense to the penalty. 

Following the issuance of the Tax Court opinion, the Tax Court 

entered its decision and adopted the IRS’s proposed deficiency computation. 

The deficiency computation deducted from Ames’s taxable income 39.5

percent of Ames’s 2014 legal expenses from Ray I and Ray III (the expenses 

related to his losses under the trading agreement), which the Tax Court had 

determined Ames could deduct as expenses for the production of income 

under § 212. The computation imposed a 20 percent penalty on Ames’s 

underpayment. The penalty was not imposed on any underpayment 

attributable to legal expenses concerning the trading agreement losses, which 

Ames was allowed to deduct under § 212. But the penalty was imposed on 

the underpayment attributable to (1) the difference in the amounts Ames 

would be allowed to deduct for legal expenses for the trading agreement 

losses if they were deductible under § 162(a) rather than § 212, and 

(2) Ames’s deduction of his legal expenses relating to his litigation to recover 

on his ex-wife’s indebtedness.

Ames timely appealed the Tax Court’s decision. 

II.

This court applies the same standard of review to a decision of the 

U.S. Tax Court as it would to a federal district court decision. We review 

factual findings for clear error and legal determinations de novo. Estate of 

Duncan v. Comm’r, 890 F.3d 192, 197 (5th Cir. 2018) (citing Terrell v. 

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Comm’r, 625 F.3d 254, 254 (5th Cir. 2010)). “Clear error exists when this 

[C]ourt is left with the definite and firm conviction that a mistake has been 

made.” Terrell, 625 F.3d at 258 (alteration in original) (quoting Green v. 

Comm’r, 507 F.3d 857, 866 (5th Cir. 2007)).

III.

We first consider whether the Tax Court erred in finding that Ames 

Ray (hereinafter referred to as “Ray”) cannot deduct his legal expenses from 

litigating to recoup his losses under the trading agreement as expenses of 

carrying on a trade or business under § 162(a) of the Internal Revenue Code.

The Tax Court held that Ray could not deduct any of his 2014 legal fees as 

expenses of carrying on a trade or business under § 162(a), finding that (1) the 

claims underlying the litigation to recover on Christina Ray’s indebtedness 

lacked any nexus to Ray’s purported computer programming business, and 

(2) the claims underlying the litigation to recoup the trading agreement losses 

lacked a sufficient nexus to a trade or business carried on by Ray because “the 

purported business was in actuality Ms. Ray’s management of a hedge fund 

and [] [Ray’s] involvement in her management of that fund extended no 

further than his initial investment.” 

On appeal, Ray argues that the Commissioner is collaterally estopped 

from litigating the issue of whether the origin of the claims underlying Ray’s 

2014 legal expenses relating to his trading agreement loss is a “business 

investment” because the 1997 stipulated Tax Court decision determined that 

his loss under the trading agreement was a deductible business loss. Ray 

argues in the alternative that he is entitled to a § 162(a) deduction for his legal 

expenses regarding the trading agreement losses because he and Christina 

Ray were jointly engaged in a hedge fund business and collaborated to 

develop a trading program, and the claims underlying the legal expenses were 

related to this business. 

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The Commissioner counters that Ray failed to preserve his collateral 

estoppel argument in the Tax Court because he raised the issue for the first 

time in his post-trial answering brief. Even so, the Commissioner further 

maintains that collateral estoppel does not apply because the 1997 stipulated 

Tax Court decision was entered pursuant to the agreement of the parties, and 

thus the issue of whether the trading agreement loss was a deductible

business loss was not actually litigated. In response to Ray’s alternative 

argument on the merits of § 162(a) deductibility, the Commissioner avers

that Ray did not carry on the trading venture as a trade or business and was 

nothing more than an investor. 

We consider, as a threshold matter, Ray’s argument that the 

Commissioner is collaterally estopped from litigating the issue of whether the 

origin of the claims underlying Ray’s trading agreement-related litigation is a 

business loss entitling him to a § 162(a) deduction. Finding that collateral 

estoppel does not bar the Commissioner from litigating this issue, we then 

assess whether Ray is entitled to a § 162(a) business-expense deduction for 

the portion of his 2014 legal expenses incurred in his efforts recoup his losses 

under the trading agreement.

A.

An argument not raised before the trial court cannot be raised for the 

first time on appeal. XL Specialty Ins. Co. v. Kiewit Offshore Servs., 513 F.3d 

146, 153 (5th Cir. 2008) (citing Stokes v. Emerson Elec. Co., 217 F.3d 353, 358 

n.19 (5th Cir. 2000)). For an argument to be preserved, it “must be raised to 

such a degree that the trial court may rule on it.” Id. (quoting Butler Aviation 

Int’l v. Whyte (In re Fairchild Aircraft Corp.), 6 F.3d 1119, 1128 (5th Cir. 1993), 

abrogated on other grounds as recognized in Matter of Diaz, 972 F.3d 713, 720 

n.6 (5th Cir. 2020)). Under the Tax Court Rules of Practice and Procedure, 

Rule 39, an affirmative defense such as collateral estoppel must be set forth 

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in a party’s pleading or else will be deemed abandoned. Tax Ct. R. 39;

Jefferson v. Comm’r, 50 T.C. 963, 966–67 (1968). The Tax Court does not 

consider issues raised for the first time in an answering brief. Dutton v. 

Comm’r, 122 T.C. 133, 142 (2004); accord Clay v. Comm’r, 152 T.C. 223, 236 

(2019).

In his appellate briefing, Ray suggests that he first raised his asserted 

collateral estoppel defense in his pre-trial submission. To the contrary, Ray’s

pre-trial submission merely mentioned the 1997 stipulated Tax Court 

decision but did not assert collateral estoppel. Ray did not raise his asserted 

collateral estoppel defense until his post-trial answering brief. 

Because the Tax Court does not consider issues raised for the first 

time in an answering brief, Ray did not raise the collateral estoppel defense 

“to such a degree that the [Tax Court could] rule on it” in accordance with 

this court’s preservation standard. See XL Specialty Ins. Co., 513 F.3d at 153 

(quoting In re Fairchild Aircraft Corp., 6 F.3d at 1128). We thus find that Ray 

has failed to preserve his asserted collateral estoppel defense.

B.

We now turn to the merits of Ray’s argument that his 2014 legal 

expenses incurred litigating to recover his trading agreement losses are 

deductible as expenses of a trade or business under § 162(a).1 The Tax Court 

found that these legal fees are not deductible as expenses of a trade or 

business under § 162(a), but did find that that Ray could deduct these legal 

fees as expenses for the production of income under § 212. Neither party 

1 Ray has abandoned by failing to brief any argument he might have against the Tax 

Court’s finding that Ray’s 2014 legal expenses incurred litigating to recover on his exwife’s indebtedness are not deductible business expenses under § 162(a). See Coury v. Moss, 

529 F.3d 579, 587 (5th Cir. 2008).

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disputes the Tax Court’s finding that these legal fees are deductible under 

§ 212. This issue remains justiciable, however, because Ray would receive

greater tax-liability relief if he were able to deduct these expenses under 

§ 162(a) rather than § 212. See Green, 507 F.3d at 870 n.7 (discussing the 

comparative advantage of deducting an expense under Internal Revenue 

Code § 162(a) versus § 212).

Section 162(a) of the Internal Revenue Code allows taxpayers to 

deduct from their taxable income “all the ordinary and necessary expenses 

paid or incurred during the taxable year in carrying on any trade or business.” 

I.R.C. § 162(a). Because “an income tax deduction is a matter of legislative 

grace,” a taxpayer claiming a business-expense deduction under § 162(a) has 

the burden to prove that the expense is rooted in the taxpayer’s trade or 

business. INDOPCO, Inc. v. Comm’r, 503 U.S. 79, 84 (1992) (quoting 

Interstate Transit Lines v. Comm’r, 319 U.S. 590, 593 (1943)); see also Marcello 

v. Comm’r, 380 F.2d 499, 504 (5th Cir. 1967); Brinkley v. Comm’r, 808 F.3d 

657, 663 (5th Cir. 2015) (“As a general rule, the Commissioner’s 

determination of a tax deficiency is presumed correct, and the taxpayer has 

the burden of proving the determination to be erroneous.”).

The phrase “trade or business” in § 162(a) “connotes something 

more than an act or course of activity engaged in for profit.” Stanton v. 

Comm’r, 399 F.2d 326, 329 (5th Cir. 1968) (quoting McDowell v. Ribicoff, 292 

F.2d 174, 178 (3d Cir. 1961)). A taxpayer can show that his activities 

constitute a trade or business within the meaning of § 162(a) by 

demonstrating that he engaged in “extensive activity over a substantial 

period of time during which the [t]axpayer holds himself out as selling goods 

or services.” Id. (quoting McDowell, 292 F.2d at 178); accord Louisiana Credit 

Union League v. United States, 693 F.2d 525, 532 (5th Cir. 1982). “One 

prearranged deal does not evidence the continuity and regularity found in 

trades or businesses.” Harris v. Comm’r, 16 F.3d 75, 81 (5th Cir. 1994). The 

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taxpayer’s management of his own investments is not a trade or business. 

Zink v. United States, 929 F.2d 1015, 1021 (5th Cir. 1991).

Legal expenses can be deductible as business expenses under § 162(a). 

Estate of Meade v. Comm’r, 489 F.2d 161, 164–66 (5th Cir. 1974). In United 

States v. Gilmore, the Supreme Court established the origin-of-the-claim test 

to determine whether a legal expense is deductible. 372 U.S. 39, 48–49

(1963). The origin-of-the-claim test asks the court to consider “the origin and 

character of the claim with respect to which [a legal] expense was incurred, 

rather than its potential consequences upon the fortunes of the taxpayer,” to 

determine whether the expense is a business or a personal expense, and thus 

“whether it is deductible or not.” Gilmore, 372 U.S. at 49; see also Estate of 

Meade, 489 F.2d at 165. In applying the origin-of-the-claim test to determine 

whether a legal expense is deductible, courts should consider the issues, 

nature, and objectives of the lawsuit, the defenses asserted, the purpose of 

the expenses, and the background of the litigation. Morgan’s Estate v. 

Comm’r, 332 F.2d 144, 151 (5th Cir. 1964).

We review the Tax Court’s factual finding as to whether the taxpayer 

was carrying on a trade or business for clear error and its legal conclusions de 

novo. See Green, 507 F.3d at 871 (“The determination of whether [the 

taxpayer] was engaged in carrying on a trade or business is a determination of 

fact that we review for clear error.”); Brinkley, 808 F.3d at 664.

In order to reverse the Tax Court on this issue, we would need to find 

that the Tax Court clearly erred in finding that the origin of the claims 

underlying Ray’s litigation to recoup his losses under the trading agreement 

did not relate to his engagement in a trade or business within the meaning of 

§ 162(a). This issue involves two distinct inquiries: (1) Did the Tax Court 

clearly err in characterizing the trading agreement venture as “Ms. Ray’s 

management of a hedge fund” rather than a computer programming

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business?; and (2) Did the Tax Court clearly err in finding that Ray was not 

involved in the trading agreement venture as a trade or business, but rather 

was merely an investor in the venture? 

In the Tax Court, Ray argued that the trading agreement venture was 

an extension of his earlier computer programming business because he took 

part of his settlement from litigation involving his Firm Decisions software 

and invested it in the trading agreement venture “to continue developing 

programs for Wall Street.” The Tax Court rejected this argument, finding 

that “the purported business was in actuality Ms. Ray’s management of a 

hedge fund.” On appeal, Ray again attempts to characterize the trading 

agreement venture as tied to his earlier computer programming business. 

However, Ray does not point to any facts establishing a link between the 

trading agreement venture and Ray’s earlier computer programming 

business beyond the source of funding. In his testimony before the Tax 

Court, in his post-trial brief, and again in his appellate brief, Ray states that 

the purpose of the trading agreement venture was to test the trading 

strategies that Christina Ray had developed. Although these trading 

strategies involved computer programs, Ray cites no evidence establishing 

that these computer programs were related to his earlier computer 

programming business or were developed by Ray. The Tax Court thus did 

not clearly err in characterizing the trading agreement venture as “Ms. Ray’s 

management of a hedge fund.”

Ray further argues that he engaged in the trading agreement venture 

as a trade or business within the meaning of § 162(a) because the venture was 

a joint collaboration with his ex-wife “to profit from the track record they 

sought to establish using Christina’s trading strategies.” To establish that he 

was engaged in a trade or business under § 162(a), Ray must demonstrate that 

he engaged in “extensive activity over a substantial period of time” with 

respect to the purported business. Stanton, 399 F.2d at 329. A mere profit 

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motive does not establish engagement in a trade or business, and the 

management of one’s own investments is not a trade or business. Id.; Zink, 

929 F.2d at 1021.

Nothing in the record establishes that Ray engaged in the trading 

agreement venture with “continuity and regularity.” Comm’r v. Groetzinger, 

480 U.S. 23, 35 (1987). Ray argues that “[c]onsistent with Groetzinger, Ray 

was regularly and continuously engaged in writing and creating financial 

software programs of a decision making and predictive nature from 1976 

through the end of his collaboration with Christina.” Ray does not identify

evidence in the record, however, establishing that Ray developed the 

computer programs that Christina Ray used in the trading agreement venture 

or meaningfully contributed to Christina’s development of these programs. 

As noted, Ray repeatedly characterized the purpose of the trading agreement 

venture as testing the trading strategies that Christina had developed. Ray 

also does not cite evidence showing that he participated in the trading aspect 

of the purported business. In fact, in Ray I, Ray testified that he did not 

“remember spending much time developing programs and models,” and that 

trading was Christina’s profession rather than his. Under the terms of the 

trading agreement, Ray disclaimed any right to be actively involved in the 

trading aspect of the purported business, as the agreement gave Christina Ray 

the authority to trade Ray’s commodities account in her sole discretion. 

Ray argues that the trading agreement’s language providing that 

either party could “advertise the accurate results” of Christina Ray’s trading 

of Ray’s account shows that “[t]here was a clear purpose and intent to 

commercially exploit what both believed would be a profitable program.” 

The existence of an intent to commercially exploit the trading program does 

not show that Ray engaged in extensive activity over a substantial period of 

time with respect to the purported trading business. Moreover, the existence 

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of a profit motive does not establish a trade or business within the meaning 

of § 162(a). Stanton, 399 F.2d at 329. 

Ray has not carried his burden of proof to show that the origin of the 

claims underlying his litigation to recoup his trading agreement losses—the 

trading agreement venture—was related to his engagement in a trade or 

business within the meaning of § 162(a). Accordingly, the Tax Court did not 

clearly err in finding that Ray is not entitled to deduct his 2014 legal expenses 

under § 162(a).

IV.

We next consider whether the Tax Court erred in finding that Ray 

cannot deduct his legal expenses incurred litigating to recover on his exwife’s indebtedness as expenses for the production of income under § 212(1)

of the Internal Revenue Code.

The Tax Court found that Ray’s legal expenses relating to the first 

cause of action in Ray I, i.e., those incurred litigating to recover on Christina 

Ray’s debts to Ray for (1) the Sagaponack property purchase, (2) the 

Manhattan apartment purchase, (3) the charges to Ray’s credit-card 

accounts, and (4) the late financial statements, are not deductible as expenses 

for the production of income under § 212(1). On appeal, Ray argues that the 

Tax Court erred in finding against deductibility because each of the relevant 

debt instruments was an interest-bearing, income-producing asset to Ray. 

The Commissioner counters that none of the claims underlying the first 

cause of action in Ray I was a claim for the production or collection of income 

because “all of the debts were personal debts unrelated to the production of 

income.” 

Section 212(1) of the Internal Revenue Code allows taxpayers to 

deduct “all the ordinary and necessary expenses paid or incurred . . . for the 

production or collection of income.” I.R.C. § 212(1). Once again, the 

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Commissioner’s deficiency determination is “presumptively correct,” and 

the taxpayer bears the burden of demonstrating their entitlement to a 

deduction. Payne v. Comm’r, 224 F.3d 415, 420 (5th Cir. 2000); INDOPCO, 

503 U.S. at 84. 

The key inquiry for determining deductibility under § 212(1) is 

“whether the expenditures were made primarily in furtherance of a bona fide 

profit objective.” Westbrook v. Comm’r, 68 F.3d 868, 875 (5th Cir. 1995) 

(internal quotation marks omitted) (quoting Agro Sci. Co. v. Comm’r, 934 

F.2d 573, 576 (5th Cir. 1991)). “A deduction claimed under § 212(1) must 

meet the same requirements applicable to trade or business expenses under 

§ 162, except that the person claiming the deduction need not be in the trade 

or business.” Green, 507 F.3d at 870 (internal quotation marks omitted) 

(quoting Simon v. Comm’r, 830 F.2d 499, 501 (3d Cir. 1987)). 

The origin-of-the-claim test applies to determine the deductibility of 

legal expenses under § 212(1) just as it applies to the deductibility of such 

expenses under § 162(a). Applying the origin-of-the-claim test, legal fees are 

considered personal expenses and thus not deductible under § 212(1) if the 

claims underlying the lawsuit are personal in nature. See Colvin v. Comm’r, 

122 F. App’x 788, 790 (5th Cir. 2005).

In considering the Tax Court’s conclusion as to whether legal fees are 

deductible as expenses incurred for the production of income, we review the 

Tax Court’s factual finding regarding profit motive for clear error and its 

legal conclusions do novo. See Westbrook, 68 F.3d at 876; Colvin, 122 F. 

App’x at 790.

We must decide whether the Tax Court clearly erred in finding that 

the origins of the claims underlying Ray’s litigation to recover on Christina 

Ray’s indebtedness were not related to the production or collection of 

income within the meaning of § 212(1). In determining whether Ray’s legal 

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expenses incurred litigating to recover on the principal of Christina Ray’s 

indebtedness are deductible under § 212(1), the key question is whether Ray 

entered into each of the following transactions “in furtherance of a bona fide 

profit objective,” Westbrook, 68 F.3d at 875: (1) Ray’s ownership and sale of 

the Sagaponack property; (2) Ray’s ownership and sale of the Manhattan 

apartment; (3) Ray’s arrangement with Christina Ray regarding the charges 

she incurred on his credit-card accounts; and (4) Ray’s agreement with 

Christina Ray for her to provide him with regular financial statements. We 

address each of these transactions in turn.

Tax Court caselaw addressing the § 212 deductibility of expenses 

incurred in the maintenance and sale of properties distinguishes between 

personal residences and investment properties. See, e.g., Murphy v. Comm’r, 

66 T.C.M. (CCH) 32, *2 (1993) (stating that, in determining the § 212 

deductibility of property-related expenses, “if property has been acquired or 

used as the taxpayer’s personal residence, it must be converted to a use 

related to the production of income in order for the taxpayer to become 

entitled to deduct such losses and/or expenses”); Thomas v. Comm’r, 42 

T.C.M. (CCH) 496 (1981) (providing that the deductibility of propertyrelated costs incurred prior to sale “depends upon whether the taxpayer has 

shown that a conversion of the property for the production of income has 

occurred”). A taxpayer can show that his property was converted from 

personal residential use to profit-producing use by demonstrating that he 

rented the property out to third parties or that, after converting the property 

from residential to investment use, he held the property and attempted to 

realize a profit from the appreciation in market value. Murphy, 66 T.C.M. 

(CCH) at *2 & n.7 (citing Newcombe v. Comm’r, 54 T.C. 1298, 1302 (1970)).

The record shows that both the Sagaponack property and the 

Manhattan apartment were used by Ames and Christina Ray for residential 

purposes for the entire period prior to Ames’s sale of his interest in the 

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properties to Christina. Ames and Christina Ray jointly purchased the 

Sagaponack property for the purpose of building a vacation home on the land. 

Construction of this vacation home was ongoing at the time that Ray sold his 

interest in the land to his ex-wife. The record does not support clear error on 

the ground that Ames and Christina Ray rented the property or were holding 

the land for an investment rather than a residential purpose. Likewise, Ames

and Christina Ray owned the Manhattan co-op shares for personal residential 

use for the full time period prior to Christina’s purchase of Ray’s interest in 

the shares. The record does not support clear error on the ground that Ray 

and Christina Ray rented the Manhattan apartment to third parties or ceased 

their residential use and held the property for investment purposes.

The record also does not support clear error on the ground that Ray 

entered into the agreements with Christina regarding her personal charges to 

his credit-card accounts or the penalty for late financial statements with the 

primary motive of profiting from these arrangements. In a deposition in Ray 

I, Ray testified that he entered into the arrangement with respect to 

Christina’s credit-card charges because he and his ex-wife had identified 

charges that were solely Christina’s responsibility and they intended to 

further separate their finances. Ray also suggested in deposition testimony 

that he entered into the agreement for Christina Ray to provide him financial 

statements in order to obtain better assurance that she could repay him for 

her debts. All of these debt arrangements were thus personal rather than 

profit-motivated. None of the origins of the claims underlying Ray’s litigation 

to recover the principal amount of Christina Ray’s indebtedness is related to 

the production or collection of income.

In his brief, Ray relies on Green, 507 F.3d at 870–71, where this court

found that a taxpayer could deduct under § 212 expenses incurred attempting 

to recover on a judgment he was awarded in a wrongful termination lawsuit. 

Green is inapposite. In Green, the judgment stemmed from the taxpayer’s 

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wrongful termination and was primarily intended to compensate the taxpayer 

for his lost employment income. Green, 507 F.3d at 867–68. Here, as 

established, the transactions underlying Christina Ray’s indebtedness to 

Ames Ray were not profit-motivated or income-generating in nature.

We next consider whether Ray’s legal expenses incurred litigating to 

recover the interest accrued on Christina Ray’s indebtedness are deductible 

under § 212(1). Ray cites Kelly v. Commissioner, 23 T.C. 682, 688 (1955), 

aff’d, 228 F.2d 512 (7th Cir. 1956), in which the Tax Court held that the 

portion of expenses attributable to the recovery of interest on a personal loan

may be deducted as expenses incurred for the collection of income. Kelly, 23 

T.C. at 688–90; accord Young v. Comm’r, 113 T.C. 152, 157 (1999), aff’d, 240 

F.3d 369 (4th Cir. 2001). The Commissioner does not dispute this caselaw 

but argues that Ray has forfeited this argument because he did not raise it in 

the Tax Court. 

As previously discussed, an argument not raised before the trial court 

cannot be raised for the first time on appeal. XL Specialty Ins. Co., 513 F.3d at 

153 (citing Stokes, 217 F.3d at 358 n.19). For an argument to be preserved, it 

“must be raised to such a degree that the trial court may rule on it.” Id.

(quoting In re Fairchild Aircraft Corp., 6 F.3d at 1128).

Ray did not raise his Kelly argument before the Tax Court, and barely 

argued for the § 212 deductibility of his legal expenses in his pre-trial and 

post-trial briefing. This argument, then, was not raised to such a degree that 

the Tax Court could have ruled on it. Ray has thus failed to preserve any 

argument he might have that the portion of his legal fees attributable to his 

efforts to recover the interest on his ex-wife’s indebtedness is deductible 

under § 212(1).

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V.

The Tax Court found Ray liable for an accuracy-related penalty under 

Internal Revenue Code § 6662, which imposes a 20 percent penalty on tax 

underpayments attributable to the taxpayer’s “[n]egligence or disregard of 

rules or regulations” or “substantial understatement of income tax.” I.R.C. 

§§ 6662(a), (b)(1), (b)(2).2 Because the Tax Court found that Ray could 

deduct his trading agreement loss-related legal expenses under § 212, the 

computation adopted by the Tax Court did not impose a penalty on any 

underpayment attributable to legal expenses concerning the trading 

agreement losses, which Ray was allowed to deduct under § 212. But the Tax 

Court did impose a penalty on Ray’s underpayment attributable to (1) the 

difference in the amounts Ray would be allowed to deduct for legal expenses 

for the trading agreement losses if they were deductible under § 162(a) rather 

than § 212, and (2) Ray’s deduction of his legal expenses relating to his 

litigation to recover on his ex-wife’s indebtedness. 

On appeal, Ray argues that the Tax Court erred in finding him liable 

for an accuracy-related penalty because he is entitled to both a “reasonable 

cause and good faith” defense and a “substantial authority” defense to the 

imposition of the penalty. The Commissioner responds that Ray has failed to 

meet his burden of proving these defenses. We address Ray’s entitlement to 

each of these asserted defenses in turn.

A.

An accuracy-related penalty does not apply to any portion of a 

taxpayer’s underpayment for which the taxpayer had “reasonable cause” 

2 An understatement of income tax is substantial if the amount of understatement 

exceeds the greater of 10 percent of the taxpayer’s total tax liability or $5,000. I.R.C. 

§ 6662(d)(1)(A).

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and acted in good faith. I.R.C. § 6664(c)(1). The taxpayer bears the burden 

of proving entitlement to the reasonable cause and good faith defense. 

Klamath Strategic Inv. Fund v. United States, 568 F.3d 537, 548 (5th Cir. 

2009); accord Brinkley, 808 F.3d at 668. The assessment of whether the 

taxpayer has met this burden is “made on a case-by-case basis, taking into 

account all pertinent facts and circumstances.” Treas. Reg. § 1.6664-4(b)(1); 

Brinkley, 808 F.3d at 669. “Circumstances that may indicate reasonable 

cause and good faith include an honest misunderstanding of fact or law that 

is reasonable in light of all of the facts and circumstances, including the 

experience, knowledge, and education of the taxpayer.” Treas. Reg. § 

1.6664-4(b)(1). “The most important factor[,]” however, “is the extent of 

the taxpayer’s effort to assess his proper liability in light of all the 

circumstances.” Klamath, 568 F.3d at 548. The Tax Court’s determinations

regarding the taxpayer’s eligibility for a reasonable cause and good faith 

defense are factual findings reviewed for clear error. Sun v. Comm’r, 880 F.3d 

173, 181 (5th Cir. 2018).

The Tax Court found that Ray failed to carry his burden of proving his 

entitlement to the reasonable cause and good faith defense because (1) Ray’s 

reliance on the 1997 stipulated Tax Court decision was unreasonable, as the 

stipulated decision “does not state or give rise to an inference that petitioner 

was involved in a computer programming business as he claims here”; and 

(2) Ray’s argument that he made a mistake of law as to the applicability of 

§ 162(a) versus § 212 was meritless because Ray never conceded in the Tax 

Court proceedings that “he was not engaged in a trade or business or even 

argue[d] in the alternative that he may only be entitled to a section 212 

deduction.” 

On appeal, Ray again contends that he reasonably relied on the 

stipulated Tax Court decision in deducting his legal expenses under § 162(a). 

The Commissioner argues that Ray could not have reasonably relied on the 

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stipulated decision because he was aware of the circumstances surrounding 

its adoption by the Tax Court and that it was the result of a settlement, he 

did not present evidence showing that he took any steps to confirm its 

applicability to his 2014 taxes, and the loss claimed in the prior Tax Court 

proceeding related solely to the trading agreement losses and not to Christina 

Ray’s indebtedness.

The Commissioner is correct that the stipulated Tax Court decision 

related solely to Ray’s trading agreement losses and not to Christina Ray’s 

indebtedness. As discussed, Ray has failed to show that the claims underlying 

his first cause of action in Ray I are related to the trading agreement venture. 

However, the 1997 stipulated Tax Court decision is related to the 

characterization of the trading agreement losses, which implicates the 

portion of the accuracy-related penalty that was imposed on the difference in 

the amounts Ray would be allowed to deduct for the relevant legal expenses 

if they were deductible under § 162(a) rather than § 212. Given the IRS’s 

prior position regarding Ray’s trading agreement venture, and considering 

the particular facts and circumstances of this case, it was reasonable for Ray 

to have relied upon the stipulated decision in assessing whether his legal 

expenses could be deducted under § 162(a) as a Schedule C business loss. We 

conclude that Ray is entitled to a reasonable cause and good faith defense for 

his understatement attributable to deducting his trading agreement legal fees 

under § 162(a) rather than § 212.

3

VI.

For the foregoing reasons, we AFFIRM the Tax Court’s decision, 

with the exception of the penalty attributable to the difference in the amounts 

3 In light of this ruling, we do not reach the issue of whether Ray is entitled to a 

substantial authority defense.

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Ray would be allowed to deduct for legal expenses for the trading agreement 

losses under § 162(a) rather than § 212. As to this exception, we VACATE

and REMAND for entry of judgment consistent with this opinion.

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James L. Dennis, Circuit Judge, dissenting in part:

I concur in Parts I through IV of the majority opinion. However, I 

respectfully dissent from Part V because, in my view, the Tax Court did not 

clearly err in finding that Ray was not entitled to the reasonable cause and 

good faith defense. The Tax Court’s determinations that Ray lacked 

reasonable cause and was not acting in good faith are factual findings subject 

to clear error review. Green v. Comm’r, 507 F.3d 857, 871 (5th Cir. 2007). 

“Clear error exists when this court is left with the definite and firm 

conviction that a mistake has been made.” Id. at 866. Whether a taxpayer 

has proven his or her entitlement to the reasonable cause and good faith

defense is a fact-intensive inquiry that is “made on a case-by-case basis, 

taking into account all pertinent facts and circumstances.” Treas. Reg. 

§ 1.6664-4(b)(1). Reviewing the record in light of the applicable law and our 

deferential standard of review, I am not “left with the definite and firm 

conviction that a mistake has been made.” See Green, 507 F.3d at 866. 

Because I would affirm fully the Tax Court’s decision, I dissent from Part V

of the majority opinion.

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