T.C. Mem o. 2 01 6- 18 8

UNITED STAT ES TAX COURT

MARY L. HATCHER AND BRADLEYJ. HATCHER, Pet it io ne rs v. COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt MARY L. HATCHER a.k.a. Ma ry L. Bell , Pet it io ne r v. COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No s. 2 32 43 -1 3, 2 37 20 -1 3. Fi le d Oct ob er 6 , 20 16
.
Mary L. Hatch er an d B rad le y

J. Hat ch er, p ro ses e. St ep hani e J. R ak os ki , for res po nd en t.

MEMORANDUM FINDINGS OF FACT AND OPINION LAUBER, Ju dg e: W ith re sp ectto pe ti ti on er wi fe’s Fed eral in co m e ta x fo r 20 08 , th e In te rn al Rev enue Serv ic e (IR S o r res po nd en t) d et erm in eda de fic ie nc y of $1 06 ,73 3 a ndanaccu racy-rela te d p en al ty of $2 1,3 47 un de r se ct io n 6 66 2( a). W ith- 2 -

[* 2] res pe ctto pe ti ti on ers ’ joi ntFed eral in co m e ta x fo r 20 10 , th e IRS de te rm in eda de fic ie nc y

of $ 10 0,9 24 an d asec ti on 66 62 (a) p en al ty of $2 0,1 85
. 1 Afte r co nc es si on s, th e p rin ci pa l i ss ue forde ci si on is whet he r pe ti ti on ers for 2 20 10 are en ti tl edto a bu si ne ss ba d d eb t d educ ti on un de r se ct io n 1 66 (a). We ho ld th atth ey are n ot ; as a co ro ll ary, we co nc lu de th atpe ti ti on ers di d n othave a ne t op erat in g l os s fo r 20 10 av ai labl e fo r carry ba ck to pe ti ti on er wi fe’s 2 00 8 re tu rn . W e al so ho ldth atpe ti ti on er hus ba nddo es no t qua li fy as areal est at e p ro fes si on al fo r 20 10 an d s o p et it io ne rs m ay no t d educ t a $ 21 ,62 4 re nt al real est at e lo ss ; tha t pe ti ti on er wi fe fo r 20 08 is li ab le foranaccu racy-rela te d p en al ty; an d t ha t p et it io ners for20 10 are l iabl e fo r m os t b utno t al l o f th e acc ur acy-rela te d p en al ty tha t re sp on de ntha s d et erm in ed
. All st atut ory

refe ren ces are t o t he Int ern al Rev enue Co de (Co de ) ineffe ct 1 fo r th e y ears inis su e, an d a ll Ru le refe ren ces are t o t he Tax C ou rt Rul es of P racti ce an d P ro cedur e. W e ro un d a ll m on et ary am ou nt s t o t he ne ares t d ol la r. Fo r 20 08 res po nd en t co nc ed es th atpe ti ti on er wi fe i s en ti tl edto a de du ct io n 2 of $1 ,37 9 fo r a cap it al lo ss carry fo rward(an d t o aco rres po nd in g re du ct io n t o a ny pe na lty de te rm in edfor

20 08 ). For

20 10 res po nd en t co nc ed es th atpe ti ti on ers are en ti tl edto a de du ct io n o f $4 ,32 4 fo r he al th in su ran ce p rem iu m s. Fo r 20 10 pe ti
ti on ers co nc ed e: (1) th atpe ti ti on er h us bandfai le d t o re po rt $ 3,6 00 of n on em pl oyee co m

pe ns at io n; (2) th atpe ti ti on ers are n oten ti tl edto de du ct io ns inth e ag gr eg at e am ou ntof $ 68 ,55 8 a s cl ai m edon two Sch edul es C, Pro fitor Lo ss Fro m Bu si ne ss ; an d (3 ) th atpe ti ti on ers are l iabl e fo r ad di ti on al sel f-em pl oym en t t ax , in th e am ou ntcal cu la te d b y res po nd en t, i n t he ev en t we d et erm in e (as we do ) th at th ey are n oten ti tl edto th e cl ai m edbu si ne ss ba d d eb t d educ ti on . All o th er ad jus tm en ts (ap artfro m

th os e d is cu ss edinth e te xt ) are co m pu tati on al
.- 3 -

[* 3] FINDINGS OF FACT So m e o f th e fac ts ha ve be enst ip ul at edan d a re s o fo un d. Th e st ip ul at io n o f fact s an d t he att ach edex hi bi ts are i nc or po rat edby thi s re fere nc e. Pet it io ne r wife , Mary B. Hatc he r, fo rm erl y

Mary Bell (Mary ), was s in gl e fo r ta xabl e y ear 2 00 8. Sh e m arri edBrad le y

J. Hat ch er (B rad le y ) in Ju ly 201 0. Th ey res id edinTexa s whe n the y

fil edth e res pe ct iv e p et it io ns . Mary rece iv edanun de rg radua te bu si ne ss de gr ee an d a n M .B.A. inco rpo rat e fi nanc e. Fro m

20 00 th ro ug h 2 01 0 s he was e m pl oyed b y Blo ckbu st er Co rp ., in it ia ll y servi ng as v ic e p res id en t fo r in ve st orrel at io ns an d, fr om 20 07 th ro ug h 20 09 , as s en io r vi ce p res id en t an d t reas ur er. Inth e la tt er capa ci ty she was re sp on si bl e fo r th e co m

pa ny’ s i nv es to r rel at io ns , tre as ury fun ct io ns , ris k m an ag em en t, fi na nc ia l p la nn in g, an d t ax . Mary ’s em

pl oym en t wi th Blo ckbu st er en de d i n t he su m m er o f 20 10 . There
aft er s he work edas a n i nd ep en de ntco nt ract orforBlo ckbu st er, co ns ul ti ng on sev eral m ed ia -rel at edtra ns act io ns . Blo ckbu st er re po rte d h er n on em pl oyee co m

pe ns ati onfor20 10 onFo rm

10 99 -MI SC, Mi sc el la ne ou s In co m e. Sin ce 2 01 1 M ary ha s be ena partn er i n apri va te equi ty firm sp eci al iz in g i n t ran sa ct io ns in vo lv in g t ech
no lo gy andm ed ia
.- 4 -

[* 4] Brad le y

li ke wis e h as anex te ns iv e b us in es s b ack gr ou nd , pri m ari ly inv ol vi ng or ig in at io n o f rea l es ta te lo an s. As a res ul t o f th e fi na nc ia l cr is is he be cam e une m pl oyed i n l at e 2 00 9; du rin g 2 01 0 h eal th pro bl em s l im it edhi s p hysic al act iv it y . He di d n otori gi na te an y

real est at e lo an s dur in g 2 01 0. Ho wev er, h e an ti ci pa te d t ha t he m ig htreturn t o t hi s l in e o f bu si ne ss inth e fu tu re, e.g ., whenlo an s tha t h e h ad br ok eredpre vi ou sl y

m atur edan d t he bo rro wers so ug htto refi nanc e. A. The BadDebt Dur in g 2 00 4 a nd20 05 Mary m ad e a s eri es of l oans to BradCarp en te r, who m sh e was th enda ti ng . Mr. Carp en te r was un em pl oyed atth e ti m e b utwas worki ng on de ve lo pi ng a go lf- th em edco m ic strip cal le d “ Inth e Ro ug h.” Mary adva nc edm on ey

to Mr. Car

pe nt er t o fu ndth e d ev el op m en t o f hi s co m ic strip an d to pa y cert ai n o f hi s p ers on al li vi ng ex pe ns es . Mary fir stadva nc ed$7 5,0 00 inMarc h 2 00 4. Mr . Carp en te r si gn eda pr om is so ry

no te for th atam ou ntbe ari ng in te res t o f 5% a nn ua ll y . The n ot e was to be rep ai d “ ba se d o n m

utua ll y ag reedco m

pa ny perfo rm an ce, b eg in ni ng 1 year fo ll owi ng di st rib ut io n o r li cen si ng ag reem en t” of h is co m ic strip . Mary di d n ot in ve st ig at e Mr. Ca rp en te r’s ab il it y to rep ay th e lo anwhen m ak in g t hi s i ni ti al adva nc e o r an y

subs eque ntadvanc es . She di d n otaskhi m to pro vi de ba nk- 5 -

[* 5] st at em en ts , cred itrep orts , tax returns , or o th er fi na nc ia l i nf orm at io n, n ordi d sh e requi re co ll at eral
. InApri l 2 00 4 M ary adva nc edMr. Car pe nt er an ot he r $5 0,0 00 , whi chhe
us edto pu rch as e a Hum

m er. Ove r th e fo ll owi ng y ear M ary m ad e ad di ti on al tra ns fers to Mr. Car

pe nt er. Altho ug h t he y

st op pe d d at in g i n Au gu st20 05 , sh e co nt in
ue d t o a dv an ce fund s fo r two m or e m on th s, wi th th e la sttra ns fer o ccurri ng on Octo be r 21 , 20 05 . In t ot al sh e adva nc edMr. Car pe nt er $ 43 0,5 00 ; re sp on de ntdo es no t d is pu te th atth is co ns ti tu te d abo nafid e d eb t. On J un e 1 , 20 06 , Mr. Car pe nt er s ig ne d apro m is so ry no te (Car

pe nt er n ot e)
ev id en ci ng th is in de bt edne ss , whi chsupe rs ed edth e March 20 04 no te . This no te ex pl ic it ly stat edth atth e p ur po se of t he lo anwas t o fu ndhi s p ers on al ex pe ns es an d th e d ev el op m en t o f hi s co m ic strip . It b or e in te res t o f 5% a ndwas p ay ab le inful l
on Decem

be r 31 , 20 07
. Mr. Ca rp en te r di d n otpa y th e Car pe nt er n ot e atth e p res cri be d t im e. Howev er, h e h adob ta in edem pl oym en t as th e ex ecu ti ve pro du cer o f a fi lm pro ject, an d Mary be li ev edth atth e res ul ti ng in co m e m ig hten ab le hi m to rep ay th e n ot e. In Feb ru ary 20 08 an d Ap ril 20 10 sh e an d M r. Carp en te r ex ecu te d a m en dm en ts to th e Carp en te r no te ; the lat te r am en dm en t re qu ire d M r. Carp en te r to rep ay th e n ot e in
m on th ly ins ta ll m en ts of $ 1,0 00 . Betwe enMarc h a ndOcto be r 20 10 he m ad e si x- 6 -

[* 6] pa ym en ts to ta li ng $7 ,00 0; he m ad e n o s ub se qu en t p aym en ts . Peti ti on ers on th ei r 20 10 tax return d idno t re po rt a ny int eres t i nc om e attri bu tabl e to th e Carp en te r no te . Dur in g Dec em

be r 20 10 Mary andMr. Car pe nt er ex ch an ge d aser ie s o f
em ai ls inwhi chsh e n ot edhi s d efau ltan d d em an de d p aym en t. Mr . Carp en te r ex pr es se d h op e th athe co ul d s ti ll rep ay th e Car pe nt er n ot e, bu t i n aDecem be r 17 , 20 10 , em ai l h e st at ed : “ I ha ve no m on ey .” Mary vie wedth is st at em en t as in di cati ng th athe wou ldm ak e n o fu rth er p aym en ts . InFeb ru ary 20 11 Mary sen t M r. Carp en te r a fo rm al no ti ce o f de fau ltan d fil edsu itinanatt em

ptto co ll ecton th e Car

pe nt er n ot e. On Fe br

uary 15 , 20 12 , sh e o bt ai ne d ajud gm en t ag ai ns t M r. Carp en te r fo r dam ag es of $ 57 3,1 75 an d at to rn ey ’s fees of $ 50 ,00 0. Inaneffo rt t o c ol le cton th is jud gm en t, s he serve d di sc ov ery to in ve st ig at e Mr. Carp en te r’s so ur ces of i nc om e; sh e al le ge d tha t h e was rece iv in g d is ab il ity

in co m e o f $7 ,50 0 p er m on th an d h adba nkde po si ts fro m anun ex pl ai ne d s ou rce. Du rin g l at e 2 01 2 M ary was st il l i n n eg ot ia ti on s i n a n effo rt t o c ol le ctth e d eb t. As o f Decem be r 31 , 20 10 , th e Car

pe nt er n ot e h adno t be co m e co m

pl et el y wort hl es s. St art in g i n 2 00 4 M ary ha d u se d h er b us in es s co nt act s t o i nt ro du ce M r. Carpe nt er t o p eo pl e who m ig htass is t h im inge tt in g h is co m ic strip syndi cat ed . She- 7 -

[* 7] rece iv edno fees forth es e se rv ic es . Apartfro m th e Car pe nt er n ot e an d
am en dm en ts th eret o, the re were no co nt ract s b etweenMary andMr. Car pe nt er. Sh e o bt ai ne d n o o wne rs hi p i nt eres t i n t he co m ic strip an d h adno rig htto sh are i n an y pro fit s i t m ig htge ne rat e. Her so le op po rtu ni ty for p ro fitwith re sp ectto th e co m ic strip was the rep aym en t o f th e p rin ci pa l o f th e Car pe nt er n ot e wit h i nt eres t. Dur in g 2 00 4- 20 10 Mary was n oten ga ge d i n t he tra de or b us in es s o f le nd in g m on ey or i n a ny trad e o r bu si ne ss ot he r th anhe r em pl oym en t wi th (orco ns ul ti ng fo r) Bl oc kb us te r. Her de ci si on to len d m on ey to Mr. Car

pe nt er was m ot iv at ed ch ie fly by

th ei r pe rs on al rel at io ns hi p. Sh e wou ldno t h av e le ntm on ey to an ot he r in di vi du al or b us in es s o n s im il ar t erm s, an d s he di d n otlen d m on ey to an y on e el se du rin g 2 00 4- 20 10 . She was n otin vo lv edinth e d ev el op m en t o f an y m ed iapro pe rty, apartfro m

Mr. Car pe nt er’s co m ic strip , du rin g t hi s p eri od
. On Oct ob er 2 1, 2 01 0, M ary co nt rib ut edth e Car pe nt er n ot e to MBH Partne rs , LLC (MBH), a l im it edli ab il it y co m pany tha t s he ha d fo rm edth e p rev io us da y . MBH h adit s b us in es s ad dr es s athe r ho m e, an d s he was i ts so le m em be r. Mary form edMBH as anen ti ty thro ug h wh ic h s he all eg ed ly int en de d t o c on du ct fu tu re ad vi so ry

an d c on su lt in g wo rk . Duri ng 20 10 MBH h adno cu st om ers or cl ie nt s, an d i t en ga ge d i n n o l en di ng act iv it ie s o r ot he r tr ad e o r bu si ne ss . Mary’ s- 8 -

[* 8] pri nc ip al pu rp os e fo r co nt rib ut in g t he Carp en te r no te to MBH was to en ha nc e th e ap pe aran ce tha t the no te was b us in es s- rel at ed
. B. Ren ta l Pr op erty Befo re h is m arri ag e to Mary in Jul y 20 10 , Brad le y

res id edina ho us e o n Ani taStr eetinDall as , Texa s (An it a p ro pe rty). Peti ti on ers own edth is ho us e aft er th e m arri ag e; itwas u no ccupi eddu rin g t he fir stha lf o f 20 10 an d o ccupi edby a te na ntdu rin g t he sec on d h al f. On Sc he du le E, Sup pl em en ta l In co m e an d Lo ss , pe ti ti on ers rep orte d fo r 20 10 a lo ss of $ 21 ,62 5 a tt rib ut ab le to th e Ani tapro pe rty. Pet it io ne rs pro du cedno co nt em po ran eo us (orot he r) d oc um en ta ti onco ncern in g t he am ou ntof t im e th ey de vo te d t o t he Ani tapro pe rty. Bradl ey tes ti fie d th at , du rin g the fir stha lf o f 20 10 , he p erfo rm edrou ti ne m ai nt en an ce an d m ad e li gh t re pa irs to pre pa re the pro pe rty for re nt al . He est im at edth atth es e ch or es co nsu m ed10 to 15 ho ur s p er week . Duri ng th e se co ndha lf o f th e y ear, h e es ti m at ed th athe de vo te d 1 0 h ou rs pe r m on th to th e Ani tapro pe rty. Peti ti on ers subm it te d
no ev id en ce o n t hi s i ss ue ap artfro m Brad le y ’s tes ti m on y . C. Return P rep arat io n a ndExam in at io n Mary ti m el y fil edhe r 20 08 in di vi du al return re po rti ng ad jus te d g ro ss in
co m e (AGI) o f $4 91 ,57 6 a ndtax du e o f $1 21 ,87 5. InFeb ru ary 20 11 sh e fi le d a n am en de d re tu rnfor

20 08 on whi chsh e cl ai m eda $3 ,00 0 l on g- te rm cap it al lo ss- 9 -

[* 9] carry fo rwardno t re fle ct edon he r or ig in al return. Th e IRS ab at edtax of $1 ,37 9 a ttrib ut ab le to th is am en de d re tu rnan d i ss ue d h er a re fund
. Mary pre pa redpe ti ti on ers ’ 20 10 joi ntreturn o n wh ic h the y rep orte d n eg ati ve AGI of $ 25 7,8 16 . Peti ti on ers in cl ud edtwo Sch edul es C with t hi s re tu rn . The fir stSch edul e C, fo r a b us in es s d es cri be d a s “ Fi na nc ia l an d R eal Est at e Co ns ul tin g,” rep orte d M ary’ s co m pe ns at io n fr om

Blo ck bu st er fo r he r co ns ul ti ng servi ces . The sec on d S ch edul e C, fo r MBH, re po rte d n o re ve nu es or i nc om e b utcla im eda ba d d eb t l os s d educ ti on of $ 60 0,8 47 att rib ut ab le to th e al le ge d wo rth le ss ne ss of th e Car pe nt er n ot e. Thi s cl ai m edlo ss de du ct io n re pr es en te d u np ai d p rin ci pa l o f $4 30 ,50 0 p lu s ac cru edin te res t o f $1 70 ,34 7. Pe ti ti on ers ha d n otpre vi ou sl yrepo rte d a ny of th is in te res t as tax ab le in te res t o n aFed eral in co m e ta x re tu rn . On Sch edul e D, Cap it al Gain s an d Lo ss es , pet it io ne rs rep orte d fo r 20 10 a ne t l on gte rm cap it al lo ss of $ 43 3,9 85 fro m th e sa le of B lo ckbu st er s to ck , coupl edwith a cap it al lo ss carry fo rward
. Pet it io ne rs ’ 20 10 return c reat eda ne t o pe rat in g l os s (NOL) tha t the y al lo cat edinful l t o M ary, an d s he th encarri edth is cla im edNOL backto he r 20 08 ta xabl e y ear. InMarc h 2 01 1 s he subm it te d F orm 10 45 , App li cat io n fo r Ten ta ti ve Refu nd , see ki ng a refu ndof $ 10 5,3 53 for20 08 on th is gro un d. Th e IRS pro ces se d th e Fo rm 10 45 an d i ss ue d M ary th e refu ndsh e reque st ed
.- 10 -

[* 10 ] The IRS s el ect edpe ti ti on ers ’ 20 10 return a ndMary’ s 2 00 8 re tu rnfor
ex am in at io n. Itdi sa ll owe d fo r 20 10 th e b us in es s b adde btde du ct io n a tt rib ut ab le to th e Car pe nt er n ot e an d (a s a c or ol la ry of t ha t d et erm in at io n) di sa ll owe d t he cl ai m edNOL carry

ba ckto 20 08 . The IR S al so di sa ll owe d t he cla im edSch edul e E lo ss de du ct io n, d et erm in in g t ha t p et it io ne rs were i ne li gi bl e to de du ctren ta l re al
es ta te lo ss es un de r se ct io n 4 69 (i) be cau se th ei r AGI ex ceed ed$1 50 ,00 0. Th e IRS
m ad e se ve ral m in oran d c om pu ta ti on al ad

jus tm en ts , see supr a p . 2 & n ot e 2 , and de te rm in edanaccu racy-rela te d p en al ty for eac h year. Res po nd en t i ss ue d p et it io ners ti m el y no ti ces of d efi ci en cy , andth ey ti m el y pe ti ti on edth is Co urt. The two cas es were co ns ol id at edforpu rp os es of t ria l, b rie fin g, an d o pi ni on . OPINION The Co m m is si on er’s d et erm in at io ns ina no ti ce o f de fic ie nc y are g en eral ly pr es 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 tho se de te rm in ati on s erro ne ou s. Ru le 14 2( a); W el chv. Hel ve rin g, 2 90 U.S. 11 1, 1 15 (19 33 ). The ta xp ay er b ears th e b ur de n o f pr ov in g h is en ti tl em en t t o d educ ti on s al lo wedby the Co de an d o f subs ta nt iati ng th e am ou nt s o f cl ai m edde du ct io ns . INDOPCO, Inc . v. Co m m is si on er, 5 03 U.S. 79 , 84 (19 92 ); s ec. 1 .60 01 -1 (a), In co m e Tax Reg s. Be
cau se we de ci de th es e cas es on a pr ep on de ran ce o f th e ev id en ce, we n eedno t- 11 -

[* 11 ] de ci de whi chpa rty has th e b ur de n o f pr oo f. See s ec. 7 49 1( a); Est at e o f Turn er v . Comm is si on er, 1 38 T.C. 30 6, 3 09 (20 12 ). A. The BadDebtDedu ct io n Sect io n 1 66 (a)( 1) pro vi de s tha t “ [t]he re s ha ll be all owe d a s a d educ ti on an y de btwhi chbe co m es [who ll y ] worth le ss withi n the tax ab le y ear.” Fora no nb us ine ss ba d d eb t h el d b y

a ta xp ay er o th er tha n aco rp or at io n, s ect io n 1 66 (a)( 1) do es no t ap pl y , andth e ta xp ay er i s al lo weda sh ort-t erm cap it al lo ss forth e ta xabl e y ear in whi chth e d eb t b eco m es co m pl et el y wort hl es s. Sec . 16 6( d) (1 ); s ec. 1 .16 6- 5( a)(2 ), In co m e Tax Reg s. Be cau se pe ti ti on ers for 20 10 ha d a n e xi st in g c ap it al lo ss inex ces s o f $4 30 ,00 0, an d b ecau se anin di vi du al foran y y ear c anno t d educ t ag ai ns t o rd in ary in co m e a capi ta l l os s i n e xc es s o f $3 ,00 0, s ee s ect io n 1 21 1( b) , pe ti ti on ers co ul d d eri ve no curren t t ax be ne fitin20 10 fro m cla im in g alo ss de du cti onforth e Car

pe nt er n ot e unl es s tha t n ot e were c la ss ifi edas abu si ne ss de bt
. Sect io n 1 66 (d )(2 ) de fin es a bu si ne ss de btas “ a d eb t cr eat edor a cqui red * * * i n c on ne ct io n wi th a tr ad e o r bu si ne ss of the tax pay er” o r “ a d eb t the lo ss fro m th e worth le ss ne ss of wh ic h i s i nc urredinth e ta xp ay er’s trad e o r bu si ne ss .” To b e el ig ib le to de du cta lo ss as abu si ne ss ba d d eb t, a t ax pa y er m us t s ho w th at sh e was en ga ge d i n atra de or b us in es s an d t ha t the de btwas p ro xi m at el y rel at edto he r tr ad e o r bu si ne ss . Put om a Co rp . v. Co m m is si on er, 6 6 T.C. 6 52 , 67 3 (1 97 6) ,- 12 -

[* 12 ] aff’d, 6 01 F.2d73 4 (5 th Cir . 19 79 ); s ec. 1 .16 6- 5( b) , Inc om e Tax Reg s. A ta xp ay er m ay

be en ga ge d i n m or e th anon e tr ad e o r bu si ne ss at ati m e. See B el l v
. Co m m is si on er, 2 00 F.3d54 5, 5 47 (8t h C ir. 2 00 0) , aff’g T.C. Mem o. 1 99 8- 13 6. Bu t t o b e en ga ge d i n atra de or b us in es s, the tax pa y er m us t p art ic ip at e in th e act iv ity with c on ti nu ity

an d re gu la rity , andhe r pr im ary pu rp os e fo r en ga gi ng in th e act iv it y

m us t b e fo r in co m e o r pr of it . Commis si on er v . Groe tz in ge r, 48 0 U.S. 23 , 35 (19 87 ). The m an ag em en t o f on e’s in ve st m en ts , no m at te r ho w ext en si ve , is
no t a “ tra de or b us in es s.” Whi pp le v. Co m mis si on er, 3 73 U.S. 19 3, 2 00 (19 63 ). 1. Bu si ne ss vs . Nonbu si ne ss Debt Altho ug h p et it io ne rs ass ertth atth e Car pe nt er l oa n was a bu si ne ss de bt , th ey ha ve no t i de nt ifi edan y

tra de or b us in es s wi th whi chitco ul d b e as so ci at ed . Mary
was no t en ga ge d i n t he tra de or b us in es s o f le nd in g m on ey when sh e adva nc ed fund s t o M r. Carp en te r. Whe n o ne in di vi du al len ds m on ey to an ot he r, “ [t]he rig ht to de du ctba d d eb ts as b us in es s l os se s i s ap pl ic ab le on ly to the ex cep ti on al si tu at io ns inwhi chth e ta xp ay er’s act iv it ie s i n m ak in g l oa ns * * * [are] so ex te ns iv e an d c on ti nu ou s as to ele va te th atact iv it y to th e st atus of asep arat e b us in es s.” Im el v. Co m

m is si on er, 6 1 T.C. 3 18 , 32 3 (1 97 3) ; Co op er v . Comm is si on er, T.C. Mem o. 2 01 5- 19 1, at*1 3 (d es cri bi ng fact or s u se d t o e va lu at e whe th er a t ax pa y er’s le nd in g a ct iv ity

ris es to th e le ve l o f a d is cret e tr ad e o r bu si ne ss ).- 13 -

[* 13 ] Not hi ng inth e rec or d i nd ic at es th atMary was ev er i n t he bu si ne ss of l en din g m on ey . She was e m

pl oyed fu ll ti m e b y

Blo ckbu st er dur in g 2 00 4- 20 05 , and sh e n ev er l en t m on ey

to any on e b utMr. Car

pe nt er, wh om

sh e was dati ng at t he ti m e. See C oo pe r, at*1 5. Inm ak in g the se advanc es sh e d idno t co nduc t h ers el f
as a prud en t l en de r wou ld ; s he pe rfo rm edno cred itch eck s, s ou gh t n o fi nanc ia l in fo rm at io n, an d re qu ire d n o s ecu rit y . W e fi ndno ev id en ti ary supp ort fo r th e pr op os it io n t ha t the Carp en te r no te was “ a d eb t cr eat edor a cqui red* * * i n co nn ect io n wi th a tr ad e o r bu si ne ss ” o f le nd in g m on ey inwhi chMary was p ers on al ly eng ag ed . See s ec. 1 66 (d )(2 )(A). Norwas any los s o n t he Carp en te r no te “ in cu rredinth e ta xp ay er’s trad e o r bu si ne ss ,” na m el y , Mary’ s o ccupa ti on of s erv in g a s a B lo ck bu st er em pl oyee. See
se c. 16 6( d) (2 )(B) . Alth ou gh sh e te st ifi edth atsh e o ccas io na ll y work edon de al s fo r m ed iaco nt en t i n h er ro le as aBlo ckbu st er ex ecu ti ve , len di ng pe rs on al fun ds to de ve lo pe rs of c om ic strip s (o r ot he r m ed iaco nt en t) wa s cl earl y be y on d t he sco pe of he r co rp or at e dut ie s. Bl oc kb us te r pe rm it te d i ts ex ecu ti ve s t o p ur su e o ut si de in
ve st m en t ac ti vi ti es , pro vi de d t ho se act iv it ie s en ta il edno co nf li ctof i nt eres t. Bu t su chact iv it ie s, b y

de fin it io n, wer e n otin cu rredinMary’ s trad e o r bu si ne ss as a Bl oc kb us te r em

pl oyee.- 14 -

[* 14 ] Fi na ll y , pet it io ne rs pre se nt edno ev id en ce tha t M ary was en ga ge d dur in g 20 04 -2 01 0 i n a ny m ed ia -rel at edbu si ne ss ap artfro m th atof b ei ng a Bl oc kb us te r ex ecu ti ve or c on su lt an t. Ci ti ng he r fam il iarity with l ic en si ng en te rta in m en t p ro du ct s, p et it io ne rs urg e th atsh e en ga ge d dur in g 2 00 4- 20 10 inth e b us in es s o f “ de
ve lo pi ng m ed iaco nt en t,” o f whi chMr. Car pe nt er’s co m ic strip was s up po se dl y an ex am pl e. Bu t s he ex erci se d t he se sk il ls so le ly in h er capa ci ty as a Bl oc kb us te r ex ecu ti ve ; the re i s n o e vi de nc e th atsh e o ffer ed(orwou ldha ve be enpe rm it te d b y he r em pl oyer to off

er) the se servi ces to ot he rs . She cit edno ex am pl e o f any

co nt en tde ve lo pm en t ac ti vi ty, ap artfro m “ Inth e Ro ug h,” with wh ic h s he was i nv ol ve d du rin g 2 00 4- 20 10 . Andev enth ere h er ro le was l im it edto th atof a n i nv es to r: Sh e fin an cedMr. Car

pe nt er’s act iv ity

rathe r th andi rect ly part ic ip at in g i n i t. See Co m m is si on er v . Groe tz in ge r, 48 0 U.S. at35 (no ti ng th ata “ sp or ad ic act iv ity ” d oe s n ot qu al ify as a trad e o r bu si ne ss ). Ass um in g a rg ue nd o t ha t M ary was en ga ge d i n s om e tr ad e o r bu si ne ss ap art fro m he r em pl oym en t, the cir cu m st an ces su rro un di ng th e Car pe nt er n ot e in di cat e th atitlac ke d apro xi m at e rel at io ns hi p t o s uc h b us in es s. A lo ss is de du ct ib le as a bu si ne ss ba d d eb t o nl y

if the tax pa y er i s i n abu si ne ss an d t he de btinqu es ti on is pr ox im at el y

rel at edto th atbu si ne ss . Uni te d S ta te s v . Gene res , 40 5 U.S. 9 3, 9 6 (1 97 2) ; Dag res v. Co m

m is si on er, 1 36 T.C. 26 3, 2 82 (20 11 ). To d et erm in e whe th
-- 15 -

[* 15 ] er a l os s i s p ro xi m at el y rel at edto th e ta xp ay er’s b us in es s, we ev al ua te he r do m in an t m ot iv e fo r m ak in g t he lo an . Gener es , 40 5 U.S. at10 3. InVian i v . Com is si on er, T.C. Mem o. 1 99 4- 47 1, 6 8 T.C.M . (CCH) 7 76 , we co ns id eredth e ta xp ay ers ’ do min an t m ot iv e in gu aran te ei ng ba nklo an s fo r th ei r so n’s fa rm . Alth ou gh th e ta xp ay ers were p rev io us ly farm ers th em se lv es , we fou nd th atth ei r do m in an t m ot iv at io n fo r ex te nd in g c red itwas a ffec ti on forth ei r so n a nd th e d es ire to see hi m

su ccee d i n fa rm in g. Vi an i, 6 8 T.C.M . (CCH) at78 6. We
no te d t ha t the tax pay ers “wou ldno t h av e ag reedto th e lo angu aran te es th atth ey un de rto okon be ha lf o f th ei r so n fo r an y on e el se .” Ib id . W e acc or di ng ly rule d t ha t th ey di d n otin cu r a b us in es s b adde btlo ss when , up on th ei r so n’s d efau lt , th ey pa idoff th e b an k p ur su an t t o t he ir g ua ran ty. Sev eral fact or s p oi nt in g t o t he no nb us in es s ch arac te r of th e d eb t i n Vi an i po in t t o t he same con cl us io n h ere. Mary ’s do m in an t m ot iv at io n fo r le nd in g m on ey to Mr. Car

pe nt er was pe rs on al , st emm in g fr om th ei r ro m an ti c rel at io ns hi p du rin g 2 00 4- 20 05 . She wou ldno t h av e le nt$4 30 ,50 0 t o a nyon e el se on co m pa rab le term s, an d s he infactm ad e n o l oa ns to an y on e el se . Befo re ad va nc in g fu nd s, sh e d idno t p erfo rm

a cred itch eckon Mr. Car pe nt er o r rev ie w fin an ci al in fo rm ati onrel ev an t t o h is ab il ity to rep ay . Andon e expl ic itpu rp os e o f th e lo anwas t o fundMr. Car

pe nt er’s p ers on al li vi ng ex pe ns es , in cl ud in g t he pu rch as e o f a Hu m -- 16 -

[* 16 ] m er. The se cir cu m st an ces pa in t the Carp en te r lo anas ape rs on al fav or rathe r th ananact iv ity

pro xi m at el y

co nn ect edwith apro fit -s eek in g b us in es s. Inanap paren t ef

fo rt t o p ortra y

a pe rs on al ba d d eb t as a bu si ne ss ba d d eb t, Mary co nt rib ut edth e Car

pe nt er n ot e to MBH i n Oct ob er 2 01 0, s ho rtl y be fo re d ecl ari ng th e n ot e worth le ss . The Ca rp en te r no te cle arl y was n ot“ acqui red* * * i n co nn ect io n wi th ” an y

tra de or b us in es s ca rri edon by MBH. See se c. 16 6( d) (2 )(A). Mary

tes ti fie d t ha t s he form edMBH as th e v eh ic le th ro ug h wh ic h sh e in te nd edto pro vi de advi so ry an d c on su lt in g s erv ic es aft er l eav in g B lo ck
bu st er’s em

pl oy. MBH h adno cu st om ers or c li en ts du rin g 2 01 0, an d i t en ga ge d i n no len di ng act iv it ie s o r othe r bu si ne ss du rin g t ha t year. Andev enif M BH were th ou gh t t o h av e co nduc te d atra de or b us in es s dur in g 2 01 0, the Carp en te r no te was no t p ro xi m at el y

rel at edto it . MBH was no t i n the de btco ll ect io n b us in es s, an d i t is hardto see ho w an a ss etth atMary all eg ed ly bel ie ve d t o b e worth le ss co ul d ha ve a pr ox im at e co nn ect io n t o h er fu tu re co ns ul ti ng bu si ne ss . Insu m , we fin d t ha t the Carp en te r no te was n ot“ crea te d o r acqui red* * * i n co nn ect io n wi th ” an y

tra de or b us in es s co nduc te d b y Mary or MB H andth atitwas no t “ a d eb t the lo ss fro m

th e worth le ss ne ss of wh ic h * * * [was ] in cu rred ” in an y tra de or b us in es s co nduc te d b y Mary or MB H. Sec. 16 6( d) (2 )(A) an d (B ). The- 17 -

[* 17 ] Carp en te r no te was the refo re a n onbu si ne ss ba d d eb t wh ic h, upo n b eco m in g worth le ss , wou ldge ne rat e o nl y a sh ort-t erm

cap it al lo ss . See s ec. 1 66 (d )(1 )(B)
. 2. W orth le ss ne ss Duri ng 20 10 Sect io n 1 66 (a)( 1) all ows a de du ct io n fo r a b us in es s b adde btlo ss on ly if th e de bt“be co m es [who ll y ] worth le ss withi n t he tax ab le y ear.” Even if the Carp en te r no te were a b us in es s d eb t, p et it io ne rs di d n otcarry th ei r bu rd enof p ro vi ng th atth e no te was wh ol ly w orth le ss as o f Decem be r 31 , 20 10 . For t hi s re as on as we ll , th ey were n oten ti tl edto eit he r anord in ary ora cap it al lo ss de du ct io n fo r 20 10 on acco un t o f th e Car

pe nt er n ot e. 3 The y ear i n wh ic h ade btbe co m es wort hl es s i s fi xe d b y id en ti fiabl e ev en ts th atm ak e itreas on ab le forth e le nd er t o aba nd on an y ho pe of r eco ve ry . Cro wn v . Co m m is si on er, 7 7 T.C. 5 82 , 59 8 (1 98 1) . W orth le ss ne ss ina pa rti cu la r y ear i s a qu es ti on of f

actth atm us t b e d et erm in edby “ anex am in at io n o f al l the cir cu m st an ces .” Dall m ey er v . Comm is si on er, 1 4 T.C. 1 28 2, 1 29 1 (1 95 0) . There is no st an da rdtes t o r fo rm

ul a fo r de te rm in in g wo rth le ss ne ss ; re le va ntfact s i nc lu de th e de bt or ’s so lv en cy

an d the len de r’s co ll ect io n e ffo rts . See Lu cas v. Am . Cod e Co ., If the Carp en te r no te ha d b eco m e worth le ss du rin g 2 01 0, p et it io ne rs ’ cap i- 3 ta l l os s wo ul d b e li mit edto th e unp ai d p rin ci pa l, o r $4 30 ,50 0. A b adde btde du cti onon acco un t o f acc ru edin te res t ($ 17 0,3 47 inth is cas e) wo ul d b e al lo wedon ly if t ha t i nt eres t h adpre vi ou sl y be en“ returne d a s i nc om e.” Sec . 1.1 66 -6 (a)( 2) , In co m e Tax Reg s.- 18 -

[* 18 ] 28 0 U.S. 4 45 , 44 9 (1 93 0) ; As to n v . Comm is si on er, 1 09 T.C. 40 0, 4 15 (1 99 7) ; s ec. 1 .16 6- 2( a), In co m e Tax Reg s. Th e ta xp ay er m us t es tabl is h o bjec ti ve fact s fr om

whi chwort hl es sn es s ca n b e d et erm in ed ; m ere b el ie f of wort hl es sn es s i s in su ffi ci en t. Fo x v . Comm is si on er, 5 0 T.C. 8 13 , 82 2- 82 3 (1 96 8) , aff’d p er cu ria m , 70 -1 U.S. Tax Ca s. (C CH) p ara. 9 37 3 (9 th Cir . 19 70 ). On the reco rdbe fo re u s, we co nc lu de th atth e Car pe nt er n ot e was no t wh ol
ly w orth le ss as o f Decem be r 31 , 20 10 . As anid en ti fiabl e ev en t es tabl is hi ng th e no te ’s worthl es sn es s, p et it io ne rs po in t t o t he Decem be r 20 10 em ai l i n wh ic h M r. Carp en te r st at ed : “ I have no m on ey .” Bu t p et it io ne rs ’ subs eque ntact io ns sh ow th atth ey ha d n otab an do ne d re as on ab le ho pe of r eco ve ry . InFeb ru ary 20 11 pe ti ti on ers co m m en cedli ti ga ti on ag ai ns t M r. Carp en te r to en fo rce r ep aym en t o f th e Car pe nt er n ot e, an d t he y

sec ur eda $5 73 ,17 5 ju dg m en t th e n ex t year. Duri ng 20 12 th ey serve d p os t-ju dg m en t d is co ve ry on Mr. Car

pe nt er in aneffo rt t o c ol le cton th is jud gm en t, al le gi ng th athe ha d s ub st an ti al m on th ly in co m e an d une xp la in edba nkde po si ts . They co nt in ue d n eg ot ia ti on s wi th Mr. Carp en te r th ro ug h l at e 2 01 2 i n a n e ffo rt t o re co ve r atlea stso m e p orti on of the de bt . Giv enpe ti ti on ers ’ ex te ns iv e b us in es s an d fi na nc e b ack gr ou nd s, i t i s i m pl au si bl e th atth ey

wou ldha ve ke ptth ro win g g oo d m on ey aft er b adif the y

ge nu in el y be li ev edth e Car

pe nt er n ot e h adbe co m e who ll y wort hl es s two years p rev io us ly.- 19 -

[* 19 ] B. Ren ta l Re al Est at e Los s Pet it io ne rs for20 10 in cu rreda ren ta l re al est at e lo ss of $ 21 ,62 5 o n t he Ani ta pr op erty . Sect io n 4 69 (a) g en eral ly dis al lo ws a d educ ti on fora “pa ss iv e act iv it y lo ss ” in cu rredby an in di vi du al . Sect io n 4 69 (c) d efi ne s “pa ss iv e act iv it y ” to in
cl ud e act iv ity

in vo lv in g atra de or b us in es s i n wh ic h t he tax pa y er d oe s n ot“ m at eria ll y pa rti ci pa te ” an d “ an y

ren ta l ac ti vi ty” rega rd le ss of wh ethe r th e ta xp ay er m ate ria ll y parti ci pa te s. Sec . 46 9( c)(1 ), (2 ), (4 ). Sect io n 4 69 (i) all ows anin di vi du al who act iv el y pa rti ci pa te s i n aren ta l re al
es ta te act iv ity

to de du ctag ai ns t o rd in ary in co m e up t o $ 25 ,00 0 o f lo ss es fro m th e act iv ity , bu t o nl y

if h is AGI is les s tha n $ 15 0,0 00 . Sec. 4 69 (i) (1 ) an d (2 ); s ee s ec. 46 9( i)( 3) (pr ov id in g fo r gr adua l p ha se ou t o f de du ct io n o nc e AGI ex ceed s $1 00 ,00 0) . Relyin g o n the se pro vi si on s, p et it io ne rs on th ei r 20 10 return c la im eda $2 1,6 25 lo ss de du ct io n fr om th e Ani tapro pe rty, tak in g the po si ti on th atBrad le y act iv el y pa rti ci pa te d i n m an ag in g t he pro pe rty andth atth ei r AGI (o win g t o t he lo ss on th e Car

pe nt er n ot e) was zero . Upo n d is al lo win g t he ba d d eb t l os s de du ct io n, the IRS l ik ewis e d is al lo wedpe ti ti on ers ’ cl ai m edSch edul e E lo ss de du ct io n, d et erm in in g t ha t the ir AGI ex ceed ed$1 50 ,00 0 andhe nc e th atth ei r de du ct io n fo r pa ss iv e rea l es tate lo ss es ha d b eenco m pl et el y ph as edou t. See sec . 46 9( i)( 3)
.- 20 -

[* 20 ] Ass um in g a rg ue nd o t ha t n o d educ ti on is av ai labl e und er s ect io n 4 69 (i) , pe ti ti on ers co nt en d i n t he alt ern at iv e th atBrad le y was areal est at e p ro fes si on al
-- th atis , a tax pa y er i n a“ real pro pe rty bu si ne ss ” withi n t he m ean in g o f se ct io n 46 9( c)(7 ). Thatsec ti on pro vi de s tha t the ren ta l re al est at e act iv it ie s o f a rea l es ta te pr of es si on al are n otpe r se pa ss iv e. Sec. 4 69 (c)( 7) (A); see Kos on env. Co m m is
si on er, T.C. Mem o. 2 00 0- 10 7, 7 9 T.C.M . (CCH) 1 76 5; sec . 1.4 69 -9 (b )(6 ), (c)( 1) , In co m e Tax Reg s. If areal est at e p ro fes si on al m at eri al ly part ic ip at es ina ren ta l real est at e act iv ity , th atact iv ity is tre at edas n onpa ss iv e an d t he sec ti on 46 9( a) di sa ll owa nc e d oe s n otap pl y . See Sh ie kh v. Co m m is si on er, T.C. Mem o. 2 01 0- 12 6; Fo wlerv. Co m

m is si on er, T.C. Mem o. 2 00 2- 22 3; sec . 1.4 69 -9 (e)( 1) , Inc om e Tax Reg s. To qua li fy

as areal est at e p ro fes si on al , a tax pa y er m us t (a m on g o th er th in gs ) “pe rfo rm [] m or e th an75 0 h ou rs of s erv ic es durin g t he tax ab le y ear i n re al pr op erty tra de s o r bu si ne ss es inwhi ch* * * [h e] m at eri al ly part ic ip at es .” Sec. 46 9( c)(7 )(B) (ii ). Fortax pa y ers fil in g ajoi ntreturn, o nl y on e sp ou se ne edqu al ify
un de r th is rul e. Sec. 4 69 (c)( 2) . A “real pro pe rty trad e o r bu si ne ss ” m ean s “ an y real pro pe rty dev el op m en t, re de ve lo pm en t, co ns tru ct io n, re co ns tru ct io n, ac qu is iti on , con ve rs io n, re nt al , op erat io n, m an ag em en t, l eas in g, o r br ok erag e tr ad e o r bu si ne ss .” Sec. 4 69 (c)( 7) (C). A ta xp ay er m ay subs ta nt ia te th e requi red75 0 h ou rs- 21 -

[* 21 ] of p art ic ip at io n b y

an y reas on ab le m ean s, b uta m ere “ ba ll pa rkgu es st im at e” wil l n otsu ffi ce. Mo ss v. Co m mis si on er, 1 35 T.C. 36 5, 3 69 (20 10 ); s ec. 1 .46 9- 5T(f )(4 ), Tem po rary Inco m e Tax Reg s., 5 3 F ed . Reg . 57 27 (Feb . 25 , 19 88 ). Altho ug h B rad le y

act iv el y pa rti ci pa te d i n m an ag in g t he Ani tapro pe rty and ha d p rev io us ly orig in at edreal est at e lo an s, we fi ndth atfor20 10 he di d n otqu al ify
as a real est at e p ro fes si on al . He di d n otori gi na te any real est at e lo an s dur in g 20 10 , andpe ti ti on ers m ai nt ai ne d n o d oc um en ta ti on of t he ti m e th ey de vo te d t o t he Ani tapro pe rty. Bradl ey

cred ib ly test ifi edth athe de vo te d 1 0 t o 1 5 h ou rs pe r week to th e p ro pe rty durin g the fir stha lf o f 20 10 an d 1 0 h ou rs pe r m on th du rin g t he
se co ndha lf. Th is tes ti m on y in di cat es th athe pe rfo rm edat m os t 4 50 ho ur s o f se rvi ces inreal pro pe rty bu si ne ss es du rin g 2 01 0. Be cau se th is is sh ort o f th e 7 50 ho ur s re qu ire d, Br ad le y

was n ota real est at e p ro fes si on al du rin g 2 01 0 a ndpe ti
ti on ers were n oteli gi bl e to de du ctth ei r $2 1,6 24 ren ta l re al est at e lo ss . 4
Pet it io ne rs co nt en d tha t Br ad le y was areal est at e p ro fes si on al be cau se he 4 ha d e xt en si ve ex pe rie nc e o rig in at in g re al est at e lo an s b efo re 2 01 0. Fo r pu rp os es of de du ct in g p as si ve lo ss es , ho wev er, the Co de de fin es a real est at e p ro fes si on al , no t b y refe ren ce t o h is sk il l s etor e xp eri en ce, b utby referen ce (a m on g o th er th in gs ) to hi s “ ho ur s o f se rv ic es du rin g t he tax ab le y ear i n re al pro pe rty trad es or bu si ne ss es .” Sec. 4 69 (c)( 7) (B)( ii ). Brad le y ’s sk il ls inori gi na ti ng real est at e lo an s, an d t he ho ur s h e d ev ot edto lo anori gi na ti on inpri or y ears , are thu s irr el ev an t t o t he in qu iry tha t we m us t p erfo rm . Becau se we fin d t ha t Br ad le y di d no t m eetth e 7 50 ho ur s re qu ire m en t, we n eedno t co ns id er wh ethe r hi s p rio r lo an or ig in at io n a ct iv ity

wou ldco ns ti tu te a “ real pro pe rty trad e o r bu si ne ss .”- 22 -

[* 22 ] C. Accu racy-Rel at edPen al ty The Co de im

po se s a 2 0% p en al ty upo n t he po rti on of a ny un de rp aym en t o f in co m e ta x t ha t i s at tri bu tabl e (am on g o th er thi ng s) to “ ne gl ig en ce” o r an y “ subst an ti al un de rs ta te m en t o f in co m e ta x.” Sec. 6 66 2( a) an d (b )(1 ) an d (2 ). “ Neg li
ge nc e” i s d efi ne d a s “ an y fai lu re t o m ak e a rea so nabl e at te m ptto co m pl y ” wit h t he pr ov is io ns of t he Co de . An und ers ta te m en t o f in co m e ta x i s “ subs ta nt ia l” if i t ex ceed s the gre at er o f $5 ,00 0 o r 10 % of the tax requi redto be sh own on th e return. Sec. 6 66 2( d) (1 )(A). Inth e cas e o f anNOL carry ba ck , th e p en al ty for n eg li ge nc e ap pl ie s t o a ny po rti onof a n u nd erp aym en t fo r th e carry ba cky ear t ha t i s at tri bu tabl e to ne gl ige nc e inth e y ear i n wh ic h t he NOL aros e (l os s year). Sec. 1 .66 62 -3 (d )(1 ), In co m e Tax Reg s. Si m il arl y , th e subs ta nt ia l u nd ers ta te m en t p en al ty app li es to an y po rti on of anun de rp aym en t i n t he carry ba cky ear tha t i s at tri bu tabl e to a “ ta in te d i te m ” in th e lo ss y ear. Se c. 1.6 66 2- 4( c)(1 ), In co m e Tax Reg s. Th e d et erm in at io n o f whe
th er an un de rs ta te m en t i s “ subs ta nt ia l” fora carry ba ck y ear i s m ad e wit h re sp ectto th e return fo r th aty ear. Ib id . A “ta in te d i te m ” is an y it em forwhi chth ere i s n ei
th er s ub st an ti al au th or ity no r ad equa te di sc lo su re wi th res pe ctto th e lo ss y ear. Id
. subp ara. (3 )(i ).- 23 -

[* 23 ] Und er s ect io n 7 49 1( c) the Co m m is si on er b ears th e b ur de n o f pr oduc ti on with re sp ectto th e li ab il ity of a n i nd iv idua l fo r an y

pe na lt y . See Hig be e v . Com
m is si on er, 1 16 T.C. 43 8, 4 46 (20 01 ). Res po nd en t m ethi s b ur de n b y sh owi ng th at pe ti ti on ers were n oten ti tl edto th e $ 60 0,8 47 ba d d eb t d educ ti oncla im edon th ei r 20 10 return o r to th e $ 33 0,2 39 NOL deduc ti on cla im edon Mary’ s 2 00 8 re tu rn . The un de rs ta te m en ts of i nc om e ta x a tt rib ut ab le to th os e im pr op er d educ ti on s ex ceedbo th $5 ,00 0 a nd10 % of t he tax requi redto be sh own on each return. Th e bu rd enth us sh ift s t o p et it io ne rs to pro ve th atth e p en al ty doe s n otap pl y . See i d. at 44 7. Sect io n 6 66 4( c)(1 ) pr ov id es th atth e acc ur acy-rela te d p en al ty sha ll no t b e im po se d wi th res pe ctto an y po rti on of a n u nd erp aym en t “ if i t i s s ho wn tha t the re was a reas on ab le cau se forsu chpo rti on an d t ha t the tax pay er ac te d i n g oo d fa it h” with re sp ectto it . The d eci si on as t o wh ethe r th e ta xp ay er ac te d wi th reas on ab le
cau se an d i n g oo d fa ith i s m ad e o n acas e-b y -cas e b as is , tak in g i nt o a cco un t al l pe rti ne ntfact s an d c irc um st an ces . See s ec. 1 .66 64 -4 (b )(1 ), In co m e Tax Reg s. Gen eral ly, th e m os t i m

po rta ntfact orinde te rm in in g t he ex is te nc e o f rea so nabl e cau se is th e ta xp ay er’s eff ort t o a sc ert ai n h er co rrec t t ax li ab il it y . Circ um st an ces th atm ay si gn al reas on ab le cau se an d g oo d fa it h “ in cl ud e anho ne stm is un de rst an di ng of f

actor l aw th atis reas on ab le inli gh t o f al l the fact s an d c irc um -- 24 -

[* 24 ] st an ces , in cl ud in g t he ex pe rie nc e, kn owl ed ge , andeduc at io n o f th e ta xp ay er.” Ib id
. Mary was aso ph is ti cat edfin an ci al pro fes si on al with a n M .B.A. inco rp or at e fin an ce. Sh e p rep aredhe r in di vi du al return fo r 20 08 an d p et it io ne rs ’ joi ntreturn fo r 20 10 . She tes ti fie d tha t s he rel ie d p rin ci pa ll y on IRS Publ ic at io n 5 35 , Bus ine ss Exp en se s, t o d et erm in e th atth e Car pe nt er n ot e was a bu si ne ss ba d d eb t tha t ha d b eco m e worth le ss du rin g 2 01 0. Publ ic at io n 5 35 no te s tha t “ a b us in es s b ad de btis on e th atco m es fro m op erat in g your tr ad e o r bu si ne ss .” It c au ti on s t ax pa y ers ab ou t the di sp arat e tr eat m en t o f bu si ne ss an d n onbu si ne ss ba d d eb ts , di rect in g th em to Publ ic at io n 5 50 , Inv es tm en t In co m e an d Ex pe ns es , forin st ru ct io ns reg ard
in g t he lat te r. Whi le tes ti fy in g t ha t s he ho pe d t o p ro fitby len di ng to Mr. Car pe nt er, Ma ry di d n otex pl ai n wh y

sh e b el ie ve d t ha t the Carp en te r no te was abu si ne ss de bt . Her actof c on tri bu ti ng th atno te to MBH i n Oct ob er 2 01 0 s ug ge st s tha t s he actua ll y he ldth e o pp os it e b el ie f. MBH was a ne wly crea te d e nt it y th atMary form edas a ve hi cl e fo r ren de rin g fu tu re co ns ul ti ng servi ces . She off eredno pl au si bl e b us in es s reas onforco nt rib ut in g t o M BH, as it s o nl y ass et , a fo rm er b oyfrien d’s p ro m is so ry no te th atsh e b el ie ve d t o b e worth le ss . The Co urt i nf ers th athe r actua l re as on for- 25 -

[* 25 ] m ak in g t hi s co nt rib ut io n was to pu t the Carp en te r no te in to a “bu si ne ss ” to
en ha nc e th e ap pe aran ce tha t i t was bu si ne ss rel at ed
. Inan y ev en t, p et it io ne rs ’ ov eral l co nduc t d oe s n otsh ow tha t the y m ad e a go od -fai th effo rt t o d et erm in e th ei r co rrec t t ax li ab il it y with re sp ectto th e Car

pe nte r no te . The b adde btlo ss de du ct io n t he y cla im edin cl ud ed$1 70 ,34 7 o f acc ru ed in te res t. Publ ic at io n 5 35 , up onwhi chMary sai d s he rel ie d, ex pl ic it ly info rm s t ax pa y ers th atth ey

cancla im

a bu si ne ss ba d d eb t d educ ti onforin te res t “ on ly if th e am ou ntowedto y ouwas p rev io us ly inc lu de d i n g ro ss in co m e.” Ma ry pre pa redall rel ev an t t ax returns , andsh e kne w or s ho ul d h av e kno wn tha t n o i nt eres t fr om th e Carp en te r no te was e ve r in cl ud edinhe r gr os s i nc om e. Publ ic at io n 5 35 als o m ak es cle ar tha t a d eb t b eco m es wort hl es s o nl y when th ere i s n o l on ge r an y

ch an ce i t wi ll be rep ai d. Pe ti ti on ers were ac ti ve ly pur su in g co ll ect io n re m ed ie s ag ai ns t M r. Carp en te r aft er Dece m be r 31 , 20 10 , in cl ud in g li ti ga ti on th aty ie ld edth em a $5 73 ,17 5 ju dg m en t i n 2 01 2. Th ey were s ti ll pu rs uin g c ol le ct io n fr om

Mr. Car pe nt er i n l at e 2 01 2 i n a n e ffo rt t o s ecu re atlea stpa rti al rep aym en t o f th e Car

pe nt er n ot e. Thes e fac ts sh ow tha t p et it io ne rs di d n otreg ard th e n ot e as to ta ll y

wort hl es s atth e cl os e o f th e 2 01 0 t ax y ear. W e fi ndth atpe ti ti on ers di d n otactwith re as on ab le cau se an d g oo d fa it h i n cl ai min g abu si ne ss ba d d eb t l os s d educ ti on forth e Car pe nt er n ot e o n t he ir 2 01 0- 26 -

[* 26 ] joi ntreturn andth atth ey are l iabl e fo r th e acc ur acy-rela te d p en al ty w it h
res pe ctto th e p orti on of t he un de rp aym en t at tri bu tabl e to di sa ll owa nc e o f th at de du ct io n. We con cl ud e th atpe ti ti on ers are al so li ab le forth e acc ur acy-rela te d pe na lty onth e p orti on of t he 20 10 un de rp aym en t at tri bu tabl e to Brad le y ’s
un rep orte d i nc om e o f $3 ,60 0 a ndpe ti ti on ers ’ un subs ta nt ia te d S ch edul e C d educ ti on s o f $6 8,5 58 . See s up ra p . 2 an d n ot e 2 . Andbe cau se th e und erp aym en t fo r 20 08 was a ttrib ut ab le to ne gl ig en ce wi th res pe ctto a “ ta in te d i te m ” in 20 10 , see se c. 1.6 66 2- 4( c)(1 ), (3 )(i ), In co m e Tax Reg s., Ma ry is li ab le foranaccu racyrel at edpe na lty

with re sp ectto th e NOL carrybackto th aty ear. Fo r 20 10 we reac h t he op po si te co nc lu si on with re sp ectto th e Sch edul e E lo ss of $ 21 ,62 5 andth e ad di ti on al sel f-em pl oym en t t ax . See s up ra p . 2 & n ot e 2
. Brad le y act iv el y pa rti ci pa te d i n m an ag in g t he Ani tapro pe rty, andsec ti on46 9( i)
en ti tl edpe ti ti on ers to a real est at e lo ss de du ct io n o f up to $2 5,0 00 on th e b as is of th ei r AGI as rep orte d o n t he ir r eturn. Th e d is al lo wan ce o f th e Sch edul e E lo ss de du ct io n, as well as t he ad di ti on al sel f-em pl oym en t t ax , aro se au to m at ic al ly from di sa ll owa nc e o f th e b adde btlo ss de du ct io n, wh ic h i nc reas edth ei r AGI subs ta nti al ly. Our re vi ew of

th e te st im on y

an d re co rdas awho le co nv in ces us th at 5 The di sa ll owanc e o f th e Sch edul e E lo ss de du ct io n andth e ad di ti on al sel f- 5 em pl oym en t t ax are n ot“ ta in te d i te m s” forpu rp os es of c al cu la ti ng th e subs ta nt ia l (co nt in ue d...)- 27 -

[* 27 ] pe ti ti on ers act edwith re as on ab le cau se an d i n g oo d fa it h wi th res pe ctto th es e two it em s. Acco rd in gl y , th ey are n otli ab le forth e acc ur acy-rela te d p en al ty on th e p orti on of t he 20 10 un de rp aym en t at tri bu tabl e th eret o. To re fle ctth e fo reg oi ng an d t he co nc es si on s o f th e p art ie s, Deci si on s wi ll be en te redun de r Ru le 15 5.

(...co nt inue d) 5 un de rs ta te m en t p en al ty. The “ ta in te d i te m s” rul e ap pl ie s o nl y to subs ta nt ia l un de rs ta te m en ts of i nc om e ta x t ha t ar e at tri bu tabl e to NOL carry ba ck s. See sec . 1.6 66 2- 4( c)(1 ), In co m e Tax Reg s.