TAX COURT OPINION

Case: Kevin M. Wagner & Lauren H. Wagner
Docket Number: 3285-17
Judge: Toro
Opinion Type: bench
Filed: 11/16/2020
Pages: 37

UNITED STATES TAX COURT WASHINGToN, DC 20217 DRC KEVIN M. WAGNER & LAUREN H. WAGNER, Petitioners, v. ) ) ) ) ) Docket No. 3285-17. COMMISSIONER OF INTERNAL REVENUE, Respondent ) ) ) ORDER Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it is hereby ORDERED that the Clerk of the Court shall transmit herewith to petitioners and to respondent a copy of the pages of the transcript of the trial in the above case before Judge Emin Toro, at Richmond, Virginia (remote proceeding), on October 2, 2020, containing his Oral Findings of Fact and Opinion rendered at the remote trial session at which the case was heard. In accordance with the Oral Findings of Fact and Opinion, a decision will be entered for petitioners. Dated: Washington, D.C. November 16, 2020 (Signed) Emin Toro Judge SERVED Nov 16 2020 RECEIVED 11/2/20 IN THE UNITED STATES TAX COURT DRC In the Matter of: ) KEVIN M. WAGNER & LAUREN H. WAGNER ) Docket No. 3285-17 ) Petitioners, v. COMM1ss IONER OF INTERNAL REVENUE, Respondent. ) ) ) ) Pages: 1 through 35 Place: Richmond, Virginia (Remote Proceeding) Date: October 2, 2020 IN THE UNITED STATES TAX COURT In the Matter of: ) KEVIN M. WAGNER & LAUREN H. WAGNER, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. ) Docket No. 3285-17 ) ) ) ) ) ) ) ) ) Old Post Office Building Tween Courtroom, Room 414D 10th and Main Streets Richmond, VA 23219 (Remote Proceeding) October 2, 2020 The above-entitled matter came on for bench opinion, pursuant to notice at 3:00 p.m. BEFORE: HONORABLE EMIN TORO Judge APPEARANCES : For the Petitioners: No Appearance For the Respondent: No Appearance 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 P R O C E E D I N G S 2 (3:00 p.m.) THE CLERK: Calling from the calendar docket number 3285-17, Kevin M. Wagner and Lauren H. Wagner. (Whereupon, a bench opinion was rendered.) 1 2 3 4 5 6 8 10 11 12 13 14 15 16 18 20 21 22 23 24 25 3 1 2 3 4 5 6 7 8 9 Bench Opinion by Judge Emin Toro October 2, 2020 Kevin M. Wagner & Lauren H. Wagner v. Commissioner Docket No. 3285-17 THE COURT: THE COURT HAS DECIDED TO RENDER ORAL FINDINGS OF EACT AND OPINION IN THIS CASE AND THE FOLLOWING REPRESENTS THE COURT'S ORAL FINDINGS OF FACT AND OPINION. THE ORAL FINDINGS OF FACT AND OPINION SHALL NOT BE RELIED UPON AS PRECEDENT IN ANY OTHER CASE. 10 This Bench Opinion is made pursuant to the 11 authority granted by section 7459(b) of the Internal 12 Revenue Code of 1986, as amended (the "Code"), and Rule 13 14 152 of the Tax Court Rules of Practice and Procedure. By a statutory notice of deficiency dated 15 November 16, 2016, the Commissioner of Internal Revenue 16 determined deficiencies in the Federal income tax of 17 Petitioners Kevin M. Wagner and Lauren H. Wagner totaling 18 19 $15,211 and $11,610 for tax years 2013 and 2014, respectively, along with accuracy-related penalties 20 totaling $5,364 under section 6662(a) of the ode. The 21 Commissioner has since conceded that Mr. and Mrs. Wagner 22 23 are not liable for the accuracy-related penalties. The sole issue for decision in this case is 24 whether, during the 2013 and 2014 tax years, Mr. and Mrs. 25 Wagner's kart racing activity was an activity "not engaged 1 2 3 in for profit" under Code section 183, so that expenses incurred in connection with that activity are subject to the limitations of that section. We find that the 4 Wagners' kart racing activity was an activity engaged in 5 6 7 8 9 for profit during the 2013 and 2014 tax years, and we therefore hold that the related expenses are not subject to the limitations of section 183. Findings of Fact Some of the facts have been stipulated and are 4 ! 10 so found. The parties' joint first stipulation of facts, 11 12 joint first supplemental stipulation of facts, and all attached exhibits are incorporated herein by this 13 reference. Trial of this case was held during the Court's 14 15 16 remote trial session for Richmond, Virginia, on September 29, 2020. At the time they filed their petition, Mr. and 17 Mrs. Wagner resided in Virginia. Mr. and Mrs. Wagner 18 filed Form 1040, u.S. 1ndividual 1ncome Tax aeturn, for 19 the 2013 and 2014 tax years. 20 Education and Background 21 Mr. and Mrs. Wagner are both college graduates. 22 Mrs. Wagner graduated with a degree in Education and was 23 employed as a teacher before becoming a homemaker. Mr. 24 Wagner graduated with a major in Business Management and a 25 minor in Marketing. After college, Mr. Wagner worked as a 5 manager for several businesses, supervising up to 50 employees. During the years at issue, Mr. Wagner was an information technology ("IT") architect in the health care space. He currently assists state Medicaid agencies with cost savings measures and helps improve access to health care for Medicaid recipients. Mr. Wagner has more than 20 years of experience in the IT field. During 2013 and 2014, Mr. Wagner earned W-2 wages of $151,792 and $179,387, respectively. The Wagner family had no other 1 2 3 4 5 6 7 8 9 10 material sources of income for those years. 11 Wagner Family Racing 12 The Wagner family has a long history in racing. 13 Both Mr. and Mrs. Wagner participated in local kart and 14 15 stock car racing events for approximately 11 years before their two children were born. Mr. Wagner had some success 16 at the local level, securing sponsorships and winning 17 18 races in both pure stock and late-model stock cars. The Wagners' eldest son, Gresham, was born in 19 1997, and their youngest son, Christian, was born in 2001. 20 The Wagners stopped racing in 2001 when Christian was 21 born. Until 2001, the Wagners viewed their racing 22 activity purely as a hobby in which they did not engage 23 for profit. 24 Gresham Wagner Racing 25 1. Establishment and Early Years Gresham Wagner began kart racing in 2003 at 6 about age 6 and quickly attracted the attention of the karting world. In 2006, Gresham joined MRP Motorsports, a racing team based in Indiana. Gresham gained his first national podium in 2007. In 2008, at age 10, Gresham was the vice-champion for the Cadet K80 class in the STARS of Karting EAST series and he also earned an opportunity to compete in the European BRDC Stars of Tomorrow Championship in England. 1 2 3 4 5 6 7 8 9 10 Encouraged by Gresham's performance, Mr. and 11 Mrs. Wagner established Gresham Wagner Racing ("GWR") in 12 13 2008. The Wagners believed, based on Gresham's race results and feedback from industry professionals, that 14 Gresham' s talent was sufficient to propel GWR to 15 Profitability over the long term. Mr. Wagner compared 16 these indicators with his own experience in racing. Mr. 17 Wagner understood his own limitations as a racer. By 18 contrast, the Wagners thought Gresham was on a trajectory 19 20 to become a professional racecar driver. To establish GWR, the Wagners opened a bank 21 account, obtained a Federal employer identification number 22 23 ("EIN") , and reported gross receipts and expenses each year on their Federal income tax return, Schedule C, 24 Profit or Loss From Business. They also created a website 25 at "greshamwagnerracing . com" to promote Gresham' s 1 2 3 4 5 abilities and to document his racing record. The website -- which is no longer active -- listed Gresham's race appearances and his finishing position in each event. Mr. and Mrs. Wagner kept invoices and receipts related to GWR, and Mr. Wagner created a spreadsheet of expenses, 7 6 mileage logs, and travel logs to use each year when 7 8 9 preparing the couple's tax returns. Mr. Wagner also Prepared a spreadsheet that reflected GWR's gross receipts, although that portion of the spreadsheet was not 10 included in the record. 11 12 After GWR's formation in 2008, Gresham continued to compete successfully in karting races. In 2009, 13 Gresham was the vice-champion for the Cadet K80 class in 14 the WSK North American series. In 2010, Gresham was the 15 national champion for the Cadet K80 class and the Yamaha 16 KT100 class in the WKA series. Gresham was also the vice- 17 18 19 champion for the IANE Komet Piston Port class in the WKA series. Around 2011, at about age 13, Gresham joined a new racing team, KartSport North America, headquartered in 20 Mooresville North Carolina. This new team allowed 21 Gresham to build connections with professional drivers and 22 23 demonstrate his abilities within premier divisions of the racing community. Gresham did not win any national 24 championships or vice championships in 2011 or 2012, but 25 he continued to have success at the local level. Between 2008 and 2014, Gresham had 49 local kart-racing wins. 2013, Gresham was the vice-champion in the IAME MYO9 Leopard class in the USPKS series. In the same year, Gresham won the Robopong 200 support race in the Yamaha 8 In KT100 class, earning a purse of $3,250. 2. Business Plan for 2013 and 2014 The Wagners did not have a written business plan or formal budget for GWR. However, based on the Wagners' experience in kart and stock car racing, the Wagners 1 2 3 4 5 6 7 8 9 10 understood the costs and demands of maintaining a racing 11 business and structured their affairs accordingly. They 12 13 14 15 expected the initial five to ten years of the business to generate losses, but anticipated profits that would exceed those losses once Gresham achieved success at a more senior level. Although the Wagners did not have a formal 16 budget, they did track their expenses for every race and 17 estimated their budget generally based on their 18 anticipated event schedule. 19 During the years at issue, the Wagners' plan was 20 to pursue an industry model known as the Mazda Motorsports 21 22 Ladder Program, which was sponsored by Mazda Motorsports. The program set out a tiered progression of race series 23 for drivers to transition from karts to cars over a period 24 of years, with two primary options: the open wheel racing 25 ladder (known as the "Mazda Road to Indy") and the sports 1 2 3 4 5 6 7 8 9 car racing ladder (known as the "Mazda Road to 24"). The Wagners planned to transition from karting to sports car racing by pursuing the Mazda Road to 24. The first step in the Mazda Road to 24 was the Battery Tender Mazda MX-5 Cup. The MX-5 Cup featured a series of 12 races with a purse of $3,750 for the first- place finisher in each race, and smaller purses for second- to fifth-place finishers. In exchange for race entry fees, drivers received the right to compete, as well 10 as access to on-site assistance from marketing, 11 operations, and technical professionals who provide 12 technical support, conduct technical inspections, 13 coordinate race operations, and deliver PR and marketing 14 support. Entrants also received assistance from 15 Professional engineers, driver coaches, data experts, and 16 crew. 17 18 The series champion for the MX-5 Cup would receive a $200,000 scholarship to progress to the next 19 step in the ladder, which consisted of the Continental 20 Tire SportsCar Challenge and the Cooper Tires Prototype 21 Lites. Each of these series featured 10 races, and each 22 race had significantly larger purses -- first-place 23 finishers received purses ranging from $11,000 to $15,000 24 for each race. Like the MX-5 Cup, these series also 25 Provided scholarships of $100,000 to $200,000 for series 10 champions, in addition to contingency payouts. The final step in the Mazda Road to 24 was the weatherTech Sports Car Championship, a 12-race series featuring high-profile events such as the Rolex 24 at Daytona and Petit Le Mans. Across all classes of racers, Purses for these events ranged from $20,000 to $100,000 for first-place finishers and smaller amounts were available for second to fifth place finishers in each race. At the end of the WeatherTech Sports Car 1 2 3 4 5 6 7 8 9 10 Championship series, purses ranging from $10,000 to 11 $75,000 would be provided to the overall first- to tenth- 12 place finishers, and certain additional payouts might be 13 available. 14 Separate from the Mazda Road to 24, the Wagners 15 Planned that Gresham would enter kart races at the senior 16 level during 2013 and 2014. In prior years, Gresham had 17 18 raced only at the junior level, where drivers competed for trophies, gift cards, and championship points that 19 enhanced their standing in the racing community. At the 20 senior level, cash purses were available. Considering 21 both the MX-5 Cup and kart racing events, the Wagners 22 anticipated that Gresham would have the opportunity to 23 race for purses totaling roughly $85,600 in 2014, a 24 scholarship in the amount of $200,000, and access to 25 additional higher-profile racing opportunities in the 1 2 3 4 5 6 7 8 9 10 11 future. Other opportunities, such as the Teen Mazda Challenge, were available to Gresham in 2012 and 2013, but the Wagners determined that the Mazda Road to 24 provided a greater opportunity for profit. In 2012, the Teen Mazda Challenge was a first-year, "exploratory program," and would have required GWR to purchase a car for roughly $40,000. Additionally, the Teen Mazda Challenge required Gresham to enter into 10 to 18 additional races since it initially was separate from the Mazda Road to 24, and the Teen Mazda Challenge series champion was not guaranteed 12 entry into the Mazda Shootout, where larger purses and 13 scholarships were available. In Mr. Wagner's view, 14 Gresham's participation in the Teen Mazda Challenge would 15 have required an additional investment of $100,000, with a 16 low probability for profit. 17 18 By contrast, the Mazda Road to 24 was advertised to drivers as the "best value in sports car racing." 19 Participating in the Mazda Road to 24 also would have 20 21 required the purchase or rental of additional equipment: a car that at the time was retailing new for $45,000. 22 However, the Mazda Road to 24 included purses for each 23 event and large scholarship opportunities for series 24 25 champions at all levels. Accordingly, the Wagners decided to continue pursuing the Mazda Road to 24 and did not pursue the Teen Mazda Challenge in 2013 or 2014. 12 3. Activities During 2013 and 2014 During 2013 and 2014, in addition to his full- time job, Mr. Wagner spent at least 20 hours per week engaging in activities related to GWR. Mr. Wagner's work related to GWR included upkeep and maintenance to the kart, travel for testing and individual coaching sessions, and travel for races. The Wagners traveled to approximately 20 racing 1 2 3 4 5 6 7 8 9 10 events in 2013. In 2014, GWR's planned schedule was 11 interrupted when Gresham unexpectedly required surgery as 12 13 described below. The trips to events often lasted several days. 14 More often than not, the whole family would attend, but 15 Mr. Wagner and Gresham occasionally traveled alone. 16 Mrs. Wagner typically drove the family's RV so 17 that Mr. Wagner could work during the drive. The RV 18 which had towing capabilities, allowed the Wagners to 19 reduce costs by limiting the need to pay for kart 20 transport services, airfare, hotels, and meals in 21 22 restaurants. The drives to and from races sometimes lasted through the night so that the family could limit 23 the number of days that Gresham and Christian would miss school. 24 25 At Gresham's races, the Wagners operated under 13 the GWR name, wearing GWR-branded attire. Mr. Wagner also made efforts to obtain sponsorships for GWR. At various times during 2008 through 2014, GWR had product sPonsorships with MG Tires, Zamp Helmets, and Fleming Racing Engines. Under these arrangements, GWR acted as a registered, formal dealer of products on each sponsor's behalf. GWR's sponsorship deal with MG Tires involved GWR selling tires for MG Tires in exchange for free tires to use during races and a portion of the sales revenue. 1 2 3 4 5 6 7 8 9 10 Similarly, Zamp Helmets provided GWR with racing helmets 11 12 13 14 15 and Fleming Racing Engines offered GWR a discount on the cost of racing engines. GWR was not able to secure any monetary sponsorships during the years at issue, and the record does not include documentation of receipts from GWR's 16 revenue sharing under its product sponsorships. 17 18 4. GWR's Financial Results GWR lost money from 2008 to 2014, despite the 19 Wagners' efforts to secure sponsorships, advertise their 20 racing business, and cut costs. From 2008 to 2012, GWR 21 had gross income of $4,150, $8,115, $12,200, $3,850, 22 $5,800 in each year, respectively. After taking into 23 account expenses for those years, GWR suffered net losses 24 of approximately $38,000 in 2008 (its first year of 25 OPeration); $33,000 in 2009; $39,000 in 2010; $28,000 in 2011; and $38,000 in 2012. 14 In 2013 and 2014, GWR earned gross receipts of $11,450 and $4,100, respectively, and incurred approximately $58,000 and $45,000 in expenses, respectively, ror repairs and maintenance, supplies, fuel, travel, meals, engines, chassis, race entry fees, and lodging. This resulted in net losses of approximately $46,000 in 2013 and $41,000 in 2014. Because of these shortfalls, the Wagners frequently deposited personal funds into GWR's bank account and paid GWR expenses using funds from their own personal bank account. Gresham's racing career continued its upward trajectory during the early months of 2014 -- he won every regional karting race he entered during the year, he 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 placed fifth at the SKUSA Spring Nationals, and he was 16 leading the GoPro Karting Challenge Championship. 17 18 5. Gresham's Unexpected Health Issues In 2012, Gresham was diagnosed with scoliosis. 19 Although the condition did not affect his performance in 20 2012 and 2013, his momentum was halted after the promising 21 start in 2014 by the progress of the condition. In the 22 spring of 2014, the Wagners learned that Gresham needed 23 immediate surgery to address significant issues in his 24 SPine. Gresham underwent surgery on June 11, 2014, and 25 was restricted to a bed for six weeks. As a result, he 15 was unable to compete in the races the Wagners had planned to participate in for the remainder of 2014. Gresham emerged from rehabilitation pain-free 1 and in time was cleared to return to kart racing. The Wagners attempted to salvage GWR and Gresham's racing career by investing in extra testing sessions, new racing equipment, and a new racing chassis to allow Gresham to compete safely on the national level. However, the physical side effects of Gresham's 1 2 3 4 5 6 7 8 9 10 SPinal fusion surgery prevented him from effecting the 11 weight transfer necessary to drive a racing kart. With 12 Gresham physically unable to race, the Wagners decided in 13 early 2015 to abandon karting altogether and focus on 14 Gresham's college education. 15 16 OPINION A taxpayer who is carrying on a trade or 17 business may deduct ordinary and necessary expenses 18 incurred in connection with the operation of that 19 business. Code sec. 162(a). However, a taxpayer cannot 20 reduce his taxable income by claiming as deductions 21 exPenses he incurs for his hobby or other non-profit 22 activity. Section 183(a) of the Code provides that if an 23 activity is not engaged in for profit, "no deduction 24 attributable to such activity shall be allowed," except as 25 Provided for in section 183(b). See Hendricks v. Commissioner, 32 F.3d 94, 98 (4th Cir. 1994), aff'g T.C. 16 Memo. 1993-396. Code section 183(c) defines an "activity not engaged in for profit" as "any activity other than one 1 2 3 4 5 with respect to which deductions are allowable for the 6 7 8 9 taxable year under section 162 or under paragraph (1) or (2) of section 212." An activity constitutes a "trade or business" within the meaning of section 162 -- thus escaping the limitations of section 183 -- if the 10 taxpayer's "actual and honest objective" in pursuing the 11 activity is to realize a profit. See Dreicer v. 12 Commissioner, 78 T.C. 642, 645 (1982), aff'd without 13 OPinion, 702 F.2d 1205 (D.C. Cir. 1983); Engdahl v. 14 Commissioner, 72 T.C. 659, 666 (1979); Golanty v. 15 Commissioner, 72 T.C. 411, 426 (1979), aff'd without 16 published opinion, 647 F.2d 170 (9th Cir. 1981); see also 17 Dwyer v. Commissioner, T.C. Memo. 1991-123. While "a 18 reasonable expectation of profit is not required," the 19 taxpayer's profit objective must be "bona fide." Dreicer 20 v. Commissioner, 78 T.C. at 645; Allen v. Commissioner, 72 21 T.C. 28, 33 (1979); see also Treas. Reg. sec. 1.183-2(a). 22 Whether the requisite profit objective exists is 23 determined by looking at all the surrounding facts and 24 25 circumstances, Keanini v. Commissioner, 94 T.C. 41, 46 (1990). Greater weight is given to objective facts than to a taxpayer's mere statement of intent. Thomas v. Commissioner, 84 T.C. 1244, 1269 (1985), aff'd, 792 F.2d 17 1256 (4th Cir. 1986). In this regard, as the United States Court of Appeals for the Fourth Circuit (the court to which any appeal in this case would ordinarily lie) has acknowledged, section 1.183-2(a) of the Treasury regulations "is instructive." Hendricks, 32 F.3d at 98. That regulation provides that: taking into account all of the facts and [t]he determination whether an activity is engaged in for profit is to be made by reference to objective standards, circumstances of each case. Although a reasonable expectation of profit is not required, circumstances must into the activity, or continued the activity, with the objective of making a profit. In determining whether an activity is engaged in for profit, greater weight taxpayer's mere statement of his intent. is given to objective facts than to the indicate that the taxpayer entered the facts and . . T The regulations set out a list of factors to be 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 considered when evaluating a taxpayer's profit objective. 18 As the Fourth Circuit has noted, under the regulations, 19 20 21 22 23 24 25 (2) the extent to which the taxpayer carries on the courts typically examine nine factors in determining whether a taxpayer engaged in an activity for profit: (1) activity in a business-like manner; of the taxpayer and his advisors; expended by the taxpayer in conducting the activity; (4) the expectation that assets used in the activity may appreciate in value; in carrying on similar or dissimilar activities; the taxpayer's history of income or losses in the activity; earned, if any; and, in the activity. the taxpayer's financial status; (9) elements of personal pleasure or recreation the taxpayer's success (6) the amount of occasional profits the expertise time and effort (3) (5) (7) (8) 18 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Hendricks, 32 F.3d at 98 (citing Treas. Reg. sec. 1.183-2(b)(1)-(9)). These factors are nonexclusive and no one factor, or number of factors, is dispositive. Id. (citing Faulconer v. Commissioner, 748 F.2d 890, 894 (4th Cir. 1984), rev'g, T.C. Memo. 1983-165); Golanty v. Commissioner, 72 T.C. 411, 426 (1979), aff'd without published opinion, 647 F.2d 170 (9th Cir. 1981)). Instead, all facts and circumstances must be considered, and more weight may be given to some factors than to others. See Dunn v. Commissioner, 70 T.C. 715, 720 (1978), aff'd, 615 F.2d 578 (2d Cir. 1980). Generally, the Commissioner's deficiency determinations set forth in a notice of deficiency are presumed correct, and the taxpayer bears the burden of showing the determinations are erroneous. Welch v. Helvering, 290 U.S. 111, 115 (1933); Hendricks, 32 F.3d at 98 (citing Faulconer 748 F.2d at 893); Tax Court Rule 142(a). Thus, if the Commissioner determines that a given activity is not engaged in for profit, that determination is presumed correct, and the taxpayer must prove otherwise. Under certain circumstances, the burden of proof as to factual matters may shift to the Commissioner pursuant to Code section 7491(a). Although at trial the Wagners requested that we shift the burden to the Commissioner under section 7491(a), because our 19 disposition would be the same regardless of who bears the burden of proof, we need not resolve this issue. Discussion The question whether GWR was "a business or a hobby is essentially a question of fact." Faulconer, 748 F.2d at 895; see also Hendricks, 32 F.3d at 97. This Court has often determined that automobile or motorcycle racing activities were not engaged in for profit. See, 1 2 3 4 5 6 7 8 9 10 e.g., Johnson v. Commissioner, T.C. Memo. 2012-231; 11 Emerson v. Commissioner, T.C. Memo. 2000-137; Nichols v. 12 Commissioner, T.C. Memo. 1990-546; Schlafer v. 13 Commissioner, T.C. Memo. 1990-66; Stair v. Commissioner, 14 T.C. Memo. 1989-302; Smith v. Commissioner, T.C. Memo. 15 1989-198; Hill v. Commissioner, T.C. Memo. 1988-414; 16 Kraettli v. Commissioner, T.C. Memo. 1988-413; Conover v. 17 Commissioner, T.C. Memo. 1987-60. Many of these cases 18 involved races with small purses, such that taxpayers were 19 unlikely to generate profits even if they won a number of 20 races. See Plunkett v. Commissioner, T.C. Memo. 1984-170; 21 22 see also owyer v. Commissioner, T.C. Memo. 1991-123 (discussing authorities). In other cases, taxpayers raced 23 only infrequently, failed to operate in a businesslike 24 manner, or had no plan to improve their performance. See 25 Johnson v. Commissioner, T.C. Memo. 2012-231; Emerson v. 20 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Commissioner, T.C. Memo. 2000-137; Nichols v. Commissioner, T.C. Memo. 1990-546. By contrast, the Court has found that automobile or motorcycle racing activities were engaged in for profit where larger purses were available, where the effort exPended by the taxpayers was indicative of a business endeavor, and where profit potential appeared to drive the taxpayers ' decision-making. See Bolt v. Commissioner, 50 T. C. 1007, 1014 (1968) ; Dwyer v. Commissioner, T. C. Memo. 1991-123; Plunkett v. Commissioner, T.C. Memo. 1984-170. The fact that the taxpayer was unlikely to actually generate a profit, or that crashes, mechanical breakdowns, and disappointing performances resulted in significant losses was not determinative. See Bolt v. Commissioner, 50 T.C. at 1014-1015; Dwyer v. Commissioner T.C. Memo. 16 1991-123; Plunkett v. Commissioner, T.C. Memo. 1984-170. 17 After all, as the Court has observed, racing is a costly 18 and competitive business in which only a few ultimately 19 20 are successful. Dwyer v. Commissioner, T.C. Memo. 1991- 123; see also Johnson v. Commissioner, T.C Memo. 2012-231, 21 at *24-*25 ("It is certainly true that the initial 22 investment in a racing team would be a significant one. 23 The expenses associated with an investment of such 24 magnitude would likely require some time to recoup."). 25 This is a difficult case. During the years in question, Gresham was transitioning from junior kart racing, which had little to no profit potential, into senior-level kart racing, where substantial cash purses 21 were available. If Gresham had succeeded in the MX-5 Cup, he would have had the opportunity to earn significant amounts for GWR, and his prior success suggested that he had the talent to perform well. Up to 2012 and for a Portion of 2013, however, Gresham was primarily racing for trophies, gift cards, and championship points. Although it is a close question, in light of the case law and the nine factors provided in the regulations, under all of the facts and circumstances, we conclude 1 2 3 4 5 6 7 8 9 10 11 12 13 GWR's activities were engaged in for profit during 2013 14 15 and 2014. The Wagners' "actions, coupled with [their] sincere and credible testimony as to [their] business 16 goals, . . . support [their] claim that [they had] a bona 17 fide profit objective." Den Besten v. Commissioner, T.C. 18 Memo. 2019-154. 19 Our determination today is a narrow one. It 20 applies to 2013 and 2014. We do not opine on years before 21 22 2013 or after 2014. We have no jurisdiction over those years and therefore reach no conclusion with respect to 23 them. 24 We turn next to explaining our decision in 25 greater detail in light of the nine factors in the regulations and Fourth Circuit precedent. 22 1. Manner in which the taxpayer carries on the activity To begin with, the fact that a taxpayer carries on an activity in a business-like manner and maintains complete and accurate books and records may indicate that the activity is engaged in for profit. Treas. Reg. sec. 1.183-2(b)(1). Similarly, where an activity is carried on in a manner substantially similar to other activities of 1 2 3 4 5 6 7 8 9 10 the same nature that are profitable, a profit motive may 11 be apparent. Id. A change of operating methods, 12 adoption of new techniques or abandonment of unprofitable 13 methods in a manner consistent with an intent to improve 14 profitability may also indicate a profit motive. Id. 15 When the Wagners created GWR, they established a 16 bank account for the business and obtained an EIN. They 17 also established a website at greshamwagnerracing.com 18 where they promoted Gresham's abilities and track record. 19 At Gresham's races, the Wagners operated under the GWR 20 name, wearing GWR-branded attire. Each year, Mr. and Mrs. 21 Wagner kept invoices and receipts related to GWR, and Mr. 22 Wagner created a spreadsheet of income and expenses, 23 mileage logs, and travel logs to use when preparing the 24 Wagners' tax returns. 25 In 2013 and 2014, GWR planned to transition from 23 junior kart races to more profitable senior kart races and the Mazda Motorsports Ladder Program, an industry-standard development program. The Wagners also considered other opportunities, such as the Teen Mazda Challenge, but determined that the profit potential associated with those 1 2 3 4 5 6 OPportunities was less realistic. 7 8 9 10 11 12 13 14 The Wagners took steps to operate their racing activities cost-effectively. When possible, they used an RV with towing capabilities to travel to events, which reduced expenses for kart transport, airfare, hotel rooms, and meals in restaurants. This sometimes required driving through the night to arrive at an event or return home on schedule. When he could, Mr. Wagner maintained GWR's karts himself. The Wagners also sought sponsorships to 15 offset the cost of their activities, albeit without 16 securing a monetary sponsorship. 17 The Commissioner appears to accept the accuracy 18 of the Wagners' records, but contends that they failed to 19 use those records to reduce expenses or increase 20 profitability. The Commissioner further argues that the 21 Wagners did not maintain a business plan or a written 22 23 budget, practice cost control, or change how they operated the business to improve profitability. And the 24 Commissioner notes that the Wagners comingled their 25 personal funds with GWR's by depositing personal funds into GWR's bank account and paying GWR's expenses with 24 personal funds. On balance, we find that factor number 1 favors the Wagners. See)Faulconer at 896. We are persuaded that the Wagners did make efforts to conserve costs and that, in 2013 and 2014, they had a plan to improve profitability. The records the Wagners maintained reflected nearly all of GWR's transactions and were sufficient to discern "the expenses and profits from the 1 2 3 4 5 6 7 8 9 10 various aspects of the. . . activity." Id. Given the 11 nature of racing and the relatively limited scope of the 12 Wagners' enterprise, we view these records as adequate and 13 do not find the absence of a formal budget determinative. 14 Cf. id. Moreover, a business plan need not be written or 15 oral; it can be evidenced by a taxpayer's action. See Den 16 Besten v. Commissioner, T.C. Memo. 2019-154 (citing Dennis 17 v. Commissioner, T.C. Memo. 2010-216; Phillips v. 18 Commissioner, T.C. Memo. 1997-128). Here, the record 19 makes clear that the Wagners were pursuing senior-level 20 21 kart racing and the Mazda Road to 24. Similarly, we are unsurprised that the Wagners 22 made personal deposits in the GWR bank account during the 23 years at issue given GWR's losses and the need to fund its 24 activities. Indeed, it is unclear how GWR could have 25 continued without infusions of cash from the Wagners. 25 1 While the Wagners' payment of certain GWR expenses out of 2 3 4 5 6 7 personal accounts arguably was not business-like, we find that this lapse was outweighed by the Wagners' other practices under the circumstances. 2. The expertise of the taxpayer or his advisers A taxpayer's preparation for an activity by extensive study of its accepted business, economic, and 9 scientific practices, or consultation with experts in the 10 activity, may indicate that the taxpayer has a profit 11 motive where the taxpayer carries on the activity in 12 accordance with such practices. Treas. Reg. sec. 1.183- 13 2(b)(2). Where the taxpayer has such knowledge or advice 14 but does not carry on the activity in accordance with good 15 practice, a lack of intent to derive profit may be 16 indicated. Id. 17 18 The Wagners had expertise that was relevant to the operation of GWR. Mr. Wagner has a degree in Business 19 Management with a minor in Marketing, and has successfully 20 21 served as a manager for several businesses. Moreover, Mr. and Mrs. Wagner participated in local kart and stock car 22 racing events for approximately 11 years before their two 23 children were born. Mr. Wagner was successful in this 24 endeavor at the local level, securing sponsorships and 25 winning races in both pure stock and late-model stock 26 cars. Additionally, GWR's participation in racing events from 2008 to 2014 provided numerous opportunities to consult with industry experts, and Mr. Wagner credibly testified that GWR availed itself of these opportunities. Given the Wagners' experience in kart and stock car racing, as well as Mr. Wagner's trial testimony, the Court is convinced that the Wagners understood the costs and demands of maintaining a racing business and structured their affairs accordingly. The facts on record 1 2 3 4 5 6 7 8 9 10 demonstrate that the Wagners had a plan for Gresham's 11 Progression through different racing levels and series, 12 13 14 15 and that they sought to implement that plan within their financial limits. Accordingly, we find that this factor favors the Wagners. 3. The time and effort expended by the taxpayer 16 in carrying on the activity 17 The fact that a taxpayer devotes much of his 18 Personal time and effort to carrying on an activity, 19 Particularly if the activity does not have substantial 20 personal or recreational aspects, may indicate an 21 intention to derive a profit. Treas. Reg. sec. 1.183- i 22 2(b)(3). A taxpayer's withdrawal from another occupation 23 to devote most of his energies to the activity may also be 24 25 evidence that the activity is engaged in for profit. Id. The fact that the taxpayer devotes a limited amount of time to an activity does not necessarily indicate a lack of Profit motive where the taxpayer employs competent and 27 qualified persons to carry on such activity. Id, Mr. Wagner continued to work full-time at his IT job during the years at issue. Despite his full-time job, his investment of time in GWR remained significant at no less than 20 hours per week. The Wagners traveled to approximately 20 events in 2013, generally lasting several days each. Mr. Wagner and Gresham also traveled for 1 2 3 4 5 6 7 8 9 10 testing sessions, and Mr. Wagner spent additional time 11 maintaining the kart, seeking sponsorships, and working on 12 other aspects of the business. 13 Some of this time undoubtedly was enjoyable, and 14 Mr. Wagner has acknowledged as much. The Wagners loved 15 racing, and GWR offered them an opportunity to share their 16 Passion with their son. But a business will not be turned 17 into a hobby merely because the owner finds it 18 Pleasurable; suffering is not a prerequisite to 19 deductibility. Jackson v. Commissioner, 59 T.C. 312, 317 20 21 22 (1972); Dwyer v. Commissioner, T.C. Memo 1991-123; Green v. Commissioner, T.C. Memo. 1989-599. Moreover, much of the time Mr. and Mrs. Wagner spent on GWR was less 23 Pleasant, and required the Wagners to miss other family 24 Priorities. We are unconvinced, for example, that a trip 25 where Mrs. Wagner drove the RV through the night or where 28 Mr. Wagner worked in the back of the RV was equivalent to a family vacation, as the Commissioner contends. On balance, this factor favors the Wagners. 4. Expectation that assets used in activity may appreciate in value Mr. Wagner concedes, and the Court agrees, that this factor is not applicable given the nature of Mr. and 1 2 3 4 5 6 7 8 Mrs. Wagner's kart racing activity. We therefore consider 9 this factor neutral, in that it weighs neither for nor 10 against a finding in the Wagners' favor. 11 5. The success of the taxpayer in carrying on 12 other similar or dissimilar activities 13 The fact that a taxpayer has engaged in similar 14 activities in the past and converted them from 15 unprofitable to profitable enterprises may indicate that 16 he is engaged in the present activity for profit, even 17 though the activity is presently unprofitable. Treas. 18 Reg. sec. 1.183-2(b)(5). 19 20 The Wagners have experience in the racing industry, but they acknowledge that their activities 21 before GWR were conducted as a hobby. The Wagners also 22 acknowledge that they have no prior experience running a 23 24 for-profit racing activity and that they have never converted an unprofitable racing activity into a 25 Profitable one. Accordingly, this factor favors the Commissioner. 29 6. The taxpayer's history of income or losses 1 2 3 with respect to the activity 4 5 6 7 8 9 A series of losses during the initial or start- up stage of an activity may not necessarily indicate that the activity was not engaged in for profit. Treas. Reg. sec. 1.183-2(b)(6). However, where losses continue to be sustained beyond the period which customarily is necessary to bring the operation to profitable status, such 10 continued losses, if not explainable, as due to customary 11 business risks or reverses, may be indicative that the 12 activity is not engaged in for profit. Id. If losses are 13 14 15 sustained because of unforeseen or fortuitous circumstances that are beyond the control of the taxpayer, such losses would not be an indication that the activity 16 is not engaged in for profit. Id. A series of years in 17 which net income was realized would be strong evidence 18 that the activity is engaged in for profit. Id. 19 GWR incurred losses from 2008 to 2014. Its 20 losses for 2013 and 2014 were approximately $46,000 and 21 22 $41,000, respectively. Mr. Wagner testified that these losses were expected because GWR was in the start-up phase 23 of a venture that would take five to ten years to succeed. 24 Before Gresham's health challenges, the Wagners expected 25 to recoup GWR's losses starting in 2014 as Gresham entered 1 2 3 4 5 6 7 8 9 senior-level kart races and pursued the MX-5 Cup. 30 This court has acknowledged that significant startup costs may be incurred in a racing business over a number of years. see, e.g., pwyer v. Commissioner, 2 Memo 1991-123. We express no view as to whether GWR's expenses for 2008 to 2012 were sufficiently profit-driven to constitute startup costs. However, we do find merit in the Wagner's arguments as they relate to 2013 and 2014, when opportunities to earn significant prize money were 10 forthcoming and determinable. Nevertheless, given the 11 overall amount of GWR' s losses and the number of years 12 over which they were incurred, this factor favors the 13 Commissioner. We note, however, that courts have 14 frequently recognized that "a taxpayer may have a profit 15 motive despite a history of losses." Hendricks, 32 F.3d at 16 17 18 99 (citing Bessenyey v. Commissioner, 45 T.C. 261, 274 (1965), aff'd, 379 F.2d 252 (2d Cir. 1967)). 7. The amount of occasional profits, if any, 19 which are earned 20 The amount of profits in relation to the amount 21 of losses incurred, and in relation to the amount of the 22 23 taxpayer's investment and the value of the assets used in the activity, may provide useful criteria in determining 24 the taxpayer's intent. Treas. Reg. sec. 1.183-2(b)(7). An 25 occasional small profit from an activity generating large 31 losses, or from an activity in which the taxpayer has made a large investment, would not generally be determinative that the activity is engaged in for profit. Id. However, substantial profit, though only occasional, would generally be indicative that an activity is engaged in for profit where the investment or losses are comparatively small. Moreover, an opportunity to earn a substantial ultimate profit in a highly speculative venture is ordinarily sufficient to indicate that the activity is 1 2 3 4 5 6 7 8 9 10 engaged in for profit even though losses or only 11 occasional small profits are actually generated. Id. 12 During the years at issue, GWR was poised to 13 enter a new phase. Unlike prior years, Gresham was 14 beginning to enter races with substantial purses, winning 15 his first such purse in 2013. The Wagners' near-term plan 16 was for Gresham to compete in senior-level kart races and 17 the MX-5 cup. These races combined would have provided 18 Gresham with the opportunity to win purses of more than 19 $80,000 in 2014, plus a $200,000 scholarship. 20 Additionally, race-winners would progress to the next step 21 in the ladder, where larger purses were available. 22 23 GWR was unable to execute on this plan due to the deterioration of Gresham's health in 2014. Up to that 24 point, however, we agree that the Wagners had a chance, 25 however small, to earn a substantial ultimate profit in a highly speculative venture. Accordingly, this factor 32 favors the Wagners. 8. The financial status of the taxpayer The fact that the taxpayer does not have substantial income or capital from sources other than the activity may indicate that an activity is engaged in for profit. Treas. Reg. sec. 1.183-2(b)(8). Substantial income from sources other than the activity (particularly if the losses from the activity generate substantial tax 1 2 3 4 5 6 7 8 9 10 benefits) may indicate that the activity is not engaged in 11 for profit, especially if there are personal or 12 13 recreational elements involved. Id. We have said before that "the tax incentive for 14 incurring large expenditures in a hobby-type business are 15 much greater for one who has a great deal of income from 16 other sources." Jackson v. Commissioner, 59 T.C. at 317. 17 Although Mr. Wagner had other sources of income, racing 18 expenses were significant relative to his total income, 19 and thus had a real impact on the family's opportunities 20 to save or pursue other priorities. This is not a case 21 where all the taxpayer's conceivable needs have been met 22 and the taxpayer has essentially unlimited funds to spend 23 on a hobby. As in Jackson, "[w]e are impressed by 24 petitioner[s'] relatively modest income." Id. This factor 25 either tends to favor the Wagners or is neutral. 33 9. Elements of personal pleasure or recreation The presence of personal motives in carrying on an activity may indicate that the activity is not engaged in for profit, especially where there are recreational or Personal elements involved. Treas. Reg. sec. 1.183- 2(b)(9). On the other hand, a profit motivation may be indicated where an activity lacks any appeal other than profit. Id. It is not, however, necessary that an activity be engaged in with the exclusive intention of 1 2 3 4 5 6 7 8 9 10 deriving a profit or with the intention of maximizing 11 Profits. Id. 12 As this Court has recognized, "the fact that [a 13 taxpayer) derived personal pleasure from auto racing is 14 not sufficient to cause it to be classified as not engaged 15 in for profit if the activity is, in fact, engaged in for 16 profit as evidenced by other factors." Dwyer v. 17 Commissioner, T.C. Memo. 1991-123 (citing Treas. Reg. sec. 18 1.183-2(b)(9); Pirnia v. Commissioner, T.C. Memo. 1989- 19 20 21 22 627). The Fourth Circuit has expressed a similar view: "[G]ratification received from an activity is insufficient in itself to cause the activity to be considered not engaged in for profit.- nendricks, 32 F.3d at 99 (quoting 23 Faulconer, 748 F.2d at 901). The Wagners have 24 25 acknowledged that they took pleasure in and enjoyed their karting activities. However, our discussion of the preceding eight factors shows that GWR was an activity 34 engaged in for profit. Considering that discussion, this factor is neutral. Conclusion Based on the foregoing analysis, we find that the Wagners' continued GWR's activity in 2013 and 2014 based on a good faith belief that Gresham would succeed as a kart and racecar driver and that GWR would profit from that success. We therefore conclude that the Wagners' 1 2 3 4 5 6 7 8 9 10 kart racing activity was engaged in for profit during 2013 11 12 and 2014 tax years, and therefore that the related expenses are not subject to the limitations set forth in 13 Code section 183. 14 To reflect the foregoing, decision will be 15 entered for the petitioners. This concludes the Court's oral Findings of Fact and Opinion in this case. (Whereupon, at 3:58 p.m., the above-entitled matter was concluded.) 16 17 18 19 20 21 22 23 24 25 CERTIFICATE OF TRANSCRIBER AND PROOFREADER 35 CASE NAME: Kevin M. Wagner & Lauren H. Wagner v. Commissioner DOCKET NO. : 32 85-17 We, the undersigned, do hereby certify that the foregoing pages, numbers 1 through 35 inclusive, are the true, accurate and complete transcript prepared from the verbal recording made by electronic recording by cary Baldwin on October 2, 2020 before the United States Tax 1 2 3 4 5 6 7 8 9 10 Court at its remote session in Richmond, VA, in accordance 11 with the applicable provisions of the current verbatim 12 13 14 15 17 18 19 20 21 22 23 24 25 reporting contract of the Court and have verified the accuracy of the transcript by comparing the typewritten transcript against the verbal recording. Meribeth Ashley, CET-507 Transcriber 10/21/20 Date Lori Rahtes, CDLT-108 Proofreader 10/21/20 Date