TAX COURT OPINION

Case: Matthew M. Hutchings & Shari L. Hutchings
Docket Number: 13321-20
Judge: Buch
Opinion Type: bench
Filed: 03/07/2024
Pages: 19

United States Tax Court Washington, DC 20217 MATTHEW M. HUTCHINGS & SHARI L. HUTCHINGS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 13321-20 ORDER Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it is ORDERED that the Clerk of the Court shall serve with this Order a copy of the pages of the transcript of the trial in this case containing his oral ﬁndings of fact and opinion rendered at the trial session at which the case was heard. In accordance with the oral ﬁndings of fact and opinion, and a concession by the Commissioner, a decision will be entered for the Commissioner as to the deﬁciency and for the Hutchingses as to the penalty under section 6662(a). (Signed) Ronald L. Buch (Signed) Ronald L. Buch Judge Judge Served 03/07/24 RECEIVED 02/07/24 IN THE UNITED STATES TAX COURT In the Matter of: MATTHEW M. HUTCHINGS & SHARI L. HUTCHINGS, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Docket No. 13321-20 ) ) ) ) ) ) ) ) ) ) ) ) ) Pages: 1 through 17 Place: Washington, DC (Remote Proceeding) Date: January 19, 2024 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 1 IN THE UNITED STATES TAX COURT In the Matter of: MATTHEW M. HUTCHINGS & SHARI L. HUTCHINGS, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Docket No. 13321-20 ) ) ) ) ) ) ) ) ) ) ) ) ) United States Tax Court 400 Second Street, NW Room 400 Washington, DC 20217 (Remote Proceeding) January 19, 2024 The above-entitled matter came on for bench opinion, pursuant to notice at 9:01 a.m. Judge HONORABLE RONALD L. BUCH BEFORE: APPEARANCES: For the Petitioners: LARRY D. HARVEY, ESQ. LARRY D. HARVEY, PC 4582 South Ulster Street, Suite 1350 Denver, CO 80237 For the Respondent: ERICA D. ZEILER, ESQ. PATRICK A. GREENLEAF, ESQ. INTERNAL REVENUE SERVICE OFFICE OF CHIEF COUNSEL 600 17th Street, Suite 300N Denver, CO 80202 2 P R O C E E D I N G S (9:01 a.m.) THE CLERK: Recalling docket number 13321-20, Matthew M. Hutchings and Shari L. Hutchings. (Whereupon, a bench opinion was rendered.) 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 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 Bench Opinion by Judge Ronald L. Buch January 19, 2024 3 Matthew M. Hutchings & Shari L. Hutchings v. Commissioner of Internal Revenue Docket No. 13321-20 THE COURT: The Court has decided to render oral findings of fact and opinion in this case. These oral findings of fact and opinion are made pursuant to the authority granted by section 7459(b) of the Internal Revenue Code and Tax Court Rule 152. Any Rule references in this opinion are to the Tax Court Rules of Practice and Procedure, any section references are to the Internal Revenue Code, and any regulation references are to the Code of Federal Regulations, in effect at all relevant times. These oral findings of fact and opinion may not be relied upon as precedent in any other case. Shari and Matthew Hutchings bought and improved real property in 2017. They hoped at some point to turn that property into a wellness retreat, ranch, and wedding venue. But in 2017, it was a passion project and not yet a business. The Hutchings reported expenses in 2017 relating to this potential future business. The Commissioner disallowed those expenses and determined a deficiency. Section 162 allows a deduction for trade or business expenses. Because the Hutchings' project was not 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 yet a trade or business, we sustain the Commissioner's 4 determination. FINDINGS OF FACT Mrs. Hutchings earned a Bachelor's degree in Scientific Nutrition in the late 80's. After receiving her degree, she worked as a nutritional specialist in a hospital for two years. She did not work as a nutritionist between then and 2017, the year in issue. Mrs. Hutchings dreamed of opening her own health and wellness retreat. She began researching getting back into the nutrition and wellness profession in 2013. During that year, she filed a Certificate of Ownership for a business called Happy Eating Nutritional Consulting. The Hutchings worked with a realtor to identify property that might be suitable for their interests. With both being from Texas, their focus was on areas in Texas where they might be interested in living. They looked for property that was suitable not only for a wellness retreat, but also for maintaining longhorn cattle, an interest of Mr. Hutchings. Ideally, they were also looking for a site that might be used as a wedding venue, because if the site could be used as a wedding venue it could generate additional revenue. In 2017, the Hutchings took steps toward making Mrs. Hutchings dream a reality. During that year, they 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 purchased a ranch that could be used as the site for a 5 wellness retreat, cattle ranch, and wedding venue. That property consisted of roughly 120 acres of land in Texas Hill Country. In addition to its potential as a wellness retreat, the ranch was also well-suited for agricultural purposes, specifically the rearing of cattle. From Mr. Hutchings' perspective, the property was priced below market value and likely to appreciate. The Hutchings purchased the ranch in their names, not in the name of Happy Eating Nutritional Consulting. The property and the buildings on it were in disrepair. Mrs. Hutchings made significant improvements to the property, hiring contractors for some of the improvements and purchasing supplies to make other improvements herself. Supplies, improvements, and furnishings were purchased and creditors (including a mortgage lender) were paid using the Hutchings' personal credit cards or out of the Hutchings' personal bank accounts. The Hutchings maintained records substantiating these expenses, including the mortgage interest. The Hutchings owned a personal vehicle (a Ford F-350 truck) that they used in connection with the ranch. They did not maintain a mileage log or record of the use 24 of the vehicle. By late 2017, Mrs. Hutchings was ready to hold 25 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 what she characterized as a "soft opening" of her wellness 6 camp, dubbed Happy Eating Nutritional Consulting Wellness Camp (Happy Eating). Mrs. Hutchings hoped that Happy Eating would be a wellness camp and retreat where she could provide nutritional, spiritual, and physical fitness consultation to those who attended. Mrs. Hutchings held a total of three soft openings, two in 2017 and one in 2018. Mrs. Hutchings did not charge for these soft openings because their main purpose was for Mrs. Hutchings to receive feedback from those attending about the services that were or might be provided. For the soft openings, Mrs. Hutchings invited a small group of friends or acquaintances for a long weekend at the ranch. The soft openings were by invitation only. Mrs. Hutchings did not identify for the Court any attendees to the retreats in 2017, 2018, or 2019. From 2017 to 2019, Happy Eating's revenue was negligible. It did not generate any revenue in 2017 because it did not hold itself out to paying customers; it only held two soft openings. Happy Eating held two retreats in all of 2018, one of which was another soft opening. The other generated $3,000 of revenue. Happy Eating held two retreats in 2019, generating $6,000 in revenue. Even in the years it had revenue, Happy Eating's expenses exceeded its revenue by more than tenfold. 1 2 3 4 5 6 7 8 9 Happy Eating did not engage in any public 7 marketing or advertising; it had no website; and it did not hold itself out as a business to the general public. The Hutchings filed a joint tax return for 2017. That return included a loss reported on Schedule C, Profit or Loss from Business, for Happy Eating. The loss stemmed from the following expenses: car and truck expenses, repairs and maintenance, supplies, utilities, and other expenses. The other expenses represented mortgage 10 interest. Happy Eating did not report any gross income 11 for 2017. 12 13 14 15 16 17 18 19 20 21 22 23 24 25 On September 14, 2020, the Commissioner issued a Notice of Deficiency to the Hutchings for 2017, determining a deficiency of $43,002. The Commissioner determined the deficiency based on the disallowance of (1) Schedule C expenses in the amount of $111,201, and (2) itemized deductions in the amount of $3,336. Because the itemized deductions are merely computational, they are not at issue here. The Commissioner also determined a penalty but has since conceded it. While residing in Colorado, the Hutchings filed a timely Petition. In their Petition, the Hutchings assert that the Commissioner erred in disallowing the Schedule C expenses. On January 17, 2024, the Court held a trial 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 remotely over Zoom. At trial, the Hutchings took the 8 position that, in 2017, Happy Eating was a trade or business and not a start-up, and that they adequately substantiated all expenses related to Happy Eating. The Hutchings provided testimony and documents to support their positions. The Hutchings provided to the Court documents to substantiate their claimed expenses. The documents included various receipts, invoices, and expense records. These documents showed the amounts spent on improving the property, as well as mortgage interest repayments. However, the documents did not substantiate all the reported Schedule C expenses. The expense related to excavation was not substantiated for 2017 because the Hutchings own records showed that the amount was not paid until 2018. Furthermore, the Hutchings did not provide any log or similar document showing the use of their truck in connection with Happy Eating. DISCUSSION The Hutchings challenge the Commissioner's determination to disallow their Schedule C expenses, arguing that the expenses related to Happy Eating were properly substantiated. The Commissioner disagrees, arguing that the Hutchings did not operate Happy Eating with the intent of making a profit, and that even if they did, they failed to adequately substantiate their 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 expenses. The Hutchings adequately substantiated most of 9 the expenses they reported on their Schedule C, however because Happy Eating was not a trade or business in 2017, the Hutchings cannot deduct their expenses for that year. I. Burden of proof In general, the Commissioner's determinations in a notice of deficiency are presumed correct, and taxpayers bear the burden of proving that they are incorrect. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). But if the Commissioner raises a new matter, seeks an increase in deficiency, or asserts an affirmative defense, then the Commissioner has the burden of proof as to the new matter, increased deficiency, or affirmative defense. Rule 142(a)(1). In disposing of pretrial motions, we held that the issues of whether Happy Eating was a trade or business or start-up during 2017 are new matters and that the burden of proof on these issues shifts to the Commissioner. However, the Hutchings still bear the burden of proof to substantiate the Schedule C expenses they reported on their 2017 return. II. Schedule C Expenses Taxpayers bear the burden of proving entitlement to any deduction. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). Except when the burden is shifted, this burden requires taxpayers to prove 1 2 3 4 5 6 7 8 9 that they incurred an expense and to establish that a 10 deduction is allowable under the Code. I.R.C. § 6001; Treas. Reg. § 1.6001-1(a), (e); see also Hradesky v. Commissioner, 65 T.C. 87, 89-90 (1975), aff'd, 540 F.2d 821 (5th Cir. 1976). Here, because we did not shift the burden as to substantiation, the Hutchings bear the burden of establishing that they paid the claimed expenses. The Commissioner bears the burden of establishing that Happy Eating was not a trade or business or that it was a start- 10 up in 2017. 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 A. Substantiation At trial, the Hutchings substantiated most of the Schedule C expenses listed on their return through receipts, other documentation, and testimony. They substantiated their supplies and the mortgage interest paid. They did not substantiate their excavation expense, because their own receipts show that it was not paid until 2018. They also did not adequately substantiate their vehicle expense. They did not maintain any log of the mileage or purpose of travel with their vehicle. They used a round number to estimate their mileage and had no record of specific use. This does not meet the strict substantiation that is required for vehicle use. See I.R.C. § 274(d); Temp. Treas. Reg. § 1.274-5T(c)(1) and (2)(i); Roumi v. Commissioner, T.C. Memo. 2012-2. 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 B. Trade or Business 11 The Commissioner argues that the Hutchings cannot deduct Happy Eating's Schedule C expenses because in 2017, they did not operate Happy Eating with the intent of making a profit under section 183 and therefore it is not a trade or business under section 162. Section 162(a) allows a deduction for ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. To be engaged in a trade or business within the meaning of section 162(a), "the taxpayer must be involved in the activity with continuity and regularity, and that the taxpayer's primary purpose for engaging in the activity must be for income or profit. A sporadic activity, a hobby, or an amusement diversion does not qualify." Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987). However, even if a taxpayer has spent considerable money in preparation for entering a business, a taxpayer is not engaged in a trade or business within the meaning of section 162(a) until the business has crossed the threshold of functioning as a going concern. Estate of Morgan v. Commissioner, T.C. Memo. 2021-104, at *14-15. Before crossing that threshold, the taxpayer is acting within the confines of a start-up for which deductions are not allowed. Id. at 15; see also I.R.C. § 195(a) ("no deduction shall be allowed for start- 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 up expenditures"). 12 It is well established that the existence of a genuine profit motive is the most important criterium for finding that a given activity constitutes a trade or business. Brydia v. Commissioner, T.C. Memo. 1970-147, aff'd, 450 F.2d 954 (1971); see also Keanini v. Commissioner, 94 T.C. 41, 45 (1990). Therefore, if we conclude that, as of 2017, the Hutchings were not engaged in Happy Eating with the intent of making a profit, then we cannot conclude that it was a trade or business pursuant to section 162(a) at that time. Section 183 provides guidance on whether an activity is engaged in for profit. It states that if an activity is not engaged in for profit, no deduction attributable to the activity is allowed except to the extent that there is gross income derived from that activity. I.R.C. § 183(a) and (b). Section 183(c) defines an activity not engaged in for profit as "any activity other than one with respect to which deductions are allowable for the taxable year under section 162." Treasury regulation section 1.183-2(b) provides a non-exhaustive list of factors to consider when determining whether an activity is engaged in for profit. The factors include: (1) the manner in which the taxpayer carried on the activity; (2) the expertise of the taxpayer 1 2 3 4 5 6 7 8 9 10 11 or her advisors; (3) the time and effort expended by the 13 taxpayer in carrying on the activity; (4) the expectation that assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer's history of income or losses with respect to the activity; (7) the amount of occasional profit, if any, that is earned; (8) the financial status of the taxpayer; and (9) whether elements of personal pleasure or recreation are involved. Treas. Reg. § 1.183-2(b). No single factor controls. See Louismet v. Commissioner, T.C. Memo. 1982- 12 294. 13 14 15 16 17 18 19 20 21 22 23 24 25 While we make no determination as to subsequent years, it is clear that in 2017, Happy Eating was not yet operated with the intent of making a profit. As a result, it was not an active trade or business within the meaning of section 162(a). The factors listed in Treasury regulation section 1.183-2(b) weigh against Happy Eating being operated for profit. While Mrs. Hutchings has a bachelor's degree and work experience in nutrition, that experience was nearly three decades old in 2017. She had no expertise or prior experience in running a health and wellness business, nor did she seek out a person who did. And while we agree that Mrs. Hutchings had an interest in health and wellness 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 and put a lot of hours into Happy Eating, in 2017 the 14 business was a passion project, perhaps with the hope of one day turning it into a trade or business. Mrs. Hutchings did not run Happy Eating as an active business. Happy Eating did not have an official website or present itself to the general public. It did not have separate bank accounts, credit cards, or records. The supplies used to repair and maintain the property were purchased using the Hutchings' personal credit cards. Furniture and services were purchased using the Hutchings' personal credit cards. Creditors were paid using the Hutchings' personal credit cards or with personal checks or wire transfers from the Hutchings' personal bank accounts. The Hutchings did not treat Happy Eating as an active trade or business. The Hutchings purchased a ranch that might be used for Happy Eating as an eventual trade or business. But it was purchased for other reasons. Mr. Hutchings hoped to raise longhorn cattle, something he loves. He also hoped and expected that the property would appreciate in value. And the Hutchings thought it might someday be used as a wedding venue. Those combined activities might someday have profit potential and rise to the level of a trade or business, but as for Happy Eating in 2017, it was not operated with the intent to make a profit. Indeed, 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Happy Eating had no revenue in 2017, negligible revenue in 15 2018 and 2019, and no prospect of being profitable without adding the additional businesses that were not yet on the horizon. Together, these factors show us that in 2017, Happy Eating was not operated for profit. Furthermore, even if the Hutchings hoped to make a profit, Happy Eating was a start-up in 2017; thus, its expenditures are not deductible in that year. Section 195(a) provides that start-up expenditures are nondeductible. A start-up expenditure is any amount paid or incurred in connection with (1) investigating the creation of an active trade or business, or creating an active trade or business, or (2) any activity engaged in for profit and for the production of income before the day on which the active trade or business begins. I.R.C. § 16 195(c)(1). 17 18 19 20 21 22 23 24 25 Mrs. Hutchings held two soft openings in 2017 that no one paid to attend. Even the first retreat of 2018 was an unpaid soft opening. These retreats were held so that she could receive feedback on the services she provided and to figure out what other services she should provide in the future. The two retreats held in 2017 and the first retreat in 2018 were research for Mrs. Hutchings. Therefore, in 2017, Happy Eating was still in the research and investigative stage of the business. It had not yet crossed the threshold of carrying on as an 16 active trade or business. See McKelvey v. Commissioner, T.C. Memo. 2002-63 (finding a taxpayer's research into and investigation of the business potential of creating a tree farm was not yet a functioning business.) Accordingly, the Hutchings may not deduct any trade or business expenses related to Happy Eating for 2017. III. Conclusion The Hutchings substantiated that they in fact incurred many of their reported expenses, but the Commissioner established that Happy Eating was not yet a trade or business in 2017. Accordingly, we sustain the Commissioner's disallowance of the reported expenses. Because the Commissioner conceded penalties, decision will be entered for the Commissioner as to the deficiency in tax and for the Hutchings as to penalties. This concludes the Court's oral findings of fact and opinion in this case. (Whereupon, at 9:19 a.m., the above-entitled matter was concluded.) 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 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 CERTIFICATE OF TRANSCRIBER AND PROOFREADER 17 CASE NAME: Matthew M. Hutchings & Shari L. Hutchings v. Commissioner DOCKET NO.: 13321-20 We, the undersigned, do hereby certify that the foregoing pages, numbers 1 through 17 inclusive, are the true, accurate and complete transcript prepared from the verbal recording made by electronic recording by MetMez Group on January 19, 2024 before the United States Tax Court at its remote session in Washington, DC, in accordance with the applicable provisions of the current verbatim reporting contract of the Court and have verified the accuracy of the transcript by comparing the typewritten transcript against the verbal recording. _______________________________________________ Susan Patterson, CDLT-174 1/22/24 Transcriber Date _______________________________________________ Traci Fine, CDLT-169 Proofreader 1/24/24 Date