t c memo united_states tax_court scott a householder and debra a householder petitioners v commissioner of internal revenue respondent docket nos filed date kacie n c dillon and tim alan tarter for petitioners michael r harrel doreen marie susi john r gordon and brandon keim for respondent memorandum findings_of_fact and opinion holmes judge scott and debra householder deducted dollar_figure million in losses for amounts they paid to classicstar a horse-leasing operation that turned out to be a scam they say they should still get the losses because they materially participated in the trade_or_business of breeding horses the commissioner disagrees--he thinks they were in it only for the losses findings_of_fact i background a scott and debra1 scott householder had an mba with an emphasis in finance and ten years of experience as a financial adviser with american express when he founded householder group in householder group is a financial advisory firm that earns fees and commissions for selling investments it is also phenomenally successful and by was the fastest growing affiliate of sun america securities today it has more than forty offices scott’s wife debra always liked horses she started taking riding lessons when she was nine showed horses in neighboring states by the time she was fourteen and showed nationally for a time after high school hauling her horse brandy susie bar with a truck and trailer that her dad bought her during college she had internships where she gave riding lessons trained horses and participated the record shows that debra sometimes goes by householder and sometimes by davis her maiden name to avoid confusion we will sometimes use the householders’ first names in the day-to-day aspects of horse breeding--which included artificially inseminating mares debra moved to colorado when she wa sec_24 and worked for a tour company there she met scott and in the decades that followed she raised three children and went to graduate school she earned a ph d and in she became a licensed psychologist but even with all their education and obvious intelligence the householders got a big surprise when their accountant drafted their tax return--an extra dollar_figure in income from sun america this wasn’t sitting in their bank account but was instead cancellation of indebtedness coi income in their case the debt sun america canceled was part of the money scott had borrowed to start his business and sun america forgave the loan because householder group had more than met certain performance goals this coi significantly increased scott and debra’s taxable_income and householder group’s success meant there would be more to come in later years b classicstar enter bob holt a friend of scott from his days at american express holt sold investments on commission for private consulting group pcg and in date he pitched one to scott and debra--classicstar’s thoroughbred mare-leasing and breeding program he showed scott classicstar’s marketing materials which included ostensibly independent tax opinions it was a private-placement program which means it was not offered to the general_public the program seemed simple participants leased mares from classicstar paid for their board and stud fees to breed them and owned any foals that resulted thoroughbreds are usually bred between february and june and have eleven- month gestation periods so a single breeding cycle usually stretches across two calendar years participants in classicstar would pre-pay mostly with borrowed money all of the expenses in the year before the mare became pregnant this would generate net operating losses nols for that year that participants could carry back to even earlier years and if they sold a foal when it was a yearling -- meaning when it was around a year old--any income would be capital classicstar had a lender lined up for its clients--the national equine lending company nelc classicstar recommended taking out both short- term financing for about of the total cost--which participants would pay back with money from their tax refunds--and long-term financing for of the total cost these loans were secured_by the expected foals classicstar said it had arranged for the nelc financing but in reality classicstar and nelc were commonly controlled--classicstar president s david plummer iii’s brother-in- law gary thompson ran nelc all of nelc’s business was with classicstar and classicstar gave nelc the money to fund the loans though nelc sometimes returned it the next day scott and debra testified that they didn’t know classicstar and nelc were related but correspondence they received from both classicstar and nelc’s loan servicer said to direct any questions to terry green who was both classicstar’s cpa and a member of the firm that serviced the loans green also spoke at a classicstar event that scott attended and even sent scott and debra a letter on nelc letterhead classicstar also offered participants the option of converting their mare-leasing interests into stakes in two related entities--first equine energy partners feep and gastar exploration gastar gastar securities are publicly traded but feep was another private-placement program that claimed to hold interests in both horses and coal-bed methane gas properties and feep’s private- the record refers to both gastar exploration ltd and gastar exploration inc the commissioner says these are the same entity at different times and scott and debra don’t disagree gastar’s annual report says it’s traded on the toronto and american stock exchanges and the parties introduced into evidence a table of its historic trading prices placement memorandum explained that nelc would accept feep units as substitute collateral for the outstanding loans classicstar participants have been to our court before see generally raifman v commissioner tcmemo_2018_101 tax-avoidance-motivated participation romanowski v commissioner tcmemo_2013_55 activity_not_engaged_in_for_profit pederson v commissioner tcmemo_2013_54 same van wickler v commissioner tcmemo_2011_196 not carrying on trade_or_business and expenses unreasonable we’ve also encountered holt before see generally goyak v commissioner tcmemo_2012_13 contribution to pcg- pitched employee_benefit_plan not deductible c scott and debra sign up back in however this all sounded great to scott and debra they sent holt their recent tax returns which he said he needed to determine that they were qualified investors in date holt sent them a proposed mare lease and breeding activity report that began with a table labeled potential net_operating_loss that table showed an nol needed of dollar_figure million--needed because it matched the amount of taxable_income the report said scott and debra had from to the report also explained that u nder recent signed legislation net operating losses can be carried back five years and agricultural mare lease deductions are not subject_to alternative_minimum_tax amt it then laid out a plan to generate a total mare leasing and breeding loss of dollar_figure million and described how to later convert the mare-leasing interest into a methane gas working_interest convert that interest into common_stock and then sell it for a capital_gain in date the householders signed both a letter of intent to participate in classicstar’s mare-leasing program and a confidentiality agreement debra wrote classicstar a check for dollar_figure and classicstar gave them a revised mare-leasing program report the first page of this revised report showed an dollar_figure nol needed which was the amount of taxable_income the report said scott and debra would have in alone it also had more detailed information about how to convert interests into gastar stock and exit the program which included a strategy timeline that showed a purchase in and a liquidation in that report listed a put price for gastar stock of dollar_figure per share but also included calculations for probable and potential share prices of dollar_figure and dollar_figure scott and debra attended classicstar’s breeders’ cup weekend in kentucky in october which featured a dinner party with a hawaiian theme and the 4th annual classicstar breeders’ cup eve gala party there they could hear presentations by tony ferguson who was classicstar’s chairman and gastar’s executive vice president and david plummer d correspondence from classicstar during the next few months classicstar sent scott and debra several letters one had the subject classicstar mare lease program--financing it read in part classicstar has arranged with national equine lending company to provide the short-term financing tax_refund which is approximately of the mare lease program the loan will mature date it is very important that the client files his her tax_return in a timely manner a letter dated date explained that t o obtain the full tax benefits of the program participants must spend a minimum of hours per year participating on a continuous regular and substantial basis and it suggested they record their participation in a journal it also recommended opening a checking account for the equine business and creating either an s corporation4 or an llc which scott and debra did--in december they formed an llc called medaca investments medaca and the following year they transferred all of their mare-leasing interests to it they also used medaca’s checking account to pay unrelated expenses such as utility bills and their monthly payment on a land rover a date email from classicstar’s vp of operations jennifer stahle reiterated that the householders needed to show regular continuous and substantial participation in order to claim losses that email had an attachment which listed various classicstar activities that could count as participation-- including webex conference call s meeting with david plummer touring classicstar facilities and even watching horse races on tv and a letter dated date began with e nclosed is the compiled material and an s_corporation is a business that meets the requirements of sec_1361 and elects to have its income and losses flow through to its shareholders without paying corporate tax see sec_1362 sec_1363 and b all section references are to the internal_revenue_code in effect for the years at issue and all rule references are to the tax_court rules_of_practice and procedure unless otherwise indicated llc stands for limited_liability_company a hybrid form of business_entity that shares some of the characteristics of a partnership and some of the characteristics of a corporation unless it elects to be taxed as a corporation an llc’s profits and losses pass through to its owners who are called members see sec_301_7701-3 and b proced admin regs information you requested and explained how to get discounted subscriptions to the magazines the blood-horse and thoroughbred times e stallworthy scott and debra tried to get their cpa margaret stallworthy involved she told them that she wasn’t qualified to give an opinion about classicstar’s horse- breeding program but she did explain that the irs might consider it an active investment a passive investment or even a hobby depending on how well scott and debra could document the level of their participation and expertise at scott’s urging stallworthy met with holt in date holt showed her a marketing brochure for classicstar which she thought was clearly an investment for high net_worth individuals holt also brought a private offering memorandum to the meeting but he refused to show it to stallworthy because she wouldn’t sign a nondisclosure agreement her only followup from the meeting was to tell holt that scott and debra’ sec_2002 taxable_income would be between dollar_figure and dollar_figure ii mare leasing a the program the paperwork on date scott and debra signed a mare lease and breeding agreement that said they desire d to lease from classicstar the mare or mares selected by scott and debra on the attached schedule a but there was no schedule a attached to the agreement--or anywhere else at trial the householders’ own expert said that horse breeders don’t usually sign agreements without knowing what horses are involved which the commissioner’s expert explained is so because the characteristics of the specific horses are what determine whether a breeding operation will be successful this seems so obvious that an expert shouldn’t be necessary to support a finding that it’s true but we’ll just find their testimony credible on this point no matter--scott gave classicstar a check for dollar_figure and debra gave one for dollar_figure debra testified that there was a verbal ie oral schedule a because she told spencer plummer--david plummer’s son6--which mares she wanted to lease and which stallions she wanted to breed them with she claims she picked seven other classicstar employees included shane plummer and nick plummer classicstar appears to have been a family business pairings and expected she would get three or four of them but the agreement debra and scott signed said this agreement shall constitute the entire agreement between the parties and any prior understanding or representation both written and oral of any kind preceding the date of this agreement shall not be binding upon either party except to the extent incorporated in this agreement it also said that any subsequent modification was binding only if it was in writing so regardless of what debra did or didn’t discuss with classicstar before signing this agreement--and we’re not convinced that she discussed anything--she paid hundreds of thousands of dollars to breed horses without knowing which horses were to be bred scott and debra also signed three other agreements with classicstar one was a boarding agreement in which they hired classicstar to board and care for the mare or mares described on the attached schedule a --though this agreement lacked a schedule a as well a second agreement made classicstar the nominee for the foals set forth on exhibit a attached on which each space where foals and their parents should have been listed was blank the third agreement said classicstar agreed to board f oals identified on exhibit a which is attached but once again there was no exhibit a on or within days of signing these riderless agreements scott and debra took out a dollar_figure short-term loan and a dollar_figure long-term_loan with nelc they also executed a revised letter of intent that listed the dollar_figure debra had paid in september the dollar_figure that scott and debra had paid that month the dollar_figure funded by the short-term loan and the dollar_figure funded by the long-term loan--for a total of dollar_figure in early date classicstar sent the householders a letter to remind them that the sooner they filed their tax_return and received their refund the sooner they could pay off their short-term loan it also said that jennifer stahle-- who signed the letter--and terry green were available to answer any questions and later shane plummer sent them a timeline reminding them that they should l og at least hours of material_participation before december the breeding season the actual breeding for the breeding program should have happened in early classicstar’s materials said that pregnancy checks would be performed and days after breeding and that the unknown foals’ sexes would be determined pincite days but classicstar didn’t tell scott and debra whether any pregnancies had begun or anything else about their mares--and neither of them ever asked trips a the kentucky derby in date scott and debra traveled to kentucky for classicstar’s exclusive kentucky derby weekend where they went on tours had dinners and mingled with other classicstar clients debra said that during that trip she received a written schedule that purported to list the mares she and scott had leased for the program debra said she never saw it again after the trip and it wasn’t produced at trial according to her it listed pairings some of which included quarter horses--which are generally less expensive than thoroughbreds and cost much less to breed debra says spencer plummer told her the quarter horses were placeholders --a practice debra said she’d heard about during her internships but which we specifically find is not common in the horse-breeding industry scott said he thought the reason classicstar hadn’t told debra and him which horses they’d paid to breed even by the end of the breeding season was that it was administratively challenged debra also testified that during the kentucky derby trip classicstar paraded a thoroughbred mare named gogo past its clients and announced that scott and debra householder had selected her this surprised her because she had researched gogo when she looked up classicstar’s horses wasn’t interested in her and didn’t select her but there was something else even odder about gogo--classicstar didn’t own her in date it bought her only in date at the keeneland sale perhaps the premiere thoroughbred auction and when it bought her she was already pregnant by a stallion called mr greeley b yellowstone and the virgin islands at the end of july scott and debra went on another classicstar trip--this time to david plummer’s house near yellowstone they met there with other classicstar owners participated in a fternoon activities and discussed feep yellowstone was debra’s last classicstar trip for but scott made one more--to the u s virgin islands scott had to pay his own way to tampa where he met with tony ferguson from there on classicstar paid his expenses the agenda included talks by david plummer tony ferguson and terry green--who spoke about material-participation logs it also included golf shopping gambling and cocktails b the program by date scott and debra still hadn’t received any updates about the breeding program but that month they nevertheless executed on behalf of medaca a letter of intent to participate in the program after handwriting some adjustments to the numbers typed on the letter they said they would pay dollar_figure--which was also the nol needed on an date report they received from classicstar that report showed that dollar_figure would be from tax savings and refunds dollar_figure would be from a loan and dollar_figure would be a downpayment from the lessee in november scott paid classicstar the dollar_figure with a check from medaca scott and debra also got a dollar_figure short-term loan and a dollar_figure long-term_loan from nelc a month later in date scott and debra--again on behalf of medaca--executed a mare lease and breeding agreement a boarding agreement a foal agreement and a nominee agreement all for the program these again referred to a schedule a that was supposed to show the specific mares and stallions to be bred there actually was a schedule a for this program--although it’s undated that schedule a lists five pairings for a total cost of dollar_figure but only one of the horses is a thoroughbred--gogo the mare debra says she saw at classicstar’s kentucky derby weekend the schedule a paired gogo with a cutting horse--a less-expensive type of horse--for a breed fee of dollar_figure even though his normal stud fee was only dollar_figure the other listed horses were all quarter horses and one of the horses in the mare column was actually a gelding--a male horse that had been castrated the listed pairings were therefore worth much less than what the householders paid and at least one couldn’t have produced a foal scott and debra nevertheless signed this schedule a as with the program scott and debra neither received nor asked for any updates about the leased mares’ pregnancies c the program in date scott and debra signed up for a third year again planning to generate dollar_figure in nols they paid half themselves--dollar_figure with a check from medaca in may and dollar_figure with a check from the householder group in september but they later backed out of the program and classicstar refunded their dollar_figure in date d cashing out on date--three days after they’d signed up for the program-- scott and debra told classicstar’s parent company geostar that they wanted to exchange part of their mare lease breeding business for a working_interest in geostar’s coalbed methane drilling program in date they traveled with holt and his wife to a gastar property in australia and on the last day of exchanged the majority of their interest in the breeding program and their entire_interest in the breeding program for units of feep and shares of gastar they got big_number feep units--which their subscription documents valued at dollar_figure each--and big_number gastar shares--which were trading for dollar_figure a share but which the purchase agreements valued at dollar_figure each same as the put price on the initial mare-lease program reports they’d received these shares came with the restriction that scott and debra couldn’t sell them for one year without gastar’s permission in date scott and debra gave all big_number of their feep units to nelc in satisfaction of the dollar_figure long-term_loan from and the dollar_figure long-term_loan from e phoenix heat although they’d supposedly paid for multiple horse pairings in and scott and debra received only one foal--phoenix heat phoenix heat was born in date and classicstar had purchased her mother in foal at the keeneland sale in date debra saw phoenix heat for the first time during classicstar’s kentucky derby weekend in date the foal had some problems--it was pigeon toed and had parrot mouth basically an overbite --that scott and debra spent dollar_figure to correct debra put phoenix heat up for auction at the date keeneland sale during which she signaled nick plummer to place bids on her behalf in order to drive up the price phoenix heat sold for dollar_figure from which scott and debra got dollar_figure after a commission f classicstar’s demise the irs raided classicstar’s offices in date in date david plummer spencer plummer and terry green each pleaded guilty to conspiring to defraud the united_states by impairing and impeding the internal_revenue_service with classicstar’s mare-leasing program during the plea hearing david plummer admitted he’d helped people take tax deductions they weren’t entitled to spencer plummer admitted that the nelc loans were the source of the deductions that classicstar didn’t own enough mares for its program and that feep interests were worthless and terry green said he’d helped people under audit provide misleading and back-dated documents to the irs classicstar itself collapsed into bankruptcy in date scott and debra filed a proof_of_claim for dollar_figure million--which included the dollar_figure scott paid for the program that classicstar had refunded in date the bankruptcy court reduced their claim by the dollar_figure million they’d listed for the dollar_figure million figure also double counted the amount scott and debra paid classicstar by adding separate lines for out-of-pocket and borrowed money paid with a line for total program assessed paid and expected tax penalties interest and estimated_tax for debt forgiveness and they ultimately received dollar_figure from the bankruptcy trustee scott said he didn’t sue holt--although holt’s other clients did--because he didn’t think holt had stolen from him and he didn’t sue classicstar because he didn’t think he’d get any money back iii the householders’ tax returns a the householders’ cpa prepared all their returns the amended joint tax_return that scott and debra filed in date showed almost dollar_figure in adjusted_gross_income agi which included the dollar_figure coi income from sun america and a tax_liability of dollar_figure but in they filed a second amended_return on which they reduced their agi to under dollar_figure the adjustment included a dollar_figure nol_carryback from b classicstar emailed holt instructions on how scott and debra should fill out the schedule f profit or loss from farming on their tax_return it said it also reduced their claim by the dollar_figure they’d received for the sale of phoenix heat although they’d already shown that amount as cash received on their initial claim board and mare care expenses board fees mare lease insurance total expenses dollar_figure--line big_number -line big_number -line 26b big_number -line big_number -line scott gave these instructions to stallworthy and told her to follow them after scott assured her that he and debra had really participated in a business stallworthy transcribed the numbers from the email onto the schedule f although scott and debra had around dollar_figure in wage business and schedule e income the agi they reported for was a loss of dollar_figure c on their tax_return scott and debra reported dollar_figure in schedule f losses related to their involvement with classicstar this made their agi negative and created the nol_carryback they reported on their amended return iv the audit a debra’s notebook the commissioner began an audit in in november of that year a revenue_agent met with debra and asked her for the names of the horses she’d leased debra couldn’t name any and even at trial scott said he had no idea how many pairings he’d paid for or which mares he’d leased during the audit the agent repeatedly asked scott and debra to turn over any documents showing their due diligence and the horses involved they never did send any original documents in response to these requests but in they gave the revenue_agent a document labeled householder outline of facts that listed original pairings and trade out s for the and programs several of the horses listed were also quarter horses--including some listed after the trade-outs despite not producing any original documents during the years-long audit a few weeks before trial the householders turned over a coverless spiral notebook full of handwritten notes they say debra made between and while researching classicstar’s horses loose inside were printouts of spreadsheets that according to debra showed information on horse sales that she found on the internet it also listed pairings that debra said are the ones she wanted for the program debra said she hadn’t turned over the notebook in the nine years since the audit began because it was misfiled in scott’s office at trial the householders called a nanny they’d employed in to testify that it was debra’s notebook and that it originally had a green cover with a picture of a horse on it except for its missing cover it was in very good condition for a twelve-year-old notebook and the notes--which bear dates spanning two years--all appear to have been written with the same type of pen the nanny also testified that in and debra spent a few hours each monday through thursday evening as well as some weekend hours in her home_office the nanny believed debra was both making spreadsheets of horses and working on her schoolwork at those times b scott’s notes scott also turned over handwritten notes about classicstar shortly before trial he too testified that he hadn’t turned them over earlier because they’d been misfiled he had however previously provided a printout of a article from bloodhorse com about the criminal case against classicstar on which he’d written d iscuss w debby he testified that he’d discussed the article with his wife around the time it was written in but the print date in the lower right corner of the page is a m we do not find these late-produced materials reliable and they reduced the credibility of the householders’ testimony on other issues c the material_participation log in the householders did turn over a participation log that covered date through date for date they listed hours each for their meeting with holt where they d iscussed classicstar investment opportunities between february and may they logged a total of hours of research on classicstar and its horses in each of those months and in every subsequent month debra also listed hours for r ead ing thoroughbred times and blood horse --the magazines classicstar sent them a letter about in date starting in date scott and debra also listed a total of hours each month for r ead ing classicstar emails and articles of interest for twelve of the twenty-three months in the log reading emails articles of interest and magazines were the only activities scott and debra logged scott and debra’s trips make up most of the rest of the activities in the log debra logged hours for b ook ing breeder’s cup weekend for that date trip and hours for f irm ing up plans for breeder’s cup weekend and together they logged hours for traveling to kentucky meeting classicstar staff going on tours and attending the hawaiian-themed dinner they recorded a similar amount of time for their kentucky derby trip debra logged hours for planning the trip and she and scott together logged hours for activities such as travel to and from lexington dinner at embassy suites tour kentucky horse museum and mingle with other classicstar clients for the yellowstone trip they logged hours for travel meeting with other classicstar owners a fternoon activities with group and discussing feep and for his u s virgin islands trip scott logged hours for travel dinner meetings and reviewing and signing documents this all amounted to hours for and hours for d the notices of deficiency during the audit scott and debra signed several consents to extend the statute_of_limitations but in the commissioner finally sent scott and debra a notice_of_deficiency for the and tax years it determined several adjustments for each year though the only ones still at issue by the time of trial were 2001’s dollar_figure nol_carryback 2002’s dollar_figure schedule f loss 2003’s dollar_figure schedule f loss and sec_6662 penalties for negligence and substantial_understatement for all three years the commissioner also sent them a notice_of_deficiency for the tax_year the parties have settled all of the issues it raised but in their amended petition scott and debra claimed an dollar_figure theft_loss and that contention remains before us v petitions and trial scott and debra filed timely petitions they lived in phoenix arizona when they filed their petitions and that is where we tried these cases each side had expert witnesses the commissioner’s expert who evaluated the pairings on the householder outline of facts was of the opinion that the amounts scott and debra had paid for leasing inseminating and boarding mares were grossly inflated and unwarranted the householders’ expert thought those amounts were reasonable but represented a premium but he didn’t evaluate the same pairings--the pairings he considered were ones the householders’ lawyer told him to and his report makes clear that his opinion was based upon the assumption that the householders requested the matings discussed in his report there is also a graev issue here although he determined sec_6662 penalties in the notices of deficiency at trial the commissioner didn’t introduce any evidence that he’d complied with sec_6751 see graev v commissioner graev iii t c ___ ___ slip op pincite date citing 851_f3d_190 2d cir aff’g in part rev’g in part t c memo supplementing and overruling in part 147_tc_460 after we released graev iii the commissioner moved to reopen the trial record to fix his omission for a portion of the sec_6662 penalties he’s conceded the rest we recently granted his motion and consider the commissioner’s additional evidence here opinion i the parties’ arguments scott and debra argue that horse breeding was a trade_or_business they engaged in for profit and they also say they meet the regulatory standards for material_participation they claim they would’ve made a profit if classicstar hadn’t been a scam and they think they should get a theft_loss in because in that year they both realized they’d been swindled and determined there was no reasonable chance of getting their money back they also argue that they shouldn’t have to pay penalties because they had reasonable_cause acted in good_faith and relied on substantial_authority the commissioner replies that scott and debra didn’t materially participate in horse breeding that their involvement with classicstar wasn’t a trade_or_business and that they shouldn’t get a theft_loss because the only thing they lost was impermissible tax savings and he says scott and debra should pay penalties because they knew exactly what they were doing we must therefore answer four questions did scott and debra materially participate in a horse-breeding activity was the horse-breeding activity a trade_or_business are scott and debra entitled to a theft_loss deduction in for amounts they paid classicstar in and are scott and debra liable for sec_6662 penalties we address each in turn ii material_participation taxpayers can usually deduct the ordinary and necessary expenses of carrying_on_a_trade_or_business or otherwise producing income sec_162 sec_212 but they can’t deduct passive_activity_losses that exceed their passive_activity income sec_469 d passive activities include the conduct of any trade_or_business in which the taxpayer does not materially participate sec_469 and the code tells us that material_participation means being the commissioner also argued that the amounts of the long-term loans were never at risk a theory scott and debra say the commissioner failed to mention in his notice_of_deficiency whether those amounts were at risk doesn’t affect our decisions in these cases so we don’t need to determine when the commissioner first raised the issue or who would have the burden_of_proof scott and debra also contest the admissibility of some exhibits the commissioner proffered--82-r 84-r 85-r 126-r 128-r 149-r and 206-r we didn’t rely on those exhibits and we will exclude them involved in the operations of the activity on a regular continuous and substantial basis sec_469 the regulations say that a taxpayer is a material participant only if he meets one of seven enumerated tests sec_1_469-5t temporary income_tax regs fed reg date scott and debra say they’re entitled to the losses they claimed for and 2003--and the associated nol_carryback they reported on their amended return--because they satisfy two of those tests we consider each a hours the householders first say they satisfy the test in sec_1_469-5t temporary income_tax regs supra which says an individual materially participates if he participates in the activity for more than hours during the year their participation log shows that together they spent only hours on horse-breeding-related activities in and only such hours in undeterred by their own records they point out that we may find the extent of an activity by any reasonable means sec_1_469-5t temporary income_tax regs fed reg date and urge us to find that debra alone spent hours a year on horse breeding because their nanny testified that in debra spent both monday through thursday evenings and some weekends in her home_office working on horse business we were not persuaded the nanny gave only vague indications of when this practice began and ended she knew it started around the time scott and debra met with holt in early but said that by debra’s office time varied more and i t wasn’t monday through thursday always necessarily plus she was usually taking care of the children whenever debra was in the office and only occasionally actually saw debra working the nanny also acknowledged that debra did her schoolwork in the evenings though we can use any reasonable means to estimate the hours a taxpayer spends on an activity see tolin v commissioner tcmemo_2014_65 at we don’t accept ballpark guesstimate s jordan v commissioner tcmemo_2009_223 wl at aff’d 469_fedappx_460 6th cir we do not find that the nanny’s testimony makes it more_likely_than_not that debra spent at least hours a year on horse-breeding-related activities--especially when debra’s own log lists less than half as much time b regular continuous and substantial the householders also argue that they satisfy the test in sec_1 5t a temporary income_tax regs fed reg date which mirrors the code by saying a taxpayer materially participates if b ased on all of the facts and circumstances he participates in the activity on a regular continuous and substantial basis but an individual who tries to clutch this exception still has to spend at least hours a year on related activities see sec_1_469-5t temporary income_tax regs fed reg date --though scott and debra together count as an individual because they’re married see sec_1_469-5t temporary income_tax regs fed reg date management activities however count toward the hours only if no one else gets paid for them or spends more time on them sec_1 5t b ii temporary income_tax regs supra and all the material-participation tests--including the 500-hour test we discussed above--disregard work an individual does as an investor unless the individual is directly involved in the day-to-day management or operations of the activity sec_1_469-5t temporary income_tax regs fed reg date according to the regulations working as an investor includes s tudying and reviewing financial statements or reports on operations of the activity p reparing or compiling summaries or analyses of the finances or operations of the activity for the individual’s own use and m onitoring the finances or operations of the activity in a non-managerial capacity sec_1_469-5t temporary income_tax regs supra let’s look at the activities that the householders logged initial research scott and debra’s log says they spent hours researching classicstar and hours meeting with holt to discuss classicstar investment opportunities between february and date--well before they signed their first letter of intent in date we have specifically found that research done before deciding to raise livestock doesn’t count as material_participation in the raising of livestock syed v commissioner tcmemo_2017_226 at we think the same here--the householders’ initial research doesn’t count--it was at best work they did as investors researching a potential investment reading talking and thinking starting in date scott and debra logged hours a month for reading the magazines thoroughbred times and the blood-horse and starting in may they logged an additional hours each month for r ead ing classicstar emails and articles of interest they logged these hours every month until the end of and these hours constitute of hours for and of hours for almost all of the rest of the hours they logged--46 hours in and hours in 2003--were spent planning and going on trips during these trips they logged hours for so-called breakfast meetings lunch meetings and dinner meetings--including the one with a hawaiian theme touring classicstar’s facilities watching the kentucky derby and talking to other classicstar clients the remaining hours in their log show initial research viewing classicstar materials or reviewing contracts none of these activities are the day-to-day management or operation of a horse-breeding business while scott and debra were doing them other people far away were supposedly taking care of the horses they’d purportedly leased and making the day-to-day decisions about their care see lapid v commissioner tcmemo_2004_222 wl at owner of hotel rooms didn’t materially participate where someone else cleaned and checked people in what’s more we’ve previously said that the types of activities scott and debra logged are not material_participation in syed at a putative rancher logged hours for reading magazines about animal husbandry talking with other ranchers and thinking about ranch matters there we explained that reading talking and thinking don’t count as material_participation if other people are doing the actual work see id at they don’t count here either at best the activities which the householders logged were things investors might do to monitor an investment management scott and debra nevertheless argue that these activities should count as material_participation they say they alone managed their horse-breeding operation because they decided how much to spend selected pairings and authorized veterinary care for phoenix heat but phoenix heat wasn’t born until and debra didn’t see her until so any involvement they had with her wasn’t material_participation in and plus we aren’t convinced that they actually selected thoroughbred pairings--they signed contracts that didn’t list any horses signed a schedule a that listed nonthoroughbreds and a gelding and their outline of facts and debra’s late-produced notebook aren’t consistent about which pairings she purportedly requested orally and deciding how much to spend sounds a lot like an investment activity even if we counted all these things it still wouldn’t help scott and debra sec_1_469-5t example temporary income_tax regs fed reg date says that someone who owns an interest in a cattle business and periodically makes unilateral decisions about feeding and selling the cattle doesn’t satisfy the test in sec_1_469-5t temporary income_tax regs fed reg date where someone else receives income for managing the cattle’s day-to-day care changing cattle to mares in this example gives us something very close to scott and debra’s version of events--even if we assume they made the financial and breeding decisions classicstar still managed the day-to-day care scott and debra’s decisionmaking we find doesn’t count as material_participation c principal purpose we note as well that the regulations say that hours spent on an activity don’t count toward material_participation if o ne of the principal purposes for the performance of such work is to avoid the disallowance under sec_469 and the regulations thereunder of any loss or credit from such activity sec_1 5t f i b temporary income_tax regs fed reg date the evidence here shows classicstar repeatedly told the householders to read magazines and emails listen to talks and take trips we agree that the householders followed those instructions and did all these things--but only because they wanted the losses classicstar sold them virtually every hour they spent was done to show material_participation so they could avoid disallowance of losses which means those hours don’t count toward material_participation the householders didn’t spend hours a year breeding horses they didn’t handle any day-to-day operations or management and they did what they did just to avoid disallowance of their deductions that means their involvement with classicstar’s mare-leasing program was a passive_activity and their passive losses are allowable only to the extent that they have passive_income iii trade_or_business even if scott and debra did materially participate in a horse-breeding operation we have another reason for disallowing their horse-breeding deductions sec_162 permits deductions for ordinary and necessary expenses paid_or_incurred in carrying on any trade_or_business but an activity is a trade_or_business only if a taxpayer does it continuously and regularly with the honest intent of making a profit 480_us_23 see also sec_183 c sec_212 allows a taxpayer to deduct expenses_incurred in the production_of_income generally but again only if he actually intends to make a profit see 776_f2d_1428 9th cir aff’g in part rev’g in part 81_tc_840 72_tc_28 see also sec_183 c a taxpayer’s profit expectation doesn’t have to be reasonable but it does have to be genuine see 78_tc_642 aff’d without published opinion 702_f2d_1205 d c cir metz v commissioner tcmemo_2015_54 at sec_1_183-2 income_tax regs taxpayers bear the burden of showing they had a profit_motive 4_f3d_709 9th cir aff’g tcmemo_1991_212 and profit means economic profit--not tax savings id 81_tc_210 did the householders intend to make a profit breeding horses the regulations tell us to determine taxpayers’ subjective intent to make a profit by reference to objective standards taking into account all of the facts and circumstances sec_1_183-2 income_tax regs they give us nine factors to consider but tell us that n o one factor is determinative that we can consider factors not on the list and that we shouldn’t simply compare the number of factors that suggest a profit_motive to the number of factors that don’t sec_1_183-2 income_tax regs the seventh circuit has called this a goofy regulation and has said we’d be better off if instead of wading through the nine factors we took a more holistic approach to determining whether a taxpayer intended to turn a profit 820_f3d_247 7th cir rev’g tcmemo_2014_74 it did something like that in a recent opinion in a horse- breeding case see 811_f3d_890 7th cir but the cases before us are appealable to the ninth circuit so we’ll screw in our calks and into the mud we go a manner in which the activity is conducted the first factor tells us to look at how the taxpayer conducts the activity it says the fact that the taxpayer carries on the activity in a businesslike manner and maintains complete and accurate books_and_records may indicate that the activity is engaged in for profit sec_1_183-2 income_tax regs scott and debra say they were businesslike because they researched classicstar formed an llc and got it a bank account maintained an activity log and had a business plan--not a written one but one whose existence we should infer from their actions they also rely on a participation log that simply lists activities classicstar told them to list and handwritten notes they say they’d misfiled for nine years and fortuitously discovered only on the eve of trial their administration of the llc was hardly businesslike--they kept few records for it and they used its bank account to pay personal bills such as payments on their land rover also unbusinesslike for people engaged in horse breeding was scott’s and debra’s apparent uninterest in whether their horses got pregnant least businesslike of all is their signing up for thoroughbred horse breeding purportedly worth dollar_figure in and dollar_figure in without knowing what horses they were paying to breed for the program they signed contracts that referred to but didn’t actually contain a schedule of horses and for the program they signed a schedule that listed quarter horses and a gelding and even if there was a verbal schedule a or an oral agreement about placeholders or tradeouts-- which we doubt--the contracts themselves said any prior agreements were invalid and said subsequent agreements were valid only if written signing such contracts was under the circumstances decidedly unbusinesslike this factor weighs against scott and debra b expertise of taxpayers or advisers consulting with experts when preparing for an activity can suggest a profit_motive sec_1_183-2 income_tax regs scott and debra say they consulted extensively with two experts--themselves they point out that scott was a successful businessman and that debra spent time with horses in her youth but neither scott nor debra had any experience breeding thoroughbreds scott’s background was in finance and although a young debra bred her show horse brandy susie bar twice she managed to sell only one foal and only for the amount of the stud fee these experiences did not turn them into thoroughbred- breeding experts and they can’t claim reliance on holt or classicstar because they were the ones selling them the program see romanowski at pederson at this factor weighs against them c time and effort expended on the activity the fact that the taxpayer devotes much of his personal time and effort to carrying on an activity particularly if the activity does not have substantial personal or recreational aspects may indicate an intention to derive a profit sec_1_183-2 income_tax regs scott and debra argue that in addition to the activities they recorded on their material_participation log debra spent countless hours researching yearling sales information for classicstar’s horses but that argument relies on the nanny’s unpersuasive testimony see supra p even the material-participation log fails to show devotion of much personal time and effort close to half of the hours were logged for reading emails articles and magazines and these were the only activities for about half the months in the log reading magazines doesn’t show time and effort spent managing a horse- breeding business and we have our doubts about how much time debra actually spent reading them--nothing about the log suggests that entries in it were made contemporaneously with the activities recorded and although debra started logging magazine hours in date she didn’t get information about the magazines from classicstar until december of that year most of the rest of the time was spent on trips to the breeders’ cup the kentucky derby yellowstone and the virgin islands--each of which included large dollops of recreation this factor also weighs against them d expectation that assets used in activity may appreciate an expectation that assets will appreciate can suggest a profit_motive sec_1_183-2 income_tax regs the householders claim they expected to receive and sell several foals but the documents they reviewed and signed tell a different story the initial reports from classicstar show only losses not profits based on those reports scott and debra decided to participate signed the contracts not knowing what horses they were supposedly breeding and signed a schedule a for that included quarter horses and a gelding and they knew all along that they’d be able to exchange their mare-leasing interest for participation in feep and gastar which also suggests that they weren’t really interested in making money from horses deductible losses not profitable foals are what they expected this factor weighs against them e taxpayers’ success in similar activities the fact that the taxpayer has engaged in similar activities in the past and converted them from unprofitable to profitable enterprises may indicate that he is engaged in the present activity for profit sec_1_183-2 income_tax regs the householders point out that scott ran an extremely successful financial advisory business and that debra had experience with horses but scott had no experience with thoroughbred breeding--although he testified that he did due diligence on classicstar he said debra was the horse expert see annuzzi v commissioner tcmemo_2014_233 at taxpayer’s success in concrete business doesn’t show profit_motive for thoroughbred activities debra also lacked any experience as a manager of a breeding business--her horse experience was hands-on and during her youth and her two attempts at breeding her own horse were commercial failures this factor weighs against them f history of income or losses with respect to the activity long periods of losses following the initial startup phase can indicate the lack of a profit_motive sec_1_183-2 income_tax regs the householders argue that their and losses were basically startup costs because they expected to receive the program’s foals in and sell them in they also say we shouldn’t count their continued losses against them because they would’ve made money if classicstar had been on the level it’s true that many businesses are unprofitable at first and many also fail without ever making money but as we’ve already pointed out the documents scott and debra based their participation on show that they didn’t expect economic profits--they expected only losses and in amounts that would entirely offset their income see supra p they can’t now argue that they would’ve made money but for classicstar’s criminality when they never planned to make money to begin with this factor counts against them g amount of occasional profits if any occasional profits can show a profit_motive but the size and frequency of profits relative to losses are what matter sec_1_183-2 income_tax regs s ubstantial profit though only occasional is therefore a better indicator of a profit_motive than occasional small profit from an activity generating large losses id scott and debra say this factor should count in their favor because there was a small chance they’d make big money breeding horses once again we reject this argument because the record shows that losses not profits motivated their involvement with classicstar and the only horse-breeding revenue they received was the dollar_figure they got from the sale of phoenix heat which was occasional and small compared to the dollar_figure million they claim to have spent in and this factor also weighs against them h the taxpayers’ financial status substantial income from sources other than the activity particularly if the losses from the activity generate substantial tax benefits may indicate that the activity is not engaged in for profit sec_1_183-2 income_tax regs in scott and debra reported dollar_figure of income from the householder group and dollar_figure of coi income and in they reported dollar_figure of business income but thanks to the losses they reported from their involvement with classicstar they reported zero taxable_income for each of those years--and realized substantial tax benefits as a result scott and debra say that horse breeding was debra’s business and that we should consider only her portion of their income when weighing this factor but by filing jointly they enjoyed the tax losses together and their log credits scott with of the hours and only he went to the classicstar event in the u s virgin islands scott and debra together offset huge joint income with purported joint losses from their joint involvement with classicstar this factor weighs very heavily against them i elements of personal pleasure or recreation the presence of personal motives in carrying on of an activity may indicate that the activity is not engaged in for profit especially where there are recreational or personal elements involved sec_1_183-2 income_tax regs scott and debra admit that debra loved horses yet they argue that personal pleasure wasn’t a motive here because debra didn’t spend time with them--after all she was in arizona and the horses were in kentucky pointing out that debra was thousands of miles from her horses is a curious way to argue that she was engaged in a real horse-breeding business more to the point of the hours in scott and debra’s participation log are from trips--to the breeders’ cup the kentucky derby yellowstone and the u s virgin islands and the activities listed on these trips are almost all recreational--tours lunches and dinners recreation was a large part of scott and debra’s involvement with classicstar so this factor counts against them this is not a case where slogging through the goofy regulation would ever lead to a result different from taking a holistic approach the regulatory factors together show that the householders got involved with classicstar with the intent to generate losses not profits the documents classicstar sent them before each breeding season showed them how to offset the income they expected from other sources they signed a contract not knowing what horses they were leasing and they signed a schedule of horse pairings that included quarter horses and a gelding the activities they logged were largely recreational and from the beginning they knew they’d be able to convert their mare-leasing interests into stakes in related entities--some of which they later used to satisfy their nelc loans looked at all together we find that what they wanted from their horse- breeding activity was tax savings to offset their large income from other sources they lacked a subjective intent of making a profit see wolf f 3d pincite surloff t c pincite scott and debra’s purported horse-breeding activity was not a trade_or_business iv theft_loss the householders argue that even if they didn’t materially participate in a horse-breeding business they can still deduct as a theft_loss any amounts they gave to classicstar but didn’t get back see sec_165 c to deduct a theft_loss a taxpayer has to show by a preponderance_of_the_evidence that theft or something similar under state law caused the loss see eg 34_tc_688 see also sec_1_165-8 income_tax regs theft includes larceny embezzlement and robbery the taxpayer also has to show the year in which he discovered the loss which becomes the year he can claim the deduction as long as there’s no reasonable chance of recovery see sec_165 sec_1_165-8 income_tax regs and of course he has to show the amount of the loss see sec_1_165-8 income_tax regs see also eg elliot v commissioner 40_tc_304 the householders say that the federal criminal convictions of david plummer spencer plummer and terry green show that classicstar committed theft by deception under kentucky law they also say they discovered the loss in when classicstar was raided and in the same year determined that there was no hope of recovery in their opening brief they argue that they paid dollar_figure--an amount that includes what they gave classicstar directly the principal and interest they paid on the short-term loans and the interest they paid on the long-term loans but not the long-term_loan principal they satisfied through feep--but got back only dollar_figure from selling phoenix heat leaving them with a dollar_figure loss the commissioner doesn’t contest the amount the householders paid but he says there was no loss he points out that in addition to the dollar_figure for phoenix heat the householders received big_number shares of gastar stock they exchanged part of their mare-leasing interest for these shares on the same day they traded for their feep units--date the parties stipulated that gastar stock traded at dollar_figure at the end of which made these shares worth dollar_figure million and at the end of 2006--the year for which the householders claimed a theft loss--gastar still traded at dollar_figure a share which made their shares worth dollar_figure classicstar didn’t steal from scott and debra--it gave them assets worth more than they’d paid scott and debra acknowledge that they received the gastar stock they point out however that they weren’t allowed to sell it for one year without gastar’s permission and they say that even though they signed the purchase agreements in date this restriction was still in effect at the end of because they didn’t actually receive the shares until s ometime after april of that yeardollar_figure they now ask us to find a marketability discount for this restriction and determine that they still had a loss scott and debra didn’t present any expert testimony or other evidence that would enable us to accurately determine a marketability discount for restricted gastar shares they instead ask us to make a finding based on questionable inferences first they say that because the purchase agreements allocated dollar_figure to each gastar share we should find that dollar_figure was the fair_market_value of a restricted share at that time gastar was trading at dollar_figure then meaning the marketability discount they want is over next they say that because the the purchase agreements had boilerplate clauses stating that the shares weren’t registered that scott and debra received them only under the accredited- investor exemption see small_business investment incentive act of pub_l_no sec stat pincite codified as amended pincite u s c sec_77d a see generally 953_f2d_256 6th cir and that they cannot sell them unless the shares got registered or an exception to registration applies but the record also shows that gastar was publicly traded--the parties stipulated to gastar’s share-price history and introduced gastar’s annual report which says that its shares were listed on the american and the toronto stock exchanges these facts overcome the boilerplate clauses and lead us to find that they do not affect the value of the shares value of unrestricted gastar stock dropped about from the end of to the end of the value of restricted shares would’ve fallen by the same percentage making them worth just dollar_figure to make this finding we’d have to assume that the allocation on the purchase agreement between the householders and classicstar accurately valued the stock we won’t make that assumption scott and debra entered into agreements with classicstar that arbitrarily valued mare leases and related expenses and there’s no reason to think the allocation here is any more reliable we’d also have to assume that the marketability discount rate didn’t fluctuate over time and we’d have to ignore the fact that on their date bankruptcy proof_of_claim scott and debra valued the stock--which they said on the claim they still hadn’t received--at dollar_figure a share only less than the dollar_figure it was trading for that day we won’t do that either more importantly the householders raised the issue of the gastar stock’s marketability for the first time in their reply brief and we don’t let parties raise new issues or theories on brief when doing so would surprise and prejudice the other side see 116_tc_450 seligman v they didn’t do the calculation but this would make their purported loss only dollar_figure--the dollar_figure they claim minus the dollar_figure they now say their shares were worth commissioner 84_tc_191 aff’d 796_f2d_116 5th cir a party is prejudiced if it would need to present additional evidence to respond to the new issue or theory see 91_tc_200 aff’d 905_f2d_1190 8th cir to respond to the marketability- discount theory the commissioner would have to amass evidence of what restricted gastar shares were worth his lack of opportunity to do so would prejudice him we therefore won’t consider it scott and debra didn’t lose the money they paid classicstar so they didn’t suffer a theft_loss v penalties the commissioner determined sec_6662 penalties against scott and debra for and that section imposes a penalty on understatements that are substantial see sec_6662 d or that are due to negligence or disregard of rules and regulations see sec_6662 c when the taxpayers are individuals the commissioner has the initial burden of production for penalties sec_7491 he meets part of his burden for substantial-understatement penalties here because scott and debra’s understatements are more than dollar_figure and more than of the tax they should’ve reported each year see sec_6662 he meets the initial part of his burden for negligence too because he showed and we so find that scott and debra should’ve known that their return position--which offset all of their income with horse-leasing expenses prepaid with sham loans--was too good to be true and they made no real effort to ascertain the correctness of that position see sec_1_6662-3 income_tax regs a reasonable_cause and good_faith scott and debra say they’re not liable for penalties because they had reasonable_cause for their return position and acted in good_faith when they took it see sec_6664 sec_1_6664-4 income_tax regs they argue that three things show their reasonable_cause and good_faith they relied on a cpa they relied on holt and pcg’s materials and they conducted their horse-breeding endeavor in a businesslike manner we’ve already held that their conduct was not businesslike see supra pp so we address only the first two contentions reasonable reliance on an adviser such as a cpa can excuse a taxpayer from an accuracy-related_penalty 115_tc_43 aff’d 299_f3d_221 3d cir reliance is reasonable if the adviser was a competent professional with sufficient expertise to justify reliance the taxpayer provided necessary and accurate information to the adviser and the taxpayer actually relied on the adviser’s judgment in good_faith id pincite scott and debra point out that they discussed their classicstar participation with stallworthy their cpa and the commissioner doesn’t dispute that she was a competent professional but stallworthy refused to give them an opinion she also didn’t come up with scott and debra’s return position--she merely filled out their returns using numbers scott gave her and only after he assured her that he and debra materially participated far from relying on their cpa’s advice scott and debra told her what to do that doesn’t protect them see eg bronson v commissioner tcmemo_2012_17 wl at aff’d 591_fedappx_625 9th cir kaplan v commissioner tcmemo_2006_16 wl at next they say that they reasonably relied on the opinion letter in the pcg materials that holt gave scott but the householders can’t claim reliance on holt because commissions he received for placing people with classicstar make him a promoter--someone who participated in structuring the transaction or is otherwise related to has an interest in or profits from the transaction 136_tc_67 quoting tigers eye trading llc v commissioner tcmemo_2009_121 wl at aff’d 684_f3d_84 d c cir scott knew holt was getting commissions for placements with classicstar and he knew holt was placing multiple people in the same program--another hallmark of a promoter see id pincite no reasonable reliance there either b substantial_authority scott and debra also say they shouldn’t have to pay penalties because they had substantial_authority for their return position substantial_authority is not a defense to negligence it’s a defense only to substantial understatements see sec_1_6662-4 income_tax regs and the tax opinion they got from holt-- which is the only thing they say they relied on--doesn’t excuse their understatement because opinions rendered by tax professionals are not authority id this argument also fails c sec_6751 part of the commissioner’s burden of production on penalties is showing that they were personally approved in writing by the immediate supervisor of the individual making such determination see sec_6751 graev iii t c at ___ slip op pincite the commissioner didn’t introduce any evidence of such approval at trial but we recently granted his motion to reopen the trial record and added to it penalty-approval forms for the and negligence penalties these are enough for the commissioner to meet this part of his burden of production for the and negligence penalties and he’s conceded any othersdollar_figure so we sustain the sec_6662 penalties for scott and debra’ sec_2002 and tax years and despite their lack of reasonable_cause or good_faith we don’t sustain the sec_6662 penalties for their tax_year decisions will be entered under rule more specifically the commissioner’s conceded the negligence_penalty and the and substantial-understatement penalties


internal_revenue_service department of the treasury index number washington dc number release date telephone number refer reply to cc dom p si 1-plr-104750-00 date date person to contact legend x d1 this responds to a letter dated date submitted on behalf of x requesting relief under sec_1362 of the internal_revenue_code facts x was incorporated on d1 x intended to be treated as an s_corporation for federal_income_tax purposes effective on d1 but the s election was not timely filed law and analysis sec_1362 provides that a small_business_corporation may elect to be an s_corporation sec_1362 provides the rule on when an s election will be effective if an s election is made within the first two and one-half months of a corporation’s taxable_year then the corporation will be treated as an s_corporation for the year in which the election is made if the election is made after the first two and one-half months of a corporation’s taxable_year then the corporation will not be treated as an s_corporation until the taxable_year after the year in which the s election is made sec_1362 provides that if no election is made pursuant to sec_1362 or if plr-104750-00 made the election is made after the date prescribed for making such an election and the secretary determines there was reasonable_cause for the failure to timely make the election then the secretary may treat such an election as timely made for such taxable_year and effective as of the first day of that tax_year x did not file a timely election to be treated as an s_corporation under sec_1362 effective on d1 x has however established reasonable_cause for not making a timely election and is entitled to relief under sec_1362 conclusion based solely on the facts submitted and representations made and provided that x otherwise qualifies as a subchapter_s_corporation we conclude that x will be recognized as an s_corporation effective d1 within days from the date of this letter x should submit a properly completed form_2553 with a copy of this letter attached to the relevant service_center except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter this ruling is directed only to the taxpayer s requesting it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative sincerely s dianna k miosi dianna k miosi chief branch office of the assistant chief_counsel passthroughs and special industries enclosures copy of this letter copy for sec_6110 purposes


t c summary opinion united_states tax_court marko filipovich petitioner v commissioner of internal revenue respondent docket no 13302-06s filed date marko filipovich pro_se mayer y silber for respondent goldberg special_trial_judge this case was heard pursuant to the provisions of sec_7463 of the internal_revenue_code in effect at the time the petition was filed pursuant to sec_7463 the decision to be entered is not reviewable by any other court and this opinion shall not be treated as precedent for any other case unless otherwise indicated subsequent section references are to the internal_revenue_code petitioner filed a petition with this court in response to a notice_of_determination concerning collection action s under sec_6320 and or notice_of_determination for and pursuant to sec_6330 petitioner seeks review of respondent’s determination the issue for decision is whether respondent abused his discretion by sustaining the filing of a federal_tax_lien background some of the facts have been stipulated and are so found the stipulation of facts and the exhibits received into evidence are incorporated herein by reference at the time the petition was filed petitioner resided in illinois petitioner has a longstanding history of not paying his federal income taxes specifically petitioner failed to pay his federal income taxes due for taxable years through petitioner filed his form sec_1040 u s individual_income_tax_return for and on date and date respectively and the amounts reported due for those years dollar_figure and dollar_figure respectively were assessed a notice_and_demand for payment was mailed to petitioner within days of each assessment as required under sec_6303 in response petitioner submitted an offer-in-compromise oic on date in his oic petitioner offered dollar_figure to settle in full his unpaid taxes for the years through on date the internal_revenue_service irs rejected petitioner’s oic and petitioner protested by letter received by the irs on date on date respondent notified petitioner that his protest was untimely and that his file was being returned to the offer unit on date letter notice_of_federal_tax_lien intent to levy and your right to a hearing under sec_6320 notice_of_federal_tax_lien was mailed to petitioner with respect to the years at issue the notice_of_federal_tax_lien indicated that a federal_tax_lien could be filed at any time a notice_of_federal_tax_lien was filed against petitioner on date at the office of the recorder of deeds for dupage county illinois on date petitioner submitted form request for a collection_due_process_hearing in which he claimed that the notice_of_federal_tax_lien was filed as an act of retaliation by the same appeals officer who he claimed denied his oic petitioner also claimed that sustaining the notice_of_federal_tax_lien would not be in the best interest of the government and that it would impair his ability to find a job on date petitioner filed a bankruptcy petition under chapter of the bankruptcy code in the u s bankruptcy court for the northern district of illinois on date the bankruptcy court granted a discharge of petitioner’s federal tax_liabilities for taxable years through on date the collection_due_process_hearing was held between petitioner and appeals officer karin banks ms banks who had earlier mailed to petitioner a letter that listed the statutory requirements to obtain a withdrawal of a notice_of_federal_tax_lien pursuant to sec_6323 during the hearing petitioner presented an account of his financial situation and reiterated his interest in making an oic on the basis of her review of the financial information provided by petitioner ms banks did not extend an offer to settle the tax_liabilities owed petitioner did not offer any arguments as to why the notice_of_federal_tax_lien should be withdrawn pursuant to sec_6323 petitioner only reiterated his position that the appeals officer who denied his dollar_figure oic filed the notice_of_federal_tax_lien in retaliation on date the appeals_office in chicago issued petitioner a notice_of_determination sustaining the filing of the notice_of_federal_tax_lien and finding that none of the statutory requirements for withdrawal pursuant to sec_6323 had been met in response to the notice_of_determination petitioner timely filed his petition with this court on date discussion as this case does not concern petitioner’s underlying federal_income_tax liabilities the court’s review falls under the abuse_of_discretion inquiry of sec_6330 see 114_tc_604 114_tc_176 this standard requires the court to decide whether respondent’s rejection of petitioner’s request to have the federal_tax_lien withdrawn was arbitrary capricious or without sound basis in fact or law see 112_tc_19 keller v commissioner tcmemo_2006_ fowler v commissioner tcmemo_2004_163 sec_6321 imposes a lien in favor of the united_states on all property and rights to property of a person liable for tax and any additions to tax penalties interest and costs that may accrue in addition thereto if there has been a demand for payment and the person has failed to pay 122_tc_287 this lien arises at the date of the assessment sec_6322 so that the federal_tax_lien will take precedence over other liens or security_interest the irs must file a notice_of_federal_tax_lien sec_6323 118_tc_572 sec_6323 provides in pertinent part sec_6323 withdrawal of notice in certain circumstances -- in general --the secretary may withdraw a notice of lien filed under this section if the secretary determines that-- a the filing of such notice was premature or otherwise not in accordance with administrative procedures of the secretary b the taxpayer has entered into an agreement under sec_6159 to satisfy the tax_liability for which the lien was imposed by means of installment payments unless such agreement provides otherwise c the withdrawal of such notice will facilitate the collection of the tax_liability or d with the consent of the taxpayer or the national_taxpayer_advocate the withdrawal of such notice would be in the best interests of the taxpayer as determined by the national_taxpayer_advocate and the united_states petitioner contends for the following reasons that ms banks abused her discretion by failing to withdraw the notice_of_federal_tax_lien under sec_6323 c --because the withdrawal of the notice would help facilitate the collection of tax and under sec_6323 d --because it serves no purpose other than to retaliate against petitioner and prevent him from securing a job for the reasons discussed infra we disagree with petitioner at the outset we note that although petitioner has not challenged the administrative procedures followed in the filing of the notice_of_federal_tax_lien we find that the notice_of_federal_tax_lien was not filed prematurely the filing of the federal_tax_lien took place after assessment and notice_and_demand and at each step petitioner was properly notified petitioner offered not one scintilla of evidence to show how the withdrawal of the notice_of_federal_tax_lien would facilitate the collection of the liabilities owed in fact looking at the long history of petitioner’s failure to pay federal income taxes coupled with his filing a petition for bankruptcy under chapter it is obvious to the court that the irs would have no easier time collecting the liabilities without the filing of a notice_of_federal_tax_lien than with it being filed it is our opinion that the appeals officer correctly determined that a withdrawal of the notice_of_federal_tax_lien would not be in the best interests of the government given petitioner’s history of nonpayment and his financial status moreover by sustaining the notice_of_federal_tax_lien respondent properly protected the government’s interests in petitioner’s assets petitioner also contends that an abuse_of_discretion occurred when ms banks refused to accept a second oic at the hearing he claims that ms banks’s rejection of that oic based on her knowledge of his failure to pay past and current taxes constituted an abuse_of_discretion we disagree in 129_tc_107 we held that a reliance on a failure to pay current taxes in rejecting a collection alternative does not constitute an abuse_of_discretion moreover during the hearing petitioner was never clear as to what amount he would be willing to pay to settle his outstanding liabilities we view his demeanor at that hearing to be nothing more than uncooperative so as to prolong this matter and accordingly the time at which he would be finally required to pay the amounts owed as to petitioner’s argument that the filing and sustaining of the notice_of_federal_tax_lien was an act of retaliation by ms banks petitioner provided no specific evidence in support of this accusation moreover we are not convinced that ms banks was even the appeals officer responsible for rejecting petitioner’s original oic even if she was there is no evidence to support petitioner’s contention that the notice_of_federal_tax_lien filed against him was the result of a personal vendetta on the part of ms banks in short we find petitioner’s assertion that the notice_of_federal_tax_lien was filed as a retaliatory act to be both inflammatory and without merit petitioner did not offer any evidence pursuant to sec_6323 to support his contention that the national_taxpayer_advocate determined that a withdrawal of the notice_of_federal_tax_lien would be in the best interests of petitioner and the united_states the record contains a letter dated date from the national taxpayer service in chicago illinois this letter does not contain any determination on the part of the national_taxpayer_advocate to wit the letter was sent to petitioner long before the notice_of_federal_tax_lien was filed the letter only relates information regarding what publications petitioner should refer to for an explanation of the collections process finally petitioner did not offer any evidence to support his contention that the withdrawal would allow him to secure a job this assertion is purely conjecture on our review of the record we conclude that respondent’s appeals officer did not abuse her discretion in sustaining the notice_of_federal_tax_lien to reflect the foregoing decision will be entered for respondent


internal_revenue_service department of the treasury number release date index number washington dc person to contact telephone number refer reply to cc psi 1-plr-123421-02 date date legend x d1 state owner dear this responds to a letter dated date submitted on behalf of x requesting an extension of time under sec_301_9100-3 of the procedure and administration regulations for x to elect to be treated as an association_taxable_as_a_corporation for federal tax purposes and relief under sec_1362 of the internal_revenue_code facts according to the information submitted x an eligible_entity was formed under the laws of state as of d1 x was wholly owned by owner x intended to elect to be treated as an association_taxable_as_a_corporation and then to elect to be treated as an s_corporation with both elections effective d1 however x inadvertently failed to timely file either election law and analysis sec_301_7701-3 provides that a business_entity that is not classified as a corporation under sec_301_7701-2 or an eligible_entity can elect its classification for federal tax purposes an eligible_entity with at least two members can elect to be classified as either an association and thus a corporation under sec_301_7701-2 or a partnership and an eligible_entity with a single owner can elect to be classified as an association or to be disregarded as an entity separate from its owner plr-123421-02 sec_301_7701-3 provides guidance on the classification of a domestic eligible_entity generally a domestic eligible_entity will be a partnership if it has two or more members unless it elects otherwise a domestic eligible_entity with one owner will generally be disregarded as an entity separate from its owner unless it elects otherwise sec_301_7701-3 provides that an eligible_entity may elect to be classified other than as provided under sec_301_7701-3 by filing form_8832 entity classification election with the service_center designated on form_8832 sec_301_7701-3 provides that an election made under sec_301 c i will be effective on the date specified by the entity on form_8832 or on the date filed if no such date is specified on the election form the effective date specified on form_8832 can not be more than days prior to the date on which the election is filed and can not be more than months after the date on which the election is filed under sec_301_9100-1 the commissioner may grant a reasonable extension of time to make a regulatory election or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the code except subtitles e g h and i sec_301_9100-2 and sec_301_9100-3 provide the standards the commissioner will use to determine whether to grant an extension of time to make an election sec_301_9100-2 provides automatic extensions of time for making certain elections sec_301_9100-3 provides extensions of time for making elections that do not meet the requirements of sec_301_9100-2 requests for relief under sec_301_9100-3 will be granted when the taxpayer provides evidence to establish that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government sec_1362 provides that a small_business_corporation may elect to be an s_corporation sec_1362 provides the rule on when an s election will be effective if an s election is made within the first two and one-half months of a corporation's taxable_year then the corporation will be treated as an s_corporation for the year in which the election is made however if an s election is made after the first two and one-half months of a corporation's taxable_year then that corporation will not be treated as an s_corporation until the taxable_year after the year in which the s election is filed plr-123421-02 sec_1362 provides that if no sec_1362 election is made for any taxable_year and the secretary determines that there was reasonable_cause for the failure to timely make such election then the secretary may treat such an election as timely made for such taxable_year and sec_1362 shall not apply conclusion based solely on the facts submitted and the representations made we conclude that the requirements of sec_301_9100-1 and sec_301_9100-3 have been satisfied as a result x is granted an extension of time to elect to be taxed as an association effective d1 x has days from the date of this letter to file form_8832 with the appropriate service_center to elect to be treated as an association for federal tax purposes effective d1 the form must be signed as specified in sec_301_7701-3 i - iii a copy of this letter should be attached to that form in addition based solely on the facts submitted and the representations made and provided that x otherwise qualifies as an s_corporation we conclude that x will be recognized as an s_corporation effective d1 x has days from the date of this letter to file a properly completed form_2553 with the appropriate service_center a copy of this letter should be attached to that form except as specifically provided herein no opinion is expressed or implied as to the federal tax consequences of the facts described above under any other provision of the code specifically no opinion is expressed concerning whether x is in fact an s_corporation for federal tax purposes this ruling is directed only to the taxpayer requesting it sec_6110 provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative s heather c maloy sincerely heather c maloy associate chief_counsel passthroughs and special industries enclosures copy of this letter to be attached to form_8832 copy of this letter to be attached to form_2553 copy for sec_6110 purposes