department of the treasury internal_revenue_service washington d c tax exempt and government entities dwvision number release date date date uil contact person identification_number contact number employer_identification_number form required to be filed tax years dear this is our final_determination that you do not qualify for exemption from federal_income_tax as an organization described in intemal revenue code sec_501 recently we sent you a letter in response to your application that proposed an adverse determination the letter explained the facts law and rationale and gave you days to file a protest since we did not receive a protest within the requisite days the proposed adverse determination is now final since you do net qualify for exemption as an organization described in code sec_504 donors may not deduct contributions to you under code sec_170 you must file federal_income_tax returns on the form and for the years listed above within days of this letter unless you request an extension of time to file we will make this letter and our proposed adverse determination_letter available for public inspection under code sec_6110 after deleting certain identifying information please read the enclosed notice notice of intention to disclose and review the two attached letters that show our proposed deletions the instructions in notice if you agree with our deletions you do not need to take any further action if you disagree with our proposed deletions you should follow n accordance with code sec_6104 c we will notify the appropriate state officiais of our determination by sending them a copy of this final letter and the proposed adverse letter you should contact your state officials if you have any questions about how this determination may affect your state responsibilities and requirements if you have any questions about this letter please contact the person whose name and telephone number are shown in the heading of this letter federal_income_tax status and responsibilities please contact irs customer service pincite-820-1040 or the irs customer service number for businesses the irs customer service number for people with hearing impairments is if you have any questions about your sincerely robert choi director exempt_organizations rulings agreements enctosure notice redacted proposed adverse determination_letter redacted final adverse determination_letter letter cg catalog number department of the treasury internal_revenue_service washington d c tax exempt and covennment entites divisron date date law firm k company contact person identification_number contact number fax number employer_identification_number uil number l employes m applicant o website p country t dollar_figure amount u amount v dollar_figure amount w amount dollar_figure amount x dear we have considered your application_for recognition of exemption from federal_income_tax under internal_revenue_code sec_501 a based on the information provided we have concluded that you do not qualify for exemption under code sec_501 the basis for our conclusion is set forth below facts you m were formed in b on c your stated purposes listed in the articles of incorporation are as follows a to function as a forum and meeting place in d for accredited investors and representatives of financial organizations and representatives of stage technology companies in a professional bi-monthly meeting club event in d the companies presenting in m and seeking investments will be screened by m e early- in addition to becoming a c in itself in each one e-related philanthropy accredited in the us as a c organization the club meeting m will provide b opportunity to promote its cause and present its mission to the dedicate funds beyond its operating_expenses and reserves to support such philanthropies at the end of each budget-year aitending m will your c purpose as stated in your form_1023 is to help the e economy grow through charitable economic development the united_states central intelligence agency and the intemational monetary fund both consider p a developed country you are membership_organization having both individual and corporate members an individual membership is open to any accredited investor under rule of the securities_and_exchange_commission sec regulations as any natural_person whose individual net_worth or joint net_worth with that person's spouse at the time of his purchase exceeds dollar_figure has a reasonable expectation of reaching the same income level in the current_year an entity an individual represents qualifies for membership if it is an accredited investor as defined under rule of the sec regulations and the individual is attending as a representative of the corporation and not in an individual capacity an accredited investor is defined corporate level memberships are open to accredited investors defined under rule as follows any entity whose equity owners are accredited investors acorporation partnership business_trust limited_liability_company or sec_501 organization with total assets of million dollars a broker dealer registered pursuant to sec_15 of the securities exchange act of a bank savings and loan association as defined in sec_3 of the securities act of whether acting in its individual or fiduciary capacity an insurance_company as defined in sec_2 of the securities act of an investment_company registered under the investment act of or a business_development_company as defined in sec_2 of that act aplan established and maintained by a state its political subdivisions or any agency_or_instrumentality of a state or its political subdivisions for the benefit of its employees if such a plan has total assets in excess of milion dollars an employee_benefit_plan established within the meeting of erisa provided that the investment decision is made by a plan fiduciary as defined in sec_3 of such act which is a bank savings and loan association insurance_company or registered investment_advisor or that employee benefit pian has total assets in excess of milion dollars or if the plan is self directed with investment decisions made solely by persons that are accredited investors aperson attending a meeting as the representative of a corporate member cannot simultaneously attend in an individual capacity there are also levels of membership consisting of platinum and gold the platinum membership costs dollar_figure and entitles the member to one complimentary pass and two reduced price guest tickets for each of your events written acknowledgement on all marketing materials including those on your web site as a platinum member access to the past and future company presentation data base and access to information on all mambers the gold membership costs dollar_figure and entitles the member to one complimentary pass and one reduced price guest ticket for each event written acknowledgement on all marketing materials including those on your web site and access to the past and future company presentations as well as the membership-only section of your web site including the data base membership is not required for participating in your activities but members will have benefits consisting of accass to more information prior to and after club meetings as well as the benefits associated with the platinum and gold memberships you bring together us investors primarily with e early stage technology companies in a bimonttily event in d these companies will operate in the fields of life sciences intemet telecom software clean tach securily and defense from e early stage companies of which only the most promising companies will have the opportunity to make presentations to potential investors at the bimonthly events growth companies are located by your management team and screened by your hand picked person pool of well established professionals a two member screening committee reviews and selects the most promising early stage companies in each spacific technology area to make presentations at meetings you expect to receive applications the early the company must complete an application and to be eligible for consideration the early stage company must first meet the criteria to register in your database located on your website provide detailed information conceming technological innovation intellectual_property protection financial reports and projections corporate and contractual governance management and development teams and must pay a registration fee of t as part of the application process the company must include a year business forecast the requested investment amount the legal and ip status a marketing plan and founders and management team background information the early stage company may also submit a slide power point presentation if approved the fee is processed the application is forwarded to one of your member screening teams the screening team reviews the application and will determine if the company meets the criteria to present at the bimonthly meeting at the end of the process the screening teams meet and make final decisions and will invite the most promising companies to make presentations at your next meeting those chosen will pay an additional presentation fee of t those selected will present their business plans in club meetings before who have the financial ability to invest in early stage e technology in addition you will give one e related philanthropy the opportunity to address the assembled investors to solicit funding in order to be considered an organization must submit a 2-page summary of its activities showing that itis involved in a worthy e cause the organization must investors also exhibit a transparent accounting system and efficient operations the page summary must also describe the impact the organization has made and its funding needs a registration fee of u'is processed only after it has been selected after the presentation start_up early stage technology companies atypical meeting consists of a cocktail reception which has an allotted minute time period hours devoted to presentations by four e alongside one e focused philanthropy opportunity to pose specific questions to the companies who have presented then the will be asked if they would like te meet with any of the companies in a separate meeting place on the following day at these meetings who are interested in making investments in specific companias that have made presentations decide whether to make a firm commitment to conduct due diligence and proceed to an actual investment if there is no firm commitment at this time notice is sent to your members who are then free te approach the company directly and negotiate an investment an an individual basis investors will have the the firm specializes in g and l are partners with the law firm of j the board consists of three members f g and h in later correspondence the applicant began referring to has l commercial law this includes corporate mergers and acquisitions corporate financing contracts intellectual_property and ant trust litigation and commercial real_estate the law firm provides you services pincite of its customary billing rates however g’s individual services are provided free of charge information obtained through correspondence shows that that f owns k an advisory investment_company in d services to you moreover your members will not be required to make use of k's services you are primarily operated by volunteers who serve on the executive committee these volunteers assist in screening business pians for investment potential from dozens of e early stage companies the volunteers are professionals involved in e technology and ara well established you operate from the offices of k rent free k does not provide you use an independent_contractor as an administrator approximately hours per month and be compensated v per year you also have a comprehensive website o which lists the services and benefits to members and provides early stage technology companies with information about your program and the steps involved in becoming registered in your data base the about section of o reads this administrator will work mis the first club established in the us exclusively focusing on bringing us investors with e early stage companies in an upscale professional environment it further reads there are many ways to help p as business people we have focused on companies from the sectors in which e technology is currently demonstrating exceptional abilities inctuding life sciences internet electronics telecom software clean-tech and homeland security our hand selecting executive committee carefully evaluates and screens the numerous companies applying to m eventually choosing four to five most promising companies to present before our esteemed group of m's members are given valuable benefits such as access to m's members’ online data base alongside an club meetings opportunity to hear about the selected companies in members or guests of m are not in the business of making profits our sole all purpose is to promote our philanthropic causes we have identified an opportunity to provide us with an exciting format to support p doing good for p while doing well for yourself is no longer a vision the who is m section reads a core value of m’s club is to encourage philanthropic contribution alongside deal making therefore at each meeting a prescreened e related charitable cause will present its case for the support and consideration of the members you are supported by membership fees registrant fees and corporate sponsorship there are levels of sponsorship - emerald and diamond an emerald sponsorship costs w and entitles the sponsor to logo acknowledgment on your website a one page informational flyer in all club folders an invitation to present a 3-minute sales pitch along with an information desk at a club meeting acknowledgment of your representative in the greetings of six events and one complimentary pass and one reduced price ticket for each event diamond sponsorships limited to firms in specific fields having to do with finance such as commercial banks accounting firms venture capital firms law firs and consulting firms cost x diamond sponsors receive the came benefits as emerald sponsors sec_501 of the intemal revenue code of provides for the exemption from federal_income_tax for organizations described in sec_501 such organizations are recognized if they are organized and operated exclusively for religious charitable and educatlanal purposes law sec_501 -1 a of the regulations states that in order to be exempt as an organization described in sec_501 of the code an organization must be both organized and operated exclusively for one or more of the purposes specified in that section if an organization fails to meet either the organizational_test or the operational_test it is not exempt sec_1 -1 of the income_tax regulations provides that an organization will be regarded as operated exclusively for ong or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes specified in sec_501 an organization will not be regarded if more than an insubstantial part of its activities is not in furtherance of an exempt_purpose sec_1_501_c_3_-1 and d li of the regulations state that an organization whose net eamings inure to the benefit of private shareholders or individuals or which is operated for the benefit of private interests is not operated exclusively for exempt purposes revrul_61_170 196_2_cb_112 describes a nurses association which maintained an employment registry primarily for the employment of members it was nat granted exemption as a charitable_organization under sec_501 since it was engaged in rendering particular services for individual persons revrul_68_117 1968_1_cb_251 describas an organization that was formed and operated to assist needy families in developing counties that qualified under sec_601 c this organization conducted regular guided self help programs as well as assisted in arranging credit for farmers on reasonable terms with a realistic repayment schedule revrul_74_587 1974_2_cb_162 describes an organization that qualified under sec_501 the organization was formed to relieve poverty eliminate prejudice reduce neighborhood tensions and combat community deterioration through a program of financial assistance in the form of low cost or long term laans to or the purchase of equity interests in various business enterprises in economically depressed areas revrul_76_268 1976_2_cb_144 describes an organization that enabled prospective investors to make sound investments by the mutual exchange of investment information the organization carried on rot only educational activities but other activities directed to the support and promotion of the economic interests of its members it did not qualify for exemption under sec_501 c of the code in better business bureau of washington d c inc v united_states 326_us_179 the supreme court held that the presence of a single non-exempt purpose if substantial in nature will destroy a claim for exemption regardless of the number or importance of truly exempt purposes 295_f2d_924 ct ‘owned controlling interests in several businesses engaged in selling and distributing petroleum products its net_income was distributed to teachers colleges for scholarships the court concluded that although the organization gave its profits ta charitable organizations it did not qualify for exemption under sec_501 cl involved a nonstock corporation that the court found that an in 92_tc_1053 organization that trained individuals for careers as political campaign professionals was denied exemption because of the secondary benefit accruing to entities of a political_party and its candidates since all its graduates became employed by or consultants to these entities and candidates the court concluded that the school was not primarily engaging in activities that accomplish educational_purposes because it benefited private interests to more than an insubstantial degree the court accepted the irs's argument that where the training of individuals is focused on furthering a particular targeted private interest the conferred secondary benefit ceases to be incidental to the organization’s exempt purposes application of law you do not meet the organizational_test of sec_1_501_c_3_-1 of the regulations because your purposes are broader than those permitted specifically you provide services to your members to enable tham to make investments consequently you do not meet the organizational_test described in sec_501 c you are not as described in sec_1 c -1 c of the income_tax regulations because you ae not engaged primarily in activities which accomplish one or more of such exempt purposes specified in sec_501 c of the code further more than an insubstantial part of your activities are not in furtherance of an exempt_purpose you are not as described in sec_1 c -a c and d if of the regulations because you are operated for the benefit of private interests you are operating like the organization described in revrul_61_170 1961_2_cb_112 because you are primarily engaged in the performance of specified services for your members for example your website indicates that you rigorously prescreen the business plans of startup businesses in order to find the most promising investment opportunities for members ‘you maintain that you are operating to grow the economy of p however you are not like the organization described in revrul_68_117 1968_1_cb_251 the united_states central intelligence agency as well as the intemational monetary fund both considers p a developed ‘country you are also not like the organization described in revrul_74_687 1974_2_cb_162 you primarily select recipients of your services based on the potential return cn investment and not on any community benefit whether or not start-up businesses are located in an impoverished area of p is not even considered your operations appear to be similar to those in revrul_76_366 1976_2_cb_144 because your activities are directed to the support and promotion of the economic interests of your members moreover the statement on the website m's members are given valuable benefits such as access to to hear about the selected companies in are operating to provide investment opportunities to members along with permitting persons from start_up businesses to solicit financial backing from your members you are also allowing one representative from a c charity with a mission and activities in p to make a presentation at your meeting in order to solicit donations the charities like the startup businesses must pay a fee to be considered then undergo a rigorous screening process and compete with other charities you have not established how allowing a charity to solicit donations from your members accomplishes a purpose described in sec_501 c investor's members’ online database alongside an opportunity investor club meeting further confirms that you ‘you are similar to the organization described in 295_f2d_924 you assert sico’s position for exemption based on donating excess revenue to charity this by itself is ineutficient to warrant tax exemption applicant's position you believe you qualify under sec_501 you wrote that you are incorporated as a charitable and educational_organization with no profitable intentions through bringing together e computer scientists entrepreneurs not for profit organizations us philanthropists and potential investors you will achieve your goals of developing a stable and growing economy in p you reiterate that there are no profitable or non exempt purposes which you intend to pursue all net_earnings will ba distributed to a not-for-profit organization you state that one of the primary activities is to encourage and emphasize contributions and active_participation in not-for-profit_organizations at your events alongside your message of economic development in p thus you believe you qualify under sec_601 c additionally you were founded to support p because of the constant fear of war and terror p relies ina large part on assistance from overseas in order to assist in its growth you intend to facilitate the same furthermore you state that a valid c purpose is the advancement of science and will achieve this purpose by seeking to further advanced computer sciance and technology in p you describe how many of today's current technologies were invented in p you will continue to serve the e economy by contributing to new scientific technology and helping it grow moreover you state that your intent to bring together americans who wish to donate and invest in e companies and charities accomplishes a c purpose for a large number of charities presenting at meetings will enable them to solicit a significant amount of revenue with your assistance charities will interface directly with potential donors who will hopefully take an active role in their growth and development you then wrote that you seek to illuminate and educate american investors as to the needs of computer knowledge and high tech industry in p ‘you are apen to any potential business leader who is interested in contributing to e organizations you also provide opportunities for lesser known e entrepreneurs and not-for- profit organizations that would not have the opportunity to seek funds the chance to present and advance their causes and ideas to a us audience the real opportunity is provided for the ‘small business entrepreneurs and not-for-profit_organizations by giving them access to foreign and domestic investment opportunities in response to the service's assertion that you are operating for the benefit of members you maintain that your main purpose is to advance science and the economy in p and thus yau are not similar to the organization described in 92_tc_1053 you assert that your invastment activity is merely a tool used to achieve this purpose any secondary benefits that inure to the investors de so because of your intent to contribute to the success of the e economy including both p's not-for-profit sector and various science sectors of its economy you believe that the amelioration and growth of the e economy by far outweighs any particular benefit that inures to members you also dispute the contention that you have a substantial non-exempt v purpose like the organization described in better business bureau of washington d c united_states you maintain that your purpose fits entirely within the exempt framework as you seek to advance science in an innovative way by connecting various start_up companies with investors you will enable companies to bring these innovations and scientific progress to the market place inc qur response to applicant’s position you failed to provide any information from which it can be concluded that your activities further or advance a charitable purpose nor are you first your financial support to organizations described in sec_501 is an insignificant part of your total activities your charitable giving is limited to your annual excess revenues any public benefit resulting from this is tenuous compared to the service of private interests serving any public and charitable purpose by allowing one hand-pickad charity for a fee ta solicit donations at your organization's meetings second you substantiate that helping p’s economy grow accomplishes an exempt_purpose described in sec_501 while it may be true that certain organizations which ultimately accomplish exempt purposes through the provision of assistance to for-profit businesses may qualify as an economic development_corporation described in sec_501 these organizations must demonstrate that by providing assistance to new businesses they are achieving an exempt_purpose by relieving the poor in an area considered to be depressed you have not demonstrated that the services provided to help establish private businesses would p is not an area considered to ultimately help relieve the poor and distressed in a blighted_area be blighted or distressed and you have not shown how your activities will ameliorate the conditions of distressed members of that country third although the advancement of science may promate a purpose exempt under sec_501 you have not explained how providing technology start_up companies a forum to seek investments from your members advances science your investment-fostering activity is not merely a toal to achieve exempt purposes you do not agree that you are like the organization in 92_tc_1053 however like the organization in the court case at least one of the intended classes of beneficiaries of your activities are not members of any charitable_class neither your members nor other participating accredited investors nor the early stage technology entrepreneurs are members of a charitable_class because the benefits of your program are targeted to these classes of persons they could not be considered incidental to the accomplishment of any exempt_purpose even if you could demonstrate that your activities tended to benefit one or mora charitable classes as well as these purely private interests conclusion based on the facts that you have provided we conclude that you are not organized and operated for exempt purposes within the meaning of sec_501 c of the code because you are primarily operating for the economic benefit of members you have the right to file a protest if you believe this determination is incorrect to protest you must submit a statement of your views and fully explain your reasoning you must submit the ‘statement signed by one of your officers within days from the date of this letter we will consider your statement and decide if the information affects our determination if your ‘statement does not provide a basis to reconsider our determination we will forward your case to our appeals_office you can find more information about the role of the appeals_office in publication exempt_organization appeal procedures for unagreed issues types of information that should be included in your sppeal can be found on page of publication under the heading ‘regional office appeal must be accompanied by the following decleration the statement of facts item under penalties of perjury declare that have examined the statement of facts presented in this appeal and in any accompanying schedules and statements and to the best of my knowledge and belief they are true correct and complete the declaration must be signed by an officer or trustee of the organization who has personal knowledge of the facts your appeal will be considered incomplete without this statement 1f an organization's representative submits the appeal a substitute declaration must be included stating that the representative prepared the appeal and accompanying documents and whether the representative knows personally that the statements of facts contained in the appeal and accompanying documents are true and correct an attorney certified_public_accountant or an individual enrolled to practice before the intemal revenue service may represent you during the appeal process if you want representation during the appeal process you must file a proper power_of_attorney form_2848 power of attomey and declaration of representative if you have not already done so you can find more information about representation in publication practice_before_the_irs and power_of_attorney all forms and publications mentioned in this letter can be found at www irs cov forms and publications if you do not file a protest within days you will not be able to file a suit for declaratory_judgment in court because the internal_revenue_service irs will consider the failure to appeal as a failure to exhaust available administrative remedies code sec_7428 provides in part that a declaratory_judgment or decree shall not be issued in any proceeding unless the tax_court the united_states court of federal claims or the district_court of the united_states for the district of columbia determines that the organization involved has exhausted all of the administrative remedies available to it within the irs if you do not intend to protest this determination you do net need to take any further action if we do riot hear from you within days we will issue a final adverse determination_letter that letter will provide information about filing tax returns and other matters mail to deliver to internal_revenue_service eo determinations quality assurance room p o box cincinnati oh internal_revenue_service eo determinations quality assurance main street room cincinnati oh ‘you may fax your statement using the fax number shown in the heading of this letter if you fax your statement please call the person identified in the heading of this letter to confirm that he or she received your fax if you have any questions please contact the person whose name and telephone number are shown in the heading of this letter sincerely robert choi director exempt_organizations rulings agreements


tcmemo_1997_284 united_states tax_court james j lencke and janene b lencke petitioners v commissioner of internal revenue respondent docket no filed date margret g robb and suzanne c klinghammer for petitioners angela j kennedy for respondent memorandum findings_of_fact and opinion dawson judge respondent determined deficiencies in petitioners' federal income taxes and penalties for the taxable years and as follows with the consent of counsel for the parties the chief_judge reassigned this case after the death of judge irene f scott to judge howard a dawson jr for disposition on the existing record accuracy-related_penalties - sec_6662 a year deficiency sec_6662 sec_6662 dollar_figure --- dollar_figure big_number dollar_figure big_number --- --- several issues have been conceded or settled by the parties the issues presented for decision are whether petitioners are entitled to claimed losses_incurred in their model railroad activity for and so as to allow the expenses in excess of the income from the activity to be deducted for federal_income_tax purposes whether petitioners are entitled to a nonbusiness_bad_debt deduction for whether amounts received by petitioner james j lencke as residual insurance premiums and in lieu of renewal insurance commissions during and are subject_to self-employment_tax under sec_1401 and sec_1402 whether petitioners are liable for an accuracy- related penalty for an underpayment_of_tax attributable to a substantial_understatement for and whether petitioners are liable for accuracy-related_penalties for negligence or disregard of rules or regulations for and findings_of_fact some of the facts have been stipulated and are found accordingly the stipulation of facts and three supplemental all section references are to the internal_revenue_code in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure unless otherwise indicated stipulations of facts together with attached exhibits are incorporated herein by this reference at the time they filed their petition in this case james j lencke and janene b lencke petitioners were residents of lafayette indiana they timely filed their joint federal_income_tax returns for the taxable years and claimed business loss deductions for model railroad activity james j lencke mr lencke has been collecting model railroad equipment and memorabilia for over years his model railroad collection is elaborately displayed in the basement of his home it includes a complete circus with a big top operating carnival rides complete circus trains hundreds of buildings signals lights and figurines and at least locomotives big_number freight cars and big_number passenger cars mr lencke is very knowledgeable about model railroads because mr lencke had become disabled in date and needed an activity to occupy his mind and his time petitioners started a model railroad activity called red caboose operated from their home in both mr lencke and janene b lencke mrs lencke participated in the activity during the years in issue and both were still engaged in the activity at the time this case was tried before deciding to begin their operation of red caboose petitioners visited model railroad shows and sought advice from various vendors of model railroad supplies although they considered entering into other types of activities such as a craft activity petitioners chose the model railroad activity because they believed it would be a feasible activity for them to pursue given mr lencke's extensive model railroad knowledge and his physical limitations prior to forming red caboose petitioners had a retail merchant certificate for one of their former activities a craft activity called kiln classics in early they attempted to have the name red caboose substituted for the name kiln classics on their retail merchant certificate however the name was not changed by the state of indiana until several years later petitioners are not zoned to conduct a retail business in their home during after petitioners had selected red caboose as the activity they would conduct they asked various suppliers whether they would sell model railroad merchandise to them at wholesale prices however the suppliers refused to do so until sometime in petitioners also contacted credit card companies visa and mastercard to discuss the possibility of red caboose accepting their credit cards for its model railroad during the years in issue mr lencke suffered from glaucoma and diabetes and previously he had had open heart surgery in addition he is deaf in one ear completely blind in one eye and partially blind in the other eye and must keep one of his legs in a cast thus mrs lencke along with mr lencke's brother does most of the physical work involved in the operation of red caboose and mr lencke does most of the paperwork orders visa and mastercard would not allow red caboose to accept their credit cards during the years in issue while planning the activities to be pursued through red caboose mr lencke looked through model railroad magazines to find model railroad shows which would be convenient and feasible for them to attend he investigated the cost to rent tables at the shows for petitioners to display and sell their merchandise and he made arrangements for them to become vendors at the shows furthermore petitioners advertised red caboose in model railroad and toy magazines and in they published a two-page flyer describing red caboose and listing its merchandise the flyer was distributed at model railroad shows they also created red caboose business cards during and used the elaborate model railroad display in their basement as a way to entice visitors' interests in collecting model railroads however they did not formulate a written business plan for red caboose during the years in issue petitioners did not maintain a separate telephone line at their home for red caboose their home telephone number was not listed in the local telephone directory and although it was listed on the business cards they distributed it was not provided in either their advertisement sec_4 mr lencke treated visitors to his house to tours of the model railroad collection in his basement although he did not charge a fee for the tours he encouraged donations by placing a donations bucket near his collection some visitors donated as much as dollar_figure in the train and toy magazines or the two-page flyer distributed to their customers thus petitioners primarily conducted a mail-order model railroad activity from their home they used the model railroad shows they attended as a way to attract mail- order customers during and petitioners attended and model railroad shows respectively the number of tables they rented at the shows increased during that time during a week in which petitioners were not preparing to travel to a show they surveyed their inventory which was stored in their two-car garage and in a by 30-foot shed adjacent to their house to assess which items sold well which items needed to be reordered and which items needed to be marked down they also discussed whether each railroad show they attended was worthwhile and processed orders from their mail-order customers during a week in which petitioners were preparing for a show they made sure they had all the merchandise they would need for the show after marking a price on each of the items they packed the merchandise in their truck to take it to the show each item's price was generally based on the price for which the item was advertised in model railroad magazines however if they realized that another vendor at a show was selling an item at its inception red caboose's merchandise consisted of cardboard signs imprinted with train logos different railroads and mugs and buttons red caboose's merchandise expanded during the years in issue for less than the price petitioners had marked on the item they adjusted that item's price accordingly none of their merchandise was sold below cost usually petitioners left on friday morning when they were going to a saturday show once they arrived at the show they unloaded the merchandise and set up their tables the shows were generally held on saturday and sunday and lasted hours each day on sunday evening they packed the merchandise that was not sold into their truck and returned home petitioners did not hire an accountant to assist with the preparation of red caboose's books_and_records they did not have a traditional bookkeeping system for the activity red caboose's records were kept in the same way mr lencke had previously kept his insurance_business records to keep track of merchandise sold during a show petitioners dictated descriptions of the items sold into a hand-held tape recorder once they returned home they listened to the tape and made a note of the amount of money received and the items sold at each show during and petitioners recorded the amount and nature of red caboose's sales in their personal appointment book during they prepared a tally sheet for each show indicating which items were sold and the amount of money received at each show petitioners testified that red caboose's sales were recorded in their personal ledger during the years in issue however the stipulation of facts to which the parties agreed continued petitioners placed the receipts for red caboose's expenses along with some of the receipts for their personal expenses in manilla envelopes but the receipts were not labeled personal or business at the end of each year working from memory they prepared a list of red caboose's expenses and attached the list to the outside of the envelopes petitioners could not have presented a complete set of records for red caboose separate from their personal records at any point during the years in issue mr lencke deposited some of the proceeds from red caboose into his tippecanoe agency account at valley federal bank which was the account he had maintained as an insurance agent with united farm bureau insurance_companies the account no longer contained funds from his former business as an insurance agent when the red caboose proceeds were deposited mr lencke's social_security_benefits were also deposited into the tippecanoe agency account during the years in issue in fact petitioners used some of mr lencke's social_security_benefits to fund red caboose in addition petitioners paid some of red caboose's expenses with funds from their personal bank account continued indicated that for and the sales were recorded in their appointment book and for the sales were recorded on a separate tally sheet for each show we have resolved this inconsistency by finding that for and the sales were recorded in their personal appointment book and for the sales were recorded on a separate tally sheet for each show in connection with red caboose petitioners incurred among other operating_expenses table rental fees postage expenses advertising expenses utility expenses banking fees and travel_expenses however other than staying at less expensive hotels and eating at less expensive restaurants while they were attending shows petitioners were unable to reduce their operating_expenses during the years in issue petitioners enjoyed their model railroad activity and never considered abandoning it although they regularly incurred losses while attending the model railroad shows they occasionally purchased items from other vendors but they did not sell any part of mr lencke's personal model railroad collection in connection with their model railroad activity on line of their joint federal_income_tax returns for and petitioners reported taxable pension income in the amounts of dollar_figure dollar_figure and dollar_figure respectively during and the gross_receipts less cost_of_goods_sold from petitioners' model railroad activity were dollar_figure dollar_figure and dollar_figure respectively petitioners claimed losses from the operation of their model railroad activity on the schedule c attached to their and federal_income_tax returns as follows gross_receipts cost_of_goods_sold - big_number gross_income big_number big_number dollar_figure big_number big_number operating_expenses big_number big_number big_number big_number big_number big_number depreciation big_number big_number big_number income loss big_number big_number big_number although petitioners' gross_income from their model railroad activity increased to dollar_figure in dollar_figure in and dollar_figure in their operating_expenses substantially increased so that their claimed losses were dollar_figure dollar_figure and dollar_figure respectively for those years thus the claimed losses for through totaled dollar_figure and petitioners anticipated no net profit for their model railroad activity in since petitioners' activity has been operated in the name of jim's house of trains because they were informed that the name red caboose is a trademark in the notice_of_deficiency respondent determined that petitioners' model railroad activity was not engaged in for profit and therefore disallowed the claimed loss deductions claimed nonbusiness_bad_debt deduction on date petitioners lent dale and gloria christopher dollar_figure to enable them to purchase a flower shop in monticello indiana they had known the christophers for or years prior to lending them the dollar_figure and they had become friends through church and other social activities at that time both couples lived in battleground indiana which is a small community with less than big_number residents on date the christophers signed a promissory note obligating them to repay the dollar_figure to petitioners at ten percent interest in monthly payments of dollar_figure on date the christophers became the owners of main street floral the christophers allowed petitioners to place some candy on consignment at their flower shop petitioners felt that main street floral was not prospering during they visited the flower shop several times during and on each visit they noticed very few customers and very little inventory in the shop although the christophers sold the candy petitioners placed on consignment at the flower shop they told them that they could not pay them their share of the proceeds from the sales petitioners received three checks from the christophers during which represented four of the monthly payments required under the terms of the promissory note however mrs christopher requested that the checks not be cashed nonetheless in date petitioners took the checks to the bank to cash them but were told by the bank teller that the christophers did not have enough money in their account to cover the checks and that petitioners should not attempt to cash them in addition petitioners heard rumors that the christophers were experiencing financial problems and had sought help through various local charities after petitioners learned that the christophers' home was foreclosed and in the christophers filed for divorce during date mr lencke contacted the christophers to discuss repayment of the dollar_figure loan he was informed that mr christopher was currently out of work and the christophers would therefore not be able to repay the loan petitioners then decided not to pursue further collection of the debt mr christopher told petitioners that main street floral had been sold by the christophers in date however the christophers did not enter into a contract to sell the floral shop until date main street floral was sold for dollar_figure and the christophers received the initial installment in the amount of dollar_figure on date in date the christophers informed petitioners that any money they received from the sale of their business would be used to repay their obligation to the bank and would not be used to repay the dollar_figure the christophers owed to petitioners in date mr christopher was employed by wabash national corporation because of the christophers' failure to repay petitioners the dollar_figure loaned to them petitioners claimed a nonbusiness_bad_debt deduction on their federal_income_tax return in the notice_of_deficiency respondent disallowed petitioners' claimed bad_debt deduction because they failed to establish that the debt became worthless in self-employment taxes on residual and renewal insurance commissions from to date mr lencke was an insurance agent of united farm bureau family life_insurance_company and united farm bureau mutual_insurance_company farm bureau he and farm bureau considered their association to be an independent_contractor relationship while he worked as farm bureau's agent mr lencke had his own clients who could not be assigned to a different agent he received a 5-percent renewal commission on the life_insurance policies he sold throughout his career as an agent with farm bureau mr lencke maintained his insurance office in his home during date mr lencke became disabled and decided that he could not continue to work as farm bureau's agent the relationship was terminated in general when one of its insurance agents becomes disabled and terminates his or her agency relationship farm bureau pays the agent a 5-percent renewal commission for a limited period on the life_insurance policies sold by him however mr lencke was concerned that some of his clients would not renew their farm bureau life_insurance policies once they learned that he would no longer be working for farm bureau thus to provide him with a fixed amount of income during the months following his separation_from_service and to enable farm bureau to assign his clients to other agents he and farm bureau agreed after negotiations that his previously executed agreement to sell insurance on behalf of farm bureau would be amended an amendment to contract between james j lencke and united farm bureau family life_insurance_company united farm bureau mutual_insurance_company and their subsidiaries contract amendment executed in date provided that mr lencke would not earn any new commissions other than first writings on policies previously written and would receive in lieu of renewal_commissions five monthly payments of dollar_figure petitioner received two of the monthly payments in which totaled dollar_figure mr lencke also received dollar_figure in residual premiums in and dollar_figure in residual premiums in in mr lencke had premium returns totaling dollar_figure petitioners reported the amounts mr lencke received as residual premiums in and as other income on line of their joint federal_income_tax returns for and respectively however they did not report the dollar_figure mr lencke received in lieu of renewal_commissions in as income on their tax_return for that year petitioners have conceded that the dollar_figure less the premium returns for should have been reported as income on their return but they allege in their petition that the residual premiums received by mr lencke in and and the amount received by him in lieu of renewal_commissions in are not subject_to self-employment_tax in the notice_of_deficiency respondent determined that the amounts mr lencke received as residual premiums and in lieu of renewal_commissions constitute income from self-employment within the meaning of sec_1401 and therefore were subject_to self- employment_tax accuracy-related_penalties petitioners' federal_income_tax returns for and were prepared by an attorney petitioners reported a tax_liability of only dollar_figure on their federal_income_tax return they failed to report net_income received in lieu of renewal_commissions for their tax_liability was substantially understated for that year petitioners claimed depreciation_deductions on the schedule c attached to their and federal_income_tax returns for several items for which they have conceded they were not entitled to depreciation_deductions the items for which petitioners claimed depreciation_deductions included a boat lawn mower and sprinkler which were personal assets they failed to maintain or present adequate substantiation to support some deductions claimed on their tax returns for and respondent determined in the notice_of_deficiency that petitioners are liable for accuracy-related_penalties under sec_6662 for and sec_6662 for and opinion we begin by noting that respondent's determinations are presumed correct and petitioners bear the burden of proving that those determinations are erroneous rule a 290_us_111 deductions are a matter of legislative grace and petitioners have the burden of proving that they are entitled to any claimed deductions 503_us_79 i claimed business loss deductions for model railroad activity section provides in general that an individual will not be sec_183 activities not engaged in for profit a general_rule --in the case of an activity engaged in by an individual or an s_corporation if such activity is not engaged in for profit no deduction attributable to such activity shall be allowed under this chapter except as provided in this section b deductions allowable --in the case of an activity_not_engaged_in_for_profit to which subsection a applies there shall be allowed-- the deductions which would be allowable under this chapter for the taxable_year without regard to whether or not such activity is engaged in for profit and a deduction equal to the amount of the deductions which would be allowable under this chapter for the taxable_year only if such activity were engaged in for profit but only to the extent that the gross_income derived from such activity for the taxable_year exceeds the deductions allowable by reason of paragraph c activity_not_engaged_in_for_profit defined --for purposes of this section the term activity_not_engaged_in_for_profit means any activity other than one with respect to which deductions are allowable for the taxable_year under sec_162 continued allowed a deduction in excess of gross_income attributable to an activity if the activity is not engaged in for profit an activity_not_engaged_in_for_profit is any activity other than one with respect to which deductions are allowable for the taxable_year under sec_162 or under paragraph or of sec_212 sec_183 therefore whether an activity is engaged in for profit is determined with reference to sec_162 and sec_212 deductions are allowed under sec_162 for all ordinary and necessary expenses of carrying on an activity that constitutes a trade_or_business the supreme court has stated that to be engaged in a trade_or_business the taxpayer must be involved in the activity with continuity and regularity and 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 480_us_23 to be entitled to a trade_or_business expense deduction the taxpayer must have an actual and honest objective of making a profit 78_tc_642 affd without opinion 702_f2d_1205 d c cir continued or under paragraph or of sec_212 petitioners contend that red caboose was an activity in which they engaged with the objective of making a profit during the years in issue respondent on the other hand contends that petitioners' operation of red caboose was an activity_not_engaged_in_for_profit within the meaning of sec_183 whether the required profit objective exists is to be determined on the basis of all the facts and circumstances of each case 72_tc_28 sec_1_183-2 income_tax regs sets forth some of the relevant factors to be considered in deciding whether an activity is engaged in for profit no one factor is controlling 70_tc_715 affd 615_f2d_578 2d cir the factors include the manner in which the taxpayer carries on the activity the expertise of the taxpayer or his advisers the time and effort expended by the taxpayer in carrying on the activity the expectation that assets used in the activity may appreciate in value the success of the taxpayer in carrying on other similar or dissimilar activities the taxpayer's history of income or losses with respect to the activity the amount of occasional profits if any which are earned the financial status of the taxpayer and whether elements of personal pleasure or recreation are involved sec_1_183-2 income_tax regs while the focus of the test is on the subjective intention of the taxpayer greater weight is given to the objective facts than to the taxpayer's mere statement of his or her intent dreicer v commissioner t c pincite sec_1_183-2 income_tax regs after considering all the facts and circumstances in this case it is our view that petitioners' operation of red caboose was an activity_not_engaged_in_for_profit during the years in issue some of the more significant factors we have weighed are the manner in which petitioners carried on red caboose red caboose's loss history the time and effort expended by them in carrying on red caboose their financial status and their interest in model railroads as a recreational activity that a taxpayer operates an 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 b income_tax regs respondent contends that petitioners did not maintain adequate books_and_records for their model railroad activity we agree petitioners commingled their records for red caboose with their personal records for and they recorded red caboose's sales in their personal appointment book during and they commingled the receipts for red caboose's expenses with their personal receipts they could not have presented a complete set of records for red caboose separate from their personal records at any time during the years in issue furthermore they conducted some of red caboose's banking transactions through their personal bank account and mr lencke's former insurance bank account petitioners argue that their record-keeping system for red caboose was complete and accurate and thus evidence of their profit_motive because mr lencke used the same system for his insurance activity we do not find their reasoning persuasive even if the record-keeping system used by petitioners for red caboose was an adequate record-keeping system for mr lencke's insurance activity which is an issue we do not address it does not follow that such a system was a complete and accurate record- keeping system for a model railroad activity it is significant that petitioners did not have a concrete plan for improving the profitability potential of red caboose during each year in issue and in later years they sustained sizeable losses in connection with red caboose in they reported a loss of dollar_figure in they reported a loss of dollar_figure and in they reported a loss of dollar_figure however in spite of these large losses they failed to substantially change their method of operating red caboose other than staying at less expensive hotels and eating at less expensive restaurants while they were attending model railroad shows they did little if anything to reduce red caboose's operating_expenses moreover they were not successful in implementing remedial measures to increase red caboose's revenues for example they did not consider installing a separate telephone line for red caboose so they could profit from telephone orders in fact petitioners' record-keeping system for red caboose was in such a disorganized state that we doubt they could have constructively analyzed red caboose's expenses and revenues and formulated a plan for increasing its profitability as we stated in 45_tc_261 affd 379_f2d_252 2d cir the presence of losses in the formative years of a business is not inconsistent with an intention to achieve a later profitable level of operation bearing in mind however that the goal must be to realize a profit on the entire operation which presupposes not only future net_earnings but also sufficient net_earnings to recoup the losses which have meanwhile been sustained in the intervening years see also sec_1_183-2 income_tax regs petitioners assert that they expected to incur losses from red caboose operations in its early years but that eventually as red caboose's sales increased they expected to realize a profit if mr lencke were to die they point out his social_security_benefits would cease and mrs lencke would have to support herself with the proceeds from red caboose we are not persuaded by these assertions petitioners have not formulated a concrete business plan to reverse the substantial losses sustained by them in operating red caboose thus we are not convinced that red caboose now jim's house of trains will ever show a profit let alone recoup the present history of losses a taxpayer who 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 have an intention to derive a profit sec_1_183-2 income_tax regs here however the record shows that petitioners failed to devote much of their personal time and effort to red caboose during the years in issue the relatively small amounts of gross_receipts reported by petitioners from red caboose during and which were dollar_figure dollar_figure and dollar_figure respectively and the relatively few model railroad shows they attended during and which were and respectively show that petitioners did not devote much of their personal time and effort to red caboose particularly in light of the recreational aspects involved in its operation therefore based on the testimonial and documentary_evidence in this record we think petitioners did not devote sufficient personal time and effort to red caboose during and to establish that they engaged in their model railroad activity with an actual and honest objective of making a profit in our opinion petitioners' primary motivation in operating red caboose was other than to earn a profit respondent suggests that their motive was to use the losses it generated to offset income they received during and this seems probable substantial income from sources other than the activity particularly if the losses from the activity generate substantial tax benefits may indicate that an activity is not engaged in for profit especially if there are personal or recreational elements involved sec_1_183-2 income_tax regs on their and federal_income_tax returns petitioners reported taxable pension income in the amounts of dollar_figure dollar_figure and dollar_figure respectively the losses claimed by them from the operation of red caboose for and were dollar_figure dollar_figure and dollar_figure respectively consequently the losses that petitioners sustained in the operation of red caboose resulted in appreciable tax savings for them the operation of red caboose it appears to us provided a method for attempting to achieve these tax savings while enabling mr lencke to pursue his lifelong hobby of collecting model railroad equipment and memorabilia respondent further contends that petitioners may have viewed red caboose as a recreational activity the presence of personal or recreational motives in carrying on an activity may indicate that the activity is not engaged in for profit sec_1 b income_tax regs both petitioners enjoy their model railroad activity and have never considered abandoning it mr lencke has been collecting model railroad equipment and memorabilia for over years one reason petitioners started red caboose was to provide mr lencke with an activity to occupy his mind and his time after his retirement as an insurance agent thus we think red caboose allowed mr lencke to pursue upon his retirement his interest in and the pleasures of collecting model railroad equipment and memorabilia although its operation extended petitioners' interest in model railroading into a more formal pursuit it does not necessarily follow that they were primarily motivated by an intention to make red caboose a profitable venture while it is not required that a taxpayer dislike an activity before it will be considered a business and not a hobby 59_tc_312 petitioners have not shown a profit objective with respect to their model railroad activity consequently their interest in operating red caboose has strong recreational and personal elements in reaching our conclusion that red caboose's operation was not an activity engaged in by petitioners for profit we have considered that before starting red caboose they planned and coordinated the activities to be pursued through red caboose visited model railroad shows and sought advice from various vendors of model railroad supplies and that they promoted red caboose by advertising in model railroad and toy magazines publishing and distributing a two-page flyer listing red caboose's merchandise creating business cards and allowing visitors to tour the model railroad collection displayed in the basement of their home we have also considered that petitioners persuaded suppliers to sell to them at wholesale prices during and after that they later obtained a retail merchant certificate for red caboose and that they attempted to persuade credit card companies visa and mastercard to allow red caboose to accept their credit cards for its model railroad orders during the years in issue however in weighing these facts along with all the other facts in this record we have concluded on balance that petitioners' objective in operating red caboose was not the actual and honest intention of making a profit during the years in issue accordingly we sustain respondent's determination having decided that petitioners are not entitled to the loss deductions resulting from their model railroad activity in and it is unnecessary to address respondent's alternative position that petitioners are not entitled to additional_depreciation deductions claimed for and ii claimed nonbusiness_bad_debt deduction sec_166 allows a deduction for a nonbusiness_debt that becomes worthless within the taxable_year but provides that the loss shall be treated as a short-term_capital_loss to a taxpayer other than a corporation to qualify for a deduction for a worthless_debt the taxpayer must show that the debt became totally worthless within the taxable_year in which the deduction is claimed because no deduction is allowed for a nonbusiness_debt which is recoverable in part during the taxable_year sec_1_166-5 income_tax regs 54_tc_239 whether a debt has become worthless within a particular year is a question of fact 22_tc_968 to be determined on the basis of objective factors not on the taxpayer's subjective judgment as to the worthlessness of the debt 50_tc_813 affd per curiam without published opinion aftr 2d ustc par 9th cir generally the year of worthlessness must be fixed by identifiable events which form the basis of reasonable grounds for abandoning any hope of recovery 77_tc_582 the court_of_appeals for the seventh circuit has set forth some of the relevant factors to be considered in determining whether a debt is worthless these factors include the debtor's serious financial reverses insolvency lack of assets persistent refusals to pay on demand ill health death disappearance abandonment of business bankruptcy and receivership as well as the debt's unsecured and subordinated status and expiration of the statute_of_limitations 871_f2d_64 7th cir affg tcmemo_1987_228 some of the factors indicating that a debt is not worthless are the creditor's failure to pursue payment especially if the debtor is a relative or friend willingness to make further advances availability of collateral or guarantees by third parties the debtor's earning capacity minor defaults payment of interest and sluggish business conditions id petitioners rely on the christophers' poor financial condition as proof that the debt became worthless during but the evidence of worthlessness upon which they rely is tenuous at best for example some of the factors which caused them to consider the debt worthless in are they heard rumors the christophers were experiencing financial problems in and had sought help through various local charities they believed mr christopher was out of work in the christophers sold their flower shop in the christophers' home was foreclosed after the christophers asked petitioners not to cash their checks and the christophers said they could not repay the debt however the test for worthlessness is objective not subjective 155_f2d_319 1st cir affg a memorandum opinion of this court petitioners' belief that the christophers were unable to pay their debt was based on subjective concerns rather than the objective view of the christophers' financial inability to pay an examination of the facts shows that petitioners had a significant hope for recovery_of at least a portion of the amount_loaned to the christophers although they discussed repayment of the dollar_figure loan with the christophers in date they did not persistently press them for payment the christophers sold their flower shop for dollar_figure in yet petitioners failed to make any attempt to recover some of the proceeds received from the sale petitioners failed to persuade us that their friendship with the christophers was not the main reason for the refusal to press them for payment petitioners also failed to show among other things whether the christophers lacked assets were in ill health had filed for bankruptcy were insolvent or were incapable of paying their debt for some other reason in short petitioners have not shown that collection efforts would have been futile their belief that the debt was worthless and their choice not to pursue reasonable collection efforts are insufficient to establish worthlessness accordingly we hold that petitioners have failed to prove that the debt which the christophers owed them became worthless in therefore they are not entitled to a nonbusiness_bad_debt deduction in that year iii self-employment taxes on residual and renewal insurance premiums sec_1401 imposes a tax upon each individual's self- employment income self-employment_income is defined in sec_1402 as net_earnings_from_self-employment with certain exceptions not relevant to this case net_earnings_from_self-employment are defined in sec_1402 as gross_income derived by an individual from any trade_or_business carried on by such individual less the deductions allowed by this subtitle which are attributable to such trade_or_business it is well established that the earnings_of an insurance agent who is an independent_contractor are self-employment_income subject_to self-employment_tax 64_tc_974 in 76_tc_441 this court held that for income to be taxable as self-employment_income there must be a nexus between the income received and a trade_or_business that is or was actually carried on under our interpretation of the nexus standard any income must arise from some actual whether present past or future income- producing activity of the taxpayer before such income becomes subject_to self-employment_tax id pincite and sec_1_1402_a_-1 income_tax regs provides that gross_income derived from an individual's trade_or_business may be subject_to self-employment_tax even when it is attributable in whole or in part to services rendered in a prior taxable_year first we must decide whether the residual premiums received by mr lencke in and from farm bureau are subject_to self-employment_tax respondent contends that sec_1401 imposes self-employment_tax upon this type of income we agree petitioners have the burden of proving that the residual premiums received by them are not subject_to self-employment_tax because they have chosen not to pursue this issue in either their opening brief or reply brief we consider it to have been conceded rule e remuzzi v commissioner t c memo affd without published opinion 867_f2d_609 4th cir second we must decide whether the payments in lieu of renewal_commissions received by petitioners in are subject_to self-employment_tax petitioners contend that these payments are analogous to the termination_payments received by the taxpayer in 38_f3d_1094 9th cir revg t c memo and are therefore not subject_to self-employment_tax to the contrary respondent contends the payments merely provided a uniform manner of payment of renewal_commissions and retained the characteristics of renewal_commissions thus respondent concludes that the payments are subject_to self-employment_tax just as renewal_commissions are subject_to self-employment_tax we agree with respondent the courts which have examined the issue of whether payments made in lieu of renewal_commissions are subject_to self- employment_tax agree that the payments are of the same character as renewal_commissions and are therefore subject_to self- employment_tax see becker v tomlinson aftr 2d ustc par big_number s d fla erickson v commissioner tcmemo_1992_585 affd without published opinion 1_f3d_1231 1st cir in the becker case the taxpayer an insurance agent was entitled to receive renewal_commissions after the termination of his contract an amendment to his original contract however allowed the taxpayer to choose to receive uniform regularly scheduled payments in lieu of his renewal_commissions upon his retirement as an insurance agent the taxpayer elected to receive the uniform regularly scheduled payments rather than the renewal_commissions to which he was entitled the district_court reasoned that the payments made to the taxpayer in lieu of renewal_commissions merely provided for a uniform manner of payment of renewal_commissions and did not alter the nature of the payments because renewal_commissions are subject_to self-employment_tax the district_court held that the payments made in lieu of the renewal_commissions are also subject_to self-employment_tax similarly in the erickson case this court held that payments made under a settlement agreement that replaced the taxpayer insurance agent's former agreement governing the payment of renewal_commissions were subject_to self-employment_tax the taxpayer in the erickson case who had recently separated from service as an insurance agent was entitled to receive renewal_commissions pursuant to a leveling agreement that provided for monthly payments over a 180-month period however as a result of disputes between the taxpayer and the insurance_company the insurance_company entered into a settlement agreement with the taxpayer the settlement agreement nullified the leveling agreement and provided that the taxpayer was to receive uniform monthly payments over a 240-month period and then smaller uniform monthly payments for the remainder of his life reasoning that the payments under the settlement agreement had the same character as the renewal_commissions we concluded that the payments were subject_to self-employment_tax like the payments received by the taxpayers in the becker and erickson cases the payments received by mr lencke in lieu of renewal_commissions retained the character of the renewal_commissions they replaced petitioners cite 86_f3d_1126 fed cir and 38_f3d_1094 9th cir revg tcmemo_1992_655 to support their position that the payments received by mr lencke in lieu of renewal_commissions were analogous to termination_payments and therefore not subject_to self- employment_tax however the payments in the gump and milligan cases were not payments made in lieu of renewal_commissions the right to the payments in those cases arose from the cancellation of the insurance agents' business arrangements they were payments specifically designated as termination_payments or extended earnings and under certain circumstances the agents could have lost their right to receive the payments milligan in 38_f3d_1094 9th cir revg tcmemo_1992_655 the agent's right to receive termination_payments would have been canceled if all of his former customers had canceled their non-life insurance policies during the first post-termination year in 86_f3d_1126 fed cir the agent would not have received his extended earnings if he had attempted to induce his agency's policyholders to lapse cancel or replace their insurance contracts v commissioner f 3d pincite gump v united_states f 3d pincite thus the milligan and gump cases are not factually similar to the situation confronting us here moreover the court_of_appeals for the ninth circuit specifically noted that renewal_commissions are subject_to self-employment_tax milligan v commissioner f 3d pincite citing erickson with approval the court_of_appeals_for_the_federal_circuit also recognized the distinction between renewal_commissions and extended earnings gump v united_states f 3d pincite likewise our recent opinion in 108_tc_130 following the decision of the court_of_appeals in milligan which dealt only with termination_payments is distinguishable from the renewal_commissions involved in this case accordingly we hold that the payments received by mr lencke in lieu of renewal_commissions are subject_to self- employment_tax because they retained the character of the renewal_commissions they replaced iv accuracy-related_penalties sec_6662 imposes a penalty equal to percent of the portion of the underpayment due to any substantial_understatement_of_income_tax sec_6662 defines both understatement and substantial_understatement pursuant to sec_6662 when the amount of tax required to be shown on a return exceeds the amount actually shown less any rebates provided in sec_6211 then there is an understatement_of_tax this understatement is substantial if the excess_amount exceeds the greater of dollar_figure or percent of the amount of tax required to be shown on the return sec_6662 however sec_6662 provides that the understatement is reduced to the extent that the tax treatment of an item shown on the return was supported by substantial_authority or the facts affecting the item's tax treatment are adequately disclosed and there is a reasonable basis for such treatment petitioners' federal_income_tax return reported a tax_liability of dollar_figure based upon concessions made by petitioners in the stipulations of facts without accounting for the contested adjustments there appears to exist an understatement_of_tax which exceeds the greater of dollar_figure or percent of the amount of tax required to be shown on the return sec_6662 imposes a penalty equal to percent of the portion of the underpayment due to negligence or disregard of rules or regulations the term negligence includes any failure to make a reasonable attempt to comply with the provisions of the internal_revenue_code and disregard includes any careless reckless or intentional disregard sec_6662 on their and federal_income_tax returns petitioners admittedly claimed a depreciation deduction for a boat which they now concede is not properly deductible mr lencke purchased the boat with no business_purpose petitioners also claimed a depreciation deduction for their lawn mower and a sprinkler which had no apparent business_purpose for an answering machine when they did not have a business telephone line they now concede that the answering machine was not depreciable and for percent of a shed which they now concede was only percent depreciable during and percent depreciable during petitioners have also conceded some deductions they claimed because they were either improper or unsubstantiated therefore we hold that they are liable for the negligence_penalty for the above items we conclude however that petitioners made a reasonable attempt to comply with the code provisions with respect to their model railroad activity and therefore are not liable for a penalty on that portion of the underpayment for or sec_6664 in reaching all of our conclusions herein we have considered all arguments made by petitioners and to the extent not discussed above find them to be without merit to reflect conceded and settled issues and our conclusions with respect to the disputed issues decision will be entered under rule


t c summary opinion united_states tax_court don e kramer petitioner v commissioner of internal revenue respondent docket no 12198-99s filed date george edward marifian and mary e lopinot for petitioner james a kutten 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 the decision to be entered is not reviewable by any other court and this opinion should not be cited as authority unless otherwise indicated subseguent section references are to the internal_revenue_code in effect for the year in issue respondent determined a deficiency in petitioner’s federal - - income_tax in the amount of dollar_figure and an accuracy-related_penalty under sec_6662 of dollar_figure for the tax_year the issues for decision are whether petitioner is entitled to deduct on his individual_income_tax_return losses_incurred in the operation of a restaurant or if such losses are deductible by berm hospitality services inc a corporation in which petitioner was the sole shareholder and whether petitioner is liable for an accuracy-related_penalty under sec_6662 for the year in issue issues relating to capital losses self-employment_tax itemized_deductions and earned_income_credit are computational and depend upon the holding in this case background some of the facts have been stipulated and are so found the stipulation of facts and the attached exhibits are incorporated herein by this reference at the time of filing the petition petitioner resided in marion illinois in date petitioner and rich maker mr maker formed berm hospitality services inc berm d b a d k ’s steak seafood house as a corporation under illinois law petitioner and mr maker were the initial shareholders of berm each owning percent of the stock berm conducted business operating a restaurant a cocktail bar and lounge and banquet facilities at the holiday inn motel holiday inn mt vernon illinois beginning in date petitioner hired a corporate service company to prepare and file the incorporation documents on behalf of petitioner and mr maker the articles of incorporation of berm were filed with the tllinois secretary of state on date along with an application to adopt an assumed corporate name d k ’s steak seafood house on date berm also filed an application_for an employer_identification_number ein with respondent the tllinois department of revenue issued a certificate registering berm under the illinois use_tax act service occupation tax act and service use_tax act petitioner negotiated berm’s lease with f m pat sullivan and dorothy jane sullivan as trustee of the dorothy sullivan trust dated date to operate the restaurant cocktail bar and lounge and banquet facilities at the holiday inn berm purchased commercial general liability insurance excess liability insurance and liquor liability insurance for the period from date until date however the insurance agreements were canceled at the end of date initially petitioner participated minimally in the daily operations of d k ’s steak seafood house petitioner considered himself the investor or financial supporter and mr maker the operating expert handling the day-to-day operation of the restaurant petitioner was also in charge of securing - other investors however he was unsuccessful petitioner’s initial investment in berm was approximately dollar_figure shortly after the restaurant’s opening in date petitioner and mr maker had disagreements over mr maker’s management practices at that time petitioner was winding down his law practice in marion illinois about miles away and was not involved with berm full time mr maker made numerous requests to petitioner for additional money and after further inguiry petitioner found that mr maker was spending money like there was no tomorrow petitioner also noticed a high rate of employee turnover because of disagreements in management petitioner asked mr maker to take a few weeks off while petitioner decided whether or not to continue with the venture in date petitioner and mr maker agreed that mr maker would no longer have any involvement with berm to this end on date mr maker sold his stock in berm to petitioner for dollar_figure leaving petitioner as the sole shareholder of berm although an agreement memorializing this sale was fully executed by the parties there are no corporate minutes or resolutions by berm with respect to distributions to any shareholders in fact berm did not maintain a corporate minute book after petitioner’s initial dollar_figure investment in berm he continued to use his own money or money lent to him by friends to maintain berm’s operations petitioner filed on date an illinois business registration with the illinois department of revenue for the entity kramer hospitality services kramer hospitality d b a d k ’s steakhouse also on date petitioner drove to springfield to file an application_for a new ein form ss-4 for the entity kramer hospitality on date the tllinois department of revenue issued a certificate registering kramer hospitality under the illinois use_tax act service occupation tax act and service use_tax act the record does not indicate that illinois sales_taxes were reported or remitted by petitioner or kramer hospitality during all times relevant kramer hospitality did not have a bank account rather throughout petitioner continued to use berm’s corporate bank account in the name of d k ’s steak seafood house to deposit receipts and pay creditors kramer hospitality did not purchase liability insurance during berm’s commercial liability insurance agreements were maintained until date when berm ceased operations also kramer hospitality did not obtain a lease to operate the restaurant cocktail bar and lounge and banquet facilities at the holiday inn nor did berm execute a written_agreement assigning it sec_1 the record is unclear as to whether these amounts were loans to the corporation or additional contributions to capital -- - interest in the written lease to kramer hospitality as required under section of the lease agreement ’ for the taxable_year ending date berm filed a form_1120 u s_corporation income_tax return and a form 1120x amended u s_corporation income_tax return the tax_return was filed on date and the boxes were checked for initial return and final return berm did not file form_966 corporate dissolution or liquidation with respondent as required under sec_6043 berm also failed to file articles of corporate dissolution with the illinois secretary of section of the lease agreement entitled assignment and subleasing states as follows this lease may be assigned in whole or in part and the project may be subleased in whole or in part by the lessee only with the written consent of the lessor sec_6043 liquidating etc transactions a corporate liguidating etc transactions ---- every corporation shall-- within days after the adoption by the corporation of a resolution or plan for the dissolution of the corporation or for the liquidation of the whole or any part of its capital stock make a return setting forth the terms of such resolution or plan and such other information as the secretary shall by forms or regulations prescribe and when required by the secretary make a return regarding its distributions in liquidation stating the name and address of the number and class of shares owned by and the amount_paid to each shareholder or if the distribution is in property other than money the fair_market_value as of the date the distribution is made of the property distributed to each shareholder - state on date berm was administratively dissolved by operation of law for the failure_to_file the annual report due_date and pay an annual franchise tax see ill comp stat dollar_figure west ill comp stat dollar_figure west petitioner reported the restaurant’s operating losses of dollar_figure on his individual schedule c profit or loss from business and abandonment losses’ of dollar_figure on form_4797 sales of business property for taxable_year in a notice_of_deficiency respondent determined that petitioner was not entitled to deduct the business operating and abandonment losses resulting in a tax_liability of dollar_figure respondent also determined a penalty of dollar_figure pursuant to sec_6662 however in the notice_of_deficiency respondent determined petitioner incurred a capital_loss of dollar_figure from his investment in berm and allowed petitioner a deduction therefor of dollar_figure pursuant to sec_165 and sec_1211 discussion the first issue for decision is whether petitioner operated the restaurant business at the holiday inn as a sole_proprietorship or a corporation during asked differently ‘ petitioner’s reported abandonment losses are with respect to equipment and leasehold improvements that were abandoned when the restaurant ceased doing business in date --- - did berm distribute its assets to petitioner in a complete liguidation during so that from that date forward petitioner operated the business as a sole_proprietorship petitioner contends that berm had completed a de_facto_liquidation of its assets to him as the sole shareholder in date petitioner further contends that upon liquidation he held berm’s former assets as a sole_proprietorship and continued to run the restaurant located at the holiday inn thus petitioner is entitled to claim the losses on his schedule c for the taxable_year respondent contends that berm was not dissolved until the state of illinois administratively dissolved it in date for failure_to_file its annual filings and pay an annual franchise tax respondent further contends that petitioner failed to show that a liguidating distribution occurred in thus berm was the true owner of the assets during and petitioner is not entitled to personally deduct the operational and abandonment losses whether a corporation has liguidated is a question of fact see 27_bta_162 murphy v commissioner tcmemo_1996_59 this court has applied a three-pronged test in making a factual determination that a de_facto_liquidation had occurred for federal tax purposes whether there is a manifest intention to liquidate whether --- - there is a continuing purpose to terminate corporate affairs and dissolve the corporation and whether the corporation’s activities are directed and confined to that purpose see 50_tc_130 although the term complete liguidation is not defined in the code or the regulations to sec_331 we have noted in olmsted v commissioner tcmemo_1984_381 that the regulations under sec_332 offer a definition of complete_liquidation that applies equally to sec_331 a status of liquidation exists when the corporation ceases to be a going concern and its activities are merely for the purpose of winding up its affairs paying its debts and distributing any remaining balance to its shareholders a liquidation may be completed prior to the actual dissolution of the liquidating corporation however legal dissolution of the corporation is not reguired sec_1_332-2 income_tax regs under illinois law a corporation is prohibited from making a distribution if after giving it effect the corporation would be insolvent see ill comp stat c west a corporation is insolvent when it is unable to pay its debts as they become due in the usual course of its business see id m petitioner relies on rendina v commissioner tcmemo_1996_392 to support his contention that berm had de_facto liguidated during date for tax purposes however after reviewing rendina we find that it is distinguishable in -- - rendina the court found that the intent to ligquidate was apparent from the sales of wsai’s assets its cessation of business and the agreement of petitioner and ackerman that wsai would distribute the last two condominium units to petitioner in consideration of petitioner’s assumption of the corporation’s liabilities to its lenders and his recovery_of his investment out of the balance with that final distribution wsai held title to no further assets of any substantial consequence unlike the facts in rendina the record does not clearly show an intent to liquidate there is no evidence of a written or oral agreement to liquidate berm after mr maker sold his shares in the corporation no management agreement showing petitioner’s obligation to indemnify the corporation of any loss at the end of the year no partnership_agreement showing a new entity to carry on the business of berm no books_and_records showing daily accounts or value of assets and liabilities and no canceled checks or loan agreements establishing the amounts of loans petitioner personally made to berm or any other entity in fact there is no evidence that berm ceased doing business at the end of on the contrary petitioner continued to enjoy the benefits of berm’ss corporate form throughout particularly petitioner continued to use berm’s checking account to deposit receipts pay expenses and maintain the necessary cash-flow for the business petitioner also enjoyed the benefits of the insurance contracts and lease agreement entered into by berm there was no attempt to renegotiate these contracts on behalf of kramer hospitality see 87_tc_498 petitioner has failed to show that a liquidating_distribution of berm’s assets occurred in petitioner has not offered any corroborating evidence besides his testimony to establish that any distribution liquidating or nonliquidating occurred in it is well settled that we are not required to accept a taxpayer’s self-serving testimony in the absence of corroborating evidence see 99_tc_202 assuming arguendo that petitioner did attempt to distribute berm’s assets to himself illinois law prohibits such a distribution if the corporation is insolvent see ill comp stat c after reviewing berm’s bank accounts corporate tax returns for forms and 1120x and petitioner’s testimony we find that berm could not make a liquidating_distribution as petitioner suggests because it was insolvent at that time petitioner testified that he conferred with his agent about the insurance contracts and it was kind of a calculated decision to maintain berm’s insurance due to the insufficiency of his personal cash_flow according to berm’s form_1120 u s_corporation income continued on the basis of the complete record we hold that berm did not distribute its assets to petitioner during therefore petitioner is not entitled to deduct the operational or abandonment losses claimed on his schedule c accordingly respondent is sustained on this issue sec_6662 a the last issue for decision is whether petitioner is liable for an accuracy-related_penalty pursuant to sec_6662 sec_6662 imposes a penalty of percent of the portion of the underpayment which is attributable to negligence or disregard of rules or regulations see sec_6662 negligence is the lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances ’ 85_tc_934 quoting marcello v commissioner 380_f2d_499 5th cir affg t c continued tax_return berm was insolvent at the close of however berm’s form 1120x amended u s_corporation income_tax return reports an adjustment of dollar_figure as management fees received in thus transforming berm into a solvent corporation at the close of at trial petitioner testified that he did not invest dollar_figure but rather he relieved the corporation of dollar_figure in loans he had previously made to the corporation in the record does not indicate any evidence of the amount of loans petitioner made to berm other than petitioner’s testimony and the amended_return also the record contains no management agreements which petitioner testified required him to indemnify the corporation for any loss at the end of the year on the basis of the above we do not accept petitioner’s self-serving testimony in the absence of corroborating evidence see 99_tc_202 and t c memo negligence also includes any failure by the taxpayer to keep adequate books_and_records or to substantiate items properly see sec_1_6662-3 income_tax regs the term disregard includes any careless reckless or intentional disregard sec_6662 no penalty shall be imposed if it is shown that there was reasonable_cause for the underpayment and the taxpayer acted in good_faith with respect to the underpayment see sec_6664 the determination of whether a taxpayer acted with reasonable_cause and good_faith within the meaning of sec_6662 is made case-by-case taking into account all the pertinent facts and circumstances see sec_1_6664-4 income_tax regs we find petitioner’s testimony conflicting ’ and without corroborating evidence self-serving see niedringhaus v commissioner supra pincite at trial petitioner failed to establish that he acted in good_faith with respect to the claimed losses petitioner a practicing lawyer during the year in issue failed to make inquiry and obtain advice as to the necessary steps to dissolve a corporate entity he also failed for instance although petitioner testified that he obtained a new sales_tax number for kramer hospitality services as a sole_proprietorship the record shows that all relevant documents ie illinois business registration form ss-4 application_for new ein illinois department of revenue sale and use_tax return and payroll transfers new subscriber information form indicate that kramer hospitality was formed as a partnership rather than a sole_proprietorship to maintain adequate books_and_records and to act with ordinary business care and prudence in complying with the federal_income_tax requirements on the basis of the entire record we find that petitioner was negligent and hold that petitioner is liable for an accuracy- related penalty under sec_6662 for the tax_year we have considered all arguments made by the parties and to the extent not discussed above conclude they are irrelevant or without merit reviewed and adopted as the report of the small_tax_case division decision will be entered for respondent