t c memo united_states tax_court custom chrome inc and subsidiaries petitioner v commissioner of internal revenue respondent docket no filed date james j kelly jr an officer and harry j kaplan for petitioner lloyd t silberzweig for respondent memorandum findings_of_fact and opinion swift judge for the years in issue respondent determined deficiencies in and penalties to petitioner custom chrome inc 's and its consolidated subsidiaries' federal income taxes as follows tax_year ending deficiency date dollar_figure big_number date date big_number accuracy-related_penalty sec_6662 dollar_figure big_number big_number unless otherwise indicated 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 following concessions the primary issues for decision are whether dollar_figure million paid to a stockholder constitutes an amortizable business_expense for a covenant_not_to_compete or a nondeductible capital_expenditure whether dollar_figure paid to employees constitutes currently deductible payments for services rendered or nondeductible payments for a covenant_not_to_compete amortizable only in years not before the court whether other claimed business_expenses constitute nondeductible capital expenditures and the value of options issued on date for purposes of calculating original_issue_discount associated with a loan findings_of_fact some of the facts are stipulated and are so found when the petition was filed petitioner's principal_place_of_business was located in morgan hill california in petitioner was incorporated by several individuals to operate a small independent retail store selling motorcycle parts and accessories in two employees of petitioner tyrone a cruze sr cruze and ignatius j panzica panzica purchased the stock of petitioner in december of cruze became sole owner of the stock of petitioner and panzica stayed on as an employee from until under cruze's direction as sole stockholder president and chief_executive_officer of petitioner petitioner's business thrived and petitioner became the largest independent worldwide supplier of harley-davidson motorcycle parts and accessories petitioner’s employees also designed and manufactured many of the accessories that it sold for harley-davidson motorcycles petitioner maintained warehouse facilities in california and kentucky in petitioner's combined domestic and foreign sales exceeded dollar_figure million from until cruze was involved in and maintained final decision-making authority over all aspects of petitioner's business operations cruze established significant business contacts with bankers suppliers and vendors who were important to the business operations and success of petitioner cruze wa sec_1 cruze’s wife also purchased some of the stock in petitioner for convenience we treat cruze as sole owner of the stock in petitioner well known and respected in the motorcycle parts business and his ideas efforts and management skills contributed significantly to the growth and success of petitioner from until panzica served as petitioner's vice president of operations in panzica succeeded cruze as chief_executive_officer of petitioner from approximately until the mid-1990's mario battistella managed warehouse operations for petitioner from until august of dennis b navarra was vice president of finance for petitioner in navarra became chief financial officer and assistant secretary for petitioner during the 1980's panzica battistella and navarra were underpaid by petitioner for their significant services as employees of petitioner in cruze began considering selling his stock in petitioner in late or early the jordan company jc investors a new york city investment firm approached cruze regarding the potential purchase of his stock in petitioner jc investors was in the business of purchasing private companies and taking the companies public in jc investors owned substantial interests in over private companies in various industries with aggregate annual sales of dollar_figure billion generally after acquiring controlling interests in companies jc investors would retain existing management personnel of acquired companies and would require key employees of the companies to enter into covenants not to compete in after significant negotiations jc investors agreed to purchase from cruze for dollar_figure million all of the outstanding_stock in petitioner the stock purchase was structured as a leveraged_buyout lbo in order to carry out the lbo jc investors organized custom chrome holdings inc cc holdings as a wholly owned subsidiary on date a stock purchase agreement between cruze and cc holdings was entered into under which cruze was to be paid dollar_figure million in consideration for his stock in petitioner on date jc investors organized custom chrome acquisition corp cc acquisition as a wholly owned subsidiary of cc holdings cc acquisition was incorporated days prior to the lbo for the sole purpose of facilitating the lbo during its 10-day existence cc acquisition did not conduct any activities unrelated to the lbo in august of cc acquisition obtained from first national bank of boston fnbb a dollar_figure million loan in order to finance the lbo and to provide working_capital for petitioner after the lbo the dollar_figure million obtained from fnbb by cc acquisition was made available to cc acquisition under lines of credit with various interest rates and terms as follows lines of credit tranche i tranche ii working_capital amount dollar_figure big_number big_number interest rate term prime plu sec_2 years prime plu sec_1 years prime plu sec_1 years by selling debentures issued by cc holdings to mezzanine capital and income trust mezzanine capital cc holdings obtained an additional dollar_figure million to assist in financing the lbo prior to the lbo cc holdings contributed to cc acquisition the dollar_figure million received from sale of the debentures along with an additional dollar_figure that cc holdings had raised through sale of its stock the following schedule summarizes the source and amount of funds obtained by jc investors through its two controlled corporations cc acquisition and cc holdings in connection with the lbo source of funds amount fnbb line of credit dollar_figure sale of debentures to mezzanine capital big_number big_number cc holdings contribution total dollar_figure on date pursuant to the plan of acquisition and using the funds that had been obtained by cc acquisition cc holdings acquired cruze’s stock in petitioner in an lbo that for federal_income_tax purposes took the form of a taxable reverse subsidiary merger simultaneous with the acquisition by cc holdings of cruze's stock in petitioner cc acquisition was merged into petitioner with petitioner surviving the merger as a result of the reverse_merger cc acquisition did not remain in existence and petitioner became a wholly owned subsidiary of cc holdings according to the plan of acquisition and under the merger agreement petitioner became liable for debts of cc acquisition including the dollar_figure million loan obtained from fnbb the dollar_figure million used to pay cruze for the stock in petitioner was part of the dollar_figure million received as a loan from fnbb after the lbo and under various supplemental agreements relating to acquisition of the stock in petitioner and to the continued employment of the senior employees of petitioner mezzanine capital and panzica battistella navarra and other employees of petitioner acquired shares of stock in cc holdings for dollar_figure per share further on date in connection with the dollar_figure million loan made by fnbb fnbb received from cc holdings options to purchase over the course of years shares of stock in cc holdings representing up to percent of the equity in cc holdings the options will expire on date and the exercise price was set at dollar_figure per share the same price per share paid_by investors who acquired stock in cc holdings as part of the lbo of petitioner terms of the agreement under which fnbb received options to acquire stock in cc holdings for dollar_figure per share were hotly negotiated between jc investors cc holdings and fnbb financing the lbo posed significant risks for fnbb approximately dollar_figure million of the dollar_figure million loan made available by fnbb was not secured the lbo would change petitioner's capital structure from primarily equity to primarily debt in recognition of such risks the options provided fnbb the potential to earn significant additional income if the stock of cc holdings increased in value fnbb loan officers estimated that the options might have a value in years of approximately dollar_figure million immediately following the lbo transaction and under the various supplemental agreements the common_stock or in the case of fnbb options to acquire common_stock of cc holdings was owned as follows percentage ownership stockholders in cc holdings jc investors mezzanine capital cruze panzica battistella and navarra fnbb options other employees of petitioner miscellaneou sec_28 total because of restricted voting rights associated with many of the above shares jc investors controlled the board_of directors of petitioner also after the lbo and consistent with jc investors’ practice petitioner's management team and senior employees were asked to and did remain with petitioner further consistent with jc investors’ practice in acquiring companies cruze as key_employee of petitioner was requested to enter into a covenant_not_to_compete under the covenant_not_to_compete that cruze entered into with petitioner for an additional dollar_figure million that was paid to cruze in upon closing of the lbo cruze was obliged for a 3-year period of time from the date of the lbo not to enter into any business contract that would compete directly or indirectly with petitioner’s business jc investors likely would not have agreed to the purchase of the stock in petitioner if cruze had not signed this covenant_not_to_compete on date an additional dollar_figure was paid to cruze to enable him to pay certain federal income taxes that were owed by petitioner and that related to years prior to the lbo when petitioner had constituted an s_corporation the following schedule reflects total funds received by cruze on date in connection with the lbo funds received relating to outstanding_stock covenant_not_to_compete petitioner’s taxes total amount dollar_figure big_number big_number dollar_figure also upon closing of the lbo on date under separate agreements that were referred to as bonus and noncompetition agreements a total of dollar_figure million was paid to panzica battistella and navarra as stated in years prior to the lbo these individuals generally had been underpaid by petitioner for their services to petitioner and an understanding existed between cruze and these individuals that if cruze ever sold his stock in petitioner an effort would be made to pay these individuals additional compensation_for their prior services rendered to petitioner accordingly in the negotiations with jc investors cruze emphasized that he wanted a total of dollar_figure million to be paid to panzica battistella and navarra in recognition for their services in prior years in the negotiations however jc investors was hesitant to pay the employees dollar_figure million cruze then offered to have dollar_figure million reduced from the dollar_figure million that tentatively had been agreed to be paid to him by jc investors if this dollar_figure million would be paid to panzica battistella and navarra for their services in prior years petitioner and jc investors agreed to this reduction and as indicated under the final agreement that was entered into cruze was paid dollar_figure million instead of dollar_figure million for his stock in petitioner the dollar_figure million was paid to panzica battistella and navarra in the following respective amounts employee panzica battistella navarra amount dollar_figure big_number big_number dollar_figure total of the dollar_figure paid to battistella dollar_figure dollar_figure in principal and dollar_figure in interest in substance and in fact related to and constituted repayments of principal and interest on a dollar_figure loan that in earlier years petitioner had received from battistella panzica battistella and navarra were regarded by cruze as key employees of petitioner and at cruze’s suggestion they were requested to enter into and they did agree to covenants not to compete with petitioner for a period of years which period was not to begin until they left their employment with petitioner no dollar amount was allocated to the covenants not to compete that were entered into by panzica battistella and navarra cc acquisition incurred expenditures in connection with the lbo totaling dollar_figure for which petitioner became liable as the successor_corporation of these total dollar_figure in expenditures dollar_figure constituted finance_charges relating to the financing provided by fnbb and mezzanine capital the remaining dollar_figure constituted legal and professional fees on date for dollar_figure fnbb assigned the options that it held in the stock of cc holdings to bank of boston capital bank of boston a wholly owned subsidiary of fnbb subsequently on date bank of boston assigned to security pacific national bank spnb for an unspecified consideration a portion of the options representing percent of the equity in cc holdings and bank of boston retained the options with respect to the remaining percent of the equity in cc holdings on date cc holdings was merged into petitioner and petitioner’s stock was offered to the public in an initial_public_offering ipo at dollar_figure per share most of petitioner's debts were paid off using the dollar_figure million in proceeds realized from the ipo on date simultaneously with the ipo the options held by bank of boston and spnb in cc holdings’ stock were exercised and the banks received a total of big_number shares of stock in petitioner with a combined total value of dollar_figure the combined net value of the stock in petitioner that the banks realized in exercising the options equaled dollar_figure dollar_figure less the dollar_figure exercise price for the options on date a secondary public offering was held with stock in petitioner selling for dollar_figure per share through this secondary offering jc investors sold off all of its stock in petitioner during the years in issue petitioner operated as an accrual basis taxpayer with a tax_year ending january tax returns and audit on its corporate federal_income_tax returns for each of its taxable years through petitioner claimed a current business_expense deduction to amortize a ratable portion of the dollar_figure million paid to cruze in under the 3-year covenant_not_to_compete as follows tax_year ending date date date date total amortization claimed dollar_figure big_number big_number big_number big_number dollar_figure on its corporate federal_income_tax return petitioner claimed an ordinary business_expense deduction for the total dollar_figure million paid to panzica battistella and navarra under the bonus and noncompetition agreements on its corporate federal_income_tax return petitioner claimed a current business deduction of dollar_figure for financing charges allegedly incurred in connection with the lbo on petitioner’s tax returns no original_issue_discount oid was claimed as a deduction relating to the options issued to fnbb for its financial_accounting purposes fnbb reported the options it received in the stock of cc holdings as an asset on its books_and_records at a nominal value of dollar_figure and for federal_income_tax purposes no oid was reported as income by fnbb relating to the options on audit of petitioner’s taxable years and and of petitioner’s claimed net_operating_loss carryforwards from petitioner’s taxable years and respondent disallowed for through the claimed business_expense deductions relating to cruze’s dollar_figure million covenant_not_to_compete respondent also disallowed for the claimed business_expense deduction relating to the dollar_figure million paid to panzica battistella and navarra in under the bonus and noncompetition agreements the basis for respondent’s disallowance for each year of the claimed business_expenses relating to cruze’s dollar_figure million covenant_not_to_compete was the determination that the payments to cruze constitute nondeductible capital expenditures the basis for respondent’s disallowance for of the dollar_figure million paid to panzica battistella and navarra apparently was the determination that the dollar_figure million relates primarily to the noncompetition agreements each of these individuals entered into not to payments for services rendered in prior years because panzica’s battistella’s and navarra’s 3-year noncompetition obligations were not triggered until they left employment with petitioner and because in panzica battistella and navarra still worked for petitioner respondent determined that no portion of the dollar_figure million should be deducted in or in later years before the court for respondent disallowed the dollar_figure that petitioner claimed as deductible financing charges on the grounds that the expenses constitute nondeductible capital expenditures relating to acquisition of the stock in petitioner respondent now agrees that dollar_figure of the dollar_figure was properly deducted by petitioner as ordinary business_expenses only dollar_figure remains in dispute as alleged nondeductible capital expenditures although not claimed on its through corporate federal_income_tax returns as filed petitioner in its petition affirmatively asserts beginning for in order to increase or to maintain the amount of the nol claimed from and later years or beginning for and later years that it is entitled to amortize a portion of the claimed dollar_figure as original_issue_discount relating to the options that were issued to fnbb alternatively petitioner argues that the dollar_figure should be deductible as loan fees or compensation paid to fnbb under sec_83 opinion dollar_figure million paid to cruze as covenant_not_to_compete for the years in issue amounts paid for covenants not to compete generally are deductible over the useful_life of the covenants as current business_expenses whereas amounts paid for goodwill or going_concern_value of a business generally are treated as nondeductible capital expenditures 84_tc_21 to be respected for federal_income_tax purposes covenants not to compete should reflect economic reality 810_f2d_562 6th cir affg tcmemo_1985_53 52_tc_367 affd per curiam 451_f2d_173 9th cir where parties to purported covenants not to compete do not have adverse tax interests the covenants will be strictly scrutinized 294_f2d_52 9th cir affg 34_tc_235 also after trial on date petitioner filed under rule a motion for leave to amend the petition for and in order to claim that capitalized costs of dollar_figure and big_number respectively should be allowed as deductible current business_expenses relating to petitioner’s mailing and shipping operations we deny petitioner's motion for leave to amend the petition and to raise this new issue at this late date rule a 84_tc_985 o'rourke v commissioner tcmemo_1990_161 74_tc_441 further taxpayers generally bear the burden of proving entitlement to claimed deductions rule a respondent argues primarily that the covenant_not_to_compete by cruze lacks economic reality and that the dollar_figure million paid to cruze constitutes a nondeductible capital_expenditure for the goodwill or going_concern_value of petitioner respondent emphasizes that jc investors petitioner and cruze did not have adverse tax interests and that the terms of the covenant were not separately negotiated respondent notes cruze's testimony that he would have been pretty silly to sell his company and then spend his money trying to compete with it if we conclude that the covenant_not_to_compete should be respected for federal_income_tax purposes respondent argues that the proper amount to be allocated to the covenant is dollar_figure million not the dollar_figure million claimed by petitioner petitioner argues that the covenant_not_to_compete reflects economic reality and that the entire dollar_figure million paid to cruze with regard thereto should be respected petitioner emphasizes cruze's management talents knowledge of the industry business contacts financial resources and general ability to compete with petitioner as set forth in our findings_of_fact the evidence establishes the appropriateness and need for the 3-year covenant_not_to_compete between petitioner and cruze in light of cruze’s extensive experience and contacts in the motorcycle parts industry petitioner's business would have been significantly and adversely affected if cruze had attempted to compete with petitioner further jc investors would not have consummated the purchase of the stock in petitioner if cruze had not agreed to the covenant_not_to_compete we conclude that the covenant_not_to_compete between petitioner and cruze had economic reality and that the agreement is to be respected for federal_income_tax purposes petitioner's expert valued cruze's covenant_not_to_compete at dollar_figure million respondent's expert valued the covenant at dollar_figure million using a discounted cash_flow analysis of his estimate of losses petitioner might suffer if cruze established a business in competition with petitioner based on our review of the expert witness reports and based on our findings_of_fact that establish cruze’s importance to the business of petitioner and his experience and connections in the motorcycle parts industry we conclude that no discount should be applied to the covenant_not_to_compete and that the full dollar_figure million represents payment to cruze for his covenant_not_to_compete against petitioner dollar_figure9 million paid to panzica battistella and navarra amounts paid_by taxpayers to employees as compensation_for services rendered in the current or prior years are generally deductible as ordinary and necessary business_expenses sec_162 281_us_115 amounts paid for covenants not to compete are amortized as deductions over the life of the covenants warsaw photographic associates inc v commissioner supra pincite petitioner argues that dollar_figure9 million of the total dollar_figure million paid to panzica battistella and navarra dollar_figure million less the dollar_figure associated with the principal and interest payments on the loan petitioner received from battistella should be treated for federal_income_tax purposes as compensation paid to the three employees in for services rendered to petitioner in prior years petitioner argues that no portion of the dollar_figure9 million should be allocated to separate covenants not to compete between petitioner and the employees respondent argues that the entire dollar_figure9 million or some portion thereof should be allocated to covenants not to compete between petitioner and the employees and allowed as deductions and amortized only after the covenants begin to run once the employees stop working for petitioner ie in years not before the court we agree with petitioner the evidence although not extensive is credible and persuasive and establishes that the dollar_figure9 million was paid to panzica battistella and navarra as consideration for services rendered in prior years and not for covenants not to compete the dollar_figure9 million was paid in not deferred until later years after the employees terminated their employment with petitioner and was based on a longstanding understanding between cruze on the one hand and panzica battistella and navarra on the other that panzica battistella and navarra would be compensated with additional compensation_for services rendered if cruze’s stock in petitioner was sold the bonus and noncompetition agreements did not specifically allocate any of the dollar_figure9 million to the covenants not to compete see 314_f2d_1 9th cir affg per curiam tcmemo_1961_170 76_tc_239 58_tc_610 it also appears that because panzica battistella and navarra did not sell any stock in petitioner in connection with entering into the bonus and noncompetition agreements under california law the noncompetition clauses were unenforceable see cal bus prof code secs west metro traffic control inc v shadow traffic network cal rptr 2d ct app for the above reasons we conclude that the dollar_figure9 million paid to panzica battistella and navarra should be treated as compensation paid to the employees for services rendered in prior years and as deductible by petitioner for as ordinary and necessary business_expenses dollar_figure in legal and professional fees under sec_162 amounts paid_by a corporation in connection with redemption of its stock are treated as nondeductible capital expenditures sec_162 see 397_us_580 397_us_572 amounts that are to be capitalized under sec_162 include amounts paid in consideration for the stock fees incurred in connection with the redemption of the stock and legal accounting appraisal and brokerage fees and any other expenses except loan fees necessary or incidental to the redemption see h rept pincite c b vol s rept pincite c b vol 107_tc_187 supplementing 103_tc_395 also under various applications of the step_transaction_doctrine a series of formally separate steps may be collapsed and treated as a single transaction 88_tc_1415 a series of steps may be collapsed and treated as one if at the time the first step was entered into there was a binding commitment to undertake the later step binding-commitment test if the separate steps constitute prearranged parts to a single transaction intended to reach the end result end-result_test or if the steps are so interdependent that the legal relations created by one step would have been fruitless without a completion of the series mutual- interdependence test id pincite0 respondent argues that the acquisition by cc holdings of cruze’s stock in petitioner should be treated for federal_income_tax purposes as a redemption and that the dollar_figure constituted expenses_incurred in connection with that redemption alternatively if the transaction is not treated as a stock_redemption respondent argues that the expenses should be capitalized due to significant long-term benefits to petitioner and that no current deduction should be allowed in any year before us petitioner argues that for federal_income_tax purposes the purchase of cruze’s stock by jc investors did not constitute a stock_redemption and that the expenses should be deductible either for or for the year in which jc investors disposed of its interest in petitioner we agree with respondent's primary argument the evidence indicates that cc acquisition was formed as a subsidiary of cc holdings solely to facilitate cc holdings' acquisition of the stock in petitioner cc acquisition was incorporated only days prior to the lbo and cc acquisition did not conduct any activities unrelated to the lbo during the short_period of its existence the several integrated steps of the lbo involving cc acquisition -- its formation its receipt of financing its merger into petitioner and petitioner's assumption of its liabilities -- constituted prearranged integrated steps to facilitate the acquisition of the stock of petitioner and these steps were mutually interdependent we note that other than the formation of cc acquisition which occurred days prior to the lbo the remaining steps to the transaction essentially occurred simultaneously on date because cc acquisition was formed merely as a transitory corporation to facilitate the lbo we conclude that cc acquisition and the steps of the transaction involving cc acquisition should be disregarded for federal_income_tax purposes in effect the transaction is to be treated for federal_income_tax purposes as if petitioner received loans directly from fnbb and then used dollar_figure million of the loan proceeds to redeem the shares of stock that were held by cruze see bittker eustice federal income_taxation of corporations and shareholders par pincite 6th ed ginsburg levin mergers acquisitions and buyouts sec pincite ginsburg levin mergers acquisitions and buyouts sec pincite for the dollar_figure in legal and professional fees that petitioner incurred in connection with the redemption of cruze’s stock constitute under sec_162 nondeductible capital expenditures oid associated with dollar_figure million loan original_issue_discount oid associated with a loan is treated as interest and ratably over the term of the loan is deductible by the debtor and taxable as ordinary_income to the creditor sec_163 sec_1272 generally oid is incurred when the debtor at the time the loan is obtained receives from the creditor less than the face_amount of the loan where in addition to the obligation to pay the creditor the principal_amount of the loan obligation and interest a debtor_corporation grants to a creditor options to acquire stock in the debtor_corporation in determining whether oid is associated with the loan the principal_amount of the loan obligation and the value of the options are considered together and are treated as a single investment_unit sec_1273 typically in this situation the amount of oid if any associated with the loan will correspond to the amount or portion of the value of the investment_unit that is allocated to the options sec_1273 sec_1273 sec_1275 at trial and on brief the parties herein agree that oid is to be associated with the dollar_figure million loan that was received from fnbb to the extent that the options to acquire stock in cc holdings that were granted to fnbb had any ascertainable value as of the date petitioner received the loan and the options were issued to fnbb the parties however disagree as to the value of the options and thus they disagree as to the existence and amount of any oid associated with the loan petitioner values the options at or exceeding dollar_figure million and argues that it should be entitled to deduct at least dollar_figure million as oid over the separate terms of the loans that made up the total dollar_figure million loan respondent argues that no oid was associated with the dollar_figure million loan and alternatively if oid was incurred the amount thereof was no more than dollar_figure the evidence establishes and the parties agree that the options to acquire stock in cc holdings that were granted to fnbb were issued at the money with a dollar_figure per share exercise price as indicated after the lbo petitioner became liable for the debts of cc acquisition for convenience in discussing the oid issue we substitute petitioner for cc acquisition as the debtor on the loan this dollar_figure per share exercise price was equal to the price paid at that time by other investors for the stock of cc holdings this constitutes strong evidence that the options had no premium value to be associated with them at the time of issuance thus any value that might attach to the options would be speculative and would depend on the profits of petitioner and on appreciation in the value of the underlying stock in subsequent years on its original tax returns for its taxable_year the taxable_year in which the options were issued and for its through taxable years petitioner did not treat the dollar_figure million loan as having any oid associated with it similarly neither fnbb nor bank of boston treated the dollar_figure million loan as having any oid associated with it and only a nominal dollar_figure value was associated with the options by fnbb this also constitutes significant evidence that the options had no premium value to be associated with them at the time of issuance certainly representatives of fnbb and bank of boston hoped that the options in subsequent years would increase in value and increase greatly the income their banks would receive in connection with financing the lbo that speculative future value however does not establish that oid is associated with the dollar_figure million loan petitioner relies on 634_f2d_484 10th cir and the approach adopted therein to argue that the dollar_figure million loan was obtained by petitioner at an interest rate discount and that the interest rate discount gives rise to oid associated with the loan we decline to apply the approach used in monarch cement co the evidence in the instant case does not establish that the dollar_figure million loan was obtained at a below-market interest rate although bank representatives testified that they would have liked to have charged a higher interest rate on the dollar_figure million loan the credible_evidence does not establish that the parties to the dollar_figure million loan actually negotiated and agreed to a discounted interest rate as part of the compensation therefor because the options were issued at market petitioner and cc holdings incurred no direct costs in issuance of the options similarly any income to be realized by the banks on exercise of the options in subsequent years we regard as in the nature not of oid but of capital appreciation in an equity_investment petitioner makes numerous arguments as to why it should be allowed oid deductions beginning either in the year the options were issued or in the year the options were exercised as we have explained the evidence does not establish that any oid was incurred in the year of issuance with regard to the taxable_year in which the options were exercised petitioner argues that it should be allowed a deduction of dollar_figure9 million as either oid as loan fees or as compensation paid under sec_83 we disagree the existence of oid is determined as of the date_of_issue of the investment_unit sec_1273 sec_1273 sec_1275 in support of the argument that it should be entitled to a dollar_figure9 million deduction for as loan fees with regard to the dollar_figure million loan petitioner relies on cases where options were issued as trade discounts in connection with long-term sales contracts see computervision intl v commissioner tcmemo_1996_131 convergent techs inc v commissioner tcmemo_1995_320 sun microsystems inc v commissioner tcmemo_1993_467 petitioner's reliance on these cases is misplaced the options in the instant case were not issued as trade discounts but as part of a lending transaction further the cases cited do not involve loan fees or loan charges no credible_evidence supports petitioner's claimed deduction for loan fees further under sec_83 only upon exercise of stock_options received for services rendered may a corporation claim deductions for compensation paid the options at issue herein were not issued to fnbb in connection with services rendered the evidence does not support for any of the years in issue petitioner’s claim to a deduction of dollar_figure9 million for oid loan fees or compensation paid under sec_83 relating to the dollar_figure million loan we reject petitioner’s arguments on this issue for each of the years in issue and for each adjustment reflected in respondent’s notice_of_deficiency respondent determined an accuracy-related_penalty under sec_6662 against petitioner for substantial understatements of tax with regard to the disallowance for of the claimed dollar_figure in acquisition-related expenditures that we sustain herein petitioner has not demonstrated that it had substantial_authority to support this claimed deduction and we sustain imposition of this penalty to reflect the foregoing decision will be entered under rule


internal_revenue_service department of the treasury number release date index number washington dc person to contact telephone number refer reply to cc ita plr-111617-01 date date legend counsel counsel counsel counsel cpa m n taxpayer tpb w corp x corp y corp date date date month month month month month month b c d e f g h i j k l dollar_figure dollar_figure dollar_figure plr-111617-01 m dear this is in response to a request_for_ruling submitted on your behalf concerning the application of sec_453 of the internal_revenue_code with respect to the sale of stock of y corp described herein as of the beginning of month taxpayer and tpb owned m percent of the stock of x corp taxpayer was interested in selling some or all of the x corp stock as he desired to diversify his investment and retire from the operation of the business carried on by x corp on date following extensive due diligence and discussions with the management of x corp w corp announced that it had terminated an option to purchase x corp during the month following the termination of negotiations between w corp and x corp m who had worked for x corp for several years and n who had worked for an entity which had previously considered acquiring x corp approached taxpayer with a proposal for the sale of x corp under the proposed terms the stock of x corp would be transferred to y corp a public shell corporation listed on nasdaq national association of securities dealers automated quotations in exchange for stock of y corp prior to the stock exchange taxpayer would grant m and n options to purchase b and c shares respectively of the stock of the company the acquisition agreement refers to x corp and y corp collectively as the company tpb was to grant m and n options to purchase d and e shares respectively of the company the options which would allow m and n to purchase shares of the company at a price of dollar_figuref per share would have a two year term and would only be exercisable for cash on date taxpayer and tpb executed acquisition agreements which granted m and n each the right to purchase the specified number of shares of stock of the company on date the stock of x corp was transferred to y corp in exchange for a specified number of shares of y corp stock in a transaction which was represented to have qualified as a non-taxable reorganization the name of y corp was subsequently changed to that previously used by x corp all of the y corp stock which taxpayer received in exchange for his x corp stock was unregistered taxpayer had no demand or piggyback rights to either require y corp to register the shares he held or to include those shares in a registration of y corp stock which was to be publicly offered taxpayer also granted y corp the right to request that he withhold the sale of any of his y corp stock during a period beginning seven days prior to y corp’s filing of a final prospectus and ending days after such date y corp filed a final prospectus during month prior to month m and n each acquired some shares of y corp under the terms of the options a short time before the expiration of the options in month m and n plr-111617-01 advised taxpayer that they had been unable to obtain financing to acquire the remaining shares subject_to the options the options required cash settlement m and n did obtain sufficient financing to exercise the options tpb had granted them at the time y corp stock was trading at a price more than double the exercise price of the options m and n asked taxpayer to waive the option requirement for cash settlement and accept their promissory notes in payment for the stock subject_to the options they suggested that as members of the management of y corp their failure to exercise the options would be interpreted as a vote of no confidence by management that would adversely affect the market price of y corp’s publicly traded stock before agreeing to accept notes from m and n taxpayer had counsel review the proposed notes counsel advised taxpayer that his sale of y corp stock could be reported on the installment_method however approximately two weeks before the sale of the stock counsel reversed his position with respect to the availability of the installment_method the reversal was attributed to research by the cpa and discussions between the cpa and counsel these advisers believed taxpayer could not report the sale on the installment_method because the y corp stock was unregistered stock of a publicly traded corporation and the m and n notes were payable on demand of taxpayer taxpayer accepted m and n’s notes in payment for the y corp stock the notes provided fore interest at the rate of j percent per year the initial principal and interest payment on the notes was due during month four months after the date of sale and in the subsequent year the remaining principal and interest was due on the first anniversary of the initial payment or upon the holder’s written demand whichever occurred first as collateral for the notes taxpayer required m and n to escrow a number of y corp shares with a market_value which approximated the aggregate face_amount of their notes y corp stock traded in a range between dollar_figureh and dollar_figurei during the two month period beginning with the month preceding the month in which the sale of stock occurred based on the market price of y corp stock relative to the exercise price of the options the number of shares required as collateral was approximately one-third the number of shares m and n acquired upon exercise of the options after the sale of the y corp stock but before preparing taxpayer’s return for the year_of_sale the cpa discovered that the internal_revenue_service had issued a number of private letter rulings which approved the use of the installment_method to report the sale of unregistered stock of publicly traded corporations upon learning of those private letter rulings the cpa performed additional research concerning the characterization of the notes as demand notes but was unable to find sufficient authority to cause him to change his opinion that the demand feature of the notes precluded the use of the installment_method in accordance with the advice of the cpa and counsel taxpayer included the face_amount of the notes received from m and n in determining the gain from the sale of y corp stock reported on the joint federal_income_tax return filed by taxpayer for the plr-111617-01 year_of_sale m and n made timely payment of the first scheduled payment on their respective notes at the time of those payments the market price of y corp stock had declined from the level it was at when they exercised the options to purchase y corp stock the market price was still a multiple of the per share cost of the stock m and n acquired by exercising the options however the decline in the market price of y corp stock caused taxpayer to be concerned that the collateral for m and n’s notes might be inadequate he retained counsel to consider whether applicable securities laws would restrict or preclude sale of the y corp stock provided as collateral for m and n’s notes if a demand for immediate payment of the balance of the notes were not satisfied counsel advised taxpayer to resign as chairman of y corp to end his affiliate status under cfr in addition to securities law considerations taxpayer was concerned that an attempt to sell the collateral might further depress the market price of y corp stock taxpayer taxpayer’s counsel at the time and the cpa initiated negotiations with m and n in an attempt to secure additional collateral for the notes on a number of occasions subsequent to the first payment on the notes in month m and n verbally agreed to provide additional y corp shares as collateral but failed to deliver the shares they also represented that sale of y corp was imminent a few months before the second payment was due taxpayer sent m and n letters outlining conditions for further negotiations the conditions were ultimately rejected m and n subsequently failed to pay the balance on their respective notes when due in month after the default on the notes taxpayer sought legal advice from an attorney who practices in the area of creditors rights in another office of counsel taxpayer the cpa and the attorney negotiated with m and n in an attempt to obtain additional shares of y corp stock as additional collateral for their debt after negotiations proved unsuccessful the attorney drafted a demand notice which taxpayer sent to m and n during month shortly thereafter taxpayer concluded that he would be forced to file suit and retained counsel for that purpose at the same time materials were also sent to counsel for review and advice during discussion of the history of m and n’s notes with counsel counsel was asked to prepare an opinion concerning the demand feature of the notes and the characterization of the notes as demand notes the opinion indicated that under applicable state law neither of the notes of m nor n was due in whole or in part whether payment was demanded or not prior to the date of the first scheduled payment four months after the execution of the notes in a subsequent review of the notes counsel concurred in counsel 3's analysis of the notes under applicable state law if the y corp shares sold by taxpayer were not treated as stock traded on an established_securities_market and m and n’s notes were not demand notes taxpayer’s plr-111617-01 sale of y corp would have qualified for reporting under the installment_method based on that information taxpayer initiated action to modify the manner in which he reported the sale of stock on the form_1040 filed by the taxpayer for the year_of_sale sec_453 of the code provides that income from an installment_sale shall be taken into account under the installment_method sec_453 provides in part that for purposes of that section the term installment_method means a method under which the income recognized for any taxable_year from a disposition is that proportion of the payments received in that year which the gross_profit realized or to be realized when payment is completed bears to the total_contract_price sec_453 provides in part that receipt of a bond or other evidence_of_indebtedness which is payable on demand shall be treated as receipt of payment sec_15a_453-1 of the income_tax regulations provides in part that a bond or other evidence_of_indebtedness issued by any person and payable on demand shall be treated as a payment in the year received not as an installment_obligation payable in future years sec_15a_453-1 provides that an obligation shall be treated as payable on demand only if the obligation is treated as payable on demand under applicable state or local law sec_453 provides in part that sec_453 shall not apply in the case of any installment_obligation arising out of a sale of stock_or_securities which are traded on an established_securities_market and all payments_to_be_received shall be treated as received in the year of disposition sec_453 of the code provides that sec_453 shall not apply to any sale if the taxpayer elects not to have sec_453 apply to the sale sec_453 provides that an election made with respect to any disposition may be revoked only with the consent of the secretary sec_15a_453-1 of the income_tax regulations provides that generally an election out of sec_453 is irrevocable an election may be revoked only with the consent of the internal_revenue_service a revocation is retroactive a revocation will not be permitted when one of its purposes is the avoidance of federal income taxes or when the taxable_year in which any payment was received has closed a taxpayer will not be permitted to revoke an election out of the installment_method merely because the benefit of hindsight indicates that a revocation of an election would be beneficial hindsight includes those situations where the taxpayer's desire to revoke an election out is prompted by changed plr-111617-01 circumstances subsequent events or occurrences beyond the taxpayer’s control however there are situations in which the service will allow a taxpayer to revoke its election out of the installment_method in those situations the facts reflect that the taxpayer originally intended to report the disposition on the installment_method the taxpayer's request to use the installment_method was frustrated by inadvertent errors of third persons the taxpayer acted diligently in requesting a revocation and the requested revocation did not prejudice the interest of the government before addressing the request for approval for revocation of the election out of the installment_method it is necessary to decide whether sec_453 or sec_453 precluded the use of the installment_method with respect to taxpayer’s sale of the y corp stock sold to m and n if the use of the installment_method was precluded the request to revoke an election out of the installment_method would be moot congress enacted the installment_method to provide relief for taxpayers who were required to pay tax on the entire gain in the year they sold property on an installment basis although they may have received only a small portion of the sales_price during such year s rep no 69th cong 1st sess see also 333_us_496 at the time the installment_sales_revision_act_of_1980 was enacted the senate_finance_committee indicated that the installment_method is intended to permit the spreading of income_tax on the sale of property over the period during which payments of the sales_price are received the installment_method alleviates possible liquidity problems which might arise from the bunching of gain in the year_of_sale when a portion of the selling_price has not actually been received s rep no 96th cong 1st sess when congress added sec_453 in it indicated that the installment_method should not be available for sales of publicly traded property because such property is considered to be sufficiently liquid to be treated the same as a payment for cash for purposes of applying the installment_method publicly traded property does not present the same liquidity problem the installment_method is intended to alleviate since a taxpayer can easily sell such property for cash in the public market s rep no 99th cong 2nd sess although the y corp stock in this case generally was publicly traded on an established_securities_market the y corp stock held by taxpayer was unregistered and thus was restricted from sale to the public under federal securities laws in enacting sec_453 congress determined that the installment_method should not be available to a taxpayer who accepts an installment note for the sale of publicly traded property such property can easily be sold for cash in a public market and does plr-111617-01 not present the liquidity problem the installment_method was intended to mitigate in effect congress felt that the installment_method was not warranted for a taxpayer who has the option of selling property in a public market for cash in this case however taxpayer is precluded from selling the y corp stock in a public market and cannot pick and choose between selling the stock for cash or notes under these circumstances application of sec_453 would not be appropriate and taxpayer’s use of the installment_method would not be precluded on this basis with respect to whether the m and n notes were payable on demand taxpayer has provided two opinions of counsel concluding that taxpayer’s demand privilege did not extend to the initial payments due under the notes and thus under applicable state law the notes were not payable on demand in the year_of_sale consequently taxpayer’s receipt of the notes in the year_of_sale of the y corp stock will not be treated as the receipt of payment in that year for purposes of sec_453 accordingly taxpayer is not precluded from using the installment_method for this reason either the inclusion of the face_amount of the notes in determining the amount of the gain reported on the joint_return filed by taxpayer was based on advice received from the cpa and counsel it has been represented that taxpayer received no tax_benefit eg offset of capital_loss deduction of investment_interest by electing to treat a portion of the gain on the y corp stock as investment_income etc as a result of reporting the entire gain on the y corp stock sold to m and n on the federal_income_tax return filed for the year_of_sale it has been represented that taxpayer initially intended to report the sale of stock on the installment_method and never abandoned that intent between the date of the sale and the date of the submission this request_for_ruling in the circumstances described taxpayer is granted permission to revoke the election out of the installment_method for the sale of y corp stock to m and n this ruling is conditioned upon taxpayer filing amended federal_income_tax returns for any taxable_year impacted by this ruling the ruling is further conditioned upon taxpayer’s determination and satisfaction of the liability if any for sec_453a interest with respect to tax that is deferred through the use of the installment_method to report taxpayer’s sale of y corp stock to m and n this ruling is subject_to the following caveats no portion of the difference between the exercise price of the options granted m and n to purchase y corp stock and the value of such stock at the time was attributable to services or property which m or n provided to taxpayer tpb or x corp or which they agreed to provide to taxpayer tpb or y corp in the future the exchange of y corp stock for x corp stock complied with all applicable securities laws taxpayer’s sale s of y corp stock complied with all applicable securities plr-111617-01 laws taxpayer did not pledge the notes received from m and n or use the notes as security or collateral for any borrowing except as specifically ruled above no opinion is expressed as to the federal tax treatment of any transaction described herein under any provisions of the code and the income_tax regulations this ruling is directed only to the taxpayers who requested it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file in this office a copy of this letter is being sent to your authorized representative sincerely yours christopher f kane chief cc ita assistant chief_counsel income_tax and accounting enclosure copy of letter cc


internal_revenue_service number release date index number ------------------------ ------------------- --------------------------------- ------------------- ------------------------------- - department of the treasury washington dc third party communication none date of communication not applicable_person to contact ------------------------- id no ------------ telephone number -------------------- refer reply to cc ita b05 plr-112953-05 date date legend taxpayer --------------------------- ---------------------- ------------------- ------------------ -------------------------- date date date dear ------------ this letter_ruling is in reference to a form_1128 application to adopt change or retain a tax_year submitted on behalf of taxpayer taxpayer is requesting permission to change its accounting_period for federal_income_tax purposes from a taxable_year ending date to a taxable_year ending date effective date taxpayer has requested that the form_1128 be considered timely filed under the authority contained in sec_301_9100-3 of the procedure and administrative regulations sec_301_9100-3 provides that requests for extensions of time for regulatory elections that do not meet the requirements of sec_301_9100-2 automatic extensions such as in the instant case must be made under the rules of sec_301_9100-3 requests for relief subject_to sec_301_9100-3 will be granted when the taxpayer provides evidence to establish that the taxpayer acted reasonably and in good_faith and that the granting of relief will not prejudice the interest of the government sec_301_9100-3 provides that the interest of the government are deemed to be prejudiced except in unusual and compelling circumstances if an election is an accounting_period regulation election other than the election to use the required taxable plr-112953-05 year under sec_444 and the request for relief is filed more than days after the due_date for filing the form_1128 based on the facts and information submitted and the representations made we conclude that taxpayer has acted reasonably and in good_faith we further conclude that taxpayer has shown unusual and compelling circumstances and that the granting of relief will not prejudice the interests of the government accordingly the requirements of the regulations for the granting of relief have been satisfied and taxpayer’s late filed form_1128 requesting permission to change from a tax_year ending on date to one ending on date effective date is considered timely filed the ruling contained in this letter is based upon the facts and representations submitted by taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party this office has not verified any of the material submitted in support of the request for a ruling verification of the factual information representations and other data may be required as part of an examination process this ruling addresses the granting of sec_301_9100-3 relief only no opinion is expressed or implied regarding the tax treatment of the instant transaction under the provisions of any other section of the code or regulations that may be applicable thereto or regarding the tax treatment of any conditions existing at the time of or effects resulting from the instant transaction specifically no opinion is expressed or implied as to whether taxpayer is permitted under the code and applicable regulations to change to the tax_year requested in the subject form_1128 this ruling is directed only to the taxpayer that requested it sec_6110 provides that it may not be used or cited as precedent enclosed is a copy of the letter_ruling showing the deletions proposed to be made in the letter when it is disclosed under sec_6110 in accordance with the provisions of a power_of_attorney currently on filed we are sending a copy of this letter to the taxpayer’s authorized representative enclosures sincerely yours william a jackson branch chief branch office of associate chief_counsel income_tax accounting copy of this letter copy for sec_6110 purposes cc


t c memo united_states tax_court herbert j meeks and paula j meeks petitioners v commissioner of internal revenue respondent docket nos filed date edward t perry for petitioners christian a speck and bryan e sladek for respondent memorandum findings_of_fact and opinion vasquez judge in these consolidated cases respondent determined deficiencies in petitioners' federal_income_tax in the amounts of dollar_figure dollar_figure and dollar_figure for and respectively all section references are to the internal_revenue_code in effect for the years in issue and all rules references are to the tax_court rules_of_practice and procedure after concessions the issues for decision are whether education expenses that herbert j meeks herbert incurred are deductible as trade_or_business_expenses whether certain job-seeking and tax_return preparation expenses are deductible whether expenditures that paula j meeks paula incurred are deductible as trade_or_business_expenses whether petitioners' boat chartering activity was an activity engaged in for profit and whether petitioners substantiated charitable_contributions in amounts greater than respondent concedes findings_of_fact 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 petitioners husband and wife resided in sacramento california at the time they filed the petitions in this case educational expenses from date until sometime in herbert was a correctional officer with the state of california department of respondent concedes that petitioners may deduct dollar_figure of expenses from their boat chartering activity in pursuant to sec_183 corrections he was originally assigned as an inmate supervisor and later to a transportation team where his responsibilities included supervising and observing inmate behavior evaluating inmate conduct and writing activity reports in herbert entered the organizational behavior program the program at the university of san francisco in sacramento california the goal of the program was to train a student to be an effective human resource specialist in the workplace herbert did not complete the program to obtain a degree in and petitioners deducted educational expenses of dollar_figure and dollar_figure for herbert's tuition and books purchased for the courses at the university of san francisco after completing the courses herbert received a temporary assignment at the richard a mcgee correctional training facility for the state of california the academy after this assignment the academy interviewed herbert for a position as an instructor the position of instructor required years of college education in june of herbert was promoted to sergeant instructor at the academy job-seeking and tax_return preparation expenses in petitioners took a deduction of dollar_figure for tax preparation expenses in petitioners also claimed while enrolled in the program herbert completed the following courses introduction to organizational behavior research in organizations organizational communication small_group leadership social ethics interdisciplinary writing and critical thinking the courses deductions for miscellaneous expenses_incurred in job seeking and for tax_return preparation in the amounts of dollar_figure and dollar_figure respectively trade_or_business_expenses during the years in issue paula was employed full time as a dance and physical education teacher at florin high school in sacramento california she taught beginning jazz classes and gave instruction on technique and execution for the drill team additionally she developed masterpiece dance theater a touring company with dance performances by students petitioners deducted tickets to dance concerts clothing shoes and other miscellaneous items related to paula's employment at the school as miscellaneous_itemized_deductions on their and federal_income_tax returns chartering activity in and petitioners owned two boats a foot wooden chris craft river cruiser and a 24-foot cuddy cabin the boats petitioners have owned other boats for recreation in the past petitioners publicized that the boats were available for 12-hour chartered boating and fishing trips on the sacramento river and lake comanche california petitioners called their charter business it take sec_2 and charged dollar_figure to charter a boat petitioners provided fishing gear bait and safety vests for their customers before engaging in the chartering activity petitioners did not set up a business plan additionally petitioners did not analyze the possibility of making a profit petitioners tried but were unable to obtain insurance which covered commercial use of the boats petitioners did not keep books_and_records of their chartering business petitioners would go out on the boats about once a week generally on weekends occasionally petitioners would use the boats for recreational purposes petitioners had four to six paying customers in and had none in and petitioners primarily promoted their chartering services primarily through announcements made at the church they attended and flyers posted at other churches barber shops and bait shops in addition petitioners distributed business cards and attached them to the flyers for and petitioners deducted dollar_figure dollar_figure and dollar_figure respectively for expenses related to their chartering activity in petitioners reported dollar_figure in income from the activity petitioners reported no income from the chartering activity in or charitable_contributions petitioners regularly attended several churches in the bay area of california including the new hope baptist church in oakland california during the years in issue petitioners made financial contributions to these churches and to other charitable organizations the new hope baptist church did not keep records of contributions before nor did the other churches maintain any tracking systems of contributions during the years at issue petitioners did not maintain records of all their contributions petitioners deducted charitable_contributions of dollar_figure and dollar_figure in and respectively respondent allowed dollar_figure and dollar_figure in and respectively after petitioners substantiated those amounts opinion all disputed items on petitioners' income_tax returns are deductions they claimed deductions are strictly a matter of legislative grace and petitioners bear the burden of proving entitlement to any deduction claimed rule a 503_us_79 education expenses sec_162 allows a deduction for all ordinary and necessary expenses_incurred in carrying_on_a_trade_or_business education expenses are considered ordinary and necessary business_expenses if the education maintains or improves skills required by the taxpayer in his employment or meets the express requirements of an employer imposed as a condition for the taxpayer's continued employment status or rate of compensation sec_1_162-5 income_tax regs education expenses however are not deductible if they are made by an individual for education which is part of a program of study being pursued by him which will lead to qualifying him in a new trade_or_business sec_1_162-5 income_tax regs this is so even if the courses meet the express requirements of the employer see 55_tc_581 it is immaterial whether the individual undertaking the education does in fact become employed in a new trade_or_business 56_tc_1357 petitioners have the burden of proving that the education does not qualify herbert for a new trade_or_business rule a petitioners contend that the courses herbert took maintained and improved his skills as a correctional officer petitioners also argue that herbert had no intention of developing another career nor did he seek to obtain a degree in organizational behavior whether the education qualifies a taxpayer for a new trade_or_business depends upon the tasks and activities which he was qualified to perform before the education and those which he is qualified to perform afterwards 52_tc_1106 affd per curiam 443_f2d_29 9th cir we have repeatedly disallowed education expenses where the education qualifies the taxpayer to perform significantly different tasks and activities 73_tc_723 62_tc_270 as a correctional officer herbert supervised inmates and handled other custodial duties the record is not clear what duties and activities were required of herbert as a sergeant instructor but the title of the position itself suggests that the primary duty would be instructing students at the academy thus we find that the duties and activities of a correctional officer and a sergeant instructor are significantly different upon completing the courses herbert met the 2-year college education requirement of the instructor position we find that these courses qualified herbert for the duties and activities of a sergeant instructor accordingly we conclude that the education qualified herbert for a new trade_or_business and sustain respondent's disallowance of the education expenses under sec_162 job-seeking and tax_return preparation expenses petitioners also claimed deductions for miscellaneous expenses_incurred in job seeking and for tax_return preparation petitioners have presented no evidence to support the claimed job-seeking expenses or the tax preparation fee we cannot be sure that petitioners intended to abandon these issues but in any case we sustain respondent's disallowance of these deductions as petitioners have not met their burden_of_proof on these matters trade_or_business_expenses as we stated earlier sec_162 allows a deduction for all ordinary and necessary expenses_incurred during the taxable_year in carrying_on_a_trade_or_business an employee's trade_or_business is earning his compensation and generally only those expenses that are related to the continuation of his employment are deductible 269_f2d_108 4th cir affg tcmemo_1958_60 pursuant to sec_162 if expenditures qualify as ordinary and necessary an employee may deduct unreimbursed employee_expenses an employee may not deduct such expenses however if the expenses are not substantiated or if the employee has a right to but fails to seek reimbursement from the employer 56_tc_936 affd without published opinion 456_f2d_1335 2d cir paula testified that her employer would have reimbursed her for the garment shields for school costumes had she sought a reimbursement we therefore sustain respondent's determination with respect to this deduction petitioners claimed deductions for concert tickets which paula attended with her husband or students for expenses to be deductible under sec_162 petitioners must show that the purpose of the expenditure was primarily business rather than personal and that paula's business benefited or was intended to benefit by the expenditure 74_tc_1266 16_tc_401 paula claims that she attended concerts to learn about the changes in jazz dance for her business as a dance instructor we conclude that petitioners have failed to demonstrate that the purpose of the concerts was primarily business rather than personal therefore we sustain respondent's determination with respect to this deduction petitioners claimed deductions for items such as musical records magazine subscriptions and office supplies the musical records enabled paula to conduct dance instruction in her business we find the expenses for jazz dance records to be ordinary and necessary to paula's business as a dance instructor although petitioners claim a business_purpose for the magazine subscriptions the types of magazines are so inherently_personal that we conclude they are not business_expenses under sec_162 paula testified that the office supplies were necessary for school petitioners however did not introduce evidence that showed that the expenses relating to the office supplies would not be reimbursed by paula's employer therefore we hold that petitioners are entitled to deduct the cost of the musical records and sustain respondent's disallowance of expenses relating to the magazine subscriptions and office supplies petitioners also claimed deductions for clothing expenses for the cost of clothing and maintaining such clothing to be deductible as an ordinary and necessary business_expense it must be required or essential in the taxpayer's employment not be suitable for general or personal wear and not be so worn 30_tc_757 petitioners claimed deductions for magazine subscriptions to highlights a children's magazine and essence and ebony magazines of style and entertainment the clothing items petitioners claimed as business_expenses include hosiery exercise wear warmup suits denim clothing athletic shoes and jazz shoes at trial paula testified that these items were necessary to teach aerobics and jazz dance she also testified that she does not wear the clothing around the house the fact that paula chose not to wear the clothing when she was away from the school does not establish that such clothing is not suitable for her private and personal wear see hynes v commissioner supra pincite it is relatively common for people to wear warmup clothes exercise wear and athletic shoes of the type purchased by petitioners while engaged in a wide variety of casual or athletic activities we however find that the jazz shoes are not suitable for general or personal wear and hold that petitioners may deduct the cost of this item as a business_expense petitioners presented no evidence that the other clothing purchased for paula's business was not adaptable for wear outside the workplace therefore we conclude that all items of clothing at issue except the jazz shoes are suitable for general or personal wear and hold that petitioners are not entitled to deduct the costs of those items chartering activity sec_183 provides generally that if an activity is not engaged in for profit no deduction attributable to the activity shall be allowed except as provided in sec_183 sec_183 defines an activity_not_engaged_in_for_profit as any activity other than one with respect to which deductions are allowable for the taxable_year under sec_162 or under paragraph or of sec_212 for a deduction to be allowed under sec_162 or sec_212 or the taxpayers must establish that they engaged in the activity with an actual and honest objective of making an economic profit independent of tax savings 91_tc_686 affd 893_f2d_656 4th cir 78_tc_642 affd without opinion 702_f2d_1205 d c cir their expectation of profit need not have been reasonable however they must have entered into the activity or continued with it with the objective of making a profit 91_tc_371 sec_1_183-2 income_tax regs whether the requisite profit objective exists is determined by looking at all the surrounding facts and circumstances 94_tc_41 sec_1_183-2 income_tax regs greater weight is given to objective facts than to a taxpayer's mere statement of intent 84_tc_1244 affd 792_f2d_1256 4th sec_183 allows deductions in situations not applicable to the instant cases cir sec_1_183-2 income_tax regs petitioners have the burden of proving that they engaged in the chartering activity with the intent to make a profit rule a sec_1_183-2 income_tax regs provides a list of factors to be considered in the evaluation of a taxpayer's profit objective the manner in which the taxpayer carries on the activity the expertise of the taxpayer or his advisors the time and effort expended by the taxpayer in carrying on the activity the expectation that assets used in 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 from the activity the financial status of the taxpayer and elements of personal pleasure or recreation the number of factors for or against the taxpayer is not necessarily determinative but rather all facts and circumstances must be taken into account and more weight may be given to some factors than to others cf 70_tc_715 affd 615_f2d_578 2d cir during the years at issue petitioners did not conduct the chartering activity in a businesslike manner petitioners failed to maintain any books_and_records herbert testified that they did not retain receipts from customers petitioners also indicated that they had no business plan for the activity although they attempted to obtain insurance for commercial use of their boat they never did herbert did not check with local authorities regarding the requirements for operating a passenger- carrying vessel on a public river in addition he did not investigate whether a business license was required for the chartering activity we are not convinced that petitioners operated their chartering service in a businesslike manner careful investigation of a potential business to ensure the chance for profitability strongly indicates an objective to engage in the activity for profit sec_1_183-2 income_tax regs while a formal market study is not required a basic investigation of the factors that would affect profit generally is necessary harrison v commissioner tcmemo_1996_509 herbert testified that he did not consult with any professionals about the profitability of the chartering activity before entering into the activity he did not analyze operating costs to determine whether the chartering business would be profitable this indicates that the chartering service was not engaged in for profit a record of substantial losses over several years may be indicative of the absence of a profit_motive 72_tc_411 affd without published opinion 647_f2d_170 9th cir petitioners never generated a profit for the chartering activity during the years at issue additionally was the only year in which petitioners received any revenue from the chartering activity furthermore there are elements of personal pleasure present in petitioners' chartering activity petitioners testified that they would occasionally use the boats for recreational purposes petitioners had also been involved in recreational boating prior to claiming the activity was a business this indicates a lack of profit objective sec_1_183-2 income_tax regs we are not persuaded that the remote and speculative possibility of profit was petitioners' objective for commencing their chartering activity after reviewing all the facts and circumstances we conclude that petitioners did not engage in the chartering activity for profit within the meaning of sec_183 we therefore sustain respondent's determination on this issue charitable_contributions under sec_170 contributions of money to or for_the_use_of a religious_organization are generally deductible henson v commissioner tcmemo_1979_110 a taxpayer however must substantiate his contributions id sec_1_170a-13 income_tax regs if the record provides sufficient evidence that petitioners made charitable_contributions but they are unable to prove the exact amount we can estimate the amount of the contributions 39_f2d_540 2d cir in order for the court to make an estimate we must have some basis in fact upon which an estimate can be made 85_tc_731 without such a basis any allowance would amount to unguided largesse 245_f2d_559 5th cir the burden is on petitioners to prove their entitlement to the claimed deductions rule a in this case petitioners credibly testified and we find that they did make cash contributions to the churches they attended however we are cautioned to bear heavily against taxpayers whose inexactitude is of their own making cohan v commissioner supra pincite accordingly we hold that petitioners are entitled to deduct dollar_figure and dollar_figure of their claimed charitable_contributions for and respectively in excess of the amounts allowed by respondent to reflect the foregoing and concessions of the parties decisions will be entered under rule