t c memo united_states tax_court richard steinberger and c maria riva petitioners v commissioner of internal revenue respondent docket no filed date james s macbeth for petitioners william f castor for respondent memorandum findings_of_fact and opinion paris judge respondent determined deficiencies of dollar_figure dollar_figure and dollar_figure in and accuracy-related_penalties of dollar_figure dollar_figure and dollar_figure in relation to petitioners’ and federal_income_tax respectively the issues for decision are whether petitioners’ elections to group certain activities with their airplane activity as a single activity for section purposes were valid elections for the years in issue the airplane activity on its own was entered into for profit for and and petitioners are liable for accuracy-related_penalties for the years in issue findings_of_fact some of the facts have been stipulated and are so found the stipulated facts and facts drawn from stipulated exhibits are incorporated herein by this reference petitioners resided in kansas when they timely filed their petition i petitioners’ medical activities dr steinberger has practiced medicine since specializing in urology he practiced as an employee and shareholder of wichita urology group p a wug from its formation in and continued to do so during the years in the federal_income_tax returns of air urology investments llc aui the entity that operated the airplane and was taxed as a partnership were not examined for the years in issue respondent disallowed the flow through losses petitioners reported on the schedules e supplemental income and loss attached to their form sec_1040 u s individual_income_tax_return for the years in issue because he determined that the airplane activity was not entered into for profit when discussing the airplane activity infra the court will refer to the activity as either aui’s or petitioners’ airplane activity unless otherwise indicated all section references are to the internal_revenue_code_of_1986 as amended and in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure respondent also made adjustments to petitioners’ alternative_minimum_tax and their minimum_tax_credit those adjustments are computational and will not be discussed further issue he and six other doctors each owned an equal one-seventh interest in wug during the years in issue at no time from its formation until the time of trial did dr steinberger serve as wug’s president his wife dr riva specialized in pediatric pulmonology as an employee of the university of kansas school of medicine during the years in issue wug after deducting certain common or shared expenses such as utilities office overhead and rent from its gross_receipts allocated its net receipts to its shareholders in two shares--a pro_rata share and a production share wug allocated one-third of its net receipts equally to its shareholders as the pro_rata share it allocated the remaining two-thirds of its net receipts to its shareholders on the basis of their respective percentages of production--receipts from services provided by an individual shareholder divided by the total receipts from services provided by all shareholders--as the production share each shareholder’s gross pay comprised his or her pro_rata and production shares wug then deducted certain individual or personal expenses--such as malpractice insurance premiums retirement_plan contributions and travel expenses--from each shareholder’s gross pay dr riva did not participate in and was not present at the proceedings she and dr steinberger filed joint federal_income_tax returns for the years in issue and she will be bound by the court’s decision all of the income wug allocated to dr steinberger for the years in issue was reported on forms w-2 wage and tax statement for the years in issue dr steinberger also held ownership interests in kansas surgery recovery lp an outpatient surgery center via christie cyberknife llc a radiosurgery center and south kansas lithotripsy ii petitioners’ farming activity petitioners also equally owned pegasus meadows llc which was organized in in they used personal funds to purchase farmland in iowa which was held by pegasus meadows petitioners contracted with farmers national co to supply a local farm manager to oversee the day-to-day operations of the farm iii petitioners’ airplane activity for as long as dr steinberger has been licensed to practice medicine he has also been a licensed pilot and was so in the years in issue in petitioners sought advice from advocate aircraft taxation co advocate about the purchase and operation of an airplane dr steinberger sought advocate’s services south kansas lithotripsy is identified as both an llc and an llp in the stipulation of facts sometime in advocate aircraft taxation co became advocate legal consulting group advocate will be used to refer to both entities after doing internet research and upon advice from the airplane dealer from whom a cirrus sr airplane airplane was purchased in date in furtherance of that goal advocate formed two limited_liability companies--air urology llc au and aui aui was taxed as a partnership dr steinberger had a membership interest and dr riva a membership interest in aui au was taxed as a disregarded_entity aui was the sole member of and wholly owned au in date au purchased the airplane the airplane had a single engine and four seats including crew seating after au purchased the airplane dr steinberger began flying it for both personal and work-related travel he was the only person who flew the airplane during the years in issue a airplane lease sec_1 lease between au and dr steinberger personally au as owner and dr steinberger as operator entered into an aircraft rental agreement some time in the pertinent provisions of the agreement are explained infra the agreement states that dr steinberger’s purpose for renting the airplane is transporting operator or its guests on a noncommercial basis the agreement the blanks to fill in the dates on the first page of the agreement are empty and is typeset on the agreement the document is not otherwise dated is an hourly rental agreement of dollar_figure per flight hour less direct_cost for any fuel purchased the rental period consists of flight time during the term of the agreement the owner will bear all maintenance and fuel costs during each rental period and keep the airplane insured under the agreement the operator assumes and shall bear the entire risk of loss theft confiscation damage to or destruction of the aircraft from any cause whatsoever dr steinberger signed the agreement as the chairman of au and for himself personally lease between au and aui au as owner and aui as operator entered into a more detailed aircraft hourly rental agreement in the pertinent provisions of the agreement are explained infra the agreement states that aui’s purpose for renting the airplane is transporting operator or its members directors officers employees and guests in furtherance of its primary non-transportation business and its employee_benefits the agreement is an hourly rental agreement for dollar_figure per flight hour with an initial rental payment of dollar_figure due on date under the agreement the similar to dr steinberger’s personal aircraft rental agreement the blanks to fill in the dates on the first page of the agreement are empty and is typeset on the agreement the delivery and acceptance certificate attached to the agreement is dated operator is responsible at its own cost and expense for the airplane’s maintenance the operator also assumes and shall bear the entire risk of loss theft confiscation damage to or destruction of the aircraft from any cause whatsoever the operator will also insure the airplane and pay to or indemnify the owner for all franchise gross_receipts rental sales use excise personal_property ad valorem value added leasing leasing use stamp landing airport use or other taxes levies imposts duties charges fees or withholdings of any nature the agreement includes an indemnification clause whereby the operator indemnifies the owner from and against any and all losses claims suits demands costs and expenses of every nature arising directly or indirectly from or in connection with the possession maintenance condition storage use operation or return operation of the aircraft dr steinberger signed the agreement as both au’s and aui’s chairman lease between au and wug au as owner and wug as operator entered into an aircraft hourly rental agreement in date the pertinent provisions of the agreement are explained infra the agreement states that wug’s purpose for renting the airplane is transporting operator or its members directors officers employees and guests in furtherance of its primary non-transportation business use the agreement is an hourly rental agreement for dollar_figure per flight hour with a stipulated loss value of dollar_figure the agreement requires that either dr steinberger or another duly licensed pilot agreed upon by the parties shall operate the airplane under the agreement the owner is responsible for maintaining and insuring the airplane the operator assumes and shall bear the entire risk of loss theft confiscation damage to or destruction of the aircraft from any cause whatsoever there is no indemnification clause in the agreement but petitioners personally this agreement like the other two agreements au entered into have no dates on the first page save typeset on the agreement and no dates next to the parties’ signatures the action of directors by written consent in lieu of meeting attached to the agreement is dated date the parties stipulated that wug paid rent of dollar_figure per flight hour for the years in issue there is no evidence in the record that wug ever agreed to pay rent of more than dollar_figure per flight hour as agreed to in the aircraft hourly rental agreement entered into by au and wug signed indemnification and release forms dated date indemnifying wug and releasing all claims against it attributable to dr steinberger’s operation of the airplane the agreement is signed by dr steinberger for au and by wug’s president attached to the agreement is a wug document entitled action of directors by written consent in lieu of meeting approving the agreement and authorizing wug’s president to enter into the agreement on wug’s behalf the document is signed by five of wug’s six directors one of whom was dr steinberger b operation of the airplane dr steinberger recorded his flights for the years in issue on flight logs advocate provided him the operator listed for each flight was either aui or wug--dr steinberger personally is not listed as the operator for any of the flights for the years in issue aui is listed as the operator for all training and maintenance flights and for any personal flights dr steinberger made during the years in issue flight hours for the years in issue in dr steinberger recorded a total of flight hours aui is identified as the operator for of those flight hours which included hours of training and maintenance and wug is identified as the operator for of those hours the flight log shows that dr steinberger flew his daughter to a club meeting on date and returned with her on date aui is identified as the operator for that flight but the log’s use column for that flight is labeled pne for personal nonentertainment the flight log also shows that dr steinberger picked up his son from college and then took him back the weekend of date aui is also identified as the operator for that flight and the log’s use column for that flight is also labeled pne in dr steinberger recorded a total of flight hours aui is identified as the operator for of those flight hours which included hours of training and maintenance and wug is identified as the operator for of those flight hours two of aui’s flights in were to iowa--the first to purchase the farmland in april and the second in septemberdollar_figure the parties stipulated that aui paid rent to au for flight hours which included hours for training and maintenance and wug paid rent to au for flight hours for the flight log for entered into evidence does not support the parties’ stipulated flight hours the parties stipulated that aui paid rent to au for flight hours which included hours of training and maintenance and wug paid rent to au for flight hours for the flight log for entered into evidence does not support the parties’ stipulated flight hours the parties stipulated that dr steinberger flew to iowa to inspect the farm two to three times a year the flight logs for and do not support that continued in dr steinberger recorded a total of flight hours through date there is no flight log for november and date in the record aui is identified as the operator for of those flight hours which included hours of training and maintenance and wug is identified as the operator for of those flight hours there was only one completed flight to the farmland in iowa in see supra note dr steinberger again flew to pick his son up from and return him to college aui is identified as the operator for that flight and the log’s use column is labeled pne wug flights although based in wichita wug’s doctors traveled to cities throughout kansas to provide services to patients at rural clinics with some doctors traveling as far as dodge city and liberal kansas which are and miles and take approximately three and four hours to travel to by automobile from wichita respectively the doctors’ personal preferences dictated their modes of continued stipulation the only other flights to iowa listed in the flight logs are an date flight and an date flight that was aborted because of weather the parties stipulated that aui paid rent to au for flight hours which included hours of training and maintenance and wug paid rent to au for flight hours the flight log from january to date entered into evidence does not support the parties’ stipulated flight hours transportation during the years in issue dr steinberger was the only wug doctor who flew to rural clinics other wug doctors began flying to rural clinics after the years in issue but their flights were by in chartered aircraft provided by the rural clinic the airplane was hangared at benton airpark which is approximately miles from wug’s main office and miles from petitioners’ residence the parties stipulated that it took dr steinberger approximately five minutes to ready the airplane for flight dr steinberger began traveling to wellington kansas in and anthony kansas in wellington i sec_40 miles from petitioners’ residence in benton airpark is also known as lloyd stearman field the parties stipulated that it took dr steinberger five minutes to travel to the airpark from his residence to reach the airpark in five minutes dr steinberger would have to drive miles per hour the parties stipulated dr steinberger’s travel times to wellington and anthony using a speed of approximately miles per hour at that rate of speed he could travel only five miles in five minutes the court has chosen to disregard that stipulation as an error the parties stipulated that dr steinberger started traveling to wellington in or exhibit 52-j is a list of cities wug doctors traveled to and when they started traveling there dr steinberger is listed as having started traveling to wellington in wug was not formed until dr steinberger could not have started seeing patients in wellington in his capacity as a wug doctor until wichita and anthony i sec_83 miles from their residence it would take dr steinberger approximately minutes to drive to wellington and approximately minutes to fly there it took him approximately minutes to drive to anthony and approximately minutes to fly there the parties stipulated that dr steinberger alternated flying to wellington and anthony once a week for the years in issue he would see patients for half a day in either wellington or anthony and then return to wichita to see patients for the remainder of the day iv federal_income_tax returns petitioners filed federal_income_tax returns for themselves and aui for the years in issue and for pegasus meadows for a petitioners’ individual returns and pegasus meadows’ return petitioners reported combined income from wug and the university of kansas of dollar_figure dollar_figure and dollar_figure on form sec_1040 for and respectively they reported passive_income from kansas surgery recovery center lp south kansas lithotripsy wug building and via christie according to dr steinberger’s flight log he did not fly to anthony between february and august cyberknife llc of dollar_figure dollar_figure and dollar_figure on schedules e supplemental income and loss attached to their and returns respectively petitioners also reported passive losses from aui of dollar_figure dollar_figure and dollar_figure on the schedules e attached to their returns for and respectively additionally petitioners reported a passive loss from pegasus meadows of dollar_figure on the schedule e attached to their return plane rental of dollar_figure is reported as an other expense on pegasus meadows’ form_1065 u s return of partnership income which generated the loss petitioners reported on their schedule e there is no aircraft rental agreement in the record with pegasus meadows as a party bkd llp a wichita accounting firm prepared petitioners’ individual returns for the years in issue and pegasus meadows’ return b aui’s partnership returns petitioners filed forms for aui for the years in issue reporting the losses they reported on the schedules e attached to their individual returns for the the parties stipulated that passive_income for was dollar_figure years in issue on the form_1065 aui included dollar_figure in its gross_receipts or sales advocate prepared all of aui’s returns for the years in issue on the form_1065 leasing is identified as the principal business activity and aircraft is identified as the principal product or service attached to the form_1065 is an election to group au and aui for purposes of sec_469 passive_activity_losses and activities not engaged in for profit signed by dr steinberger on the and forms property mgmt is identified as the principal business activity and the principal product or service attached to the and forms are elections to group aui and wug for purposes an undated unsigned invoice from aui to pegasus meadows was entered into evidence as a joint exhibit purporting to show two payments from pegasus meadows to aui on date of dollar_figure and dollar_figure and one payment on date of dollar_figure totaling dollar_figure dr steinberger testified on cross-examination that he did not prepare the invoice and did not remember seeing it before he also testified that he thought the payments had come from his personal account because pegasus meadows did not have a bank account in although pegasus meadows reported the dollar_figure as plane expenses dr steinberger testified that the payments on the invoice were management fees for his overseeing the operations on the farmland there was no explanation given for why two payments made in were reported as expenses for dr steinberger’s testimony about the dollar_figure was vague disjointed self-serving and contrary to what was reported on pegasus meadows’ form_1065 and the court need not accept it see 87_tc_74 of sec_469 and sec_183 the election for is signed by dr steinberger the election for is not signed v notice_of_deficiency and petition to the tax_court respondent issued petitioners a notice_of_deficiency for the years in issue determining that the airplane activity was not engaged in for profit for any of the years in issue and that they were liable for a sec_6662 accuracy-related_penalty for each year in issue petitioners timely petitioned the court for redetermination opinion generally the commissioner’s determination_of_a_deficiency is presumed correct and the taxpayer bears the burden of proving it incorrect see rule a 290_us_111 moreover deductions are a matter of legislative grace and the taxpayer bears the burden of proving his entitlement to any deductions claimed 503_us_79 292_us_435 under certain circumstances the burden_of_proof as to factual matters may shift to the commissioner pursuant to sec_7491 petitioners did not argue for a burden shift under sec_7491 and the record does not establish that the prerequisites for a burden shift have been met therefore the burden_of_proof remains theirs i sec_183 generally the internal_revenue_code allows deductions for ordinary and necessary expenses paid_or_incurred in conducting a trade_or_business or for the production_of_income sec_162 sec_212 under sec_183 if an activity is not engaged in for profit then no deduction attributable to that activity is allowed except as provided for in subsection b to determine whether and to what extent sec_183 and the regulations thereunder apply the activity of the taxpayer must be ascertained sec_1 d income_tax regs after all the facts and circumstances are taken into consideration a taxpayer’s multiple activities may be treated as one activity if the activities are sufficiently interconnected id the most important factors to be considered are the degree of organizational and economic interrelationship of the undertakings the business_purpose served by carrying on the undertakings separately or together and the similarity of the undertakings id generally the commissioner will accept the taxpayer’s characterization of multiple activities as either a single activity or separate activities id the taxpayer’s characterization will not be accepted however when it appears that it is artificial and cannot be reasonably supported by the facts and circumstances of the case id in addition to the factors provided in the regulations the court also considers the following factors whether the activities are conducted at the same place whether the activities were part of the taxpayer’s efforts to find sources of revenue from his land whether the activities were formed separately whether one activity benefited from the other whether the taxpayer used one activity to advertise the other the degree to which the activities shared management the degree to which one caretaker oversaw the assets of both activities whether the taxpayer used the same accountant for the activities and the degree to which the activities shared books_and_records see topping v commissioner tcmemo_2007_92 slip op pincite citing mitchell v commissioner tcmemo_2006_145 slip op pincite ii whether aui’s and au’s activities were a single activity for on a statement attached to aui’s form_1065 petitioners elected to group aui and au for purposes of sec_183 for the parties stipulated au was a disregarded_entity for federal tax purposes but can still be considered a business_entity see sec_301_7701-2 proced admin regs that aui elected to combine its activities with wug’s activities for the years in issue that stipulation is contradicted by the election attached to aui’s form_1065 and signed by dr steinberger and the court does not have to accept the parties’ stipulation see 93_tc_181 stating that the court may disregard a stipulation of the parties if it is clearly contrary to facts disclosed by the record when the factors are examined petitioners’ grouping of aui and au as a single activity for should be allowed au was a disregarded_entity and aui was its only member au purchased the airplane that aui operated on a regular basis petitioners organized both entities at the same time and dr steinberger was the caretaker and only pilot of the airplane in he also managed the books_and_records for both entities petitioners’ election to group aui and au for was not artificial therefore aui’s activity and au’s activity can be grouped as a single activity for purposes of sec_183 for iii whether aui and au’s activity was engaged in for profit for now that petitioners’ activity for has been ascertained see sec_1 d income_tax regs the court must decide whether the activity was entered into for profit to decide whether a taxpayer is carrying_on_a_trade_or_business so that his expenses are deductible under sec_162 the court examines whether the taxpayer’s primary purpose and intention in engaging in the activity is to make a profit 78_tc_642 aff’d without published opinion 702_f2d_1205 d c cir the taxpayer’s expectation of profit need not be a reasonable one but merely bona_fide id sec_1_183-2 income_tax regs whether a taxpayer expects to realize a profit is a question of fact and is resolved by examining all of the facts and circumstances of the case dreicer v commissioner t c pincite sec_1_183-2 income_tax regs the court examines the facts and circumstances of the case using the relevant factors in sec_1_183-2 income_tax regs dreicer v commissioner t c pincite those factors include 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 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 no one factor is determinative id after review of all the facts and circumstances of the case it appears aui and au’s activity was not entered into for profit for and a factor-by-factor analysis of the activity for is not warranted although aircraft leasing is identified as the principal business activity on aui’s form_1065 petitioners repeatedly stated--in the stipulation of facts through testimony and on brief--that aui was not in the airplane leasing business while decrying the notion that aui was ever in the airplane leasing business petitioners argued that aui’s profit_motive was its connections with dr steinberger’s medical practice and petitioners’ real_estate investments aui’s business activity is not identified as property management until so the proposed profit_motive of combining dr steinberger’s medical practice and petitioners’ real_estate investments was not adequately disclosed for for aui was not grouped with wug for sec_183 purposes therefore wug’s activity for will not be examined to determine aui and au’s profit_motive for that year according to dr steinberger’s flight log aui’s flights for that year were training and maintenance flights dr steinberger’s personal flights and two flights for possible investments--one to attend a land auction on date and another to inspect farmland in ottawa kansas on date petitioners made no land purchases as a result of either of those flights and there is no evidence in the record that petitioners owned any investment properties in the majority of aui’s flights for were either training and maintenance flights or dr steinberger’s personal flights therefore the court finds that aui and au’s airplane activity was not engaged in for profit for therefore respondent’s determination to disallow the airplane activity’s flow-through loss that petitioners reported on the schedule e attached to their return is sustained iv whether aui’s and wug’s activities were a single activity for and petitioners argue that dr steinberger and wug had common business concerns and goals that prompted him to form aui acquire the airplane and then use it to fly to rural communities served by wug and dr steinberger they rely heavily on the cases 868_f2d_833 6th cir aff’g in part rev’g in part tcmemo_1986_569 and 98_fedclaims_596 the court will examine each of the three factors from the regulations with the corresponding additional factors separately as well as petitioners’ reliance on petitioners combined only dr steinberger’s medical activity with the airplane activity dr riva neither piloted the airplane nor flew with dr steinberger during the years in issue campbell and morton while petitioners argue that aui and wug are economically intertwined when the entire economic relationship and its consequences are examined see campbell v commissioner f 2d pincite it is but a mere string that fastens the two a degree of organizational and economic interrelationship dr steinberger and dr riva are the only members of aui with and membership interests respectively wug is a professional association with seven members each having an equal one-seventh share dr steinberger had a one-seventh share in wug but was not its president during the years in issue dr riva was not a wug shareholder during the years in issue wug was formed in and had been in existence for five years before petitioners formed aui in petitioners did not consult with wug or its president before forming aui the two entities do not share books_and_records and do not use the same accountant while dr steinberger is the caretaker of the airplane he does not have the same role for wug he is one of seven shareholders and not its president while both of the activities are based in wichita they are not conducted at the same place wug has it own office building and the airplane is hangared at benton airpark approximately miles away in campbell v commissioner f 2d pincite the u s court_of_appeals for the sixth circuit found that the two entities involved hcc and health air had a close relationship and that their relationship established a profit_motive all of the shareholders of hcc formed the partnership health air and each partner executed full recourse promissory notes for the entire balance of the airplane id pincite here dr steinberger is the only link between the two entities and wug played no part in acquiring the airplane the degree of wug and aui’s organizational and economic interrelationship is not strong enough to support a finding that the two are a single activity under sec_1_183-1 income_tax regs b business_purpose of conducting activities separately or together petitioners argue that wug and aui had the shared business_purpose of serving wug’s patients in rural kansas communities another wug doctor and shareholder testified that dr steinberger started wug’s expansion of practice in rural areas while that may be true dr steinberger’s first foray into expanding wug’s practice was to start seeing patients in wellington kansas in wellington is approximately miles from wichita and dr steinberger drove there dr steinberger added trips to anthony kansas in after aui purchased the airplane anthony is approximately miles from wichita and dr steinberger both flew and if weather did not permit drove there during the years in issue only one other wug doctor saw patients outside wichita he drove to el dorado kansas approximately miles from wichita to see patients there while more wug doctors began seeing patients in communities other than wichita in the years following the years in issue it is important to note that the majority of them drove to their destinations including one who drove to liberal kansas which is approximately miles from wichita dr steinberger bore all of the expenses for wug flights wug deducted the rent aui charged wug through their hourly aircraft rental agreement from dr steinberger’s gross wages as a personal travel expense--just as the travel_expenses for wug doctors who drove to see patients in other communities were deducted from their wages ultimately dr steinberger personally was financially responsible for wug’s rental expenses for the airplane dr steinberger did not advertise the use of the airplane for wug business indeed he was the only wug doctor who used the airplane to travel to other communities to see patients and the airplane was not leased to any other third parties additionally dr steinberger did not use the airplane to deliver medical supplies or equipment to rural clinics on behalf of wug wug did not benefit from dr steinberger’s use of the airplane because he could have just as easily driven to wellington and anthony in 222_f3d_830 10th cir aff’g in part rev’g in part tcmemo_1997_54 the u s court_of_appeals for the tenth circuit reversed in part this court’s holding that the taxpayer’s expenses associated with the use of a lear jet were unreasonable under sec_162 id pincite the court_of_appeals put significant weight on the time savings the taxpayers enjoyed by use of the lear jet over commercial air travel id pincite there on the basis of a factual finding of hours of travel time saved with each flight on the lear jet the court found that the taxpayers saved hours of travel time over the trips they made to their oregon timber farm id pincite here dr steinberger chose to fly to wellington and anthony approximately and miles from wichita respectively it was not required for him to do so indeed there was testimony that it was a doctor’s personal choice whether he drove or flew to see patients outside wichita it took dr steinberger approximately to minutes to drive to wellington and approximately to minutes to drive to anthony it took him approximately to minutes to fly to wellington and approximately to minutes to fly to anthony the parties stipulated that it took dr steinberger five minutes to ready the airplane for flight he made these trips once a week in alternating weeksdollar_figure dr steinberger’s travel time to the airpark was closer to 7½ minutes rather than when his travel time to the airpark and the time to ready the airplane for flight are added to the stipulated flight times dr steinberger saved no time by flying to wellington--in fact it took longer than driving--and less than an hour for a round-trip flight to anthony these are not substantial time savings that would justify dr steinberger’s flying as opposed to driving to wellington and anthony see kurzet v commissioner f 3d pincite there was no change in the amount of time dr steinberger spent in wellington and anthony whether he drove or flew--he was there for half of the day and then returned to wichita to see patients theredollar_figure wug did not benefit from dr steinberger’s use of the airplane dr steinberger simply used the airplane to travel to wellington and anthony all see supra note petitioners presented no evidence about the number of patients dr steinberger saw in wellington and anthony on days that he flew versus days that he drove the only evidence presented was that he spent half a day in each location before returning to wichita to see more patients expenses related to the use of the airplane for those flights were deducted from his gross_income as personal expenses petitioners also argue that the facts here are strikingly similar to the facts of 98_fedclaims_596 there the taxpayer was the creator of the hard rock brand and a cofounder of the hard rock cafe chain id pincite he created a c_corporation and several s_corporations of which he was either the majority shareholder or the only shareholder to manage his business id one such entity was red white and blue pictures inc rwb id rwb owned the real_estate on which several hard rock cafes were built and acted as the landlord for those cafes it also owned the airplanes to which the disallowed deductions related id pincite the taxpayer used the airplanes to fly from the hard rock headquarters in los angles california to the hard rock hotel and cafe in las vegas nevada and to various other cities to conduct meetings where future hard rock hotels or casinos possibly would be built id pincite there the argument with which the u s court of federal claims agreed was that all of the taxpayer’s entities were operated as a unified business_enterprise id pincite dr steinberger’s business affairs for the years in issue were far from strikingly similar to the facts of morton dr steinberger was a one-seventh owner of a medical practice and he and his wife were the only members of an llc that owned an airplane that he used to travel to two rural kansas cities close to wichita where wug was based in morton the taxpayer was the majority or only shareholder of several corporations each used to control certain aspects of his business additionally the entity that owned the airplane rwb did more than just own the airplane--it also owned the real_property on which several of the hard rock cafes were built and served as the landlord of those cafes petitioners have failed to show that wug and aui shared the characteristics of a unified business_enterprise as the entities did in morton c similarity of activities the similarity of the activities will also be examined to determine whether two activities should be treated as a single activity here there are no similarities between the two activities one is a medical practice specializing in urology the other involved an airplane dr steinberger purchased because he enjoyed flying and personally preferred to fly instead of to drive to wellington and anthony d conclusion the court finds that petitioners’ characterization of aui and wug as a single activity is artificial and not supported by the facts and circumstances of the case v aui’s airplane activity examined on its own petitioners argue in the alternative that if aui and wug are not a single activity for sec_183 purposes aui on its own was engaged in for profit during and aui’s activity on its own is examined under the same factors used to examine aui and au’s activity for see supra pp a review of all of the facts and circumstance and the entire record shows that aui was not engaged in the airplane activity to make a profit and that a detailed factor-by-factor analysis is unnecessary the analysis of aui’s activity on its own for and is almost the same as the analysis of aui and au’s activity for 2007--the majority of flights were training and maintenance and personal flights petitioners did own farmland in iowa in and but their argument for how much time was spent there is not supported by the record the parties’ stipulation of two to three flights a year to iowa is contradicted by dr steinberger’s flight logs entered into evidence see supra note additionally as petitioners stated numerous times aui was not in the airplane rental business furthermore dr steinberger certainly took personal pleasure in flying he has been a licensed pilot for as long as he has been a licensed physician and he testified that he preferred flying to as opposed to driving to wellington and anthony on the basis of this record the court finds that aui was not engaged in the airplane activity for profit for and therefore respondent’s determination to disallow the airplane activity’s flow-through losses that petitioners reported on the schedules e attached to their and returns is sustained vi accuracy-related_penalties respondent determined sec_6662 penalties of dollar_figure dollar_figure and dollar_figure for and respectively sec_6662 and b and authorizes a penalty on the portion of an underpayment of income_tax attributable to negligence or disregard of rules or regulations or a substantial_understatement_of_income_tax under sec_7491 the commissioner bears the burden of production with regard to penalties 116_tc_438 once the commissioner has met the burden of production the taxpayer has the burden of proving that the penalties are inappropriate because of reasonable_cause or substantial_authority see rule a higbee v commissioner t c pincite- hall v commissioner 729_f2d_632 9th cir aff’g tcmemo_1982_337 there is a substantial_understatement_of_income_tax for any year if the amount of the understatement for the taxable_year exceeds the greater of of the tax required to be shown on the tax_return or dollar_figure sec_6662 higbee v commissioner t c pincite here the understatements of income_tax are dollar_figure dollar_figure and dollar_figure for and respectively which are greater than of the tax required to be shown on the returns which in turn is greater than dollar_figure for each year thus the understatement for each year in issue is substantial for purposes of the sec_6662 accuracy-related_penalty the court concludes that respondent met his burden of production in showing that petitioners substantially understated their federal_income_tax for and pursuant to sec_6664 no penalty shall be imposed under sec_6662 with regard to any portion of an underpayment if it can be shown that there was reasonable_cause for such portion and that the taxpayer acted in good_faith with respect to such portion whether a taxpayer acted with reasonable_cause and in good_faith is decided on a case-by-case basis taking into account all pertinent facts and circumstances sec_1_6664-4 income_tax regs generally the most important factor is the extent of the taxpayer’s effort to assess his proper tax_liability id see also remy v commissioner tcmemo_1997_72 reasonable_cause requires a taxpayer to have exercised ordinary business care and prudence as to the disputed item 115_tc_43 citing 469_us_241 162_f2d_628 3d cir 122_f2d_843 3d cir and 110_tc_297 aff’d 299_f3d_221 3d cir good-faith reliance on the advice of an independent competent professional about the tax treatment of an item may meet this requirement id to reasonably rely on a professional’s advice a taxpayer must prove by a preponderance_of_the_evidence that the adviser was a competent professional who had sufficient expertise to justify reliance the taxpayer provided necessary and accurate information to the adviser and the taxpayer actually relied in good_faith on the adviser’s judgment id pincite petitioners’ individual federal_income_tax returns for the years in issue were prepared by bkd llp bkd did not prepare aui’s partnership returns and was not associated with any aspect of the purchase or use of the airplane besides including aui’s losses on the schedules e attached to petitioners’ returns for the years in issue and including a plane rental expense on pegasus meadows’ form_1065 consequently the court will analyze petitioners’ reliance on a professional’s advice claim by examining advocate’s advice to petitioners about the grouping of aui and au for and the grouping of aui and wug for and and the use of the airplane advocate specializes in assisting taxpayers who wish to purchase and use an airplane for business purposes it is made up of attorneys cpas and tax advisers and has been in existence in some form or another since the late 1990s advocate was a competent professional with sufficient expertise to justify reliance upon its advice petitioners provided advocate with the airplane flight logs for each year in issue and other required_documentation to prepare aui’s returns a partner at advocate testified that aui’s returns were driven by the airplane’s flight logs more than any other document advocate prepared aui’s returns and advised grouping aui and au as a single activity for and aui and wug as a single activity for and for sec_183 purposes a although the parties stipulated that aui elected to combine its activities with wug’s for the years in issue the record makes it clear that aui elected to group aui and au for sec_183 purposes for see supra pp petitioners made no argument at trial or on brief that the election to group aui and au as a single entity for purposes of sec_183 was based on a good- faith reliance on advocate’s professional advice their entire argument focused on the grouping of aui and wug therefore the accuracy-related_penalty for must be deemed conceded see rule a 103_tc_111 citing 90_tc_488 even if petitioners had not conceded the accuracy-related_penalty for the court would still find them liable for the penalty all of the flights aui operated in except two were training and maintenance flights and dr steinberger’s personal flights the court found that aui and au as a single activity was not entered into for profit therefore petitioners are liable for an accuracy-related_penalty for a substantial_understatement_of_income_tax for b and petitioners did however rely in good_faith on advocate’s professional advice to group aui’s and wug’s activities for and petitioners had no reason to doubt advocate’s advice about grouping aui and wug for purposes of sec_183 and were not required to seek a second opinion on the matter see although petitioners made no argument that aui was engaged in for profit on its own for the court would find as it did for and that aui’s activity on its own was not engaged in for profit for boyle u s pincite to require the taxpayer to challenge the attorney to seek a ‘second opinion ’ or to try to monitor counsel on the provisions of the code himself would nullify the very purpose of seeking the advice of a presumed expert in the first place citing 178_f2d_769 2d cir petitioners have met each requirement of the three-prong test for reliance on the advice of a professional and they exercised ordinary business care and prudence in reliance on advocate’s advice for and therefore the court finds that petitioners had reasonable_cause for grouping aui and wug as a single activity for sec_183 purposes and no sec_6662 accuracy-related_penalty shall be imposed for or dollar_figure the court has considered all of the arguments made by the parties and to the extent they are not addressed herein they are considered unnecessary moot irrelevant or without merit respondent included boilerplate language in the notice_of_deficiency that petitioners were liable for accuracy-related_penalties for the years in issue because of negligence a substantial_understatement_of_income_tax or a valuation misstatement a valuation misstatement was not in issue here the parties’ arguments focused on whether petitioners had reasonable_cause for relying on advocate’s advice because the court finds they did not have reasonable_cause for their substantial_understatement_of_income_tax but did have reasonable_cause for grouping aui and wug for and there is no need to discuss whether petitioners were negligent for purposes of sec_6662 to reflect the foregoing an appropriate decision will be entered


internal_revenue_service department of the treasury number release date index number washington dc person to contact telephone number refer reply to cc psi b09-plr-162171-02 date date in re legend trust trustor year court order son a b dollar_figurex c d e date year trust court date dear this is in response to your letter dated date in which you requested a ruling concerning the generation-skipping_transfer gst tax consequences of the proposed judicial construction of a_trust agreement that is exempt from the application of gst tax imposed under sec_2601 of the internal_revenue_code plr-162171-02 the facts and representations submitted are summarized as follows trust was established under the provisions of trustor’s will trust was funded in year a date prior to date pursuant to court order no additions have been made subsequent to that funding paragraph a of court order provides that three-fifths of trust 1’s net_income is to be distributed to son in quarterly or other convenient installments one-fifth of trust 1's net_income is to be held for each of trustor’s granddaughters a and b and is payable at the discretion of the trustee and board_of advisors for their support maintenance use or benefit provided the annual payments to each do not exceed dollar_figurex upon attaining the age of thirty-five years all accumulated net_income is to be paid to the granddaughters and thereafter current net_income is to be paid to them for and during the life of son if a granddaughter should pre-decease son the net_income is to be paid to her lineal_descendants per stirpes until the death of son if a granddaughter leaves no lineal_descendants her share of net_income is payable to the other granddaughter or her lineal_descendants paragraph b provides that upon the death of son the corpus of trust is to be divided into equal shares one share for each of trustor’s five grandchildren a b c d and e then living and if not living one equal share for that grandchild’s lineal_descendants paragraph b subparagraph provides that the net_income of a grandchild’s share is payable at the discretion of the trustee and board_of advisors for the grandchild’s support maintenance use or benefit provided the annual payments do not exceed dollar_figurex upon attaining the age of thirty-five years all accumulated net_income is to be paid to the grandchild and thereafter the grandchild is entitled to the current net_income from the share set_aside for his or her benefit under paragraph b subparagraph upon the death of any grandchild after the death of son the share of the corpus from which the grandchild is receiving income at the date of his or her death together with any accumulated and undistributed_income is to vest in and immediately be transferred equally per stirpes to his or her children and or the lineal_descendants of any deceased child if there are no living lineal_descendants of any deceased child then under subparagraph the grandchild’s share of the corpus remains in the trust and the net_income is to be accumulated until the final termination of the trust according to paragraph b subparagraph trust terminates upon the death of the survivor of the five grandchildren of trustor in the event that a grandchild died leaving no lineal_descendants then upon termination of the trust the share of the deceased grandchild is to be distributed equally per capita to the lineal_descendants of trustor plr-162171-02 as a result of son’s death on date trust was divided into five equal shares one for each of trustor’s five grandchildren because all five grandchildren had reached the age of at that time they each received one-fifth of the income two of trustor’s grandchildren b and e have died and their respective shares were distributed to their children d has also died because he died without issue his share has remained in trust two grandchildren a and c are still living and receive their share of the net_income trust will terminate upon the death of the last to die of a or c pursuant to the terms of court order because d died without issue his share will be distributed per capita to the lineal_descendants of trustor upon the termination of trust the terms of court order however are not clear as to how the accumulated income earned on d’s share should be distributed since d’s death the trustee has separately accounted for the income on d’s share and since year has treated it as a separate trust trust the trustee petitioned court for an interpretation of court order the court determined that under the terms of court order the accumulated income in trust should be added to and pass with the corpus of trust on a per capita basis to the then-living descendants of trustor the trustee requests a ruling that the court’s construction of court order as providing for the distribution of the accumulated income on d’s share of trust on a per capita basis will not affect the exempt status of trust for gst tax purposes under sec_2601 sec_2601 imposes a tax on every generation-skipping_transfer a generation-skipping_transfer is defined under sec_2611 as a taxable_distribution a taxable_termination and a direct_skip sec_2612 provides that the term taxable_termination means a termination by death lapse of time release of a power or otherwise of an interest_in_property_held_in_trust where the property passes to a skip_person with respect to the transferor of the property sec_2612 provides that the term taxable_distribution means any distribution from a_trust to a skip_person other than a taxable_termination or a direct_skip under sec_2612 a direct_skip is a transfer subject_to federal estate or gift_tax made by a transferor to a skip_person under b a of the tax_reform_act_of_1986 and sec_26_2601-1 of the generation-skipping_transfer_tax regulations the gst tax provisions do not apply to any generation-skipping_transfer under a_trust that was irrevocable on date however this exemption does not apply to additions actual or constructive that are made to the trust after date plr-162171-02 sec_26_2601-1 states that if an addition is made after date to a_trust which was irrevocable on date a pro_rata portion of subsequent distributions from and terminations of interests in property held in the trust is subject_to the gst tax provisions if an addition is made the trust is thereafter deemed to consist of two portions a portion not subject_to the gst tax and a portion subject_to the gst tax sec_26_2601-1 provides rules for determining when a modification judicial construction settlement agreement or trustee action with respect to a_trust that is exempt from the generation-skipping_transfer_tax will not cause the trust to lose its exempt status sec_26_2601-1 provides that a judicial construction of a governing instrument to resolve an ambiguity in the terms of the instrument or to correct scrivener's error will not cause an exempt trust to lose its exempt status provided the judicial action involves a bona_fide issue and the construction is consistent with applicable state law that would be applied by the highest court of the state in the present case trust was irrevocable on date it has been represented that no additions have been made to the trust after that date the intention of the transferor as expressed in the instrument controls the legal effect of the dispositions made in the instrument cal prob code the intention of the testator expressed in a testamentary instrument is always the polestar in the interpretation of a will estate of hermon v urteago cal rptr 2d cal app 4th when interpreting the words of an instrument preference is to be given to an interpretation of an instrument that will prevent intestacy rather than one that will result in an intestacy cal prob code in this case court construing trustor’s intent interpreted the terms of court order to require that the accumulated income of trust be added to and pass with the corpus of trust as a result upon the termination of trust the accumulated income on d’s share will be distributed per capita to the lineal_descendants of trustor based on the information submitted and representations made we conclude that the terms of court order present a bona_fide issue regarding the method of distribution of the accumulated income on d’s share of trust upon the termination of trust we further conclude that the court’s order construing the method of distribution is consistent with applicable state law that would be applied by the highest court of the state accordingly the court’s order will not affect the exempt status of trust for gst tax purposes under sec_2601 a copy of this letter should be attached to any gift estate or generation-skipping_transfer_tax returns that you may file relating to these matters plr-162171-02 the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by the appropriate party while this office had not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination except as specifically ruled above no opinion is expressed as to the federal tax consequences of the facts described above under the cited provisions or any other provisions of the code or regulations this ruling is directed only to the taxpayer s requesting it sec_6110 of the code provides that it may not be used or cited as precedent sincerely melissa c liquerman melissa c liquerman branch chief branch office of associate chief_counsel passthroughs and special industries enclosure copy for sec_6110 purpose


t c memo united_states tax_court yung and anita f chong petitioners v commissioner of internal revenue respondent docket no filed date yung and anita f chong pro sese rebecca duewer-grenville for respondent memorandum findings_of_fact and opinion holmes judge yung chong gave money to his brother to help open a business in beijing he had another business in this country and he and his wife anita claimed large deductions on their tax_return for losses from both the commissioner disallowed almost all of them due to a near complete lack of records the chongs blame this in part on a catastrophe suffered when a labor dispute at the chong brothers’ store in beijing turned ugly--the store was ransacked and looted and his brother had to skedaddle out of china findings_of_fact yung chong works full time as a driver for federal express but he has a strong entrepreneurial spirit that impels him to seek out business opportunities his brother lok chong shares his spirit and they began to collaborate in when lok found a market in china for leftover chicken parts and yung found a way to buy those chicken parts from large chicken producers in the united_states the chong brothers did quite well for several years until those they called the big boys began selling directly to china the chongs’ chicken parts business dried up and a few years passed while lok and yung looked for a new opportunity lok who is an australian citizen moved to beijing in and spotted an opportunity to import western food for the growing expatriate population there lok took the leftover money from the chicken venture yung supplied some additional capital and gourmet down under was born gourmet down under specialized in importing and distributing australian dairy products but also sold american beef and even some authentic mexican food lok available records do not show how much yung chong contributed to the venture over the years but the parties agreed that he had contributed at least dollar_figure by the end of opened his shop next to the u s embassy and at first the store did well but then in lok discovered that several of his employees were importing yogurt from france in direct competition with gourmet down under even worse they were using company facilities storage delivery trucks and business contacts to do so lok fired five employees unfortunately he fired them during chinese new year--which as he credibly testified is a big taboo in chinese culture retribution was swift the storefront was torched the office was ransacked and the bank account was drained everything was destroyed including the business records lok filed a police report with the beijing public security bureau but made no effort to reconstruct the store’s daily business records from prior years the only documentation from the tax_year was a general profit and loss statement and a balance_sheet both of which lok sent to yung in early there were no records to support the revenue and expenses that yung and his wife reported on their return or to prove yung’s percentage ownership of the business during the year the only thing that can be determined about yung’s interest and even that by testimony alone is that he owned one-third of the business by the end of back in the united_states yung was working at his regular full-time job as well as industriously developing ways to make money on the side the main focus of his efforts was nuskin a multilevel marketing company yung acted as an independent_contractor for nuskin incurring various business_expenses such as gas car maintenance and insurance tolls and business meals by his own testimony yung was very frugal in his day-to-day expenses he scheduled his business meetings to avoid paying multiple tolls he bought a few used cars rather than a new car and got special deals from a mechanic when he needed those cars repaired and he treated his prospective clients to meals at only inexpensive restaurants yung kept receipts for many of his expenses but as with gourmet down under he did not have the sort of systematic records of income and expenses customarily kept by businessmen in date yung filed a joint tax_return with his wife anita they did not use a professional preparer and claimed more than dollar_figure in partnership losses and thousands more in self-employment expenses the effect on their tax bill was dramatic--if allowed the losses would completely eliminate their combined taxable_income the commissioner sent the chongs a notice_of_deficiency denying each of the claimed deductions stating it has not been established that the expenses were incurred and paid during the taxable_year the commissioner also added a 20-percent penalty under sec_6662 a for negligence or disregard of the rules and regulations or alternatively for substantially understating the amount of income_tax due the chongs were california residents when they petitioned this court and there was a short trial in san francisco i partnership loss opinion in early lok chong sent his brother a profit-and-loss statement for gourmet down under lok didn’t send a schedule k- nor did he provide any records to verify the business_purpose of the many expenses shown on the statement this statement showed a total partnership loss of over dollar_figure for the year about dollar_figure of which was attributed to yung yung claimed his loss on his schedule c as an other expense but has since conceded that it should have been reported as a partnership loss on schedule e there are four questions which must be answered before we can determine whether yung was entitled to a partnership loss did a partnership exist if there was a partnership what was yung’s distributive_share what was the partnership’ sec_2 all section references are to the internal_revenue_code in effect for rule references are to the tax_court rules_of_practice and procedure total loss and how much of that loss if any can yung claim a did the partnership exist sec_761 defines a partnership to include unincorporated organization through or by means of which any business financial operation or venture is carried on and which is not within the meaning of this title a corporation or a_trust or estate the commissioner concedes that the chong brothers had a partnership that began in when they started importing chicken parts into china from the united_states we find that the brothers continued to seek out new ventures for their china enterprise even after the chicken parts business ended--and because a partnership continues until no part of any business financial operation or venture of the partnership continues to be carried on by any of its partners sec_708 and b a lok and yung continued to be partners at least until when lok escaped the destruction of gourmet down under exactly how long the partnership continued after gourmet down under cratered doesn’t matter the only relevant issue is whether the partnership was valid and continuing at the end of the tax_year we find that it was b what was yung’s distributive_share a distributive_share is the portion of a partnership’s income and losses which flows through to an individual partner normally each partner’s distributive_share is set out in a partnership_agreement sec_704 when a partnership_agreement is silent each partner’s distributive_share is determined by his interest in the partnership sec_704 a partner’s interest is determined by looking at all facts and circumstances relating to the economic arrangement of the partners sec_1_704-1 income_tax regs there is a presumption that each partner has a per capita share in the partnership but this may be rebutted by facts and circumstances showing a different arrangement id based on the testimony of both lok and yung and the profit and loss statement for we find that yung had a one-third interest in the partnership at the end of however it is somewhat unclear whether he held a one-third interest for the entire tax_year or just at the end yung testified that he contributed dollar_figure during but then in the answering brief accepted respondent’s statement that he didn’t make any capital contributions after a partner’s distributive_share must take into account the various partnership interests throughout the year as well as the length of time each interest was held sec_706 but we do not find yung’s assertion that he made an additional_contribution unsupported by any check or money order receipt in to be credible we therefore find that he had a one-third interest in the partnership throughout the year c what were the partnership’s total losses just like individuals partnerships must keep records to support claims of income deductions credits etc see sec_1_6001-1 income_tax regs such records must show a sufficient business connection for any deductions gorman v commissioner tcmemo_1986_344 when it is evident that there were business-related expenses but the taxpayer is unable to produce records we do have the authority to estimate 39_f2d_540 2d cir but have to have something on which to base our estimate 245_f2d_559 5th cir sec_274 further limits our discretion by adding requirements for substantiating certain kinds of expenses--a burden we can’t lift by relying on the cohan_rule 50_tc_823 affd per curiam 412_f2d_201 2d cir this is a real problem for the chongs because yung himself had no first-hand knowledge of the partnership’s income and expenses and lok’s bookkeeping was very informal--he admitted that he fed his family by withdrawing inventory from the store and he failed to produce a single receipt deposit slip or check book in support of the summary profit-and-loss statement even by the end of the trial the only record that either brother produced to prove any item of the partnership’s income and expenses for the tax_year remained that same profit-and-loss statement lok claims and we believe that he paid chinese taxes on the partnership income but yung didn’t submit any chinese tax returns--or any other records for that matter--into evidence we do find that the primary reason there is so little in the way of documentation is that all the records were destroyed in the chong brothers--particularly lok since he was the onsite manager of gourmet down under--should have tried to salvage or reconstruct what records he could see eg cox v commissioner tcmemo_1980_244 this sort of reasonable reconstruction is always a good practice and it is required for expenses like the travel_expenses that the partnership claimed subject_to sec_274's limitations sec_1_274-5t temporary income_tax regs fed reg date see seckel v commissioner tcmemo_1974_170 we have not seen any evidence of any such reconstruction by either yung or lok we therefore are unable to apply such a defense to this case the lack of records--compounded by the absence of any testimony by lok about any specific items of income or loss-- leads us to find that the partnership has not proven its actual losses for the tax_year d how much of a loss if any can yung claim even if we could determine the partnership’s total losses yung would still only be able to claim his share of such losses to the extent of his adjusted_basis sec_704 80_tc_825 affd 752_f2d_428 9th cir adjusted_basis is essentially the partner’s contribution to the partnership increased by his distributive_share of partnership income and decreased by cash distributions and his share of partnership losses sec_705 a partner’s distributive_share of income or losses automatically flows through to him see sec_702 sec_1_702-1 income_tax regs but his adjusted_basis can’t go below zero if his distributive_share of partnership losses is greater than his available adjusted_basis the excess loss can’t be claimed in that year but must instead be carried forward until he once again has adjusted_basis available to offset the loss see sec_1 d income_tax regs to determine yung’s adjusted_basis in the chong brothers’ partnership at the end of we must know how much he contributed to the partnership and his annual distributive_share of partnership income and or losses since the partnership began both yung and lok credibly testified that there had never been a cash distribution made to yung so we needn’t concern ourselves with that portion of the adjusted_basis equation and the commissioner has conceded that yung contributed at least dollar_figure to the partnership since however even if we take that as a starting point to determine his adjusted_basis we have no record of yung’s distributive_share of income or losses in the partnership during the previous five years a line item on the balance_sheet shows losses carried forward which implies yung was unable to claim prior losses due to a zero adjusted_basis but the court probed the chong brothers on their understanding of partnership tax law and finds that this item on the statement is more_likely_than_not lok’s estimate of prior losses that should have been claimed but weren’t it is simply impossible to state with any certainty what yung’s adjusted_basis was it is therefore impossible for us to say how much of any potential loss yung could have claimed in because we are unable to determine how much loss yung could potentially have claimed we sustain the commissioner’s disallowance of the partnership loss on this alternate ground as well ii schedule c deductions in addition to full-time employment and his interest in the partnership with his brother yung also pursued a multilevel marketing business with nuskin he reported this business on his schedule c and it showed nearly dollar_figure in income that was almost entirely offset by expenses we agree with yung that it is just common sense that he would incur expenses in earning an income from his side business and the commissioner doesn’t dispute many of yung’s expenses--he disallowed only those deductions that are subject_to the limitations of sec_274 to claim a deduction for any item described in sec_274 a taxpayer must substantiate his deduction with adequate_records such as a logbook or diary or sufficient evidence corroborating the taxpayer’s own statement such as the statement of the person s entertained sec_274 sec_1 5t c i and i temporary income_tax regs fed red date these substantiation records must explain a the amount of the expense b the time and place the expense was incurred c the business_purpose of the expense and where applicable d the business relationship to the taxpayer of the person s entertained sec_274 yung didn’t meet these standards for any of the disallowed deductions- -not even breaking down any of his categories of expense into these include the deductions for repair and maintenance on yung’s cars sec_1_274-5t temporary income_tax regs fed reg date specifically lists the cost of maintenance and repairs as one of the expenditure s with respect to an item of listed_property covered by sec_274 individual items he is therefore not entitled to the disputed schedule c deductions iii penalty under sec_6662 the final issue is whether the chongs are liable for a percent accuracy-related_penalty under sec_6662 for neglecting or disregarding the tax rules and regulations or for substantially understating their income_tax the chongs have the burden of proving that the commissioner’s imposition of this penalty was in error see rule a they can do this by showing that under all the facts and circumstances they acted with reasonable_cause and in good_faith sec_6664 sec_1_6664-4 income_tax regs with regard to the partnership loss we find that the chongs did have reasonable_cause to claim the loss and acted in good_faith partnership tax law is a deceptively complex area a reasonable and prudent person with their background and experience wouldn’t necessarily know to ask about such things as adjusted_basis and distributive shares in fact if such a person received a balance_sheet and profit-and-loss statement like yung did it is much more likely that he would rely on the totals provided in those papers this is especially true in this case where lok was a trained accountant albeit not one trained in u s accounting rules who was in control of all the partnership’s records on the other hand we find that the chongs did not act reasonably and prudently in taking the disallowed schedule c deductions sec_274’s substantiation rules are not complex nor are they so little known as to be a trap for the average taxpayer the chongs could have done any number of things to discover what was needed to claim the business deductions they could have contacted a professional tax preparer or if they didn’t want to spend money on professional assistance they could have contacted the irs directly for advice the irs annually publishes an up-to-date version of publication 463--travel entertainment gift and car expenses this publication outlines in detail the various business_expense deductions which are available and the records required to substantiate them the fact that yung didn’t try to keep any sort of ledger or even keep all of his receipts re-enforces our conclusion that the chongs did not act reasonably we find that the chongs were negligent and disregarded the rules and regulations in claiming their disallowed schedule c deductions conclusion the chongs are not entitled to their claimed deductions for either the partnership loss or the schedule c business_expenses and the commissioner was correct in imposing an accuracy-related_penalty under sec_6662 for their disallowed schedule c deductions however the chongs are not liable for a penalty under that section for claiming a partnership loss decision will be entered under rule


t c summary opinion united_states tax_court johnny d and candy l foriest petitioners v commissioner of internal revenue respondent docket no 13485-06s filed date johnny d foriest and candy l foriest pro sese beth a nunnink for respondent carluzzo special_trial_judge this case was heard pursuant to the provisions of sec_7463 pursuant to sec_7463 the decision to be entered is not reviewable by any 1unless otherwise indicated section references are to the internal_revenue_code_of_1986 as amended in effect for the relevant period rule references are to the tax_court rules_of_practice and procedure other court and this opinion shall not be treated as precedent for any other case in a notice_of_deficiency dated date respondent determined deficiencies in petitioners’ income taxes and penalties as follows year deficiency penalty sec_6662 dollar_figure big_number dollar_figure dollar_figure the issues for decision are whether petitioners are entitled to deductions for unreimbursed employee business_expenses for and whether petitioners properly reported deductions related to a lawn care business for and whether petitioners are entitled to a loss from a farming activity for whether petitioners are entitled to deductions for charitable_contributions for and whether petitioners understated income earned in the lawn care business for and whether petitioners are liable for sec_6662 accuracy-related_penalties for and background some of the facts have been stipulated and are so found petitioners are and were at all times relevant married to each other at the time the petition was filed they resided in tennessee petitioners are members of the slayden baptist church contributions they made to that church during each year in issue were routinely made by check petitioners’ employment and farming activity at all times relevant johnny d foriest petitioner was employed as a firefighter by the city of dickson tennessee during each year in issue he contributed to a common meal fund for meals consumed at the firehouse he also incurred expenses for maintaining and cleaning his firefighter uniforms petitioner was also the sole_proprietor of a lawn care business that he operated during as well as for years before under the name spoon’s lawn care spoon’s petitioner maintained a business checking account for spoon’s the business account during deposits totaling dollar_figure were made to the business account income and expenses attributable to spoon’s are shown on a schedule c profit or loss from business included with petitioners’ federal_income_tax return for each year in issue petitioner sold spoon’s at the end of at all times relevant petitioners lived on what petitioner describes as a family farm the property is owned by candy l foriest’s parents who apparently conducted some farming activity on the property during years preceding the years in issue in date petitioner purchased two heifers for a total cost of dollar_figure it cannot be determined whether or if so how candy foriest was employed during the years in issue the wage income dollar_figure reported on petitioners’ federal_income_tax return strongly suggests that she was employed during that year but the record is completely silent on the point petitioners’ federal_income_tax returns petitioners filed a timely joint federal_income_tax return for each year in issue both returns were prepared by a professional income_tax_return_preparer as relevant here petitioners’ return includes a schedule a itemized_deductions a form_2106 employee business_expenses relating to petitioner’s employment as a firefighter and a schedule c on which income and expenses attributable to spoon’s are reported among other things on the schedule a petitioners claimed a dollar_figure deduction for unreimbursed employee business_expenses of this amount dollar_figure is identified as meals expenses after the application of sec_274 dollar_figure is identified merely as business_expenses dollar_figure is identified as union dues and dollar_figure is identified as uniforms for work 2this is the amount before the application of sec_67 on the schedule c petitioners claimed a dollar_figure deduction for vehicle expenses a dollar_figure deduction for depreciation and sec_179 expense a dollar_figure deduction for legal and professional services a dollar_figure deduction for supplies and a dollar_figure deduction for other expenses as relevant here petitioners’ return includes a schedule a a form_2106 relating to petitioner’s employment as a firefighter a schedule c on which expenses attributable to petitioner’s lawn care business are reported and a schedule f profit or loss from farming on which the income and expenditures attributable to petitioner’s farming activity are reported among other things on the schedule a petitioners claimed a dollar_figure deduction for unreimbursed employee business_expenses of this amount dollar_figure is identified as meals expenses after the application of sec_274 dollar_figure is identified merely as business_expenses dollar_figure is identified as union dues and dollar_figure is identified as uniforms for work on the schedule c petitioners claimed a dollar_figure deduction for depreciation and sec_179 expense as well as a dollar_figure deduction for repairs and maintenance petitioners 3petitioners now concede that the depreciation and sec_179 expense deduction reported on the schedule c is overstated 4this amount is before the application of sec_67 however did not report any income from gross_receipts or sales on their schedule c the dollar_figure net_loss shown on the schedule c is taken into account in the computation of the adjusted_gross_income reported on petitioners’ return on the schedule f petitioners claimed a net_loss of dollar_figure of which dollar_figure is attributable to a depreciation and sec_179 expense deduction dollar_figure is attributable to a deduction for repairs and maintenance and dollar_figure is attributable to a deduction for other expenses although there is no income reported on the schedule f dollar_figure is shown as cost_of_goods_sold the notice_of_deficiency some of the adjustments made in the notice_of_deficiency have been agreed to between the parties or conceded and other adjustments are computational those adjustments will not be discussed for respondent disallowed all unreimbursed employee_expenses with the exception of union dues claimed on the schedule a the entire charitable_contribution_deduction and all of the schedule c deductions listed above for respondent disallowed all unreimbursed employee_expenses with the exception of dollar_figure for union dues the entire charitable_contribution_deduction all of the schedule c deductions listed above and all of the schedule f deductions listed above for each year respondent also imposed a sec_6662 accuracy-related_penalty on several grounds including negligence or disregard of rules or regulations and substantial_understatement_of_income_tax discussion as we have observed in countless opinions deductions are a matter of legislative grace and the taxpayer bears the burden_of_proof to establish entitlement to any claimed deduction rule a 503_us_79 292_us_435 this burden requires the taxpayer to substantiate deductions claimed by keeping and producing adequate_records that enable the commissioner to determine the taxpayer’s correct_tax liability sec_6001 65_tc_87 affd per curiam 540_f2d_821 5th cir 43_tc_824 a taxpayer claiming a deduction on a federal_income_tax return must demonstrate that the deduction is allowable pursuant to some statutory provision and must further substantiate that the expense to which the deduction relates has been paid_or_incurred see sec_6001 5petitioners do not claim that the provisions of sec_7491 are applicable and we proceed as though they are not hradesky v commissioner supra sec_1_6001-1 income_tax regs except for the deductions for charitable_contributions the types of deductions here in dispute are allowable if at all under sec_162 that section generally allows a deduction for ordinary and necessary expenses paid_or_incurred during the taxable_year in carrying on any trade_or_business the term trade_or_business as used in sec_162 includes the trade_or_business of being an employee 54_tc_374 17_tc_1456 the determination of whether an expenditure satisfies the requirements for deductibility under sec_162 is a question of fact see 320_us_467 in general an expense is ordinary if it is considered normal usual or customary in the context of the particular business out of which it arose see 308_us_488 ordinarily an expense is necessary if it is appropriate and helpful to the operation of the taxpayer’s trade_or_business see 383_us_687 83_tc_356 affd 777_f2d_662 11th cir on the other hand sec_262 generally disallows a deduction for personal living or family_expenses set against these fundamental principles we turn our attention first to the deductions here in dispute a disputed deduction sec_1 unreimbursed employee_business_expense deduction the unreimbursed employee_business_expense deduction petitioners claimed for each year in issue relates to petitioner’s employment as a firefighter and consists of four components unreimbursed incidental expenditures of dollar_figure for and dollar_figure for union dues of dollar_figure for and dollar_figure for expenses for meals petitioner consumed at the firehouse and expenses for uniform maintenance we consider each in the order just listed a unreimbursed incidental expenditures the unreimbursed business_expense deduction claimed for each year includes amounts attributable to incidental expenditures such as batteries for flashlights and other work supplies for each year the deduction was disallowed for lack of substantiation and at trial petitioners failed to present any documentary_evidence to substantiate the dollar_figure deduction claimed for both and we accept petitioner’s testimony that some amounts were expended for certain items but in the absence of any documents supporting the amounts so expended we find that petitioners are allowed a dollar_figure deduction for incidental expenditures_for each year see 39_f2d_540 2d cir b union dues petitioners claim unreimbursed employee_business_expense deductions for union dues of dollar_figure and dollar_figure in and respectively respondent concedes that petitioners are entitled to a dollar_figure deduction for union dues for each year in issue that leaves dollar_figure in dispute for petitioners have failed to present any evidence that they actually paid more than dollar_figure for union dues in it would seem that written substantiation for such an expense is readily available in the absence of written substantiation petitioners are not entitled to a deduction for union dues for in excess of the amount respondent conceded c meals expenses petitioner contributed to a fund that was used to purchase food for meals that he consumed while on duty at the firehouse generally the cost of a taxpayer’s meals are nondeductible personal expenses unless the expense of the meal is incurred while the taxpayer is traveling away from home for business purposes see sec_162 sec_262 if however a fire department requires its firefighter-employees as a condition_of_employment to make contributions into a common meal fund then those contributions qualify as deductible ordinary and necessary business_expenses see eg 68_tc_422 affd 611_f2d_1260 9th cir belt v commissioner tcmemo_1984_167 on the other hand if a firefighter’s contributions into a common meal fund are not required as a condition_of_employment but are made voluntarily then such contributions are considered a personal_expense that is not deductible see eg 77_tc_911 it is obvious that the meal expenses petitioners deducted were not incurred while petitioner was traveling away from home on business and the expenses cannot be deducted on that ground furthermore nothing in the record would support a finding that the contributions petitioner made to the common meal fund were made other than voluntarily petitioners are not entitled to a deduction for amounts attributable to meal expenses included in the unreimbursed employee_business_expense deduction claimed for each year d expenses for uniform maintenance the unreimbursed employee_business_expense deduction claimed on petitioners’ returns includes dollar_figure and dollar_figure for and respectively for uniform maintenance uniform maintenance includes the cost of dry cleaning polish for petitioner’s shoes 6even if otherwise allowable we note that the amount deducted for meals expenses each year greatly exceeded the amount actually expended and brass silver and the occasional item that is not covered by the yearly uniform allowance expenses for uniforms are deductible if the uniforms are of a type specifically required as a condition_of_employment the uniforms are not adaptable to general use as ordinary clothing and the uniforms are not worn as ordinary clothing 30_tc_757 wasik v commissioner tcmemo_2007_148 beckey v commissioner tcmemo_1994_514 petitioner was required to wear a uniform provided by the city of dickson as a condition of his employment as a firefighter petitioners did not offer any evidence to substantiate the deductions claimed for uniform maintenance in the absence of any substantiating evidence we find that petitioners are entitled to a deduction of dollar_figure for each year in issue see cohan v commissioner supra lawn care schedule c deductions for the schedule c expense deductions in dispute are dollar_figure for car and truck expenses dollar_figure for legal expenses dollar_figure for supplies expenses dollar_figure for other expenses and some portion of the dollar_figure depreciation and sec_179 expense deduction as noted petitioners now concede that the depreciation and sec_179 expense deduction was overstated by dollar_figure an amount attributable to a dodge truck petitioners submitted bank records credit card company records receipts and other written documents to substantiate their deductions the organization of the documents as relating to the deductions in dispute leaves much to be desired nevertheless after a careful review of the documents we find that petitioners are entitled to the schedule c deductions as claimed with the exception of the portion of the depreciation and sec_179 expense deduction attributable to the dodge truck petitioner testified that spoon’s was sold sometime near the end of the sale of the business in perhaps explains why the schedule c shows no income what remains unexplained is why deductions attributed to that business are claimed for petitioners’ failure to justify or otherwise explain business_expense deductions claimed for the year following the year that the business apparently was sold requires that respondent’s disallowance of those deductions be sustained farming activity schedule f deductions according to petitioners the expense deductions claimed and resultant loss shown on the schedule f are allowable because the expenses were paid_or_incurred in connection with a trade or 7he was less than certain on the point but petitioners provided nothing else to otherwise establish the date the business was sold business according to respondent petitioners’ farming activity did not qualify as a trade_or_business during and expenditures incurred in connection with that activity are deductible only as provided by sec_183 to be engaged in a trade_or_business within the meaning of sec_162 and sec_165 a taxpayer must conduct the activity with continuity regularity and for the primary purpose of deriving a profit 480_us_23 whether a taxpayer is carrying_on_a_trade_or_business requires an examination of all of the facts in each case id pincite petitioners’ evidence on the point consists of the following they lived on property owned by the parents of one of them which was at one time used as an operating farm two heifers were purchased and apparently kept on the property during and petitioner observed that nobody farms as a hobby to the extent that petitioner’s observation suggests that farming is an arduous activity we agree keeping petitioner’s observation in mind as we view the matter living on a family farm and the purchase of two cows without more does not a farmer make petitioners have failed to demonstrate that the farming activity was conducted with continuity and regularity and for the purpose of making a livelihood as necessary to be considered a trade_or_business within the meaning of sec_162 id pincite respondent’s disallowances of deductions claimed in connection with that activity are sustained petitioners are not entitled to a deduction for expenses or the loss shown on the schedule f charitable_contribution deductions according to petitioners the charitable_contribution deductions of dollar_figure and dollar_figure claimed on their and returns respectively consist of contributions by check to slayden baptist church in general a taxpayer is allowed to deduct any contributions or gifts made to qualifying organizations for their use see sec_170 sec_1_170a-13 income_tax regs requires that a charitable_contribution_deduction whether made by cash or otherwise be substantiated by at least one of the following a canceled check a receipt from the donee charitable_organization showing the name of the donee the date of the contribution and the amount of the contribution or in the absence of a canceled check or receipt from the donee charitable_organization other reliable written records showing the name of the donee the date of contribution and the amount of the contribution the reliability of the records is 8a letter or other communication from the donee charitable_organization acknowledging receipt of a contribution and showing the date and amount of the contribution constitutes a receipt determined on the basis of all the relevant facts and circumstances see sec_1_170a-13 income_tax regs although petitioners claim to have made the contributions by check they presented no canceled checks or other acceptable substantiating documents showing any contributions that being so they are not entitled to the charitable_contribution deductions claimed on their and returns and respondent’s disallowance of those deductions is sustained b omitted income the deficiency results in part from the disallowed deductions discussed above it also results in part from respondent’s adjustment increasing the income reported on spoon’s schedule c and we turn our attention to that adjustment during deposits totaling dollar_figure were made to the business account but the schedule c shows income of only dollar_figure respondent increased petitioners’ income by the difference that is dollar_figure taxpayers must keep adequate books_and_records from which their correct_tax liability can be determined sec_6001 petitioners’ business records which consist in part of the monthly statements for the business account show deposits in excess of the amount reported as income according to petitioner the business account was used exclusively for business purposes and the income generated by the business was deposited into that account petitioners’ business records support respondent’s adjustment and petitioners have failed to explain the difference between the income established by the business records and the income reported on the schedule c respondent’s adjustment therefore is sustained c the accuracy-related_penalties lastly we consider whether petitioners are liable for sec_6662 accuracy-related_penalties for each year in issue respondent has determined that they are various grounds for the imposition of that penalty are set forth in the notice_of_deficiency nevertheless if it is shown that petitioners acted in good_faith and there is reasonable_cause for the deficiency for each year then the sec_6662 accuracy-related_penalty is not applicable to either see sec_6664 116_tc_438 for each year in issue petitioners relied upon a paid income_tax_return_preparer to prepare their federal_income_tax return and to compute the tax_liability shown on the return we are satisfied that petitioners had reasonable_cause and acted in good_faith with respect to the underpayment_of_tax that will remain for each year see sec_6664 they are not liable for the sec_6662 accuracy-related_penalty for either year in issue to reflect the foregoing decision will be entered under rule