Court Opinion

ID: 4910966
Source: CourtListenerOpinion
Date Created: 2021-09-15 00:00:35.486365+00
Date Added: 2024-06-11T08:13:28.660874
License: Public Domain

Case: 20-60004       Document: 00516013669      Page: 1     Date Filed: 09/14/2021

           United States Court of Appeals
                for the Fifth Circuit                             United States Court of Appeals
                                                                           Fifth Circuit

                                                                         FILED
                                                                 September 14, 2021
                                 No. 20-60004
                                                                    Lyle W. Cayce
                                                                         Clerk
   Ames D. Ray,

                                                          Petitioner—Appellant,

                                      versus

   Commissioner of Internal Revenue,

                                                          Respondent—Appellee.

                     Appeal from the United States Tax Court
                               USTC No. 14052-16

   Before Dennis, Higginson, and Willett, Circuit Judges.
   Stephen A. Higginson, Circuit Judge:
         Appellant Ames D. Ray claimed a deduction for certain legal expenses
   on his 2014 federal income tax return. The Internal Revenue Service
   disallowed this deduction and issued a notice of deficiency to Ray. The IRS
   imposed an accuracy-related penalty in addition to the deficiency amount.
   Ray filed a petition with the U.S. Tax Court challenging the deficiency
   determination and the imposition of the accuracy-related penalty. Following
   a one-day trial, the Tax Court issued a decision upholding in part the IRS’s
   deficiency determination and imposition of the accuracy-related penalty. Ray
   timely appealed the Tax Court’s decision. We affirm in part and reverse and
   remand in part.
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                                    No. 20-60004

                                          I.
          This case concerns deductions appellant Ames Ray claimed on his
   2014 federal income tax return for legal expenses incurred in litigation against
   his ex-wife, Christina Ray, and her attorneys. This litigation has been ongoing
   for over twenty years, involves four separate lawsuits, and implicates facts
   dating back several decades.
                                         A.
          Ames and Christina Ray met while they were undergraduate students
   at Michigan State University, where both obtained advanced degrees in
   physics. They married in 1972 and moved to New York City in 1976.
   Christina developed a career in the finance industry, eventually serving as an
   officer at multiple financial institutions. She developed mathematical models
   for commodities trading and authored several books on risk management and
   options trading. In 1990, she founded a consulting firm to advise finance
   industry clients. Ames also worked for several financial institutions during
   the early stages of his career, but was never a commodities trader. In 1979, he
   developed a computer program that could analyze Securities and Exchange
   Commission filings, search for company information, and print financial
   statements, which he named “Firm Decisions.” Ames licensed this software
   to Citibank and received income from Citibank for the software until 1986.
          Ames and Christina divorced in 1977, though they continued to live
   together off and on until 1992, when Ames moved to Florida. During the time
   that they lived together after their divorce, the couple continued to maintain
   joint banking and credit-card accounts and own shared assets. The Rays used
   a ledger system to track their joint and separate expenses, as well as financial
   transactions between them.
          Over time, Christina incurred various debts to Ames, which the
   couple formalized in several written documents. In 1981, Ames and Christina

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   jointly purchased land in Sagaponack, New York with the intent of building
   a vacation home on the land. Due to disagreements over construction, in 1984
   Ames sold his share of the property to Christina for $350,000. Ames lent this
   amount to Christina in exchange for her agreement to make regular payments
   to him. The Rays memorialized this agreement in a written document, which
   they notarized and accounted for in their ledger system.
          A second real-estate transaction followed. The Rays lived in an
   apartment on East 87th Street in Manhattan from the time they moved to New
   York City in 1976. When that apartment was converted to a co-op around
   1987, the Rays purchased shares in the co-op. In November 1991, Ames sold
   his interest in the co-op shares to Christina, memorialized by a document
   they each signed. Christina executed a note to Ames for $432,427, dated
   November 25, 1991. According to Ames, this note covered the amounts
   Christina owed him for both the Sagaponack property and the Manhattan
   apartment.
          Also in November 1991, Ames and Christina signed a document
   stating that Christina was solely liable for six different credit-card accounts
   in Ames’s name due to her charges to those accounts. The document further
   stated that Christina would either close out or remove Ames’s name from
   each account. Until Christina did so, the agreement would require her to
   spend no more than $1,800 per month on living and non-reimbursed business
   expenses.
          In April 1993, Christina signed a $532,288.10 “judgment by
   confession” in favor of Ames. The judgment by confession stated that it
   represented amounts due from Christina to Ames for (1) Christina’s default
   on the November 25, 1991 promissory note, (2) $99,860.43 in additional
   credit-card debt that Ames had paid or would pay on Christina’s behalf,
   (3) “legal and associated expenses incurred in connection with the

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   enforcement of the note,” and (4) interest due on these amounts through
   March 22, 1993. The judgment by confession was never entered in any court.
          In September 1993, Christina signed a letter to Ames stating that she
   would provide him with notarized financial statements on a semiannual basis
   until the judgment-by-confession amount was paid in full. Christina would be
   liable for a $50 penalty for each day she was late in providing her financial
   statements to Ames.
         On August 10, 1994, Christina signed another letter to Ames, this one
   summarizing her debts to him, which then totaled $590,222.79. This amount
   covered (1) the $532,288.10 represented by the judgment by confession,
   (2) $18,774.24 for late financial statements plus interest, (3) additional
   credit-card debt and related interest, and (4) a reduction for a rent
   adjustment of $48,625.
          In early 1993, Christina approached Ames with a proposal to use a
   trading method she had developed to “mak[e] money trading futures and
   options.” On May 24, 1993, the Rays formalized the terms of their
   arrangement in a written document (the “trading agreement”). The
   document stipulated that Christina would manage the trading of Ames’s
   commodities brokerage account in her “sole discretion.” Christina was to
   provide monthly reports to Ames with the “analysis, rationale, and logic of
   trades and positions.” Ames would pay Christina a 7 percent commission on
   the increase in value of the account on a monthly basis. The trading
   agreement further provided that “[Christina] and [Ames] may advertise the
   accurate results of [Christina’s] trading [of Ames’s] account.” The trading
   agreement stated that it would automatically terminate as of November 1993,
   and that because Christina was to trade Ames’s account “for hire,” Ames
   would be “permitted to terminate [the trading agreement] at any time.”

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   Ames deposited $500,000 into his commodities brokerage account so that
   Christina could trade his account pursuant to the trading agreement.
          On June 14, 1993, Ames proposed an amendment to the trading
   agreement that provided: “You’ll pay to me the amount of money that my
   account falls below $350[,000] . . . . Otherwise, trade my account to liquidate
   positions when my account’s value falls below $350[,000].” Christina signed
   the amendment on September 4, 1993. However, by the time Christina signed
   the amendment, the account’s value had already declined to $1,285, and she
   had thus stopped trading on the account due to insufficient capital. In August
   1994, Christina signed a letter to Ames confirming that she owed him
   $384,388 for the losses to the commodities account plus interest.
          Ames deducted his trading agreement losses as a Schedule C business
   loss on his 1993 tax return. The Internal Revenue Service (IRS) disallowed
   the deduction and sent Ames a notice of deficiency. Ames disputed the IRS’s
   deficiency determination in the U.S. Tax Court, and he and the IRS
   eventually reached a settlement, which was entered by the Tax Court on
   December 16, 1997 as a stipulated decision “[p]ursuant to the agreement of
   the parties.” Under the stipulated decision, Ames was charged a deficiency
   of $88,926.42 for the 1993 tax year and was still allowed to deduct
   $374,102.00 as a Schedule C business loss labeled “Futures Trader.”
          Then came litigation. On September 9, 1998, Ames filed a lawsuit
   against Christina in the New York Supreme Court for New York County (Ray
   v. Ray, Index No. 604381/98) (“Ray I”). Ames alleged two causes of action
   arising from (1) Christina’s failure to pay any part of the indebtedness
   amount summarized by the August 10, 1994 letter (representing her debts
   resulting from the two real estate purchase loans, the credit-card debt, and
   the late financials) and (2) Ames’s losses under the trading agreement. The
   New York Supreme Court dismissed the complaint on January 11, 2008.

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   Ames appealed, and on April 7, 2009, the Appellate Division of the Supreme
   Court of New York overturned the dismissal. As of June 2020, the case
   remained pending. See Ray v. Ray, 149 N.E.3d 443 (N.Y. 2020). In 2014,
   Ames incurred $77,724 in legal expenses for Ray I.
          On October 20, 2010, Ames again sued Christina in the New York
   Supreme Court for New York County (Ray v. Ray, Index No. 652314/2010)
   (“Ray II”). Ames alleged that Christina owed him at least $970,000, and that
   she had fraudulently conveyed property to avoid paying Ames. The New
   York Supreme Court dismissed the complaint on July 12, 2011, and the
   Appellate Division affirmed on July 9, 2013. Ames did not incur any legal
   expenses for Ray II in 2014.
          Ames filed another fraudulent conveyance lawsuit against Christina
   and her business, Guarnerius Management, LLC, in the New York Supreme
   Court on April 24, 2014 (Ray v. Ray et al., Index No. 153945/2014) (“Ray
   III”). Ames alleged that Christina mortgaged the Manhattan co-op for
   $500,000 and then fraudulently conveyed that amount—$80,000 to pay for
   legal fees and the remaining $420,000 to Guarnerius. The New York
   Supreme Court dismissed the complaint on December 22, 2014. Ames spent
   $151,500 on legal expenses for Ray III in 2014.
          On January 22, 2016, Ames sued Christina’s Ray I attorneys in the
   United States District Court for the Southern District of New York, alleging
   that they had made deceitful statements and representations to the trial and
   appellate courts in Ray I in order to obtain an advantage in the litigation (Case
   No. 1:15-cv-10176-JSR) (“Ray IV”). The district court dismissed the
   complaint on April 26, 2016, and the United States Court of Appeals for the
   Second Circuit affirmed the dismissal on April 14, 2017. Although Ames did
   not file his complaint in Ray IV until 2016, he incurred $38,000 in legal
   expenses for the case in 2014.

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          That brings us to the tax deductions at issue on appeal. On his 2014
   federal income tax return, Ames reported a negative amount of $238,937 as
   “[o]ther income” with the label “legal fees, costs.” Ames did not file a
   Schedule C (Profit or Loss from Business) with his 2014 tax return.
          The IRS issued a notice of deficiency to Ames, informing him that the
   IRS had disallowed the legal expense deduction and imposed a 20 percent
   accuracy-related penalty pursuant to Internal Revenue Code § 6662(a).
                                         B.
          Ames filed a petition with the U.S. Tax Court challenging the
   deficiency determination and the imposition of the accuracy-related penalty.
   He claimed that the IRS had erred in disallowing the deduction for his legal
   expenses, arguing that they were “deductible either under [26 U.S.C.] § 162,
   [26 U.S.C.] § 212 or as a capital loss in connection with a hedge fund of which
   [Ames] was founder, and an officer and director.” The Tax Court held a one-
   day trial on May 3, 2017, and issued an opinion on April 15, 2019.
          Applying the preponderance of the credible evidence standard, the
   Tax Court found that none of Ames’s legal expenses was eligible for a
   deduction as an expense of carrying on a trade or business under § 162(a) of
   the Internal Revenue Code. The Tax Court next held that the portion of
   Ames’s legal expenses related to the trading agreement losses (those legal
   expenses attributable to the second cause of action in Ray I and part of Ray
   III)—but not the portion of his legal expenses related to his efforts to recover
   on his ex-wife’s indebtedness for the Sagaponack property purchase, the
   Manhattan apartment purchase, the credit-card debt, and the late financial
   statements (those legal expenses attributable to the first cause of action in
   Ray I, part of Ray III, and all of Ray IV)—could be deducted under Internal
   Revenue Code § 212. The Tax Court applied the “Cohan rule” (from Cohan
   v. Commissioner, 39 F.2d 540 (2d Cir. 1930)), using the ratio of damages

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   attributed to each Ray I cause of action, to determine that Ames could deduct
   39.5 percent of the Ray I and Ray III legal expenses he paid in 2014 under
   § 212.
            The Tax Court found Ames liable for an accuracy-related penalty
   under Internal Revenue Code § 6662(a), (b)(1) and (2). The Tax Court
   further found that Ames had failed to carry his burden of proof in establishing
   an affirmative defense to the penalty.
            Following the issuance of the Tax Court opinion, the Tax Court
   entered its decision and adopted the IRS’s proposed deficiency computation.
   The deficiency computation deducted from Ames’s taxable income 39.5
   percent of Ames’s 2014 legal expenses from Ray I and Ray III (the expenses
   related to his losses under the trading agreement), which the Tax Court had
   determined Ames could deduct as expenses for the production of income
   under § 212. The computation imposed a 20 percent penalty on Ames’s
   underpayment. The penalty was not imposed on any underpayment
   attributable to legal expenses concerning the trading agreement losses, which
   Ames was allowed to deduct under § 212. But the penalty was imposed on
   the underpayment attributable to (1) the difference in the amounts Ames
   would be allowed to deduct for legal expenses for the trading agreement
   losses if they were deductible under § 162(a) rather than § 212, and
   (2) Ames’s deduction of his legal expenses relating to his litigation to recover
   on his ex-wife’s indebtedness.
            Ames timely appealed the Tax Court’s decision.
                                         II.
            This court applies the same standard of review to a decision of the
   U.S. Tax Court as it would to a federal district court decision. We review
   factual findings for clear error and legal determinations de novo. Estate of
   Duncan v. Comm’r, 890 F.3d 192, 197 (5th Cir. 2018) (citing Terrell v.

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   Comm’r, 625 F.3d 254, 254 (5th Cir. 2010)). “Clear error exists when this
   [C]ourt is left with the definite and firm conviction that a mistake has been
   made.” Terrell, 625 F.3d at 258 (alteration in original) (quoting Green v.
   Comm’r, 507 F.3d 857, 866 (5th Cir. 2007)).
                                           III.
          We first consider whether the Tax Court erred in finding that Ames
   Ray (hereinafter referred to as “Ray”) cannot deduct his legal expenses from
   litigating to recoup his losses under the trading agreement as expenses of
   carrying on a trade or business under § 162(a) of the Internal Revenue Code.
   The Tax Court held that Ray could not deduct any of his 2014 legal fees as
   expenses of carrying on a trade or business under § 162(a), finding that (1) the
   claims underlying the litigation to recover on Christina Ray’s indebtedness
   lacked any nexus to Ray’s purported computer programming business, and
   (2) the claims underlying the litigation to recoup the trading agreement losses
   lacked a sufficient nexus to a trade or business carried on by Ray because “the
   purported business was in actuality Ms. Ray’s management of a hedge fund
   and [] [Ray’s] involvement in her management of that fund extended no
   further than his initial investment.”
          On appeal, Ray argues that the Commissioner is collaterally estopped
   from litigating the issue of whether the origin of the claims underlying Ray’s
   2014 legal expenses relating to his trading agreement loss is a “business
   investment” because the 1997 stipulated Tax Court decision determined that
   his loss under the trading agreement was a deductible business loss. Ray
   argues in the alternative that he is entitled to a § 162(a) deduction for his legal
   expenses regarding the trading agreement losses because he and Christina
   Ray were jointly engaged in a hedge fund business and collaborated to
   develop a trading program, and the claims underlying the legal expenses were
   related to this business.

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          The Commissioner counters that Ray failed to preserve his collateral
   estoppel argument in the Tax Court because he raised the issue for the first
   time in his post-trial answering brief. Even so, the Commissioner further
   maintains that collateral estoppel does not apply because the 1997 stipulated
   Tax Court decision was entered pursuant to the agreement of the parties, and
   thus the issue of whether the trading agreement loss was a deductible
   business loss was not actually litigated. In response to Ray’s alternative
   argument on the merits of § 162(a) deductibility, the Commissioner avers
   that Ray did not carry on the trading venture as a trade or business and was
   nothing more than an investor.
          We consider, as a threshold matter, Ray’s argument that the
   Commissioner is collaterally estopped from litigating the issue of whether the
   origin of the claims underlying Ray’s trading agreement-related litigation is a
   business loss entitling him to a § 162(a) deduction. Finding that collateral
   estoppel does not bar the Commissioner from litigating this issue, we then
   assess whether Ray is entitled to a § 162(a) business-expense deduction for
   the portion of his 2014 legal expenses incurred in his efforts recoup his losses
   under the trading agreement.
                                           A.
          An argument not raised before the trial court cannot be raised for the
   first time on appeal. XL Specialty Ins. Co. v. Kiewit Offshore Servs., 513 F.3d
   146, 153 (5th Cir. 2008) (citing Stokes v. Emerson Elec. Co., 217 F.3d 353, 358
   n.19 (5th Cir. 2000)). For an argument to be preserved, it “must be raised to
   such a degree that the trial court may rule on it.” Id. (quoting Butler Aviation
   Int’l v. Whyte (In re Fairchild Aircraft Corp.), 6 F.3d 1119, 1128 (5th Cir. 1993),
   abrogated on other grounds as recognized in Matter of Diaz, 972 F.3d 713, 720
   n.6 (5th Cir. 2020)). Under the Tax Court Rules of Practice and Procedure,
   Rule 39, an affirmative defense such as collateral estoppel must be set forth

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   in a party’s pleading or else will be deemed abandoned. Tax Ct. R. 39;
   Jefferson v. Comm’r, 50 T.C. 963, 966–67 (1968). The Tax Court does not
   consider issues raised for the first time in an answering brief. Dutton v.
   Comm’r, 122 T.C. 133, 142 (2004); accord Clay v. Comm’r, 152 T.C. 223, 236
   (2019).
           In his appellate briefing, Ray suggests that he first raised his asserted
   collateral estoppel defense in his pre-trial submission. To the contrary, Ray’s
   pre-trial submission merely mentioned the 1997 stipulated Tax Court
   decision but did not assert collateral estoppel. Ray did not raise his asserted
   collateral estoppel defense until his post-trial answering brief.
           Because the Tax Court does not consider issues raised for the first
   time in an answering brief, Ray did not raise the collateral estoppel defense
   “to such a degree that the [Tax Court could] rule on it” in accordance with
   this court’s preservation standard. See XL Specialty Ins. Co., 513 F.3d at 153
   (quoting In re Fairchild Aircraft Corp., 6 F.3d at 1128). We thus find that Ray
   has failed to preserve his asserted collateral estoppel defense.
                                               B.
           We now turn to the merits of Ray’s argument that his 2014 legal
   expenses incurred litigating to recover his trading agreement losses are
   deductible as expenses of a trade or business under § 162(a). 1 The Tax Court
   found that these legal fees are not deductible as expenses of a trade or
   business under § 162(a), but did find that that Ray could deduct these legal
   fees as expenses for the production of income under § 212. Neither party

           1
             Ray has abandoned by failing to brief any argument he might have against the Tax
   Court’s finding that Ray’s 2014 legal expenses incurred litigating to recover on his ex-
   wife’s indebtedness are not deductible business expenses under § 162(a). See Coury v. Moss,
   529 F.3d 579, 587 (5th Cir. 2008).

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   disputes the Tax Court’s finding that these legal fees are deductible under
   § 212. This issue remains justiciable, however, because Ray would receive
   greater tax-liability relief if he were able to deduct these expenses under
   § 162(a) rather than § 212. See Green, 507 F.3d at 870 n.7 (discussing the
   comparative advantage of deducting an expense under Internal Revenue
   Code § 162(a) versus § 212).
          Section 162(a) of the Internal Revenue Code allows taxpayers to
   deduct from their taxable income “all the ordinary and necessary expenses
   paid or incurred during the taxable year in carrying on any trade or business.”
   I.R.C. § 162(a). Because “an income tax deduction is a matter of legislative
   grace,” a taxpayer claiming a business-expense deduction under § 162(a) has
   the burden to prove that the expense is rooted in the taxpayer’s trade or
   business. INDOPCO, Inc. v. Comm’r, 503 U.S. 79, 84 (1992) (quoting
   Interstate Transit Lines v. Comm’r, 319 U.S. 590, 593 (1943)); see also Marcello
   v. Comm’r, 380 F.2d 499, 504 (5th Cir. 1967); Brinkley v. Comm’r, 808 F.3d
   657, 663 (5th Cir. 2015) (“As a general rule, the Commissioner’s
   determination of a tax deficiency is presumed correct, and the taxpayer has
   the burden of proving the determination to be erroneous.”).
          The phrase “trade or business” in § 162(a) “connotes something
   more than an act or course of activity engaged in for profit.” Stanton v.
   Comm’r, 399 F.2d 326, 329 (5th Cir. 1968) (quoting McDowell v. Ribicoff, 292
   F.2d 174, 178 (3d Cir. 1961)). A taxpayer can show that his activities
   constitute a trade or business within the meaning of § 162(a) by
   demonstrating that he engaged in “extensive activity over a substantial
   period of time during which the [t]axpayer holds himself out as selling goods
   or services.” Id. (quoting McDowell, 292 F.2d at 178); accord Louisiana Credit
   Union League v. United States, 693 F.2d 525, 532 (5th Cir. 1982). “One
   prearranged deal does not evidence the continuity and regularity found in
   trades or businesses.” Harris v. Comm’r, 16 F.3d 75, 81 (5th Cir. 1994). The

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   taxpayer’s management of his own investments is not a trade or business.
   Zink v. United States, 929 F.2d 1015, 1021 (5th Cir. 1991).
          Legal expenses can be deductible as business expenses under § 162(a).
   Estate of Meade v. Comm’r, 489 F.2d 161, 164–66 (5th Cir. 1974). In United
   States v. Gilmore, the Supreme Court established the origin-of-the-claim test
   to determine whether a legal expense is deductible. 372 U.S. 39, 48–49
   (1963). The origin-of-the-claim test asks the court to consider “the origin and
   character of the claim with respect to which [a legal] expense was incurred,
   rather than its potential consequences upon the fortunes of the taxpayer,” to
   determine whether the expense is a business or a personal expense, and thus
   “whether it is deductible or not.” Gilmore, 372 U.S. at 49; see also Estate of
   Meade, 489 F.2d at 165. In applying the origin-of-the-claim test to determine
   whether a legal expense is deductible, courts should consider the issues,
   nature, and objectives of the lawsuit, the defenses asserted, the purpose of
   the expenses, and the background of the litigation. Morgan’s Estate v.
   Comm’r, 332 F.2d 144, 151 (5th Cir. 1964).
          We review the Tax Court’s factual finding as to whether the taxpayer
   was carrying on a trade or business for clear error and its legal conclusions de
   novo. See Green, 507 F.3d at 871 (“The determination of whether [the
   taxpayer] was engaged in carrying on a trade or business is a determination of
   fact that we review for clear error.”); Brinkley, 808 F.3d at 664.
          In order to reverse the Tax Court on this issue, we would need to find
   that the Tax Court clearly erred in finding that the origin of the claims
   underlying Ray’s litigation to recoup his losses under the trading agreement
   did not relate to his engagement in a trade or business within the meaning of
   § 162(a). This issue involves two distinct inquiries: (1) Did the Tax Court
   clearly err in characterizing the trading agreement venture as “Ms. Ray’s
   management of a hedge fund” rather than a computer programming

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   business?; and (2) Did the Tax Court clearly err in finding that Ray was not
   involved in the trading agreement venture as a trade or business, but rather
   was merely an investor in the venture?
          In the Tax Court, Ray argued that the trading agreement venture was
   an extension of his earlier computer programming business because he took
   part of his settlement from litigation involving his Firm Decisions software
   and invested it in the trading agreement venture “to continue developing
   programs for Wall Street.” The Tax Court rejected this argument, finding
   that “the purported business was in actuality Ms. Ray’s management of a
   hedge fund.” On appeal, Ray again attempts to characterize the trading
   agreement venture as tied to his earlier computer programming business.
   However, Ray does not point to any facts establishing a link between the
   trading agreement venture and Ray’s earlier computer programming
   business beyond the source of funding. In his testimony before the Tax
   Court, in his post-trial brief, and again in his appellate brief, Ray states that
   the purpose of the trading agreement venture was to test the trading
   strategies that Christina Ray had developed. Although these trading
   strategies involved computer programs, Ray cites no evidence establishing
   that these computer programs were related to his earlier computer
   programming business or were developed by Ray. The Tax Court thus did
   not clearly err in characterizing the trading agreement venture as “Ms. Ray’s
   management of a hedge fund.”
          Ray further argues that he engaged in the trading agreement venture
   as a trade or business within the meaning of § 162(a) because the venture was
   a joint collaboration with his ex-wife “to profit from the track record they
   sought to establish using Christina’s trading strategies.” To establish that he
   was engaged in a trade or business under § 162(a), Ray must demonstrate that
   he engaged in “extensive activity over a substantial period of time” with
   respect to the purported business. Stanton, 399 F.2d at 329. A mere profit

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   motive does not establish engagement in a trade or business, and the
   management of one’s own investments is not a trade or business. Id.; Zink,
   929 F.2d at 1021.
          Nothing in the record establishes that Ray engaged in the trading
   agreement venture with “continuity and regularity.” Comm’r v. Groetzinger,
   480 U.S. 23, 35 (1987). Ray argues that “[c]onsistent with Groetzinger, Ray
   was regularly and continuously engaged in writing and creating financial
   software programs of a decision making and predictive nature from 1976
   through the end of his collaboration with Christina.” Ray does not identify
   evidence in the record, however, establishing that Ray developed the
   computer programs that Christina Ray used in the trading agreement venture
   or meaningfully contributed to Christina’s development of these programs.
   As noted, Ray repeatedly characterized the purpose of the trading agreement
   venture as testing the trading strategies that Christina had developed. Ray
   also does not cite evidence showing that he participated in the trading aspect
   of the purported business. In fact, in Ray I, Ray testified that he did not
   “remember spending much time developing programs and models,” and that
   trading was Christina’s profession rather than his. Under the terms of the
   trading agreement, Ray disclaimed any right to be actively involved in the
   trading aspect of the purported business, as the agreement gave Christina Ray
   the authority to trade Ray’s commodities account in her sole discretion.
          Ray argues that the trading agreement’s language providing that
   either party could “advertise the accurate results” of Christina Ray’s trading
   of Ray’s account shows that “[t]here was a clear purpose and intent to
   commercially exploit what both believed would be a profitable program.”
   The existence of an intent to commercially exploit the trading program does
   not show that Ray engaged in extensive activity over a substantial period of
   time with respect to the purported trading business. Moreover, the existence

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   of a profit motive does not establish a trade or business within the meaning
   of § 162(a). Stanton, 399 F.2d at 329.
          Ray has not carried his burden of proof to show that the origin of the
   claims underlying his litigation to recoup his trading agreement losses—the
   trading agreement venture—was related to his engagement in a trade or
   business within the meaning of § 162(a). Accordingly, the Tax Court did not
   clearly err in finding that Ray is not entitled to deduct his 2014 legal expenses
   under § 162(a).
                                         IV.
          We next consider whether the Tax Court erred in finding that Ray
   cannot deduct his legal expenses incurred litigating to recover on his ex-
   wife’s indebtedness as expenses for the production of income under § 212(1)
   of the Internal Revenue Code.
          The Tax Court found that Ray’s legal expenses relating to the first
   cause of action in Ray I, i.e., those incurred litigating to recover on Christina
   Ray’s debts to Ray for (1) the Sagaponack property purchase, (2) the
   Manhattan apartment purchase, (3) the charges to Ray’s credit-card
   accounts, and (4) the late financial statements, are not deductible as expenses
   for the production of income under § 212(1). On appeal, Ray argues that the
   Tax Court erred in finding against deductibility because each of the relevant
   debt instruments was an interest-bearing, income-producing asset to Ray.
   The Commissioner counters that none of the claims underlying the first
   cause of action in Ray I was a claim for the production or collection of income
   because “all of the debts were personal debts unrelated to the production of
   income.”
          Section 212(1) of the Internal Revenue Code allows taxpayers to
   deduct “all the ordinary and necessary expenses paid or incurred . . . for the
   production or collection of income.” I.R.C. § 212(1). Once again, the

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   Commissioner’s deficiency determination is “presumptively correct,” and
   the taxpayer bears the burden of demonstrating their entitlement to a
   deduction. Payne v. Comm’r, 224 F.3d 415, 420 (5th Cir. 2000); INDOPCO,
   503 U.S. at 84.
          The key inquiry for determining deductibility under § 212(1) is
   “whether the expenditures were made primarily in furtherance of a bona fide
   profit objective.” Westbrook v. Comm’r, 68 F.3d 868, 875 (5th Cir. 1995)
   (internal quotation marks omitted) (quoting Agro Sci. Co. v. Comm’r, 934
   F.2d 573, 576 (5th Cir. 1991)). “A deduction claimed under § 212(1) must
   meet the same requirements applicable to trade or business expenses under
   § 162, except that the person claiming the deduction need not be in the trade
   or business.” Green, 507 F.3d at 870 (internal quotation marks omitted)
   (quoting Simon v. Comm’r, 830 F.2d 499, 501 (3d Cir. 1987)).
          The origin-of-the-claim test applies to determine the deductibility of
   legal expenses under § 212(1) just as it applies to the deductibility of such
   expenses under § 162(a). Applying the origin-of-the-claim test, legal fees are
   considered personal expenses and thus not deductible under § 212(1) if the
   claims underlying the lawsuit are personal in nature. See Colvin v. Comm’r,
   122 F. App’x 788, 790 (5th Cir. 2005).
          In considering the Tax Court’s conclusion as to whether legal fees are
   deductible as expenses incurred for the production of income, we review the
   Tax Court’s factual finding regarding profit motive for clear error and its
   legal conclusions do novo. See Westbrook, 68 F.3d at 876; Colvin, 122 F.
   App’x at 790.
          We must decide whether the Tax Court clearly erred in finding that
   the origins of the claims underlying Ray’s litigation to recover on Christina
   Ray’s indebtedness were not related to the production or collection of
   income within the meaning of § 212(1). In determining whether Ray’s legal

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   expenses incurred litigating to recover on the principal of Christina Ray’s
   indebtedness are deductible under § 212(1), the key question is whether Ray
   entered into each of the following transactions “in furtherance of a bona fide
   profit objective,” Westbrook, 68 F.3d at 875: (1) Ray’s ownership and sale of
   the Sagaponack property; (2) Ray’s ownership and sale of the Manhattan
   apartment; (3) Ray’s arrangement with Christina Ray regarding the charges
   she incurred on his credit-card accounts; and (4) Ray’s agreement with
   Christina Ray for her to provide him with regular financial statements. We
   address each of these transactions in turn.
          Tax Court caselaw addressing the § 212 deductibility of expenses
   incurred in the maintenance and sale of properties distinguishes between
   personal residences and investment properties. See, e.g., Murphy v. Comm’r,
   66 T.C.M. (CCH) 32, *2 (1993) (stating that, in determining the § 212
   deductibility of property-related expenses, “if property has been acquired or
   used as the taxpayer’s personal residence, it must be converted to a use
   related to the production of income in order for the taxpayer to become
   entitled to deduct such losses and/or expenses”); Thomas v. Comm’r, 42
   T.C.M. (CCH) 496 (1981) (providing that the deductibility of property-
   related costs incurred prior to sale “depends upon whether the taxpayer has
   shown that a conversion of the property for the production of income has
   occurred”). A taxpayer can show that his property was converted from
   personal residential use to profit-producing use by demonstrating that he
   rented the property out to third parties or that, after converting the property
   from residential to investment use, he held the property and attempted to
   realize a profit from the appreciation in market value. Murphy, 66 T.C.M.
   (CCH) at *2 & n.7 (citing Newcombe v. Comm’r, 54 T.C. 1298, 1302 (1970)).
          The record shows that both the Sagaponack property and the
   Manhattan apartment were used by Ames and Christina Ray for residential
   purposes for the entire period prior to Ames’s sale of his interest in the

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   properties to Christina. Ames and Christina Ray jointly purchased the
   Sagaponack property for the purpose of building a vacation home on the land.
   Construction of this vacation home was ongoing at the time that Ray sold his
   interest in the land to his ex-wife. The record does not support clear error on
   the ground that Ames and Christina Ray rented the property or were holding
   the land for an investment rather than a residential purpose. Likewise, Ames
   and Christina Ray owned the Manhattan co-op shares for personal residential
   use for the full time period prior to Christina’s purchase of Ray’s interest in
   the shares. The record does not support clear error on the ground that Ray
   and Christina Ray rented the Manhattan apartment to third parties or ceased
   their residential use and held the property for investment purposes.
          The record also does not support clear error on the ground that Ray
   entered into the agreements with Christina regarding her personal charges to
   his credit-card accounts or the penalty for late financial statements with the
   primary motive of profiting from these arrangements. In a deposition in Ray
   I, Ray testified that he entered into the arrangement with respect to
   Christina’s credit-card charges because he and his ex-wife had identified
   charges that were solely Christina’s responsibility and they intended to
   further separate their finances. Ray also suggested in deposition testimony
   that he entered into the agreement for Christina Ray to provide him financial
   statements in order to obtain better assurance that she could repay him for
   her debts. All of these debt arrangements were thus personal rather than
   profit-motivated. None of the origins of the claims underlying Ray’s litigation
   to recover the principal amount of Christina Ray’s indebtedness is related to
   the production or collection of income.
          In his brief, Ray relies on Green, 507 F.3d at 870–71, where this court
   found that a taxpayer could deduct under § 212 expenses incurred attempting
   to recover on a judgment he was awarded in a wrongful termination lawsuit.
   Green is inapposite. In Green, the judgment stemmed from the taxpayer’s

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   wrongful termination and was primarily intended to compensate the taxpayer
   for his lost employment income. Green, 507 F.3d at 867–68. Here, as
   established, the transactions underlying Christina Ray’s indebtedness to
   Ames Ray were not profit-motivated or income-generating in nature.
          We next consider whether Ray’s legal expenses incurred litigating to
   recover the interest accrued on Christina Ray’s indebtedness are deductible
   under § 212(1). Ray cites Kelly v. Commissioner, 23 T.C. 682, 688 (1955),
   aff’d, 228 F.2d 512 (7th Cir. 1956), in which the Tax Court held that the
   portion of expenses attributable to the recovery of interest on a personal loan
   may be deducted as expenses incurred for the collection of income. Kelly, 23
   T.C. at 688–90; accord Young v. Comm’r, 113 T.C. 152, 157 (1999), aff’d, 240
   F.3d 369 (4th Cir. 2001). The Commissioner does not dispute this caselaw
   but argues that Ray has forfeited this argument because he did not raise it in
   the Tax Court.
          As previously discussed, an argument not raised before the trial court
   cannot be raised for the first time on appeal. XL Specialty Ins. Co., 513 F.3d at
   153 (citing Stokes, 217 F.3d at 358 n.19). For an argument to be preserved, it
   “must be raised to such a degree that the trial court may rule on it.” Id.
   (quoting In re Fairchild Aircraft Corp., 6 F.3d at 1128).
          Ray did not raise his Kelly argument before the Tax Court, and barely
   argued for the § 212 deductibility of his legal expenses in his pre-trial and
   post-trial briefing. This argument, then, was not raised to such a degree that
   the Tax Court could have ruled on it. Ray has thus failed to preserve any
   argument he might have that the portion of his legal fees attributable to his
   efforts to recover the interest on his ex-wife’s indebtedness is deductible
   under § 212(1).

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                                             V.
           The Tax Court found Ray liable for an accuracy-related penalty under
   Internal Revenue Code § 6662, which imposes a 20 percent penalty on tax
   underpayments attributable to the taxpayer’s “[n]egligence or disregard of
   rules or regulations” or “substantial understatement of income tax.” I.R.C.
   §§ 6662(a), (b)(1), (b)(2). 2 Because the Tax Court found that Ray could
   deduct his trading agreement loss-related legal expenses under § 212, the
   computation adopted by the Tax Court did not impose a penalty on any
   underpayment attributable to legal expenses concerning the trading
   agreement losses, which Ray was allowed to deduct under § 212. But the Tax
   Court did impose a penalty on Ray’s underpayment attributable to (1) the
   difference in the amounts Ray would be allowed to deduct for legal expenses
   for the trading agreement losses if they were deductible under § 162(a) rather
   than § 212, and (2) Ray’s deduction of his legal expenses relating to his
   litigation to recover on his ex-wife’s indebtedness.
           On appeal, Ray argues that the Tax Court erred in finding him liable
   for an accuracy-related penalty because he is entitled to both a “reasonable
   cause and good faith” defense and a “substantial authority” defense to the
   imposition of the penalty. The Commissioner responds that Ray has failed to
   meet his burden of proving these defenses. We address Ray’s entitlement to
   each of these asserted defenses in turn.
                                             A.
           An accuracy-related penalty does not apply to any portion of a
   taxpayer’s underpayment for which the taxpayer had “reasonable cause”

           2
            An understatement of income tax is substantial if the amount of understatement
   exceeds the greater of 10 percent of the taxpayer’s total tax liability or $5,000. I.R.C.
   § 6662(d)(1)(A).

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   and acted in good faith. I.R.C. § 6664(c)(1). The taxpayer bears the burden
   of proving entitlement to the reasonable cause and good faith defense.
   Klamath Strategic Inv. Fund v. United States, 568 F.3d 537, 548 (5th Cir.
   2009); accord Brinkley, 808 F.3d at 668. The assessment of whether the
   taxpayer has met this burden is “made on a case-by-case basis, taking into
   account all pertinent facts and circumstances.” Treas. Reg. § 1.6664-4(b)(1);
   Brinkley, 808 F.3d at 669. “Circumstances that may indicate reasonable
   cause and good faith include an honest misunderstanding of fact or law that
   is reasonable in light of all of the facts and circumstances, including the
   experience, knowledge, and education of the taxpayer.” Treas. Reg. §
   1.6664-4(b)(1). “The most important factor[,]” however, “is the extent of
   the taxpayer’s effort to assess his proper liability in light of all the
   circumstances.” Klamath, 568 F.3d at 548. The Tax Court’s determinations
   regarding the taxpayer’s eligibility for a reasonable cause and good faith
   defense are factual findings reviewed for clear error. Sun v. Comm’r, 880 F.3d
   173, 181 (5th Cir. 2018).
          The Tax Court found that Ray failed to carry his burden of proving his
   entitlement to the reasonable cause and good faith defense because (1) Ray’s
   reliance on the 1997 stipulated Tax Court decision was unreasonable, as the
   stipulated decision “does not state or give rise to an inference that petitioner
   was involved in a computer programming business as he claims here”; and
   (2) Ray’s argument that he made a mistake of law as to the applicability of
   § 162(a) versus § 212 was meritless because Ray never conceded in the Tax
   Court proceedings that “he was not engaged in a trade or business or even
   argue[d] in the alternative that he may only be entitled to a section 212
   deduction.”
          On appeal, Ray again contends that he reasonably relied on the
   stipulated Tax Court decision in deducting his legal expenses under § 162(a).
   The Commissioner argues that Ray could not have reasonably relied on the

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   stipulated decision because he was aware of the circumstances surrounding
   its adoption by the Tax Court and that it was the result of a settlement, he
   did not present evidence showing that he took any steps to confirm its
   applicability to his 2014 taxes, and the loss claimed in the prior Tax Court
   proceeding related solely to the trading agreement losses and not to Christina
   Ray’s indebtedness.
           The Commissioner is correct that the stipulated Tax Court decision
   related solely to Ray’s trading agreement losses and not to Christina Ray’s
   indebtedness. As discussed, Ray has failed to show that the claims underlying
   his first cause of action in Ray I are related to the trading agreement venture.
   However, the 1997 stipulated Tax Court decision is related to the
   characterization of the trading agreement losses, which implicates the
   portion of the accuracy-related penalty that was imposed on the difference in
   the amounts Ray would be allowed to deduct for the relevant legal expenses
   if they were deductible under § 162(a) rather than § 212. Given the IRS’s
   prior position regarding Ray’s trading agreement venture, and considering
   the particular facts and circumstances of this case, it was reasonable for Ray
   to have relied upon the stipulated decision in assessing whether his legal
   expenses could be deducted under § 162(a) as a Schedule C business loss. We
   conclude that Ray is entitled to a reasonable cause and good faith defense for
   his understatement attributable to deducting his trading agreement legal fees
   under § 162(a) rather than § 212. 3
                                              VI.
           For the foregoing reasons, we AFFIRM the Tax Court’s decision,
   with the exception of the penalty attributable to the difference in the amounts

           3
             In light of this ruling, we do not reach the issue of whether Ray is entitled to a
   substantial authority defense.

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                                  No. 20-60004

   Ray would be allowed to deduct for legal expenses for the trading agreement
   losses under § 162(a) rather than § 212. As to this exception, we VACATE
   and REMAND for entry of judgment consistent with this opinion.

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                                   No. 20-60004

   James L. Dennis, Circuit Judge, dissenting in part:
          I concur in Parts I through IV of the majority opinion. However, I
   respectfully dissent from Part V because, in my view, the Tax Court did not
   clearly err in finding that Ray was not entitled to the reasonable cause and
   good faith defense.    The Tax Court’s determinations that Ray lacked
   reasonable cause and was not acting in good faith are factual findings subject
   to clear error review. Green v. Comm’r, 507 F.3d 857, 871 (5th Cir. 2007).
   “Clear error exists when this court is left with the definite and firm
   conviction that a mistake has been made.” Id. at 866. Whether a taxpayer
   has proven his or her entitlement to the reasonable cause and good faith
   defense is a fact-intensive inquiry that is “made on a case-by-case basis,
   taking into account all pertinent facts and circumstances.” Treas. Reg.
   § 1.6664-4(b)(1). Reviewing the record in light of the applicable law and our
   deferential standard of review, I am not “left with the definite and firm
   conviction that a mistake has been made.” See Green, 507 F.3d at 866.
   Because I would affirm fully the Tax Court’s decision, I dissent from Part V
   of the majority opinion.

                                        25