                         T.C. Summary Opinion 2012-73



                         UNITED STATES TAX COURT



  W.T. BRAMLETT II, a.k.a. WILLIAM T. BRAMLETT II AND MELINDA H.
           BRAMLETT, a.k.a. M.H. BRAMLETT, Petitioners v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 13639-10S.                          Filed July 25, 2012.



      W.T. Bramlett II and Melinda H. Bramlett, pro sese.

      Horace Crump, for respondent.



                              SUMMARY OPINION


      MARVEL, Judge: This case was heard pursuant to the provisions of section

7463.1 Pursuant to section 7463(b), the decision to be entered is not reviewable by



      1
        Unless otherwise indicated, section references are to the Internal Revenue
Code (Code), as amended and in effect for the year at issue, and Rule references are
to the Tax Court Rules of Practice and Procedure.
                                         -2-

any other court, and this opinion shall not be treated as precedent for any other

case.

        Respondent determined a deficiency of $30,274 in petitioners’ Federal

income tax and an accuracy-related penalty under section 6662(a) of $6,054.80 for

2007. After concessions,2 the issues for decision are: (1) whether petitioners are

entitled to business expense deductions claimed on their 2007 Schedule C, and (2)

whether petitioners are liable for the accuracy-related penalty under section 6662(a).

As a threshold matter, we must decide whether W.T. Bramlett II (petitioner)

commenced a trade or business during 2007.3 We hold that he did not.

                                     Background

        Some of the facts have been stipulated. The stipulated facts are incorporated

in our findings by this reference. Petitioners resided in Mississippi when they filed

their petition.




        2
       As described infra p. 9, after their Tax Court case for the year 2006 was
resolved, petitioners submitted to the Court an amended return for 2007 showing a
smaller net loss on their Schedule C, Profit or Loss From Business. We shall treat
the amended return as petitioners’ concession of the amounts of various Schedule C
deductions.
        3
       Petitioners filed a joint Federal income tax return for 2007. Mrs. Bramlett
did not participate in Mr. Bramlett’s activities at issue in this case.
                                         -3-

I.    Petitioner’s Schedule C Activities

      The adjustments in this case arise from petitioner’s alleged business activities.

Petitioner is a graduate of the U.S. Naval Academy and holds a master of science

degree in mechanical engineering from the Naval Postgraduate School and a master

in business administration degree from the University of Southern Mississippi.

Petitioner started flying aircraft in 1993, after retiring from the U.S. Navy. During

2007 he was employed by Northrop Grumman Ship Systems.

      Since the 1990s petitioner has engaged in a variety of activities, most of

which relate to aviation. Although the 2007 Schedule C identifies his business as

“Will Bramlett Aerial Photography”,4 petitioner’s aviation activities have included

aerial photography and the sale of an airplane as well as efforts to build rental

hangars, acquire an airport, and become a dealer for two aircraft manufacturers. As

we describe below, in 2007 he was pursuing only some of these efforts.




      4
       Petitioners used TurboTax to prepare their 2006 and 2007 returns, and on the
2007 Schedule C, TurboTax filled in the business name field using the 2006
Schedule C. Petitioner credibly testified, and we find, that his activities were not
limited to aerial photography.
                                         -4-

      In approximately 1993 petitioner decided to build 22 rental hangars near the

Ocean Springs Airport (airport) in Ocean Springs, Mississippi.5 Because petitioner

needed the land on which to build the hangars, in late 1993 he acquired lots adjacent

to the airport (collectively, property) from four different owners. The property was

zoned for residential use, and petitioner’s request to change the zoning was

unsuccessful. Consequently, he was unable to proceed with the hangar project.

Petitioner continues to own the property and has been seeking alternative ways to

develop it until he obtains a zoning change. For example, at some point he

unsuccessfully attempted to build a hangar that would be a residence for flight

instructors.

      In 1998 or 1999 petitioner decided to submit an application to become a

certified dealer and open a service center for Cessna.6 To do so, he, together with

the airport owners, applied for and obtained from the U.S. Department of

Transportation Federal Aviation Administration (FAA) a repair station certificate

with limited radio, limited airframe, and limited instrument ratings. The certificate

was issued in the business name “Ocean Springs Avionics”. In the meantime,

      5
       The airport had a 3,500-foot runway suitable for single-engine and twin-
engine propeller planes.
      6
       We infer from the record that Cessna is an airplane manufacturing
corporation.
                                         -5-

however, Cessna increased dealership capital requirements from $250,000 to $2.5

million. Such a large investment was not feasible for petitioner, and he abandoned

the Cessna dealership project.

      At some point before 2007 petitioner investigated the process of becoming a

dealer for Quicksilver Manufacturing, Inc. (Quicksilver), a manufacturer of light

sport aircraft (LSA). Petitioner, who was familiar with the area demographics,

believed that a large number of local professionals could afford flight training and

airplane ownership. On a date that does not appear in the record, petitioner

approached Quicksilver, and on January 23, 2007, he received a reply email

generally describing a potential dealership territory and pricing.

      Because LSAs are small aircraft, the certification requirements were feasible

for petitioner. To become a certified dealer and open a repair station, petitioner had

to demonstrate to Quicksilver that he was able to manufacture an LSA within 60

days and that he had a facility and the ability to repetitively build LSAs. As a

preliminary step, in 2007 petitioner hired concrete companies and a smoother and

expanded a hangar that he owned. In April 2007 petitioner traveled to Florida to

attend an FAA repair certification course. Thereafter, during 2007 petitioner was

building a Quicksilver LSA as a demonstration model, and he completed it by
                                          -6-

January 31, 2008. As of the date of trial, petitioner’s LSA was in his hangar. It is

airworthy but did not undergo a test flight with the FAA.

      Until petitioner meets Quicksilver’s prerequisites, he may not operate a

certified manufacturing facility and may not manufacture LSAs for sale. In 2007

petitioner did not meet Quicksilver’s prerequisites. He also did not offer himself as

a certified repairman for profit or advertise his services.

      Although petitioner built a demonstration model of an LSA, after 2007 he

ceased his efforts to obtain certification because of unexpected changes in

circumstances. In 2008 the airport owner closed the flight school, laid off

employees, and put the airport up for sale. Petitioner organized a group of

individuals to buy the airport, but the group did not raise sufficient funds. After the

flight school closure, petitioner’s plan of opening an LSA dealership was no longer

viable.

      Starting in 2002, petitioner also engaged in an aerial photography activity,

although in 2007 he did not focus on it. Petitioner used his aerial photography skills

in his employment in shipbuilding for Northrop Grumman. Petitioner’s aerial

photographs helped Northrop Grumman produce evidence of ship construction

progress, identify Hurricane Katrina as the cause of a crack in a generator’s

stainless steel exhaust, and in 2003 plan facility expansion for more efficient
                                         -7-

shipbuilding. In addition, petitioner’s aerial photos allowed his team at Northrop

Grumman to be awarded contracts. In 2006 petitioner’s aerial photographs assisted

the vice president of engineering of Northrop Grumman in determining the

necessary height of the Ocean Springs Bridge and facilitated petitioner’s transfer to

Northrop Grumman’s engineering group.

      Petitioner did not invoice Northrop Grumman for the photographs and his

aerial photography services, but Northrop Grumman compensated him with higher

wages and bonuses. Petitioner’s special contributions in the course of his

employment led to increased compensation starting in 2003, and peaking in 2006,

when he transferred to the engineering group. Petitioner’s wages from Northrop

Grumman for 2007 were also positively affected by his use of the aerial

photography skills in his employment.7

      In addition, upon the U.S. Navy’s request, petitioner took aerial photographs

of homes destroyed by Hurricane Katrina.8 The local supervisor of shipbuilding

used those photographs to show the Secretary of the Navy the extent of the

hurricane damage during a helicopter tour.

      7
        It is not clear, however, what, if any, specific aerial photography projects
petitioner worked on in 2007.
      8
      The record does not reflect whether petitioner was paid for these aerial
photographs.
                                        -8-

      Petitioner maintained a bank account in the name of Will Bramlett Aerial

Photography that he used for paying all expenses related to his Schedule C

activities. Petitioner kept all such expense-related documents in boxes organized by

year. To protect documents from flooding after Hurricane Katrina, petitioner started

scanning critical documents and keeping paper documents in plastic containers. To

prepare his returns, petitioner entered each expense into a spreadsheet and assigned

each item an expense code.

II.   Procedural History

      Petitioners timely filed their joint 2007 Federal income tax return. They

attached a Schedule C for Will Bramlett Aerial Photography on which they reported

gross receipts of $10,700 and expenses totaling $111,489. The Schedule C gross

receipts were unrelated to aerial photography or the Quicksilver dealership project;

they were generated from the sale of a truck that petitioner had renovated.

Petitioners’ Schedule C reporting for other years was as follows:
                                           -9-

            Year                   Gross receipts              Schedule C net loss

            2002                         $150                      $61,088
            2003                           450                       67,643
                                       1
            2004                         2,200                       72,261
            2005                        1,175                        90,177
                                                                   2
            2006                        1,300                        83,066
            2007                      10,700                       100,789
            2008                          -0-                        53,132
            2009                          -0-                        34,564
      1
         Gross receipts for 2004 do not include receipts from a sale of an airplane
which petitioners reported separately. Petitioners do not explain the source of gross
receipts for the years other than 2007.
       2
         The loss for 2006 does not take into account the settlement described below.


      At some point after petitioners filed their 2007 return, respondent examined

their 2006 return and issued a notice of deficiency. Petitioners filed a petition with

the Tax Court, and subsequently the parties entered into a stipulated decision,

according to which petitioners were entitled to deduct a Schedule C loss of $70,769

(settlement for 2006). After the settlement for 2006 petitioners prepared an

amended return for 2007 and reported Schedule C expenses of $48,558 and a loss

of $37,858. Respondent did not process the amended return. We shall treat the

amended return for 2007 as petitioners’ concession as to the amounts of expense

deductions claimed.9


      9
          On the basis of the amended return introduced into the record, we deem
                                                                          (continued...)
                                       - 10 -

      In the notice of deficiency for 2007 respondent disallowed in full the claimed

Schedule C deductions of $111,489 on the ground that petitioner’s activity “does

not meet the guidelines of carrying on a trade or a business within the meaning of

the Internal Revenue Code Section 162”. Respondent also stated that petitioner

failed to establish that the expenses did not arise from his employment and




      9
        (...continued)
petitioners to concede that the Schedule C expenses in 2007 were as follows:

                      Expense                              Amount

           Car and truck                                   $2,010
           Depreciation and sec. 179
            expense deduction                              13,673
           Mortgage interest                                3,901
           Other interest                                     659
           Legal and professional services                  1,175
           Office                                           7,154
           Repairs and maintenance                          1,172
           Supplies                                         2,390
           Travel                                           2,259
           Deductible meals and entertainment                 650
           Utilities                                        1,791
           Other                                           11,724
            Total                                          48,558

According to the amended return, petitioners’ “Other” expenses consisted of plane
expenses of $5,864, computer equipment of $2,980, and plane equipment of $2,880.
                                        - 11 -

that “[i]f you do not carry on your business or investment activity to make a profit,

you can not use a loss from this activity to offset other income.”

                                      Discussion

I.    Burden of Proof

      Generally, the Commissioner’s determinations are presumed correct, and the

taxpayer ordinarily bears the burden of proving that those determinations are

erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Moreover,

deductions are a matter of legislative grace, and the taxpayer bears the burden of

proving that he is entitled to any deduction claimed. INDOPCO, Inc. v.

Commissioner, 503 U.S. 79, 84 (1992). However, the Commissioner bears the

burden of proof with respect to “any new matter, increases in deficiency, and

affirmative defenses, pleaded in the answer”.10 Rule 142(a)(1). In addition, section

7491(a)(1) may shift the burden to the Commissioner with respect to factual issues



      10
         On brief respondent states that petitioners’ expenses are not deductible
because they are startup expenditures under sec. 195. Respondent did not
specifically mention sec. 195 in the notice of deficiency, but his argument on brief is
consistent with the notice of deficiency and is not a new matter. See Wayne Bolt &
Nut Co. v. Commissioner, 93 T.C. 500, 507 (1989) (“A new theory that is presented
to sustain a deficiency is treated as a new matter when it either alters the original
deficiency or requires the presentation of different evidence. * * * A new theory
which merely clarifies or develops the original determination is not a new matter in
respect of which respondent bears the burden of proof.”); see also Shea v.
Commissioner, 112 T.C. 183, 191-197 (1999).
                                        - 12 -

if the requirements of section 7491(a)(2) are met. Petitioners do not contend that

section 7491(a) shifts the burden of proof to respondent, and the record does not

permit us to conclude that the requirements of section 7491(a)(2) are met.

Accordingly, petitioners bear the burden of proving that they are entitled to the

claimed deductions.

II.   Schedule C Deductions

      Respondent contends that petitioner’s Schedule C activity was not an activity

engaged in for profit under section 183. In the alternative, respondent contends that

petitioner’s Schedule C expenses are nondeductible startup expenses.

      Generally, section 162 allows a deduction for all ordinary and necessary

expenses paid or incurred during the taxable year in carrying on any trade or

business. We examine all of the facts and circumstances to decide whether the

taxpayer’s activities constitute the carrying on of a trade or business. Commissioner

v. Groetzinger, 480 U.S. 23, 36 (1987). The taxpayer’s trade or business must be

functioning as a business when the expenses are paid or incurred, and those

expenses must be directly connected with or pertain to that business. Hardy v.

Commissioner, 93 T.C. 684, 687 (1989), aff’d in part, remanded in part per order

(10th Cir. Oct. 29, 1990); sec. 1.162-1(a), Income Tax Regs. “A taxpayer
                                         - 13 -

is not carrying on a trade or business under section 162(a) until the business is

functioning as a going concern and performing the activities for which it was

organized.” Glotov v. Commissioner, T.C. Memo. 2007-147. The taxpayer’s

activity need not have generated revenue but “‘it must nonetheless have started to

function in a particular and identifiable line of work.’” Bailey v. Commissioner,

T.C. Memo. 2012-96 (quoting Weaver v. Commissioner, T.C. Memo. 2004-108).

      Until the business starts operating as a going concern, expenses related to that

activity are not ordinary and necessary expenses currently deductible under section

162 but rather are startup or preopening expenses. Hardy v. Commissioner, 93 T.C.

at 687-688. The Code defines startup expenditures as any amount paid or incurred

in connection with investigating the creation or acquisition of an active trade or

business, creating an active trade or business, or any activity engaged in for profit

and for the production of income before the day on which the active trade or

business begins, in anticipation of the activity’s becoming an active trade or

business and which, if paid or incurred in connection with the operation of an

existing active trade or business would be allowable as a deduction for the taxable

year in which paid or incurred. Sec. 195(c).
                                        - 14 -

      Cost recovery of startup expenditures is governed by section 195. Section

195(a) provides that, except as described therein, no deduction is allowed for

startup expenditures. Under section 195(b) a taxpayer may elect to amortize startup

expenditures beginning with the month in which the active trade or business

begins.11 Because the amortization period starts when the active trade or business

begins, see sec. 195(b)(1), no deduction is allowed with respect to items incident to

a trade or business which the taxpayer does not commence, see H.R. Rept. No. 96-

1278, at 12-13 (1980), 1980-2 C.B. 709, 713-714. We must decide whether

petitioner completed the startup phase and became actively engaged in a trade or

business during 2007.

      As a preliminary matter, we note that petitioner treated all his activities as

one, having filed one Schedule C, and respondent does not distinguish among

petitioner’s activities for purposes of his section 195 argument. However, during




      11
        Even in the absence of an election, under sec. 1.195-1(b), (d), Income Tax
Regs. (as revised in 2011), a taxpayer might be entitled to sec. 195 amortization of
expenses incurred after October 22, 2004, because the taxpayer is deemed to have
made such an election. This regulation applies to expenses paid or incurred after
October 22, 2004, provided the applicable limitations period has not expired for the
year the election under sec. 195 is deemed made. Sec. 1.195-1(d), Income Tax
Regs.
                                         - 15 -

2007 petitioner’s activities included (1) the activity of attempting to become a

Quicksilver dealer, and (2) the aerial photography activity.12

      We first address the Quicksilver dealership project. Although we found

petitioner’s testimony to be credible, it established that he did not complete the

startup phase and was not actively engaged in a Quicksilver dealership business

when he incurred the expenses. During 2007 petitioner expanded his hangar,

attended an FAA course, communicated with Quicksilver regarding his interest, and

was in the process of building a demonstration model. However, petitioner did not

finish the demonstration model until January 2008 and did not manufacture any

LSAs for sale. He did not advertise his services or products and did not hold

himself out as a dealer or repairman for Quicksilver. We conclude that in 2007

petitioner did not commence the business of being a Quicksilver dealer, for which

he was preparing. Accordingly, petitioner’s expenses related to the Quicksilver

project were not paid or incurred in the course of an active trade or business. Even

if petitioner’s expenses related to the Quicksilver dealership project did qualify as

startup expenditures, the amortization period did not commence, and petitioner




      12
         All gross receipts in 2007 derived from the sale of a truck, and neither
activity generated sales.
                                         - 16 -

may not amortize those expenditures.13 We therefore sustain respondent’s

determination disallowing deductions related to the Quicksilver dealership

project.

      We now consider petitioner’s aerial photography activity. Petitioner credibly

testified that he had engaged in aerial photography for several years before 2007 and

described a number of completed projects, most, if not all, of which were for

Northrop Grumman.14 We therefore find that his aerial photography activity passed

the startup stage before 2007. However, petitioner did not establish what aerial

photography projects, if any, he worked on during 2007 and what business activity

related to the aerial photography activity he engaged in during 2007.

      Even if we were to assume that petitioner conducted aerial photography as a

business with requisite continuity and regularity, see Commissioner v. Groetzinger,

480 U.S. at 35, and that he engaged in it for profit, see sec. 183(a), the record does




      13
         The parties do not address the deductibility of the loss under sec. 165 as an
alternative ground. In any case, we find that as of the end of 2007 petitioner had not
abandoned his efforts to obtain a Quicksilver dealership, and therefore no deduction
for 2007 under sec. 165(a) is appropriate. Only the 2007 taxable year is before us,
and therefore we do not need to decide whether a sec. 165(a) deduction is
appropriate for another year.
      14
         Petitioner therefore should have reported expenses attributable to that
activity as unreimbursed employee expenses, rather than Schedule C expenses.
                                        - 17 -

not allow us to ascertain what portion of the total expenses related to the operation

of the aerial photography business in 2007 and whether those expenses meet the

requirements of section 162. As stated above, taxpayers may deduct ordinary and

necessary expenses paid or incurred during the taxable year in carrying on any trade

or business. Sec. 162. An expense is necessary if it is helpful or appropriate to the

taxpayer’s business. Welch v. Helvering, 290 U.S. at 113.

      Although petitioner introduced into the record a summary of the expenses that

he deducted, he did not present original records, nor did he explain what the

expenses were for. Most expenses, such as Home Depot expenses, appear to relate

to the Quicksilver dealership activity, and more specifically, to the hangar

expansion. As we stated above, those expenses are not deductible under section

195(a). Petitioner’s summary of expenses also suggests that he purchased photo

equipment and paid office expenses, but petitioner did not explain what specific

items he purchased and what the business purpose of each purchase was. Lastly,

petitioner claimed utility and mortgage interest expense deductions, but he
                                           - 18 -

presented no credible evidence that he maintained an office. We sustain

respondent’s determination disallowing the Schedule C deductions.15

       Petitioner also contends that the settlement for 2006 should have precedential

effect for 2007, namely that respondent should continue to recognize his business.

We consider each taxable year separately, and the Commissioner is not estopped

from asserting a different position for later years. See Rose v. Commissioner, 55

T.C. 28, 32 (1970). Accordingly, the parties’ settlement for 2006 does not affect or

control our conclusions in this case.

III.   Section 6662(a) Penalty

       In his brief respondent contends that petitioners are liable for the accuracy-

related penalty under section 6662(a) on the ground of negligence. Section 6662(a)

and (b)(1) authorizes the Commissioner to impose a 20% penalty on the portion of

an underpayment of income tax attributable to negligence or disregard of rules or

regulations. Negligence is defined as any failure to make a reasonable attempt to

comply with the provisions of the internal revenue laws. Sec. 6662(c); sec. 1.6662-

3(b)(1), Income Tax Regs. The term “disregard” includes any careless, reckless, or

intentional disregard. Sec. 6662(c); sec. 1.6662-3(b)(1) and (2), Income Tax Regs.

Disregard of rules or regulations is careless “if the taxpayer does not exercise


       15
            Because of our holding, we do not need to reach the sec. 183 issue.
                                         - 19 -

reasonable diligence to determine the correctness of a return position” and is

reckless if “the taxpayer makes little or no effort to determine whether a rule or

regulation exists, under circumstances which demonstrate a substantial deviation

from the standard of conduct that a reasonable person would observe.” Sec.

1.6662-3(b)(2), Income Tax Regs.; see also Neely v. Commissioner, 85 T.C. 934,

947 (1985).

      On the basis of petitioner’s testimony regarding his recordkeeping, which we

find credible, we find that he created and maintained a recordkeeping system and

organized records into a spreadsheet for return preparation. Petitioner attempted to

comply with the requirements for deducting business expenses under section 162

and to assess his and Mrs. Bramlett’s proper tax liability. We find that petitioners

were not negligent and did not disregard rules or regulations in believing that

petitioner’s expenses were deductible, in particular after respondent allowed

substantial deductions for similar items for 2006. Therefore, we hold that

petitioners are not liable for the section 6662(a) penalty.
                                        - 20 -

      We have considered all arguments raised by either party, and to the extent not

discussed, we find them to be irrelevant, moot, or without merit.

      To reflect the foregoing,


                                                       Decision will be entered under

                                                 Rule 155.
