                        T.C. Memo. 2015-117



                  UNITED STATES TAX COURT



         KURT ANTHONY STRODE, Petitioner v.
    COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket Nos. 1197-12, 17358-12.                  Filed June 25, 2015.



       On his 2008 and 2009 Federal income tax returns P reported
(1) significant wage income from full-time employment and (2)
business losses resulting from deductions claimed and, for 2009,
gross receipts reported, on Schedules C, Profit or Loss from Business.
R issued notices of deficiency for both tax years. In the notices R
determined that the activity allegedly generating the gross receipts
reported and the expenses underlying the deductions claimed on P’s
Schedules C had not been engaged in for profit. R further determined
that P had not adequately substantiated the expenses underlying
claimed deductions. R also determined I.R.C. sec. 6662(a) accuracy-
related penalties for both years. P contends that he engaged in his
Schedule C activity for profit and that he has adequately substantiated
his expenses.

      Held: P is liable for the deficiencies.

      Held, further, P is liable for the accuracy-related penalties.
                                         -2-

[*2] Douglas E. Klein, for petitioner.

      Willis B. Douglass, Eric M. Heller, and Jenny R. Casey, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


      WHERRY, Judge: Respondent determined the following deficiencies in

petitioner’s Federal income tax and consequent section 6662(a) accuracy-related

penalties:1

                  Determination          2008          2009
                   Deficiency         $24,213         $15,496
                   Penalty--
                    sec. 6662(a)          4,843         3,099

      The issues presented for decision are: (1) whether for 2008 and 2009 the

activity reported on petitioner’s Schedule C, Profit or Loss from Business, was an

activity not engaged in for profit within the meaning of section 183(c); (2) whether

and to what extent petitioner is entitled to the deductions claimed on his Schedules




      1
        Unless otherwise indicated, all section references are to the Internal
Revenue Code of 1986 (Code), as amended and in effect for the tax years at issue,
and all Rule references are to the Tax Court Rules of Practice and Procedure. We
round all amounts to the nearest dollar.
                                          -3-

[*3] C for 2008 and 2009; and (3) whether and to what extent petitioner is liable

for section 6662(a) accuracy-related penalties for the tax years at issue.

                                FINDINGS OF FACT

      Some of the facts and exhibits have been stipulated and are incorporated

herein by this reference. Petitioner Kurt Anthony Strode lived in California when

he filed his petitions.2 Petitioner neither appeared nor testified at the trial, and the

only evidence submitted at the trial consists of the stipulated facts and exhibits.


      2
        Respondent mailed separate notices of deficiency, and petitioner filed
separate petitions in this Court, for petitioner’s 2008 and 2009 tax years. For the
2008 tax year respondent mailed the notice on October 14, 2011, and petitioner
timely mailed his petition on January 6, 2012. See secs. 6213(a), 7502. The Court
assigned docket No. 1197-12 to that petition (2008 case). For the 2009 tax year,
respondent mailed the notice on April 19, 2012, and petitioner’s petition was
timely filed on July 9, 2012. See sec. 6213(a). The Court assigned docket No.
17358-12 to that petition (2009 case). We granted respondent’s motion to
consolidate the 2008 and 2009 cases on February 5, 2013.
       This Court previously issued an opinion in two consolidated cases involving
petitioner’s 2005 and 2007 tax years (earlier cases) and presenting facts and issues
nearly identical to those now before us. See Strode v. Commissioner, T.C. Memo.
2012-59, 103 T.C.M. (CCH) 1276 (2012). As to those tax years, we agreed with
the Commissioner that P had not shown Intcom was an activity engaged in for
profit; and because P reported no gross receipts for Intcom, we disallowed his
claimed deductions. Id., 103 T.C.M. (CCH) at 1279 & n.7. On November 9,
2012, petitioner appealed our decisions to the U.S. Court of Appeals for the Ninth
Circuit, which assigned the cases docket Nos. 12-73656 and 12-73657. Petitioner
thereafter sought and obtained three consecutive stays of appellate proceedings
pending our ruling in the 2008 and 2009 cases. On July 28, 2014, the stay was
lifted. The cases on appeal are now fully briefed but have not been set for
argument.
                                        -4-

[*4] During the tax years at issue petitioner worked at least 40 hours per week as

an attorney for and employee of Monarch HealthCare, A Medical Group, Inc.

(Monarch). The Court takes judicial notice of the State Bar of California’s records

reflecting that petitioner has been a member of the California Bar since December

1992.

        Petitioner filed Forms 1040, U.S. Individual Income Tax Return, for the

2008 and 2009 tax years. On each of those returns he reported salary income,

presumably from Monarch.3 With each return he also filed a Schedule C on which

he claimed deductions for expenses and, for 2009, reported limited gross receipts.

The Schedules C identified petitioner’s business activity as “International

Consulting” and the name of his business as “Intcom”. Intcom’s business address

is petitioner’s home address. For the 2003 through 2012 tax years petitioner

reported on his Forms 1040 (1) salary income, (2) gross income, expenses, and net

profit or loss from Intcom, and (3) adjusted gross income, as follows:




        3
      The copies of petitioner’s 2008 and 2009 income tax returns admitted into
evidence do not include Forms W-2, Wage and Tax Statement.
                                         -5-

                                       From Intcom
 [*5]         Salary                                                     Adjusted
 Year        income     Gross income Expenses Net profit (loss)        gross income
 2003       $125,741         ---         $35,263       ($35,263)          $91,988
 2004        135,527         ---          70,892        (70,892)            67,268
 2005        137,069         ---          80,345        (80,345)            62,217
 2006        133,527         ---          88,578        (88,578)            49,606
 2007        138,750         ---          84,240        (84,240)            59,501
 2008        159,229         ---          88,184        (88,184)            77,329
 2009        165,305      $5,000          91,808        (86,808)            94,710
 2010        172,779         ---          41,818        (41,818)            47,345
 2011        967,058         ---          44,071        (44,071)           926,849
 2012        219,103         ---          32,825        (32,825)           198,863
 Total      2,354,088       5,000        658,024       (653,024)         1,775,676

         Respondent examined petitioner’s 2008 and 2009 tax returns. In connection

with or during respondent’s examination of the 2008 return, petitioner sent

respondent a document entitled “ATTACHMENT: RESPONSES TO

QUESTIONS ON FORM 866-A [sic]”.4 In that document, petitioner claimed,

        4
       The Court admitted this document into evidence as Exhibit 40-P over
respondent’s objection because respondent conceded that a copy of the document
was in the Government’s administrative file. In addressing respondent’s hearsay
objection, we noted that the document need not be introduced for its truth but for
the purpose of proving its existence--i.e., that petitioner disputed respondent’s
proposed adjustments to his 2008 tax return in writing in the manner reflected in
the document. He introduced no evidence to corroborate the statements made in
                                                                         (continued...)
                                         -6-

[*6] inter alia, that Intcom provides services such as “[i]dentify[ing] potentially

lucrative business opportunities that will generate substantial income and profit

for IntCom and its clients”, “[d]etermin[ing] the best markets for your company’s

products through ISA and industrial analysis reports”, “[d]evelop[ing] an effective

marketing strategy for your product”, “[e]valuat[ing] international competition”,

“[i]dentify[ing] legal and regulatory issues”, “[l]ocat[ing] financing and

development [sic] projects that support manufacturing and promotion of

products”, and “[i]dentify[ing] programs (i.e. USAID, EXIM Bank, World Bank,

United Nations, etc.)”. This list also includes the entries “[n]egotiat[ing],

licens[ing], manufactur[ing], writ[ing] contracts, and settl[ing] trade disputes” and

“procurement and contract bid[ding]”.

      On subsequent pages, the document describes various business ventures in

which Intcom allegedly engaged from 2002 through 2008. The listed ventures,

which range from establishing a beauty salon (in 2005) to exploring the possibility

of importing “non-weapon military equipment” (in 2007) to exploring the

      4
        (...continued)
the document. We therefore treat the document as what it is: the embodiment of
petitioner’s claims concerning his Intcom activity. We give it less evidentiary
weight than we would oral trial testimony having identical content because it was
not subject to cross-examination and because the Court has had no opportunity, in
these cases or the earlier cases, to evaluate petitioner’s credibility. In both sets of
cases, he neither testified nor appeared for trial.
                                         -7-

[*7] feasibility of investing in real estate (in 2006, 2007, and 2008), were

generally sited in the Philippines or in Las Vegas and had nearly all been

abandoned.5 The document describes Intcom’s business plan as follows: “Engage

in international trade of U.S. companies into foreign markets, engage in

international trade of foreign companies into U.S. markets, and invest in

developing businesses in foreign markets all with the intent to produce income and

profit. Some projects have specific business plans or prospectus [sic].”

      For 2008 respondent determined that petitioner had not “establish[ed] that

the activity on Schedule C was engaged in for profit” and that the activity did “not

meet the guidelines of carrying on a trade or business within the meaning of

Internal Revenue Code Section 162”. Respondent therefore disallowed all of the

      5
        In his posttrial brief petitioner analogizes Intcom to Berkshire Hathaway,
one of the largest publicly traded companies in the world, whose controlling
shareholder and chairman, Warren Buffett, consistently ranks among the world’s
wealthiest people and has earned the moniker “The Sage of Omaha” for his
striking business investment acumen. Although we agree with petitioner that
Berkshire Hathaway operates as a conglomerate, holding significant stakes in
numerous other companies engaged in myriad lines of business, we do not think
petitioner’s comparison of Intcom to that company an apt one. From what little
evidence petitioner introduced, it appears that Intcom does not operate any
businesses. The only ventures not described as having been abandoned are its
ownership of an interest in a graphic design company headquartered in the
Philippines, possible establishment of a Filipino jewelry export business, and
alleged efforts to “determine the feasibility of establishing” a bakery to serve call
center workers and a REIT to invest in a real estate project, both in the
Philippines.
                                         -8-

[*8] deductions petitioner had claimed on his 2008 Schedule C, as there was no

gross income in that year from this activity.

      For 2009 respondent again determined that petitioner had not “establish[ed]

that the activity on Schedule C was engaged in for profit” and that he had in any

event not substantiated the expenses underlying his claimed deductions as actually

paid, ordinary, and necessary to his business or profession. In addition to

disallowing the deductions claimed on Schedule C, respondent moved petitioner’s

$5,000 of reported gross receipts from Intcom to his Form 1040 as “Other

Income”.

                                      OPINION

      As a general rule, the Commissioner’s determination of a taxpayer’s tax

liability is presumed correct, and the taxpayer bears the burden of proving that the

determination is improper. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115

(1933). No section 7491 or Rule 142 basis exists for deviating from the general

rule in these cases, so petitioner bears the burden of proof.

I.    Intcom’s For-Profit Status Under Section 183

      The Code divides the universe of a taxpayer’s activities into two groups:

those engaged in for profit and those not engaged in for profit. Generally,

expenses attributable to activities in the first group are deductible whereas
                                         -9-

[*9] expenses attributable to activities in the second group are deductible only to

the extent of the income they generate, subject to other limitations including those

on deductions for personal expenses. See sec. 183(c) (defining an activity not

engaged in for profit as “any activity other than one with respect to which

deductions are allowable for the taxable year under section 162 or under paragraph

(1) or (2) of section 212”).

      Thus, an individual taxpayer may deduct “ordinary and necessary expenses

paid or incurred during the taxable year * * * for the production or collection of

income”, sec. 212(1), “for the management, conservation, or maintenance of

property held for the production of income”, sec. 212(2), or “in carrying on any

trade or business”, sec. 162(a). But if the activity generating the expenses the

taxpayer seeks to deduct “is not engaged in for profit, no deduction attributable to

such activity shall be allowed”, except for (1) deductions that would be allowable

regardless of the taxpayer’s profit motive, and (2) “a deduction equal to the

amount of the deductions which would be allowable” if the taxpayer had a profit

motive, to the extent that his gross income derived from the activity exceeds the

deductions allowable regardless of profit motive. Sec. 183(a) and (b).

Respondent’s principal contention in these cases is that Intcom was an activity not

engaged in for profit, such that the foregoing section 183(a) restriction applies.
                                        - 10 -

[*10] Under our caselaw as well as that of the U.S. Court of Appeals for the Ninth

Circuit, the key element that distinguishes an activity engaged in for profit from

one not engaged in for profit is the taxpayer’s motive.6 An activity is engaged in

for profit if the taxpayer’s “predominant, primary, or principal objective” in

engaging in the activity is to realize an economic profit independent of tax

savings. See Wolf v. Commissioner, 4 F.3d 709, 713 (9th Cir. 1993), aff’g T.C.

Memo. 1991-212. An activity need not show a profit if the taxpayer has an actual

and honest objective of making one. See Dreicer v. Commissioner, 78 T.C. 642,

645 (1982), aff’d without published opinion, 702 F.2d 1205 (D.C. Cir. 1983). So

long as it is genuine, the taxpayer’s profit expectation need not even be

reasonable. See id. To ascertain a taxpayer’s motive, we conduct “a careful

analysis of all the surrounding objective facts, and greater weight is given to such

facts than to his mere statement of intent.” Id.

      The regulations under section 183 set forth a nonexclusive list of factors to

be considered in determining whether an activity is engaged in for profit. See sec.


      6
       This Court “follow[s] a Court of Appeals decision which is squarely in
point where appeal from our decision lies to that Court of Appeals and to that
court alone.” Golsen v. Commissioner, 54 T.C. 742, 757 (1970), aff’d, 445 F.2d
985 (10th Cir. 1971). When he filed his petition, petitioner lived in California, a
State within the Ninth Circuit, so we will follow decisions of that Court of
Appeals that are squarely in point. See sec. 7482(b)(1)(A).
                                          - 11 -

[*11] 1.183-2(b), Income Tax Regs. These factors are: (1) the manner in which

the taxpayer carries on the activity; (2) the taxpayer’s expertise or that of his or her

advisers; (3) the taxpayer’s time and effort expended on the activity; (4) the

expectation that assets used in the activity may appreciate in value; (5) the

taxpayer’s success in carrying on other similar or dissimilar activities; (6) the

activity’s history of income or losses; (7) the amount of occasional profits, if any,

from the activity; (8) the taxpayer’s financial status; and (9) the activity’s

elements, if any, of personal pleasure or recreation for the taxpayer.7 Id.

      7
        As he did in the earlier cases, petitioner in his posttrial brief challenges this
regulation’s validity. Petitioner’s myriad objections may be loosely classified as
challenges to the regulation’s validity either on its face or as applied. With regard
to the as-applied challenges, petitioner is tilting at windmills. There is no
evidence in the record that respondent applied the standards or took the actions
that petitioner claims he applied and did, and we will not adjudicate hypothetical
questions.
       As for the on-its-face challenges--to wit, petitioner’s contentions that sec.
1.183-2(b), Income Tax Regs., violates the Regulatory Flexibility Act (RFA), 5
U.S.C. secs. 601-612 (2012), the Administrative Procedure Act (APA), 5 U.S.C.
secs. 551-559, 701-706 (2012), and Chevron, U.S.A., Inc. v. Natural Res. Def.
Council, Inc., 467 U.S. 837 (1984)--we found them so patently meritless in the
earlier cases that we declined to even address them. Although the Court sees no
more merit in petitioner’s arguments on this round, that petitioner has raised them
again suggests he fails to see their flaws, so we will briefly note them.
       First, the RFA applies “only to rules for which a notice of proposed
rulemaking is issued on or after January 1, 1981”, see RFA, Pub. L. No. 96-354,
sec. 4, 94 Stat. at 1170, so the regulations under sec. 183, which were published
for notice and comment on August 19, 1971, see 36 Fed. Reg. 16112, 16117 (Aug.
19, 1971), and issued in final form on July 13, 1972, see 37 Fed. Reg. 13679,
                                                                            (continued...)
                                        - 12 -

[*12] This Court regularly analyzes the foregoing factors, among other facts and

circumstances, in cases in which the Commissioner challenges the taxpayer’s

claim of a profit motive, see, e.g., Metz v. Commissioner, T.C. Memo. 2015-54,


      7
        (...continued)
13683-13684 (July 13, 1972), cannot be subject to it. Second, petitioner contends
that the regulation violates the APA but has not alleged that in adopting the
regulation the Secretary failed to comply with any of the APA’s substantive
provisions, such as the notice-and-comment requirement. See generally 5 U.S.C.
sec. 553 (2012). To the extent that petitioner desires to invoke “the APA’s
omnibus judicial-review provision, which permits suit for violations of numerous
statutes of varying character that do not themselves include causes of action for
judicial review”, see Lexmark Int’l, Inc. v. Static Control Components, Inc., 572
U.S. ___, ___, 134 S. Ct. 1377, 1389 (2014), petitioner has not clearly identified
the statute he believes the Secretary has violated. He does assert that the
regulation is at odds with sec. 183(d) and/or sec. 162, and we agree that his
reading of the regulation does not align with those statutes. But petitioner’s
reading of the regulation is entirely without foundation in its text. The regulation
does not require proof of any actual profit to establish a profit motive, nor has
respondent taken the position that it does. Indeed, the regulation does not require
any particular form of proof at all. Rather, the regulation’s list of factors purports
to serve as no more than a guide. It cautions that “[n]o one factor is
determinative”, that the list of factors is nonexclusive, and that a determination
should not be made “on the basis that the number of factors * * * indicating a lack
of profit objective exceeds the number of factors indicating a profit objective, or
vice versa.” Sec. 1.183-2(b), Income Tax Regs. “[A]ll facts and circumstances
with respect to the activity are to be taken into account.” Id.
       Far from being arbitrary and capricious or contrary to law, the regulation
reflects a reasonable construction of secs. 162, 183, and 212 and provides helpful
guidance to taxpayers seeking to ascertain whether they may properly deduct
expenses associated with a particular activity. In any event, the factors listed in
the regulation were derived from caselaw, see Allen v. Commissioner, 72 T.C. 28,
33-34 (1979), so even if the regulation were invalid (which it is not), we would
consider the very same factors in deciding whether petitioner had a profit motive.
                                        - 13 -

[*13] at *3-*4; Shah v. Commissioner, T.C. Memo. 2015-31, at *25-*26; Savello

v. Commissioner, T.C. Memo. 2015-24, at *7-*9, and the Court of Appeals for the

Ninth Circuit has approved our application of the factors, see, e.g., Hill v.

Commissioner, 204 F.3d 1214, 1218 (9th Cir. 2000); Wolf v. Commissioner, 4

F.3d at 713; Carter v. Commissioner, 645 F.2d 784, 786-787 (9th Cir. 1981), aff’g

T.C. Memo. 1978-202. The regulation’s list of factors is nonexclusive, and “[n]o

one factor is determinative”. Sec. 1.183-2(b), Income Tax Regs. Further, we do

not simply tally up the factors that favor each party’s position. See id. Rather, we

take into account “all facts and circumstances with respect to the activity”,

assigning each fact or circumstance the weight appropriate to its overall context,

see id., in an effort to divine from these objective facts “‘the taxpayer’s subjective

intent’”, Wolf v. Commissioner, 4 F.3d at 713 (quoting Skeen v. Commissioner,

864 F.2d 93, 94 (9th Cir. 1989), aff’g Patin v. Commissioner, 88 T.C. 1086

(1987)).

      We apply these principles to ascertain whether in 2008 and 2009 Intcom

was an activity engaged in for profit.8 We conclude that it was not.

      8
       It is questionable whether Intcom, writ large, is the proper focus for our
analysis. Petitioner listed only one activity (Intcom) on his Schedules C, but he
claims that Intcom has explored, and in some cases launched, a wide variety of
business ventures. Under sec. 1.183-1(d)(1), Income Tax Regs., for purposes of
                                                                       (continued...)
                                        - 14 -

[*14] A.     The Manner in Which the Taxpayer Carries On the Activity

      “The fact that the taxpayer carries on the activity in a businesslike manner

* * * may indicate that the activity is engaged in for profit.” Sec. 1.183-2(b)(1),

Income Tax Regs. “What is relevant is whether * * * [the taxpayer] maintained

      8
        (...continued)
ascertaining whether a taxpayer has a profit motive, “where the taxpayer is
engaged in several undertakings, each of these may be a separate activity, or
several undertakings may constitute one activity.”
       The Court must consider all facts and circumstances to determine whether a
taxpayer’s separate undertakings constitute one activity for purposes of sec. 183.
Id. These include “the degree of organizational and economic interrelationship of
various undertakings, the business purpose * * * served by carrying on the various
undertakings separately or together * * * and the similarity of various
undertakings.” Id. We also consider, inter alia: (1) “[w]hether the undertakings
are conducted at the same place”; (2) “whether the undertakings were formed as
separate businesses”; (3) “whether one undertaking benefited from the other”; (4)
“the degree to which the undertakings shared management”; (5) “the degree to
which one caretaker oversaw the assets of both undertakings”; (6) “whether the
taxpayer used the same accountant for the undertakings”; and (7) “the degree to
which the undertakings shared books and records”. See Mitchell v.
Commissioner, T.C. Memo. 2006-145, 92 T.C.M. (CCH) 17, 19 (2006).
       Petitioner’s claims regarding Intcom’s activities suggest that these activities
should not be analyzed in the aggregate. Facts weighing against aggregation
include: that there was no apparent organizational or economic interrelationship
among its activities; that carrying on such a range of dissimilar activities served no
evident business purpose; that none of Intcom’s activities appears to have
benefited from any other activity; and that there is no evidence the undertakings
maintained books and records, let alone that these books and records were shared.
Facts weighing in favor of aggregation include: that Intcom’s activities were
largely conducted in two locations, the Philippines and Las Vegas, and that the
activities allegedly shared management. Although the relevant factors thus weigh
heavily in favor of disaggregation, because we would reach the same ultimate
conclusion regardless, we analyze Intcom’s activities in the aggregate.
                                         - 15 -

[*15] complete and accurate books and records, whether the activity was

conducted in a manner substantially similar to other comparable businesses which

are profitable, and whether changes were attempted in order to improve

profitability.” Engdahl v. Commissioner, 72 T.C. 659, 666-667 (1979).

      Petitioner claims that “[r]ecords are kept” and that “[s]ome” of Intcom’s

ventures “have specific business plans and or prospectus.” Except for petitioner’s

Schedules C, which are part of his Federal income tax returns, the record contains

no evidence that petitioner prepared any budgets, profit or loss statements, balance

sheets, or other financial analyses for Intcom, and no evidence that he maintained

any books of accounting for Intcom as a whole or for any of its various ventures.

The only business plan petitioner offered into evidence consists of a vaguely

worded sentence fragment in a document he prepared in connection with the audit

of his 2008 return. Cf., e.g., McMillan v. Commissioner, T.C. Memo. 2013-40, at

*12 (noting that, although the taxpayer claimed to have a written business plan,

she “did not present it at trial and did not attempt to orally explain her business

plan during the trial”).

      Although petitioner compares Intcom to the famously profitable

conglomerate Berkshire Hathaway, this comparison does not survive even

superficial scrutiny, see supra note 5; and even if it did, petitioner has not
                                       - 16 -

[*16] established that Intcom and Berkshire Hathaway conduct their activities in a

“substantially similar” manner. Petitioner further asserts that he “[a]bandoned

unsuccessful projects”, but there is no evidence that he changed his investment

methodology or business practices in response to these failures.

      In sum, the record is devoid of the usual indicators of businesslike activity.

The evidence that is in the record--a hodgepodge of receipts, credit card

statements, invoices, and bills, none of which bears any clear relationship to

Intcom’s alleged operations and all of which could as easily represent personal

expenditures--is not indicative of a commercial venture. Cf., e.g., Metz v.

Commissioner, at *27-*32 (describing how taxpayers “used Quickbooks for

bookkeeping and hired a CPA firm to perform monthly bank reconciliations,

accounts-payable listings, [and] monthly profit-and-loss statements”, hired legal

counsel to prepare standard contracts, prepared annual written business plans, and

extensively advertised and promoted their business). As a result, this factor favors

respondent.

      B.      The Taxpayer’s Expertise or That of His Advisers

      “Preparation for the activity by extensive study of its accepted business,

economic, and scientific practices, or consultation with those who are expert

therein, may indicate that the taxpayer has a profit motive where the taxpayer
                                        - 17 -

[*17] carries on the activity in accordance with such practices.” Sec. 1.183-

2(b)(2), Income Tax Regs. Although “a taxpayer need not make a formal market

study”, he “should undertake a basic investigation of the factors that would affect

profit”. See Westbrook v. Commissioner, T.C. Memo. 1993-634, 66 T.C.M.

(CCH) 1823, 1827 (1993), aff’d, 68 F.3d 868 (5th Cir. 1995); see also Burger v.

Commissioner, T.C. Memo. 1985-523, 50 T.C.M. (CCH) 1266, 1271 (1985)

(finding that taxpayers who “undertook the activity with no concept of what their

ultimate costs might be, how they might operate at the greatest cost efficiency,

how much revenues they could expect, or what risks could impair the generation

of revenues” did not “operate in a businesslike manner”), aff’d, 809 F.2d 355 (7th

Cir. 1987).

      Petitioner works full time as an attorney at a health care company. He

claims that Intcom has an “experienced and seasoned international management

team” and that it works with, inter alia, “[d]iplomats, U.S. Attaché [sic], U.S.

embassies, foreign consulates, trade organizations, trade delegating [sic],

international trade shows, and various other resources within the United States and

abroad.”9 These generalized assertions carry little weight. Petitioner has offered

      9
        In his posttrial brief petitioner makes additional claims concerning, among
other things, his own experience and background and the identities of agencies
                                                                        (continued...)
                                       - 18 -

[*18] no evidence of the qualifications of his alleged management team, nor

evidence that he himself possesses expertise relevant to, e.g., launching startup

businesses, operating a bakery, importing military hardware, or investing in real

estate--all of which Intcom allegedly did or attempted to do.

      Petitioner contends that he “retained consultants with the necessary

expertise to identify lucrative opportunities and advise on abandoning projects that

m[a]y not generate profits.” The evidence he provided to substantiate Intcom’s

claimed contract labor expenses consists entirely of receipts for and records of

money transfers to a single individual, Avigel Hernandez. On two of the Western

Union money transfer forms in the record, petitioner identified Ms. Hernandez as

his “girlfriend”. The record does not establish Ms. Hernandez’s role in Intcom,

her qualifications as an international business consultant, or what services she

performed for Intcom.

      Petitioner’s monthly summary sheet included as an aspect of his

substantiation evidence for September 2008 lists “Lunch at Traders with


      9
       (...continued)
with whom he allegedly consulted before launching Intcom’s various ventures.
“Statements in briefs * * * do not constitute evidence and cannot be used as such
to supplement the record.” Niedringhaus v. Commissioner, 99 T.C. 202, 214 n.7
(1992); see also Rule 143(c). We disregard all factual assertions not supported by
the evidence in the record.
                                        - 19 -

[*19] consultant G. Ferrer et al. discuss various legal/business matters.” Other

monthly summary sheets list expenses exceeding $25 for gifts of clothing to G.

Ferrer and “Nichibei Anime - gift to G. Ferrer” for January 2008 and April 2009,

respectively. As with Ms. Hernandez, petitioner has not, by the mere note “Client

Development”, established G. Ferrer’s role or qualifications or what services he or

she performed for Intcom. Otherwise, the record does not disclose the existence,

identity, or qualifications of any other “consultant”.

      Furthermore, petitioner has not shown that, on the front end, he took any

steps to investigate the factors that would affect the profitability of each new

venture. Nor has he established that, on the back end, he explored the reasons for

a venture’s failure and sought to learn from it so as to bring an end to Intcom’s

string of annual losses. Cf. Metz v. Commissioner, at *44 (“[K]nowledge of the

activity itself apart from its economics is not enough to clear the hurdle: A

taxpayer must demonstrate expertise and attempts to improve results in a money-

losing business.”). Thus, this factor favors respondent.

      C.     The Taxpayer’s Time and Effort Expended on the Activity

      “[T]hat the taxpayer devotes much of his personal time and effort to

carrying on an activity, particularly if the activity does not have substantial

personal or recreational aspects,” or withdraws “from another occupation to
                                       - 20 -

[*20] devote most of his energies to the activity” “may indicate an intention to

derive a profit.” Sec. 1.183-2(b)(3), Income Tax Regs.

      Petitioner had a full-time attorney job during the tax years at issue. In the

document he submitted to respondent objecting to respondent’s adjustments to his

2008 tax return, he claimed that he spent 10-20 hours per week on Intcom during

2008. In his posttrial brief he asserts that he devoted “on average approximately

30 hours per week”. Petitioner introduced no evidence to corroborate either

number. Although the evidence does show that petitioner traveled to the

Philippines, he did not elaborate on the nature of his activities there and how they

related to Intcom’s profitability. Cf. Mitchell v. Commissioner, T.C. Memo. 2001-

269, 82 T.C.M. (CCH) 732, 736 (2001) (finding this factor neutral where the

taxpayer “worked on the farm 750 to 2,000 hours per year” but “did not explain

how the work he performed there related to making a profit”).

      A taxpayer need not personally devote substantial time to an activity if “the

taxpayer employs competent and qualified persons to carry on such activity.” Sec.

1.183-2(b)(3), Income Tax Regs. As noted above, petitioner introduced evidence

of money transfers to his girlfriend, Ms. Hernandez, allegedly as payments for

contract labor in connection with Intcom, but there is no evidence of what she did,

let alone whether she was competent and qualified. The record is similarly devoid
                                        - 21 -

[*21] of evidence showing the competence or qualifications of any other alleged

Intcom consultant or employee. This factor favors respondent.

      D.     The Expectation That Assets Used in the Activity May Appreciate in
             Value

      The term “profit” encompasses appreciation in the value of assets,
      such as land, used in the activity. Thus, the taxpayer may intend to
      derive a profit from the operation of the activity, and may also intend
      that, even if no profit from current operations is derived, an overall
      profit will result when appreciation in the value of land used in the
      activity is realized since income from the activity together with the
      appreciation of land will exceed expenses of operation. * * * [Sec.
      1.183-2(b)(4), Income Tax Regs.]

      Petitioner contends that Intcom “[t]ook [an] equity position as payment for

present and future services” to a graphic design company allegedly launched in

2005, and that as of 2008 he continued to own stock in the company, was on the

board of directors, and acted as its legal counsel. He did not introduce evidence

that he was paid for his services or that the stock had increased in value since its

acquisition or was likely to do so in future. Cf. McMillan v. Commissioner, at *17

(where the taxpayer argued that she believed her activity’s “only significant asset”

would appreciate in value, but objective facts indicated this belief was wholly

unfounded, finding that this factor weighed in favor of respondent). The record

contains no other evidence concerning any assets used in Intcom’s activities, the
                                        - 22 -

[*22] appreciation of which might offset or exceed the continual losses from its

operation. This factor is neutral.

      E.     The Taxpayer’s Success in Carrying On Other Similar or Dissimilar
             Activities

      “[T]hat the taxpayer has engaged in similar activities in the past and

converted them from unprofitable to profitable enterprises may indicate that he is

engaged in the present activity for profit, even though the activity is presently

unprofitable.” Sec. 1.183-2(b)(5), Income Tax Regs.

      Aside from his involvement in Intcom, petitioner works full time as an

attorney for Monarch. He earns substantial wage income, from which we infer

that he has proven at least reasonably successful in that role. In our opinion in the

earlier cases, we noted that petitioner had “apparently successfully run and

operated a legal practice, some elements of which may be similar to Intcom’s

needs.” See Strode v. Commissioner, T.C. Memo. 2012-59, 103 T.C.M. (CCH)

1276, 1278 (2012). He has not, however, introduced evidence that he has ever

converted any enterprise from unprofitable to profitable or that he conducts

Intcom in a manner similar to legal work. Cf. Gardner v. Commissioner, T.C.

Memo. 2014-148, at *57 (where the taxpayer had also engaged successfully in

“real estate and insurance” activities but “introduced little evidence as to the
                                        - 23 -

[*23] manner in which he conducted these businesses”, finding this factor neutral).

This factor is neutral.

      F.     The Activity’s History of Income or Losses

      With respect to this factor, section 1.183-2(b)(6), Income Tax Regs.,

provides as follows:

      A series of losses during the initial or start-up stage of an activity may
      not necessarily be an indication that the activity is not engaged in for
      profit. However, where losses continue to be sustained beyond the
      period which customarily is necessary to bring the operation to
      profitable status such continued losses, if not explainable, as due to
      customary business risks or reverses, may be indicative that the
      activity is not being engaged in for profit. If losses are sustained
      because of unforeseen or fortuitous circumstances which are beyond
      the control of the taxpayer, such as drought, disease, fire, theft,
      weather damages, other involuntary conversions, or depressed market
      conditions, such losses would not be an indication that the activity is
      not engaged in for profit. A series of years in which net income was
      realized would of course be strong evidence that the activity is
      engaged in for profit.

      Petitioner has filed Schedules C for Intcom since at least 2003, so the

activity was in at least its sixth and seventh years during the years at issue. While

it is plausible that the “start-up stage” for an international consulting business

might embrace these years, cf., e.g., Engdahl v. Commissioner, 72 T.C. at 669

(noting that “[t]he start-up phase of an American saddle-bred breeding operation is
                                        - 24 -

[*24] 5 to 10 years”), we can only speculate on this point, as petitioner introduced

no evidence concerning it.

      For the tax years at issue petitioner reported net losses from Intcom of

$88,184 and $86,808. Five continuous years of net losses preceded them.10 In

each of the three subsequent years, petitioner again reported net losses from

Intcom. All evidence in the record indicates that Intcom has never been profitable.

In fact, petitioner reported gross receipts from Intcom on only 1 of the 10

consecutive income tax returns in the record. For 2009 petitioner reported earning

gross receipts of $5,000 from Intcom, as against $91,808 of expenses. Although

Intcom reported lesser net losses for 2010 through 2012 than it had in prior years,

it reported no income for those years. As was true in the earlier cases, “[t]here is

no indication that losses are subsiding with time”, see Strode v. Commissioner,

103 T.C.M. (CCH) at 1279, or that Intcom would be profitable in 2008 and/or

2009. This factor favors respondent.


      10
        Petitioner claims, without any other proof, that three of Intcom’s 2005
ventures--a beauty salon and two livestock projects in the Philippines--were
abandoned because a typhoon destroyed their business assets and because
“$10,000 of profits” was stolen during a robbery. Floods and theft would qualify
as unforseen factors outside petitioner’s control. We note, however, that for 2005
petitioner reported no gross receipts (let alone $10,000 of profit) on his Schedule
C and did not claim a theft loss deduction. In any event, we considered his 2005
tax year in the earlier cases.
                                          - 25 -

[*25] G.        The Amount of Occasional Profits, If Any, From the Activity

          “The amount of profits in relation to the amount of losses incurred, and in

relation to the amount of the taxpayer’s investment and the value of the assets used

in the activity, may provide useful criteria in determining the taxpayer’s intent.”

Sec. 1.183-2(b)(7), Income Tax Regs. From the evidence in the record, it appears

that Intcom has yet to turn a profit. Indeed, according to its income tax returns, it

has yielded income in only 1 year of out of 10, and then in an amount dwarfed by

its expenses. Moreover, nothing in the record indicates the source(s) of that

income, the $5,000 of gross receipts petitioner reported on his 2009 Schedule C.

The only evidence of the income’s existence is the number on petitioner’s tax

return. Petitioner has not shown Intcom actually generated these receipts. Thus,

he has not established that Intcom’s operation has ever yielded income, let alone

profit.

          Petitioner contends that a bona fide profit motive may exist in the absence

of profit. We do not disagree. But over time, where no objective facts manifest a

profit motive, the continual absence of profit--indeed, the continual absence of

income--renders the existence of such a motive increasingly less plausible. This

factor favors respondent.
                                         - 26 -

[*26] H.      The Taxpayer’s Financial Status

      On one hand, “that the taxpayer does not have substantial income or capital

from sources other than the activity may indicate that an activity is engaged in for

profit.” Sec. 1.183-2(b)(8), Income Tax Regs. On the other hand, “[s]ubstantial

income from sources other than the activity (particularly if the losses from the

activity generate substantial tax benefits) may indicate that the activity is not

engaged in for profit”. Id. As we have explained: “[T]he regulation merely

makes the commonsense point that the expectation of [being] able to arrange to

have the tax collector share in the cost of a hobby may often induce an investment

in such a hobby which would not otherwise occur.” See Engdahl v.

Commissioner, 72 T.C. at 670. “Clearly, the tax incentive for incurring large

expenditures in a hobby-type business * * * [is] much greater for one who has a

great deal of income from other sources.” Jackson v. Commissioner, 59 T.C. 312,

317 (1972).

      During 2008 and 2009 petitioner worked full time as an attorney. He earned

salary income of $159,229 in 2008 and $165,305 in 2009. Netting his claimed

losses from Intcom against these figures reduced his adjusted gross income to

$77,329 for 2008 and to $94,710 for 2009. Petitioner had substantial income from
                                        - 27 -

[*27] another source, and losses from Intcom enabled him to cut his adjusted gross

income approximately in half. This factor favors respondent.

      I.     The Activity’s Elements, If Any, of Personal Pleasure or Recreation
             for the Taxpayer

      Although it is not “necessary that an activity be engaged in with the

exclusive intention of deriving a profit or with the intention of maximizing

profits”, a taxpayer’s “personal motives in carrying on * * * an activity may

indicate that the activity is not engaged in for profit”. Sec. 1.183-2(b)(9), Income

Tax Regs. Nevertheless, “a business will not be turned into a hobby merely

because the owner finds it pleasurable; suffering has never been made a

prerequisite to deductibility.” Jackson v. Commissioner, 59 T.C. at 317.

      The evidence in the record indicates that the activities petitioner attributes

to Intcom may have entailed substantial personal pleasure or recreation to him, and

that petitioner deducted as business expenses expenditures he would have incurred

regardless for personal reasons. See sec. 262(a). To substantiate the expenses

underlying his claimed deductions he introduced reams of receipts, credit card

statements, invoices, and bills. Aside from the money transfers to Ms. Hernandez

(allegedly for contract labor) discussed above, the underlying expenses apparently

consist of, among other things: (1) air travel, ground transportation, lodging,
                                         - 28 -

[*28] meal, and incidental expenses petitioner incurred for travel to and within the

Philippines, as well as for, on one occasion, coincident travel within that country

by Ms. Hernandez; (2) petitioner’s subscriptions to the Los Angeles Times and to

the magazines The Week, Esquire, Golf, and Saveur; (3) cable, Internet, and

telephone service, apparently for petitioner’s home, as well as mobile telephone

service; (4) petitioner’s auto, health, and life insurance;11 (5) petitioner’s annual

California Bar membership dues, charges associated with his mandatory

continuing legal education (MCLE) requirement, and his 2009 membership fee for

the Divers Alert Network; (6) meals; (7) mailing and office supplies; and (8)

foreign transaction fees and finance charges imposed by various credit card

providers, as well as records of ATM withdrawals made against credit cards.

      Petitioner’s travel records suggest that he made at least six trips to the

Philippines in 2008 and 2009 and that while there, he stayed in hotels, including

Manila’s Makati Shangri-La, Mandarin Oriental, Hyatt Hotel and Casino, and

Traders Hotel, on at least two occasions with a guest. He enjoyed in-room

minibars and room service and also dined out. Petitioner prepared and included a

“Business Travel & Expense Report” for each trip on which he described the trips’

      11
      Petitioner’s substantiation evidence for his health and life insurance
premium payments consists of earnings statements provided by his employer,
Monarch, which deducted them from his paychecks.
                                        - 29 -

[*29] purpose as, uniformly, “[a]ssist client with [b]usiness [o]pportunities in

Philippines/[p]ursue [b]usiness [o]ps.”. The records themselves do not in any way

support this claimed purpose. On the contrary, traveling to a foreign and perhaps

exotic locale and staying in fine hotels is not an uncommon leisure activity; these

records could as easily substantiate petitioner’s vacations as business expenses

associated with Intcom.

      Similarly, his other records bear the hallmarks of personal expenses, and he

has made no attempt to explain how they relate to Intcom. Many people enjoy

reading the newspaper and magazines to which petitioner subscribed, watching

cable television, and using the Internet. We doubt that he derived pleasure, per se,

from his California Bar membership, from participating in MCLE, or from

maintaining life, health, and auto insurance. But even assuming that these

expenses bore some relationship to Intcom’s business (an assumption that is

dubious, at best), petitioner surely derived personal satisfaction or contentment

from incurring and paying these expenses under the umbrella of Intcom given that

he would likely have had to incur and pay them in any event. Although life and

health insurance were, for the years at issue, elective, petitioner presumably

needed to maintain his California Bar membership to continue working as an
                                          - 30 -

[*30] attorney at Monarch, and California law obliged him to insure his vehicle.

Cal. Veh. Code sec. 16020 (West 2000 & Supp. 2015).

      In sum, the evidence in the record suggests that Intcom’s alleged activities

may have yielded considerable pleasure to petitioner and may as likely have been

personal as business expenses. See secs. 162(a), 262(a). As is true in the present

cases, in the earlier cases petitioner did not testify at trial, and no witness testified

on his behalf. We noted in our opinion “that petitioner’s failure to introduce

evidence ‘which, if true, would be favorable to him, gives rise to the presumption

that if produced it would be unfavorable’”. Strode v. Commissioner, 103 T.C.M.

(CCH) at 1279 (quoting Wichita Terminal Elevator Co. v. Commissioner, 6 T.C.

1158, 1165 (1946), aff’d, 162 F.2d 513 (10th Cir. 1947)). The same presumption

applies here. This factor favors respondent.

      J.     Conclusion

      Among the foregoing factors, none provides an objective foundation for

petitioner’s claim that he operated Intcom with a subjective expectation of and

motivation to obtain profit. Taking into account all of the relevant facts and

circumstances, we conclude that petitioner has not carried his burden of

establishing that Intcom was an activity engaged in for profit. Our Opinion in
                                        - 31 -

[*31] Dreicer v. Commissioner, 78 T.C. at 645-646, supports this conclusion and

provides a remarkably fitting coda to our analysis:

              Mr. * * * [Strode] would have us find that he was like the
      wildcat driller or the inventor * * * , continuing his endeavors in the
      face of adverse results in the hope of one day reaping a large profit.
      However, such statement of intent is not supported by the objective
      facts of this case. For many years, he sustained large losses; there
      was no realistic possibility that he could ever earn sufficient income
      from his activity to offset such losses * * * ; he was able to continue
      to bear such losses only because of his large resources * * * ; a
      review of the entire record fails to convince us that Mr. * * * [Strode]
      conducted his activities in a businesslike manner calculated to earn a
      profit * * * . Rather, there is a strong indication that he enjoyed his
      life of travel. * * *

      We will sustain respondent’s disallowance of petitioner’s claimed Schedule

C deductions for 2008 and 2009, except as otherwise determined below.

II.   Availability of Deductions Under Section 183(b)

      Section 183(b) allows a taxpayer two categories of deductions with respect

to an activity not engaged in for profit. Under section 183(b)(1), the taxpayer may

deduct expenses attributable to the activity to the extent the Code allows them

regardless of the activity’s for-profit status. Under section 183(b)(2), a taxpayer

may deduct expenses attributable to an activity not engaged in for profit to the

extent that they (1) do not exceed his gross income from the activity for that year,

reduced by the amount of deductions allowable under sec. 183(b)(1); and (2)
                                        - 32 -

[*32] would have been allowable under the Code had the activity been engaged in

for profit. In other words, section 183(b)(2) permits the taxpayer to deduct

expenses that would be allowable under sections 162(a), 212(1), and/or 212(2) if

the activity were engaged in for profit, subject to a cap equal to gross income from

the activity less section 183(b)(1) deductions.12

      Deductions are a matter of legislative grace, and taxpayers bear the burden

of proving entitlement to any claimed deduction. Rule 142(a); INDOPCO, Inc. v.

Commissioner, 503 U.S. 79, 84 (1992). A taxpayer must identify each deduction


      12
         Any deductions allowable under sec. 183(b)(2) “are subject to the limit of
section 67(a) (i.e., as ‘miscellaneous itemized deductions’ allowable only to the
extent that in the aggregate they exceed 2 percent of adjusted gross income)
because they are not among those excluded from that limit by section 67(b).”
Bailey v. Commissioner, T.C. Memo. 2012-96, 103 T.C.M. (CCH) 1499, 1522
(2012), aff’d, 2014 WL 1422580 (1st Cir. 2014); see also, e.g., Purdey v. United
States, 39 Fed. Cl. 413, 417 (1997) (“[D]eductions solely permitted pursuant to
§ 183(b)(2) are miscellaneous itemized deductions.”); sec. 1.67-1T(a)(1)(iv),
Temporary Income Tax Regs., 53 Fed. Reg. 9875 (Mar. 28, 1988) (“Examples of
expenses that, if otherwise deductible, are subject to the 2-percent floor include
but are not limited to * * * [e]xpenses for an activity for which a deduction is
otherwise allowable under section 183.”). Shifting petitioner’s allowable
deductions with respect to Intcom, if any, from Schedule C to Schedule A,
Itemized Deductions, aligns with respondent’s determination in the notice of
deficiency transferring the $5,000 of gross receipts petitioner reported on
Schedule C to Form 1040, line 21, Other Income. Petitioner has not established
specifically what Intcom did to earn the alleged gross receipts and from whom and
under what circumstances it received them. Petitioner has not specifically
disputed respondent’s determination regarding the gross receipts, and we will
sustain it.
                                        - 33 -

[*33] available, show that he or she has met all requirements therefor, and keep

books or records that substantiate the expenses underlying the deduction. Sec.

6001; Roberts v. Commissioner, 62 T.C. 834, 836 (1974). The fact that a taxpayer

claims a deduction on an income tax return is not sufficient to substantiate the

underlying expense. Wilkinson v. Commissioner, 71 T.C. 633, 639 (1979).

Rather, an income tax return “is merely a statement of the * * * [taxpayer’s] claim

* * * ; it is not presumed to be correct.” Roberts v. Commissioner, 62 T.C. at 837.

      A.     Section 183(b)(1) Deductions

      The Court has reviewed the expenses reported on petitioner’s 2008 and

2009 Schedules C and the evidence he submitted to substantiate them. For 2008

we have identified no expenses for which deductions are permitted by the Code

regardless of profit motive and thus allowable under section 183(b)(1). For 2009,

however, we have found two types of expenses that meet this test.

      Under section 170(a)(1), a taxpayer may deduct any charitable contribution

made during the taxable year, but only if the contribution is “verified under

regulations prescribed by the Secretary.” A “charitable contribution” is a

contribution or gift for the use of a donee identified in section 170(c). Sec. 170(c).

The Secretary’s regulations call for verification of a cash charitable contribution

with a canceled check, a receipt, letter, or other communication from the donee
                                        - 34 -

[*34] showing the organization’s name and the amount and date of the

contribution, or other reliable written records. Sec. 1.170A-13(a)(1), Income Tax

Regs. Petitioner claimed $100 of “[d]onations” as an other expense on his 2009

Schedule C. After perusing petitioner’s substantiation evidence, we have found

adequate documentation for $41 of the claimed amount. Specifically, petitioner

introduced a receipt from KPFK Radio showing total payments during 2009 of

$135, “[p]remiums” of $94 provided in exchange, and a net deductible amount of

$41. The tax identification number listed on the receipt is that of Pacific

Foundation Radio, which was in 2009 a qualified organization within the meaning

of section 170(c). Petitioner’s summary sheet for his June 2009 Intcom expenses

indicates that he made the donation on June 25, 2009. He may deduct this $41

charitable contribution on Schedule A in addition to the $151 he originally

claimed on that schedule.

      Under section 212(3), an individual taxpayer may deduct all “ordinary and

necessary expenses paid or incurred during the taxable year * * * in connection

with the determination, collection, or refund of any tax.” In addition to the $1,200

deduction for tax preparation fees petitioner claimed on Schedule A, he deducted

$7,480 for “[a]ccounting” as an other expense on Schedule C. Among the items

petitioner provided to substantiate his Intcom expenses are: (1) an invoice from
                                        - 35 -

[*35] “William Wagstaff/Income Tax Shelter” reflecting a $1,480 fee for the

preparation of petitioner’s 2008 Federal and California income tax returns, with

$1,200 shown as paid and $280 as due; and (2) four canceled checks from

petitioner to Mr. Wagstaff, for an aggregate amount of $6,280, with notations on

the memo lines indicating that they were for a retainer, the balance of Mr.

Wagstaff’s fee for preparing petitioner’s 2008 tax returns, and something related

to “2005 TAX”. Mr. Wagstaff signed petitioner’s 2008 and 2009 Forms 1040 as

the returns’ paid preparer. It appears that petitioner double-counted his initial

$1,200 payment to Mr. Wagstaff, and respondent has not disallowed his Schedule

A deduction for that amount. We conclude, however, that petitioner has

adequately substantiated an additional $6,280 of ordinary and necessary expense

paid or incurred during 2009 in connection with the determination of his tax

obligations.

      In sum, under section 183(b)(1), for 2009 petitioner is entitled to an

additional $41 charitable contribution deduction and an additional $6,280

deduction for tax return preparation.

      B.       Section 183(b)(2) Deductions

      For two reasons, petitioner is not entitled to any deductions under section

183(b)(2). First, deductions under section 183(b)(2) are limited to gross income
                                        - 36 -

[*36] from the not-for-profit activity less deductions allowable under section

183(b)(1). Petitioner reported no gross receipts from Intcom for 2008. For 2009

he reported gross receipts of $5,000, and we have already allowed a greater

amount of expense under section 183(b)(1). Consequently, his section 183(b)(2)

limitation is zero for both years.

      Second, with the exception of those allowed above, petitioner has not

adequately substantiated his reported Intcom expenses. Pursuant to section

162(a), a taxpayer may deduct all of the ordinary and necessary business expenses

paid or incurred during the taxable year in carrying on the taxpayer’s trade or

business. Lucas v. Commissioner, 79 T.C. 1, 6 (1982). “To qualify as an

allowable deduction under [section] 162(a) * * * an item must (1) be ‘paid or

incurred during the taxable year,’ (2) be for ‘carrying on any trade or business,’ (3)

be an ‘expense,’ (4) be a ‘necessary’ expense, and (5) be an ‘ordinary’ expense.”

Commissioner v. Lincoln Sav. & Loan Ass’n, 403 U.S. 345, 352 (1971). A

taxpayer must establish these essential elements with credible evidence. See sec.

1.6001-1(a), Income Tax Regs. Deductions are allowed under section 212(1) and

(2) for ordinary and necessary expenses paid in connection with an activity

engaged in for the production or collection of income, or for the management,

conservation, or maintenance of property held for the production of income.
                                         - 37 -

[*37] A taxpayer must satisfy a heightened substantiation requirement with

respect to certain types of expenses. Section 274(d) provides that no deduction

shall be allowed for, among other things, traveling expenses, entertainment

expenses, gifts, and expenses with respect to listed property (as defined in section

280F(d)(4) and including passenger automobiles, computer equipment, and in the

years at issue and up until 2010, cellular telephones) “unless the taxpayer

substantiates by adequate records or by sufficient evidence corroborating the

taxpayer’s own statement”: (1) the amount of the expenditure or use; (2) the time

and place of the expenditure or use; (3) the business purpose of the expenditure or

use; and (4) the business relationship to the taxpayer of the party entertained,

using the facility, or receiving the gift. Sec. 274(d).

      While business expenses and expenses for the production of income are

generally deductible, personal, living, and family expenses are typically

nondeductible. See sec. 262(a). A business expense claimed as a deduction must

be incurred primarily for business rather than personal reasons. See Walliser v.

Commissioner, 72 T.C. 433, 437 (1979). Where an expense exhibits both personal

and business characteristics, the “test * * * requires a weighing and balancing of

all the facts * * * bearing in mind the precedence of section 262, which denies

deductions for personal expenses, over section 162, which allows deductions for
                                        - 38 -

[*38] business expenses.” Sharon v. Commissioner, 66 T.C. 515, 524 (1976)

(citing costs of commuting and ordinary clothing as examples of expenses helpful

and necessary to an individual’s employment that are “essentially personal” and

hence nondeductible), aff’d per curiam, 591 F.2d 1273 (9th Cir. 1978).

      Petitioner’s remaining reported expenses are not deductible under these

rules. For purposes of section 162, one critical element is missing from

petitioner’s substantiation evidence: He has not established with credible

evidence that the expenditures for which he claimed deductions on his Schedules

C were “directly connected with or pertaining to * * * [his] trade or business”.

See sec. 1.162-1(a), Income Tax Regs. Indeed, he has not established with

credible evidence that Intcom was yet a trade or business. Moreover, turning to

section 274, several categories of petitioner’s expenses, including, but not limited

to, his mobile telephone, travel, gifts, and meal expenses, are subject to heightened

substantiation requirements. See secs. 274(d)(1), (4), 280F(d)(4)(i), (ii), (v).

Petitioner’s evidence does not fulfill his burden of substantiating the business

purpose of any of the documented expenditures. For purposes of section 212(1)

and (2), the record is silent as to the source of petitioner’s $5,000 of 2009 income

from Intcom, so we cannot ascertain whether any of his expenses were ordinary

and necessary for the production or collection of that income. Finally, in reference
                                        - 39 -

[*39] to section 262(a), as discussed supra pp. 27-31, petitioner’s claimed Intcom

expenses exhibit characteristics of personal expenses, and he has not established

that he incurred them primarily for business rather than personal reasons. See

Walliser v. Commissioner, 72 T.C. at 437. For all of these reasons, we conclude

that petitioner has not adequately substantiated any of the expenses claimed on his

2009 Schedule C other than those we have found deductible under section

183(b)(1).13

III.   Accuracy-Related Penalty Under Section 6662

       In each of the notices of deficiency respondent determined an accuracy-

related penalty under section 6662(a) and (b)(1), (2), and (3) on the basis of

negligence or disregard of rules and regulations, a substantial understatement of




       13
         We have considered and rejected the possibility that petitioner’s California
Bar membership dues and MCLE expenses may have been deductible under secs.
67(a) and 162(a) as unreimbursed employee business expenses related to his
employment as an attorney for Monarch. It is well settled that an employee may
not deduct otherwise valid unreimbursed business expenses if the employee is
entitled to reimbursement from his or her employer for such expenditures. Orvis
v. Commissioner, 788 F.2d 1406, 1408 (9th Cir. 1986), aff’g T.C. Memo. 1984-
533, 48 T.C.M. (CCH) 1295 (1984); Lucas v. Commissioner, 79 T.C. 1, 7 (1982).
An employee taxpayer bears the burden of proving that claimed business expenses
were not reimbursable by his or her employer. See Christine v. Commissioner,
T.C. Memo. 2010-144, 99 T.C.M. (CCH) 1591, 1593 (2010), aff’d, 475 Fed.
Appx. 259 (9th Cir. 2012). Petitioner has not met that burden here.
                                        - 40 -

[*40] income tax, or a substantial valuation misstatement.14 As a general rule, the

Commissioner bears the burden of production and “must come forward with

sufficient evidence indicating that it is appropriate to impose the relevant penalty.”

Higbee v. Commissioner, 116 T.C. 438, 446 (2001); see also sec. 7491(c). Once

the Commissioner has met this burden of production, the burden will shift to the

taxpayer to prove that he has an affirmative defense or that he is otherwise not

liable for the penalty. See Higbee v. Commissioner, 116 T.C. at 446-447.

      Section 6662(a) and (b)(1) and (2) provides for the imposition of a 20%

penalty on the portion of an underpayment of tax attributable to negligence or

disregard of rules and regulations or a substantial understatement of income tax,

respectively. “‘[N]egligence’ includes any failure to make a reasonable attempt to


      14
         These represent alternative grounds for imposition of the penalty, as the
accuracy-related penalties do not stack. See sec. 1.6662-2(c), Income Tax Regs.
       Sec. 6662(a) and (b)(3) provides for the imposition of a 20% penalty on the
portion of an underpayment of tax required to be shown on a return that is
attributable to a substantial valuation misstatement. For returns filed after August
17, 2006, as is relevant here, a substantial valuation misstatement occurs when
“the value of any property (or the adjusted basis of any property) claimed on any
return of tax imposed by chapter 1 is 150 percent or more of the amount
determined to be the correct amount of such valuation or adjusted basis (as the
case may be)”. Sec. 6662(e)(1)(A). The notice of deficiency does not explain
what property’s value or adjusted basis was allegedly misstated. Respondent did
not discuss this issue at trial and has not addressed it on brief. As the Court can
find no basis for this penalty in the record, we find petitioner not liable for the
substantial valuation misstatement penalty.
                                        - 41 -

[*41] comply with the provisions of * * * [the Internal Revenue Code]”. Sec.

6662(c). It is “‘a lack of due care or the failure to do what a reasonable and

ordinarily prudent person would do under the circumstances.’” Freytag v.

Commissioner, 89 T.C. 849, 887 (1987) (quoting Marcello v. Commissioner, 380

F.2d 499, 506 (5th Cir. 1967), aff’g 43 T.C. 168 (1964) and T.C. Memo. 1964-

299), aff’d, 904 F.2d 1011 (5th Cir. 1990), aff’d, 501 U.S. 868 (1991).

“‘Negligence’ also includes any failure by the taxpayer to keep adequate books

and records or to substantiate items properly.” Sec. 1.6662-3(b)(1), Income Tax

Regs. Disregard of rules and regulations includes any careless, reckless, or

intentional disregard of the Code, the regulations, or certain IRS administrative

guidance. Id. subpara. (2). A substantial understatement of income tax as to an

individual taxpayer is generally an understatement that exceeds the greater of

$5,000 or 10% of the tax required to be shown on the return. Sec. 6662(d)(1)(A).

      Respondent did not specifically address the negligence penalty at trial or on

brief. Nevertheless, we note that petitioner’s failure to adequately substantiate

expenses underlying any of his claimed Schedule C deductions constitutes

negligence for purposes of section 6662(a). See sec. 1.6662-3(b)(1), Income Tax

Regs. Likewise, “attempt[s] to deduct personal expenses in contravention of the

plain language of section 262 constitute[] negligence.” Bond v. Commissioner,
                                        - 42 -

[*42] T.C. Memo. 2012-313, at *13-*14 (fn. ref. omitted); accord, e.g., Cor v.

Commissioner, T.C. Memo. 2013-240, at *8; WSB Liquidating Corp. v.

Commissioner, T.C. Memo. 2001-9, 81 T.C.M. (CCH) 1007, 1012 (2001).

Petitioner failed to establish any business purpose for the expenses he sought to

deduct on Schedule C, nearly all of which had a personal character. Respondent

has satisfied his burden of production with regard to the negligence penalty.

      He has also met that burden with regard to the substantial understatement

penalty. On his Forms 1040 petitioner reported total tax of $11,839 for 2008 and

$15,692 for 2009. We have concluded above that we will sustain all of

respondent’s adjustments in the notices of deficiency to petitioner’s 2008 and

2009 income tax returns. As recomputed in the 2008 notice of deficiency,

petitioner’s total tax liability for 2008 was $36,052. Therefore, for 2008 petitioner

understated his income tax by $24,213, which is more than both $5,000 and 10%

of the tax required to be shown on his return. As recomputed in the 2009 notice of

deficiency, petitioner’s total tax liability for 2009 was $31,182, and his

understatement of income tax was $15,496.15 Those recomputed numbers do not


      15
        In the notice respondent determined that petitioner was not entitled to the
$6 making work pay and Government retiree credit he had claimed on his 2009 tax
return and so reduced the amount of tax reported on the return from $15,692 to
$15,686.
                                           - 43 -

[*43] take into account the additional Schedule A deductions allowed in this

opinion, but even leaving aside that the additional section 212(3) deduction will be

subject to the 2% “haircut”, it is readily apparent that petitioner’s understatement

will exceed both $5,000 and 10% of his tax liability. Consequently, he is liable

for the accuracy-related penalty for underpayments attributable to substantial

understatements of income tax for both tax years.

      Petitioner did not specifically dispute the penalties in his petition, presented

no evidence or argument concerning them at trial, and did not address them in his

posttrial brief. He has not proved that he has an affirmative defense or that he is

otherwise not liable for the penalties, see Higbee v. Commissioner, 116 T.C. at

446-447, so we will sustain respondent’s determination of the 20% penalty for

both tax years.

      The Court has considered all of the parties’ contentions, arguments,

requests, and statements. To the extent not discussed herein, we conclude that

they are meritless, moot, or irrelevant.

      To reflect the foregoing,


                                                    Decisions will be entered under

                                           Rule 155.
