                         T.C. Memo. 1996-363



                       UNITED STATES TAX COURT



           GEORGE KUKES AND MARGARET KUKES, Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 19832-94.                      Filed August 8, 1996.



     George Kukes, pro se.1

     Michelle D. Korbas, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


     PARR, Judge:    Respondent determined deficiencies in, an

addition to, and penalties on income taxes of petitioners as

follows:




     1
         Margaret Kukes did not appear for trial.
                                 - 2 -


                          Addition to Tax and Penalties
     Year    Deficiency     Sec. 6651    Sec. 6662(a)

     1991      $4,566         -0-              $913
     1992      11,268        $330             2,254

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the taxable years in

issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

     The issues for decision are:

     (1) Whether petitioners are entitled to deduct a net

operating loss (NOL) consisting of estimated potential wages lost

when George Kukes (petitioner) was terminated by his employer in

1984.   We hold they are not.

     (2) Whether petitioner was in a trade or business concerning

his music activities in 1992.    We hold he was not.

     (3) Whether petitioners are subject to an addition to tax

for delinquent filing of their 1992 income tax return.    We hold

that they are.

     (4) Whether petitioners are subject to a negligence penalty

for 1991 and 1992.   We hold they are.

Petitioners have conceded the remaining issues raised in the

notice of deficiency.

                           FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

When they filed their petition in this case, petitioners resided

in Roseville, California.
                               - 3 -


     Net Operating Loss

     Petitioner filed a wrongful termination suit against a

former employer in 1984, claiming lost wages and benefits of

$209,367 based upon his attorney's calculations.   The lawsuit was

settled for $27,500, which petitioners correctly reported as

taxable income in the year received.   In 1987, petitioners began

deducting, as an NOL, the difference between $209,367 and

$27,500.   Petitioners have never included in taxable income, nor

been subject to tax on, the amounts which they are deducting as

an NOL ($29,506 in 1991 and $26,880 in 1992).

Trade or Business

     During the late 1970's, petitioner formed the Presto Co., a

sole proprietorship which involved various musical activities.

Petitioners reported gross receipts on their Schedules C for tax

years through 1985 consisting of income from teaching piano

lessons, piano sales, and piano tuning and repair.   In 1985,

petitioners' Schedule C showed gross receipts of $448 from piano

lessons; petitioner ceased teaching piano lessons in that year.

     Petitioners reported no gross receipts from music activities

on their Schedules C for 1986, 1987, 1988, 1989, 1990, and 1992

tax years.   (Gross receipts shown on petitioners' Schedule C for

1991 in the amount of $650 consisted of income from consulting
                                - 4 -


work related to a safety program, unrelated to the music

business.2)

     At some indeterminate point petitioner conceived of a unique

keyboard instruction system, which he called "Presto".    Presto is

a system of teaching keyboard techniques revolving around

flexible lesson plans.    Petitioner thought that his system could

be marketed in the form of a video, software, written material,

or another interactive form.    He hoped it could be sold to school

systems.   However, petitioner did not actually produce any

marketable video, software, or written material but instead

continued to consider and investigate various possibilities.

     Petitioners have never received any gross income from the

sale of any product associated with Presto.    Petitioners reported

losses on their Schedule C related to Presto for at least 8

consecutive years (1985 through 1992), claiming expenses during

those years of more than $65,000.    During 1992 and up to and

including the time of trial, petitioner was still in the process

of developing Presto.    In 1992, petitioners maintained no

separate bank account, had no customers, and kept no books for

the Presto activity.    Petitioners stipulated: “During the 1992

tax year there was no need for petitioners to maintain a separate

bank account for the Presto activity because it was not an income



     2
        Respondent made no adjustments in the notice of
deficiency regarding petitioners’ Schedule C for 1991. We
therefore make no findings concerning it.
                                - 5 -


generating business.”   They also stipulated that “During the 1992

tax year, Presto was not an operational 'going-concern'”.

     In 1992, petitioner's Form W-2 wages were $45,128 from full-

time employment as an engineer.

     The most significant expense claimed on petitioners' 1992

Schedule C is for depreciation of petitioners' entire residence

in Santa Maria, California, in the amount of $17,226.30.     In

December of 1991, petitioners moved from Santa Maria to Merced,

California, where they rented an apartment closer to petitioner's

place of employment.    During 1992, petitioners were attempting to

sell their Santa Maria residence.    Mrs. Kukes periodically stayed

in Santa Maria to maintain the yard and residence.     Most of

petitioners’ furniture and personal belongings remained at the

Santa Maria property, including petitioner’s piano, organ,

computer, and Presto work product.      The cost of the Santa Maria

home in 1984 was approximately $161,000.     Petitioners treated the

Santa Maria residence as their principal residence for purposes

of rolling over the gain on the sale of the home in 1994.

     In addition to depreciation, on their 1992 Schedule C

petitioners deducted $238.90 for home insurance, $6,122.05 for

mortgage interest, $1,780.54 for property taxes, and $965.41 for

utilities related to their Santa Maria residence.

Addition to Tax and Penalties

     Petitioners concede they filed their 1992 income tax return

late.   The stipulated copy of the return shows it was received by
                                - 6 -


the Internal Revenue Service Center in Fresno, California, on

April 27, 1993.

     From 1987 through 1992, petitioners prepared their own tax

returns.   When they began using a paid preparer in 1993, they

discontinued deducting the NOL.   They also discontinued filing a

Schedule C with their 1993 income tax return.   Although

petitioner called the Internal Revenue Service (IRS) to ask about

the mechanics of calculating the NOL, he did not tell anyone at

the IRS that the NOL he was planning to deduct involved lost

anticipatory wages.

                               OPINION

     Determinations made by the Commissioner in the notice of

deficiency are generally presumed correct; the burden of proof is

on the taxpayers to show those determinations are wrong.   Rule

142(a); Welch v. Helvering, 290 U.S. 111 (1933).

Net Operating Loss

     Deductions are a matter of legislative grace.    New Colonial

Ice Co. v. Helvering, 290 U.S. 435, 440 (1934).    It is well

established in case law that no deduction is allowed under

section 165 or any other Code section for loss of potential

income.    See, e.g., Hort v. Commissioner, 313 U.S. 28, 33 (1941)

(since unrealized rent is not includable in taxpayer's gross

income, taxpayer has no grounds for deduction); Stephens v.

Commissioner, T.C. Memo. 1980-131 (no deduction allowed for wages

that could have been earned had an individual's employment not
                               - 7 -


been terminated); Johnson v. Commissioner, T.C. Memo. 1978-395

(no deduction allowed for mere expectation).

     Thus, petitioner is not entitled to deduct the anticipated

wages lost because of his termination.

Trade or Business

     Section 162 provides that "There shall be allowed as a

deduction all the ordinary and necessary expenses paid or

incurred during the taxable year in carrying on any trade or

business".   Respondent contends that petitioner was not in a

trade or business with regard to Presto, because (1) he did not

have an "actual and honest objective of making a profit";3 or (2)

even if petitioner had the requisite profit objective, he was not

engaged in an active trade or business in 1992, but was only, at

most, in the startup phase of a trade or business.   Respondent

further contends that, even if petitioner was in an active trade

or business, section 280A limits depreciation of a dwelling unit

used by the taxpayer during the year as a residence to the gross

income derived from such use for the tax year, less certain

allocable deductions.   Thus, since petitioners have no gross

income, they are allowed no deduction for depreciation.

     Section 195(a) provides, in relevant part, that "Except as

otherwise provided in this section, no deduction shall be allowed

for start-up expenditures."   It is clear from the record that in



     3
        See Dreicer v. Commissioner, 78 T.C. 642 (1982), affd.
without opinion 702 F.2d 1205 (D.C. Cir. 1983).
                               - 8 -


1992 (and up until the time of trial), petitioner had not yet

developed a product for sale, had not advertised such a product,

had no bank account books or records, and had never received any

income from Presto, and that Presto has never been a going

concern.   Petitioner simply had a concept that had not yet taken

a concrete, marketable form.   We therefore need not delve into

petitioner's state of mind regarding profit objective, because it

is clear that, at most, petitioner was merely in the startup

phase of a potential business.4

     Courts have consistently denied deductions for startup or

preopening expenses incurred by taxpayers prior to beginning

business operations.   Courts have articulated two rationales for

concluding that such expenses are not deductible under section

162(a): (1) That the taxpayer was not “carrying on” a trade or

business, Kantor v. Commissioner, 998 F.2d 1514, 1518 (9th Cir.

1993), affg. in part and revg. in part T.C. Memo. 1990-380;

Aboussie v. United States, 779 F.2d 424, 428 (8th Cir. 1985);

Richmond Television Corp. v. United States, 345 F.2d 901, 907

(4th Cir. 1965), vacated and remanded per curiam on other grounds

382 U.S. 68 (1965), or (2) that preopening expenses were not

“ordinary” but capital in nature, Madison Gas & Elec. Co. v.

Commissioner, 633 F.2d 512, 517 (7th Cir. 1980), affg. 72 T.C.

521 (1979); Hardy v. Commissioner, 93 T.C. 684 (1989).   However,



     4
        If, however, we were to consider respondent’s other
arguments, we would find them well taken.
                                - 9 -


because petitioner’s own statements with regard to his activities

make it clear that his expenditures were incurred in organizing,

developing, or starting up a business, we need not choose one

rationale over the other.5   Petitioner’s expenditures would be

nondeductible under either analysis.6

     We therefore agree with respondent that the loss shown on

petitioners' Schedule C for 1992 must be disallowed.7

Addition to Tax and Penalties

     Section 6651 provides that in case of failure to file a

timely return (including extensions), unless it is shown that

such failure is due to reasonable cause and not due to willful

neglect, there shall be added to the amount required to be shown

as tax on such return 5 percent of the amount of such tax if the

failure is for not more than 1 month.   Petitioners did not

request an extension.   Their 1992 income tax return was due April

15, 1993, but was filed on April 27, 1993.   Thus, petitioners are


     5
        Petitioner has characterized his Presto activities as
“research and development”, apparently in an attempt to bring
them under sec. 174. Even if we were to find that his activities
came within that rubric (which we do not), petitioner is not
helped. He has not demonstrated a “realistic prospect” of
subsequently entering a business in connection with the fruits of
the research; i.e., by manifesting both the objective intent to
enter such a business and the capability of doing so. Kantor v.
Commissioner, 998 F.2d 1514, 1518 (9th Cir. 1993), affg. in part
and revg. in part T.C. Memo. 1990-380.
     6
         See also Pino v. Commissioner, T.C. Memo. 1987-28.
     7
        Respondent allowed the mortgage interest and real estate
taxes on petitioners’ residence, plus State taxes and
contributions, as Schedule A deductions in the notice of
deficiency.
                              - 10 -


liable for the addition, unless they can show that the delay was

due to reasonable cause.   Petitioners’ only explanation is that

they expected to receive a refund, and thus thought there would

be no penalty.   The expectation of receiving a refund is not

reasonable cause to fail to do what the law requires, and the law

does not provide for any such exception.     Petitioners are liable

for the addition to tax under section 6651.

     Respondent also determined a penalty for negligence for each

of the years in issue.   Section 6662 applies a penalty of 20

percent of the portion of any underpayment which is attributable

to negligence or disregard of rules or regulations.     Sec.

6662(b)(1).   The term “negligence” includes any failure to make a

reasonable attempt to comply with the provisions of the income

tax laws, and the term “disregard” includes any careless,

reckless, or intentional disregard.     Petitioner did not seek

advice from either the respondent or any tax professional about

the propriety of deducting his lost anticipatory wages as an NOL,

an issue that is well settled.   Neither did he seek advice about

treating his personal residence as a Schedule C expense for a

business that was, at most, in the startup phase.     We believe a

reasonable person would have sought advice before taking the

positions taken by petitioners on their return.     Petitioners have

the burden of proof on this issue.     Inasmuch as petitioners

conceded the remaining adjustments raised in the notice of
                              - 11 -


deficiency, we find that they were negligent as to the entire

amount of the underpayment.

     In light of the foregoing,

                                        Decision will be entered

                                   for respondent.
