                         T.C. Memo. 1997-292



                    UNITED STATES TAX COURT


                EDWARD S. CULLIN, Petitioner v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent


       Docket No. 12475-94.                 Filed June 26, 1997.



       Edward S. Cullin, pro se.

       Lawrence B. Austin, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION

       WHALEN, Judge:    Respondent determined deficiencies, an

addition to tax, and penalties with respect to petitioner's

Federal income tax as follows:


                              Addition to Tax      Penalty
Year        Deficiency           Sec. 6651        Sec. 6662

1989        $27,650.70               --           $5,530.14
1990         17,324.00             $4,331          3,445.00
                             - 2 -


All section references are to the Internal Revenue Code

as in effect for the years in issue.

       After concessions, the issues remaining for decision

are:    (1) Whether petitioner's losses from trading

commodity futures are capital or ordinary; and (2) whether

petitioner is liable for the accuracy-related penalties

prescribed by section 6662(a) as determined by respondent

for 1989 and 1990.

                       FINDINGS OF FACT

       The parties have stipulated some of the facts.    The

stipulation of facts filed by the parties and the exhibits

attached thereto are incorporated herein by this reference.

Petitioner was a resident of Dunwoody, Georgia, at the time

he filed his petition in this case.

       During the years 1985 through 1990, petitioner was

self-employed as a freelance writer and publisher.      Prior

to the years in issue, petitioner researched and wrote a

manuscript entitled "The Wall Street Newspaper Daytrading

Strategy".    The manuscript describes a mechanical system

for trading commodity futures which focused on the lead

story on the Commodities Page of the Wall Street Journal.

At the time the manuscript was written, there was only one

lead story on the Commodities Page.    The manuscript

instructs a reader in how to execute a day trade with
                             - 3 -

respect to the commodity that is the subject of the lead

story.   It provides mechanical rules for selecting the

month and price of the commodity, and it describes how to

offset the trade at the end of the day.    The manuscript

also sets forth the results of hypothetical day trades

using petitioner's system beginning on January 1, 1983, and

ending on the date the manuscript was mailed to the

customer.

       Petitioner arranged for the manuscript to be typed,

printed, and bound into book form.    Petitioner wrote and

designed all of the advertising and promotional materials

used to sell the manuscript.    He marketed the manuscript

using a mail order approach.

       Petitioner originally sold the manuscript under the

name "The Wall Street Journal Daytrading Strategy".

However, he received a letter dated July 24, 1984, from Dow

Jones & Co., Inc., stating that his use of the names Dow

Jones & Co., the Wall Street Journal (WSJ), and Barron's,

as well as the use of articles from, and the logo of, the

WSJ in advertising his manuscript, was prohibited under the

law.   After receiving the letter, petitioner changed the

name of his manuscript to The Wall Street Newspaper

Daytrading Strategy.

       In order to sell his manuscript, which rendered

advice on commodity futures trading, petitioner was
                              - 4 -

required to be registered as a commodity trading adviser

(CTA).   Petitioner applied for and, in 1986, obtained

registration as a CTA with the Commodity Futures Trading

Commission (CFTC).   He also applied for and, in 1987,

obtained registration as a CTA with the National Futures

Association (NFA).

     The NFA is an association responsible for regulating

the professional conduct and financial responsibility of

CTA's and others, including futures commissions merchants,

introducing brokers, and commodity pool operators.    As part

of its regulatory activities the NFA conducts periodic

audits of its members and monitors their advertising and

sales practices.

     Petitioner encountered two problems in 1988 with

respect to his manuscript.    First, on October 3, 1988, the

WSJ changed the format of its Commodities Page by expanding

it to two pages with two lead stories.    Petitioner believed

the new format would cause problems for his customers

because his manuscript was premised upon evaluating only

one lead article per day.    Petitioner believed that readers

of the manuscript would become confused as to which, if

any, commodity they should trade on a particular day.

     Second, on December 14, 1987, the NFA began a periodic

audit of petitioner, and on May 13, 1988, it issued an

audit report to petitioner.    The audit report discussed
                            - 5 -

petitioner's advertisements appearing in the Atlanta

Journal and in the October 1987 and November 1987 editions

of Future Magazine.   The report also discussed petitioner's

tape recorded message to potential customers and his

promotional material in general.

     The NFA audit report found 30 alleged violations

of CFTC regulations and NFA rules.   Many of the

deficiencies in petitioner's promotional materials and

practices involved alleged violations of NFA rule 2-29, a

rule designed to assure that potential investors in

commodity futures receive accurate and verifiable

information.   The NFA had the authority to revoke

petitioner's CTA license for violation of rule 2-29.    In

that event, petitioner could not legally continue to sell

his manuscript to others.   The NFA audit report did not

require petitioner to trade commodity futures to document

claims in his promotional material or to maintain his

status as a CTA.

     Petitioner began trading commodity futures in 1988.

He traded through seven different accounts during the years

in issue.   The record does not state the number of trades

that petitioner made in each year or the specific

commodities he traded.   The record also does not detail the

profit or loss history of petitioner's various brokerage

accounts.   Petitioner sustained losses of $101,938.26 and
                              - 6 -

$54,529.65 trading commodity futures in 1989 and 1990,

respectively.

     Petitioner received the following gross receipts from

the sale of his manuscript:

                Year           Gross Receipts

                1985               $557.30
                1986                 --
                1987              2,162.00
                1988             47,185.80
                1989            138,681.46
                1990             65,903.70


He reported the gross receipts for Federal income tax

purposes on a Schedule C, Profit or Loss From Business,

attached to his return for each of the above years.    For

1989 and 1990, petitioner's Schedules C report that he

received the above gross receipts from a business by the

name of "ED Cullin Commodity Trading Advisory" which was

in the business of "Commodity Trading Advisor/Publishing".

     The Schedules C for petitioner's publishing business

for 1989 and 1990 also report deductions for "Research &

Experimentation to Improve Trading System Formula for Sale"

of $101,938.26 and $54,529.65, respectively.    These amounts

are the losses that petitioner sustained trading commodity

futures.

     In the subject notice of deficiency, respondent

disallowed the deduction of petitioner's commodity trading

losses for 1989 and 1990.   The notice states as follows:
                            - 7 -


           It is determined that the amounts of
     $101,938.26 and $54,529.65 shown on Schedule C
     of your respective 1989 and 1990 income tax
     returns as research and experimentation to
     improve trading system formula for sale are
     not allowed because it has not been established
     that any amount was for an ordinary and necessary
     business expense. Instead, the commodities
     futures transactions constitute capital assets
     and are includable as capital gains and losses on
     Schedule D. Accordingly, your taxable income is
     increased $101,938.26 for 1989 and $54,529.65 for
     1990.

Respondent allowed petitioner to treat the losses as short-

term capital losses deductible on Schedule D, Capital Gains

and Losses.   The notice states as follows:


     It is determined that you are entitled to short-
     term capital losses in the amounts of $102,158.00
     for 1989 and $54,530.00 for 1990, limited to
     $3,000.00 for each of the years 1989 and 1990,
     resulting from commodities futures transactions.


As a consequence of disallowing the deductions that

petitioner claimed for his commodity trading losses,

respondent also determined that petitioner is liable for

additional self-employment taxes in 1989 and 1990, and

respondent allowed petitioner a deduction in the amount

of one-half of his self-employment tax liability in 1990.


                           OPINION

     The principal issue in this case is whether

petitioner's losses from trading commodity futures are

capital or ordinary.   Petitioner realized losses of
                             - 8 -

$101,938.26 in 1989 and losses of $54,529.65 in 1990.

Petitioner treated the losses as ordinary and deducted

them on a Schedule C, Profit or Loss from Business,

filed with his return for each year.     Each Schedule C

identifies petitioner's business as "Commodity Trading

Advisor/Publishing."   The gross receipts reported on each

Schedule C consist entirely of the receipts from the sale

of petitioner's manuscript for his commodity trading

system.   Petitioner labeled the deductions as "Research and

Experimentation to Improve Trading System Formula For

Sale."

     Respondent disallowed the deductions on the ground

that petitioner had not established that the amounts were

ordinary and necessary business expenses.     Respondent

determined that "the commodities futures transactions

constitute capital assets and are includible as capital

gains and losses on Schedule D."     Respondent allowed

petitioner to deduct the losses under section 165(a) but

treated them as losses from sales or exchanges of capital

assets which are allowable only to the extent allowed in

sections 1211(b) and 1212.   Accordingly, the principal

issue for decision in this case is whether the losses

realized by petitioner from his trading of commodity

futures are losses from sales or exchanges of capital

assets.   In passing, we note that petitioner does not claim
                             - 9 -

that the amounts at issue are deductible as ordinary and

necessary business expenses under section 162.

     The term "capital assets" is defined by section 1221

as follows:


          For   purposes of this subtitle, the term
     "capital   asset" means property held by the
     taxpayer   (whether or not connected with his
     trade or   business), but does not include--

               (1) stock in trade of the taxpayer
          or other property of a kind which would
          properly be included in the inventory
          of the taxpayer if on hand at the close
          of the taxable year, or property held
          by the taxpayer primarily for sale to
          customers in the ordinary course of his
          trade or business;

               (2) property, used in his trade or
          business, of a character which is
          subject to the allowance for
          depreciation provided in section 167,
          or real property used in his trade or
          business;

               (3) a copyright, a literary,
          musical, or artistic composition, a
          letter or memorandum, or similar
          property, held by--

                      (A) a taxpayer whose
                 personal efforts created such
                 property,

                      (B) in the case of a
                 letter, memorandum, or
                 similar property, a taxpayer
                 for whom such property was
                 prepared or produced, or

                      (C) a taxpayer in whose
                 hands the basis of such
                 property is determined, for
                 purposes of determining gain
                           - 10 -

                from a sale or exchange, in
                whole or part by reference to
                the basis of such property in
                the hands of a taxpayer
                described in subparagraph (A)
                or (B);

                (4) accounts or notes receivable
           acquired in the ordinary course of
           trade or business for services rendered
           or from the sale of property described
           in paragraph (1);

                (5) a publication of the United
           States Government (including the
           Congressional Record) which is received
           from the United States Government or
           any agency thereof, other than by
           purchase at the price at which it is
           offered for sale to the public, and
           which is held by--

                     (A) a taxpayer who so
                received such publication, or

                     (B) a taxpayer in whose
                hands the basis of such
                publication is determined,
                for purposes of determining
                gain from a sale or exchange,
                in whole or in part by
                reference to the basis of
                such publication in the hands
                of a taxpayer described in
                subparagraph (A).


     According to the above definition, all property held

by a taxpayer, whether or not connected with his or her

trade or business, is included in the definition of capital

asset, except for the five categories enumerated in section

1221.   See generally Arkansas Best Corp. v. Commissioner,

485 U.S. 212 (1988).   Based upon the record of this case,
                             - 11 -

we have no basis to conclude that the commodity futures

traded by petitioner during the years in issue fall within

any of the five categories.    First, petitioner does not

claim that the commodity futures were stock in trade or

inventory of his trade or business, the category described

by section 1221(1).   In this connection, we note that

petitioner asserts that he was in the trade or business of

"being self-employed, free lance writer/self-publisher"

during the years in issue.    Petitioner does not claim to

have been in the business of trading commodity futures

during 1989 and 1990.   Second, commodity futures are not

property "of a character which is subject to the allowance

for depreciation", the category described by section

1221(2).   Third, commodity futures are not "a copyright, a

literary, musical, or artistic composition, a letter or

memorandum, or similar property", the category described by

section 1221(3).   Finally, petitioner does not contend that

the commodity futures are "accounts or notes receivable",

the category described by section 1221(4), nor does

petitioner contend that they are "a publication of the

United States Government", the category described by

section 1221(5).

     Notwithstanding the above, petitioner contends his

losses from trading commodity futures are deductible as

ordinary losses.   Petitioner asserts that he opened the
                             - 12 -

commodity futures trading accounts "to hedge or solve" two

problems that affected the manuscript he wrote describing

a system for trading commodity futures and, thereby, to

"insure and protect the copyright property's value and

worth as an income producing property."      According to

petitioner, the manuscript is property described by section

1221(3) and is not included in the term "capital asset".

Thus, according to petitioner, the losses he incurred

trading commodity futures were incurred to "hedge" against

the decrease in the value of the manuscript and "should

receive ordinary treatment as well."      As authority,

petitioner cites Corn Products Refining Co. v. Commis-

sioner, 350 U.S. 46 (1955), and FNMA v. Commissioner, 100

T.C. 541 (1993).

     There is no precise or ready definition of the term

"hedging".   Wool Distrib. Corp. v. Commissioner, 34 T.C.

323, 330 (1960).   Generally, it is a label applied to

certain futures transactions which, on all the facts and

circumstances, have been found to be a form of price

insurance and thus connected so closely with the regular

conduct of a trade or business as to defy classification

as extraneous investments.    Id. at 330-331.    Whether a

transaction constitutes a hedge for Federal income tax

purposes is a question of fact.       FNMA v. Commissioner,
                             - 13 -

supra at 568; Fulton Bag & Cotton Mills v. Commissioner,

22 T.C. 1044, 1052 (1954).

     In Muldrow v. Commissioner, 38 T.C. 907, 913 (1962),

we stated that a hedge:


     is a form of insurance against unfavorable fluc-
     tuations in the price of a commodity in which a
     position has already become fixed or, as in the
     case of a producer such as a cotton grower, will
     become fixed in normal course and the sale,
     liquidation, or use of the commodity is to occur
     at some time in the future.


A bona fide hedge requires:    (1) A risk of loss by changes

in the price of something to be used or marketed in the

taxpayer's business; (2) a possibility of shifting the risk

to another person, through the purchase or sale of futures

contracts; and (3) an attempt to shift the risk.    FNMA v.

Commissioner, supra at 569; Muldrow v. Commissioner, supra

at 913.

     In every hedge there must be a direct relationship

between the product that is the basis of the taxpayer's

business and the commodity futures in which the taxpayer

deals for protection.   E.g., United States v. Rogers, 286

F.2d 277, 281-282 (6th Cir. 1961).    There must also be a

close relationship between the price of the product and

the price of the commodity future.    E.g., id. at 282;

Hoover Co. v. Commissioner, 72 T.C. 206, 231 (1979).
                          - 14 -

     For example, in Wool Distrib. Corp. v. Commissioner,

supra at 331, we discussed the relationship between the

price of the product that is the basis of the taxpayer's

business and the price of the commodity future as follows:


          A dealer with stocks of a particular
     commodity on hand runs the risk of loss should
     the market price of the commodity fall. To
     minimize that risk he will customarily enter a
     futures market and sell the same or a related
     commodity short in an amount equivalent to the
     amount in inventory. In this way he reaches an
     even or balanced position between actuals and
     futures, so that any loss resulting from a
     decline in the market price of the actuals will
     be offset pro tanto by the gains derived from
     closing out the futures at a commensurately lower
     cost. G.C.M. 17322, supra [1936-2 C.B. 151].
     However, such a balancing of gain and loss will
     not be possible unless the market prices of the
     actuals and the futures are so related that they
     normally rise or fall together. If they do not,
     then the futures will increase rather than
     diminish the overall risk. For this reason
     hedging presupposes an intimate price
     relationship between the two. The actuals and
     futures need not be in the same commodity so long
     as their prices move in relation to each other.
     Albert Kurtin, 26 T.C. 958. Nor must the futures
     be in the exact amount of the actuals; the latter
     may be covered entirely or only to the extent
     protection is desired. Stewart Silk Corporation,
     9 T.C. 174. But a larger amount of futures than
     of actuals or an absence of price relationship
     between the two will suggest that the futures
     were acquired as an investment and not as a
     hedge.


     In this case, petitioner claims to have engaged in day

trading of commodity futures as a hedge against the loss of

value or income from his manuscript describing a system of
                             - 15 -

commodity futures trading.    Both at trial and in his post-

trial brief, petitioner attempted to establish a relation-

ship between his commodity trading and his business of

being a "free lance writer/self-publisher".    As mentioned

above, he argues that he was required to trade commodity

futures in order "to hedge or solve" "two major copyright

problems [that] happened in 1988."    The first problem was

the fact that the Wall Street Journal changed the format of

its Commodities Page and expanded it to include two lead

stories.    This change threatened to make obsolete

petitioner's "mechanical" system of trading commodity

futures based upon one lead story, and, thereby, to make

petitioner's manuscript valueless.    The second problem was

the fact that petitioner's promotional literature was

audited by the NFA.    According to petitioner, he traded

commodity futures "to document the accuracy of any

statements" he made in promotional material for his

manuscript.

     It is not necessary for us to address petitioner's

argument that there was a direct relationship between his

publishing business and the commodity futures that he

traded.    Even if we agreed that such a relationship

existed, we must nevertheless sustain respondent because

petitioner has failed to show any relationship between the

price or value of his manuscript and the price of the
                           - 16 -

commodity futures that he traded.    See United States v.

Rogers, supra; Hoover Co. v. Commissioner, supra; Wool

Distrib. Corp. v. Commissioner, 34 T.C. 323 (1960).

Indeed, petitioner has not even identified the specific

commodities that were the subject of his day trades.    We

perceive no necessary relationship between the price of

petitioner's manuscript and the price of the commodities

that petitioner traded such as to qualify as a hedge.

Thus, we reject petitioner's argument that the commodity

futures that he traded during the years in issue were

hedges against the loss in value of his manuscript.

Accordingly, we reject petitioner's argument that his

losses from trading commodity futures during 1989 and 1990

are deductible as ordinary losses.

     Before leaving this issue, we note that petitioner

labeled the deduction of his trading losses in each of the

years in issue as "Research & Experimentation to Improve

Trading System Formula for Sale".    We also note that the

petition states that the losses are deductible under

section 1.174-1, Income Tax Regs., as "research &

development expenses".   However, in his post-trial brief,

petitioner does not claim that the subject losses are

deductible as research and experimental expenditures under

section 174.   Thus, petitioner has abandoned this argument.

Money v. Commissioner, 89 T.C. 46, 48 (1987); Alexander v.
                            - 17 -

Commissioner, 61 T.C. 278, 288 n.6 (1973); Bernstein v.

Commissioner, 22 T.C. 1146, 1152 (1954), affd. 230 F.2d 603

(2d Cir. 1956).    Moreover, the record of this case suggests

that petitioner incurred the subject losses in connection

with his manuscript, presumably a "literary" work.       See

Quinn v. Commissioner, T.C. Memo. 1974-64; cf. Crouch v.

Commissioner, T.C. Memo. 1990-309.    The phrase "research

or experimental expenditures", however, does not include

expenditures for "Research in connection with literary

* * * projects."    Sec. 1.174-2(a)(3), Income Tax Regs.

     The next issue for decision involves respondent's

determination that petitioner is liable for the accuracy-

related penalty imposed by section 6662(a).     Respondent

determined that the entire underpayment for 1989,

$27,650.70, and a portion of the underpayment for 1990,

$17,224, is attributable to negligence or disregard of

rules or regulations.    See sec. 6662(a) and (b)(1).

The term "negligence" includes any failure to make a

reasonable attempt to comply with the statute, and the

term "disregard" includes any careless, reckless, or

intentional disregard.    Sec. 6662(c).   Respondent's

determinations are presumed correct, and petitioner

bears the burden of proving that he is not liable for

the accuracy-related penalty.    Rule 142(a).   All Rule
                               - 18 -

references are to the Tax Court Rules of Practice and

Procedure.

     Section 6664(c) provides that no penalty shall be

imposed with respect to any portion of an underpayment

if it is shown that there was a reasonable cause for such

portion and that the taxpayer acted in good faith with

respect to such portion.   The determination of whether this

exception applies is made on a case-by-case basis, taking

into account all pertinent facts and circumstances.        Sec.

1.6664-4(b)(1), Income Tax Regs.        An honest misunderstand-

ing of fact or law that is reasonable in light of all the

facts and circumstances, including the experience,

knowledge, and education of the taxpayer, can support a

finding that the taxpayer had reasonable cause and was in

good faith.   Id.   Generally, however, the most important

factor in determining whether this exception applies is the

extent of the taxpayer's efforts to assess the taxpayer's

proper tax liability.    Id.

     Petitioner contends that he relied on "substantial

authority" and provided "adequate disclosure" of his

deductions within the meaning of the statute and,

therefore, should be absolved from the penalty.        Petitioner

also argues that he and respondent merely have an "honest

difference of opinion" with respect to the law and that

he should be absolved from the penalty on this basis.        We
                            - 19 -

construe petitioner's latter argument as invoking section

6664(c), the reasonable cause exception to the accuracy-

related penalty.

     Based upon the facts and circumstances of this case,

we find that petitioner has failed to meet his burden of

proving that he is not liable for the accuracy-related

penalty.   On the subject returns, petitioner labeled the

deduction of his commodity trading losses as "Research &

Experimentation to Improve Trading System Formula for

Sale".   That label suggests that petitioner claimed the

amounts as research or experimental expenditures under

section 174.   Neither of petitioner's returns discloses

the fact that the subject amounts are losses from trading

commodity futures.    Significantly, as mentioned above,

petitioner did not pursue the claim that the subject

amounts are research or experimental expenditures in his

post-trial brief.    Moreover, we know of no authority

permitting losses from the sale or exchange of capital

assets to be treated as ordinary in these circumstances.

Finally, we are not convinced that the underpayment was the

result of an honest misunderstanding of fact or law that is

reasonable in light of the facts and circumstances of this

case.
                          - 20 -

     Accordingly, we sustain respondent's determination of

the accuracy-related penalty.


                                Decision will be entered

                         under Rule 155.
