                          T.C. Memo. 2016-69



                   UNITED STATES TAX COURT



DAVID H. HOFFMANN AND JERRILYNN HOFFMANN, Petitioners v.
    COMMISSIONER OF INTERNAL REVENUE, Respondent



 Docket No. 29887-12.                          Filed April 19, 2016.



        In 1999 and 2000, PH purchased interests in jet aircraft in
 anticipation of leasing them profitably to E, a corporation organized
 to combine his business with similar businesses. In 2001, after E
 failed, PH's majority-owned corporation reacquired the business he
 had sold to E. Thereafter, PH could no longer earn a profit from
 leasing his aircraft to controlled corporations. Ps claim that the
 continuing, and increasing, losses incurred in PH's jet service activity
 through 2004 did not evidence the absence of a profit motive because
 the losses were attributable to E's failure and PH's inability to
 terminate his relationship with the provider of his aircraft.

        Held: Because PH's contracts with the provider of his aircraft
 allowed him to cause it to reacquire his interests in the aircraft no
 later than October 20, 2002, Ps did not establish that the losses
 incurred in PH's jet service activity in 2003 and 2004 were
 unavoidable or that PH engaged in his jet service activity for profit
 during those years; consequently, Ps can deduct expenses of that
                                         -2-

      [*2] activity paid in each of those years only to the extent allowed by
      I.R.C. sec. 183(b).

             Held, further, Ps' deficiency and I.R.C. sec. 6662(a) accuracy-
      related penalty for 2003 sustained; Ps' deficiency and I.R.C. sec.
      6662(a) accuracy-related penalty for 2004 depend on computation of
      deductions allowable for that year related to PH's jet service activity
      taking into account agreed amount of unreported income for that year.



      Royal B. Martin, Jr., Denis J. Conlon, and Steven Spencer Brown, for

petitioners.

      Angela B. Reynolds, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


      HALPERN, Judge: Respondent determined deficiencies of $112,794 and

$538,339 in petitioners' 2003 and 2004 Federal income tax, respectively, and

accuracy-related penalties of $22,559 and $107,668 for those years, respectively.

The parties entered into a stipulation of settled issues, and the only issues

remaining for decision are (1) whether petitioners are entitled to deduct expenses

related to David Hoffmann's jet service activity in excess of the gross income from

that activity and (2) whether petitioners are liable for section 6662(a) accuracy-

related penalties on their underpayments of tax for the years in issue. Unless
                                            -3-

[*3] otherwise indicated, all section references are to the Internal Revenue Code in

effect for the years in issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure. We round all dollar amounts to the nearest dollar.

                                  FINDINGS OF FACT

         Petitioners resided in Illinois when they filed their petition in this case.

Formation of EPS

         During the 1990s, Mr. Hoffmann engaged in an executive search business

through his wholly owned corporation, DHR International, Inc. (Original DHR).1

In 1998, Mr. Hoffmann pursued an opportunity to combine Original DHR's

business with many service businesses throughout the country in a new

corporation, Enterprise Profit Solutions (EPS), which had been organized to be the

nation's largest outsourcing firm. Toward that end, Original DHR sold its assets to

EPS on December 14, 1998. EPS then turned to plans for an initial public offering

(IPO).

         Investment bankers planning EPS' IPO encouraged Mr. Hoffmann to

acquire a private jet on EPS' behalf. The bankers expected that, because of EPS'

far-flung locations and, in particular, the demands of planning and executing the


         1
      Mr. Hoffmann also conducted a separate "middle market" search business
through his wholly owned subchapter S corporation, JobPlex, Inc. (JobPlex).
                                         -4-

[*4] IPO, EPS would have air travel needs that could not be met conveniently by

relying on commercial flights. Lending covenants, however, prevented EPS from

acquiring its own aircraft.

Mr. Hoffmann's Acquisition of Interests in Jet Aircraft

      Mr. Hoffmann discussed the possibility of acquiring an interest in a jet

aircraft with his friend Jeff Goldman, a pilot who had owned aircraft and profited

from their appreciation. Mr. Goldman advised Mr. Hoffmann that he, too, could

expect to realize appreciation from investing in aircraft.

      Mr. Hoffmann eventually decided to acquire an interest in a Citation X, then

the fastest executive jet available. On December 30, 1998, petitioners formed a

limited liability company, Hoffmann Holdings, LLC (Hoffmann Holdings), of

which they were the sole owners, to acquire fractional interests in aircraft.

Because interests in Citation Xs were not immediately available, Hoffmann

Holdings initially leased from NetJets Aviation, Inc. (NetJets), interests in two

Raytheon Hawker 1000 aircraft.2

      On October 7, 1999, Hoffmann Holdings purchased from NetJets a 12.5%

interest in a Citation X (Citation 1). On April 20, 2000, Hoffmann Holdings

      2
       NetJets Aviation, Inc., was the successor to Executive Jet Sales, Inc. For
ease of reference, following the parties' lead, we will refer to each of these entities,
and an affiliate, Executive Jet Aviation, Inc., without distinction as NetJets.
                                        -5-

[*5] purchased from NetJets a 6.25% interest in a second Citation X aircraft

(Citation 2).

      The purchase agreements for both Citation 1 and Citation 2 allowed

Hoffmann Holdings to cause NetJets to repurchase its interests in the aircraft after

30 months for the lesser of the original purchase price or the then fair market value

of the interest. They prohibited Hoffmann Holdings from transferring its interests

in the aircraft to a third party without NetJets' consent. NetJets could withhold

consent to any proposed transfer at its discretion unless, among other things, the

third-party transferee agreed to the terms of the agreements under which NetJets

operated the aircraft on behalf of its coowners. The management agreements

governing the use of the aircraft required Hoffmann Holdings to pay fixed

monthly management fees as well as additional charges for actual use of the

aircraft. Each management agreement had a general five-year term but would

terminate earlier upon exercise of the repurchase option.

The Aircraft Lease Between Hoffmann Holdings and Original DHR

      On the advice of tax attorney Frank Bastian, Hoffmann Holdings entered

into an aircraft lease with Original DHR to demonstrate Hoffmann Holdings' profit

motive. A signed copy of the lease introduced into evidence is dated November

18, 1998, and the parties have stipulated that Original DHR and Hoffmann
                                         -6-

[*6] Holdings entered into the lease on that date, even though they also stipulated

that Hoffmann Holdings was not created until December 30, 1998. A letter from

Mr. Bastian dated August 3, 2000, enclosed a proposed written agreement that

purportedly incorporated the terms of a prior oral contract. In that letter, Mr.

Bastian professed unconcern that the agreement predated Hoffmann Holdings'

formation. In his view, Mr. Hoffmann entered into the agreement on behalf of

Hoffmann Holdings before its formation.

      The written lease allowed Original DHR to use "two Cessna Citation X

aircraft on an 'as needed' basis." The lease provided for "a term of three years

commencing November 1, 1998 and ending October 31, 2001."

The Failure of EPS' IPO

      Financial difficulties prevented EPS from completing its planned IPO. In

response to those difficulties, EPS' board removed its initial chief executive officer

and replaced him with Mr. Hoffmann. Mr. Hoffmann's efforts, however, proved

unsuccessful, and EPS ultimately sold its various businesses back to their original

owners. In particular, on February 6, 2001, Hoffmann Acquisition Corp.

(Hoffmann Acquisition) acquired Original DHR's assets from EPS. The acquiring

corporation then changed its name to DHR International, Inc. (DHR). Mr.

Hoffmann owned 75% of the DHR stock.
                                          -7-

[*7] After DHR acquired Original DHR's assets, Hoffmann Holdings did not

invoice DHR for its use of Hoffmann Holdings' aircraft and failed to formalize its

arrangement with DHR in a written lease.

Mr. Hoffmann's Initial Attempt To Unwind His Deal With NetJets

      In a letter to David Beach of NetJets dated April 26, 2000, Mr. Hoffmann

purported to exercise his "right" to have NetJets repurchase Hoffmann Holdings'

interests in Citation 1 and Citation 2.3 Mr. Hoffmann hired an attorney named

Anthony Barone, whom Mr. Hoffmann described as having "a certain degree of

experience", to negotiate with NetJets.

      Although NetJets was apparently willing to repurchase all of Hoffmann

Holdings' aircraft at Mr. Hoffmann's request (even though the repurchase options

granted to Hoffmann Holdings had not yet become exercisable), Mr. Hoffmann

decided to retain at least one of the Citations.4 Internal DHR correspondence



      3
       As of the date of Mr. Hoffmann's letter, Hoffmann Holdings had no
apparent right to cause NetJets to repurchase its interest in either Citation 1 or
Citation 2 because Hoffmann Holdings had not yet held either aircraft for 30
months. (In fact, Mr. Hoffmann's letter was dated just six days after Hoffmann
Holdings acquired its interest in Citation 2.)
      4
       An email dated November 16, 2004, from Dianne Mahaffey of NetJets to
Donn Seidholz, also of NetJets, states: "In June of 2000 NetJets was going to
repurchase all shares Owned by Hoffman[n] Holdings." Ms. Mahaffey continues:
                                                                     (continued...)
                                        -8-

[*8] suggests that the decision to keep Citation 2 was motivated by the need to

deal with Hoffmann Holdings' use of its aircraft in excess of the hours allotted to

its interests in them. If Hoffmann Holdings had sold all of its aircraft back to

NetJets, it would have had to pay for the "over flown hours".5 Cathleen Lloyd,

DHR's chief financial officer, estimated that it would be less expensive to keep

Citation 2 and absorb the over flown hours through the continued payment of

monthly management fees without further use of the aircraft. Ms. Lloyd

determined that the over flown hours, all of which were allocated to the contract

for Citation 2, would be fully absorbed by April 20, 2002.

The Conduct of Mr. Hoffmann's Jet Service Activity During the Years in Issue

      During 2003 and 2004, DHR used Citation 2 "for certain business activity".

By 2003, however, it had become clear that Mr. Hoffmann could not earn a profit




      4
       (...continued)
"What I can gather from correspondence was that 908QS [Citation 2] would not be
sold back but assigned to David H. Hoffman[n]".
      5
        At trial, Cathleen Lloyd, DHR's chief financial officer, acknowledged the
repurchase options that allowed Hoffmann Holdings to resell its aircraft to NetJets
but claimed that there would have been "significant penalties associated with those
options", apparently referring to the obligation to pay for over flown hours.
                                        -9-

[*9] from the business use of his aircraft.6 According to Ms. Lloyd's testimony,

DHR reimbursed Mr. Hoffmann for the direct costs of its use of the aircraft and an

allocable portion of NetJets' monthly management fee but did not pay Mr.

Hoffmann enough to generate a profit. During that period, Ms. Lloyd, Gloria

Seghi, DHR's chief administrative officer, and Adam Morrison, DHR's controller,

assisted Mr. Hoffmann in recordkeeping, allocating flight costs on the basis of his

instructions. When asked to describe his duties in regard to his jet service activity,

Mr. Hoffmann referred only to his responsibility for approving proposed uses of

the aircraft.

       On November 18, 2004, Mr. Hoffmann traded in his interest in Citation 2

for a 6.25% interest in a Gulfstream 200 aircraft. As part of the exchange, he

received a trade-in allowance from NetJets of $812,563 towards the $1,123,440

purchase price of the Gulfstream 200.

       Less than four months after acquiring his interest in the Gulfstream 200, Mr.

Hoffmann advised NetJets of his decision to cancel his contract for that aircraft.

In his letter to NetJets, Mr. Hoffmann referred to repeated difficulties scheduling

       6
        Mr. Hoffmann apparently succeeded to Hoffmann Holdings' ownership
interest in Citation 2 on May 31, 2001, when the Illinois secretary of state
dissolved Hoffmann Holdings because of its failure to file an annual report for
2000. Formal documentation with NetJets of the transfer of ownership, however,
was not completed until June 23, 2003.
                                         - 10 -

[*10] flights at the times and from the departure locations he preferred. He

acknowledged that he used the plane "mostly for flights in and out of Eagle/Vail",

where petitioners had a vacation home. Mr. Hoffmann complained to NetJets of

having to call guests and change arrangements for babysitting and travel to the

airport. These scheduling difficulties, he alleged, "create[] more problems than the

plane is worth."

       In response to Mr. Hoffmann's request, NetJets agreed to repurchase the

Gulfstream 200. Thereafter, DHR met its air travel needs without resort to a

private jet.

Petitioners' Tax Reporting of Mr. Hoffmann's Jet Service Activity

       For the first four years of Mr. Hoffmann's jet service activity, petitioners

reported the following amounts on Schedules C, Profit or Loss From Business, of

their Forms 1040, U.S. Individual Income Tax Return:7

       7
       On those Schedules C, as well as on Schedules C attached to their 2003 and
2004 Forms 1040, petitioners reported a jet service business with the name
Hoffmann Holdings LLC, owned by Mr. Hoffmann. Hoffmann Holdings
purchased the Citation 1 in October 1999 and purchased the Citation 2 in April
2000. The Illinois secretary of state dissolved Hoffmann Holdings in May 2001.
The parties have stipulated, and we have found, that Hoffmann Holdings was
solely owned by petitioners. We assume that Hoffmann Holdings was classified
as a partnership for Federal tax purposes. See sec. 301.7701-3(b)(1), Proced. &
Admin. Regs. For 1999 through at least part of 2001, petitioners should therefore
have reported their distributive shares of its income, deductions, and the like on
                                                                        (continued...)
                                       - 11 -

 [*11]                   1999            2000           2001              2002
 Gross receipts         $800,935      $760,229       $124,391              -0-
 Depreciation            150,357       155,000        265,714          $189,796
 Loan prepayment
   charge                 -0-          153,196          -0-                -0-
 Other expenses          761,417       739,885        101,589            166,610
   Loss                 (110,839)      (287,852)      (242,912)          (356,406)

For the years in issue, petitioners reported the following amounts on the Schedules

C for Mr. Hoffmann's jet service activity:

                                       2003                     2004
 Gross receipts                       $35,978                  $78,061
 Depreciation                         135,569                  398,801
 Mortgage interest                     91,890                   81,887
 Legal & professional                   -0-                      4,851
 Repairs and maintenance              107,481                  111,507
 Other expenses                       218,082                  254,791
   Loss                              (517,044)                (773,776)

On their 2003 Federal income tax return, petitioners reported adjusted gross

income of $179,787 after claiming a $517,044 loss deduction from Mr.



      7
       (...continued)
Schedule E, Supplemental Income and Loss. The error appears to be one of form
and not one of substance.
                                         - 12 -

[*12] Hoffmann's jet service activity. For 2004, they reported adjusted gross

income of $2,980,944 after claiming a $773,776 loss deduction from that activity.

Petitioners relied on others to prepare their tax returns.

Petitioners' Unreported Income

       Mr. Hoffmann received a payment of $115,726 from DHR in 2004 in

reimbursement of repair and maintenance expenses attributable to his aircraft that

petitioners failed to include in the income reported on their 2004 Federal income

tax return. The parties stipulated that Mr. Hoffmann deducted the expenses

relating to the $115,726 payment on the 2004 Schedule C for his jet service

activity.8

Tax Advice Received by Petitioners

       The record fails to disclose in detail any advice petitioners received

regarding the deductibility of the expenses incurred in Mr. Hoffmann's jet service

activity. Edward Ruberry, EPS' outside general counsel, Ms. Lloyd, and Mr.

Hoffmann all testified that tax attorney Frank Bastian gave advice in regard to Mr.




       8
       The total amount reported as repair and maintenance expense on the 2004
Schedule C for Mr. Hoffmann's jet service activity, however, was only $111,507,
which the parties stipulated to have been paid by JobPlex.
                                         - 13 -

[*13] Hoffmann's aircraft.9 Neither Mr. Ruberry nor Ms. Lloyd described the

content of Mr. Bastian's advice. Mr. Hoffmann claimed that Mr. Bastian had told

him that he "could claim a deduction for * * * [his] use of the jets". He admitted,

however, that he did not remember what, specifically, Mr. Bastian had told him.

The only evidence of the specific content of any advice provided by Mr. Bastian's

firm is a letter from one of his partners that explains the rules relating to the

imputation of income from an employee's use of an employer-provided aircraft.

The Notice of Deficiency

      Respondent's notice of deficiency (notice) disallowed in full the deductions

for depreciation, mortgage interest, and repair and maintenance expenses claimed

by petitioners in each of the years in issue in regard to Mr. Hoffmann's jet service

activity. In addition, the notice disallowed in each year the amount of "other

expenses" claimed by petitioners in excess of the gross income they reported from

the jet service activity. The notice also disallowed petitioners' deduction for 2004

of legal and professional fees related to that activity and increased petitioners'

income for that year by the $115,726 reimbursement of repair and maintenance




      9
     Ms. Lloyd denied that she provided any tax advice herself regarding Mr.
Hoffmann's jet service activity.
                                       - 14 -

[*14] expenses that Mr. Hoffmann received from DHR. Petitioners have conceded

the other adjustments made in the notice.

Mr. Hoffmann's Testimony

      Mr. Hoffmann testified that he intended to make a profit from his jet service

activity. He admitted, however, that he "wasn't astute on the recordkeeping"

involved in allocating costs between business and personal use of his aircraft. He

viewed any such allocation as "irrelevant". Because he "owned all the

company",10 he said, "it really didn't seem to make much difference to me."11

      Mr. Hoffmann claimed not to have read the provision in each of the

purchase agreements between NetJets and Hoffmann Holdings providing the

latter's repurchase option. He acknowledged that his understanding of his rights

under the agreement was based on "an assumption" rather than familiarity with the

terms of the agreement.




      10
        In fact, Mr. Hoffmann owned only 75% of the DHR stock. The record
does not identify the owners of the remaining 25% of DHR stock or their
relationship to Mr. Hoffmann.
      11
        Mr. Hoffmann's testimony on the importance of distinguishing between
business and personal uses of his aircraft, however, was inconsistent. Upon
questioning by the Court, he professed concern that DHR's minority shareholders
not bear the cost of his personal use of the aircraft.
                                       - 15 -

[*15] In addition, Mr. Hoffmann was unable to explain the calculation of the

amounts reported on the 2003 and 2004 Schedules C for his jet service activity.

When asked by respondent's counsel about the derivation of the figures, he

repeatedly professed not to know. He could not even identify the property in

regard to which depreciation had been claimed, saying he had "no idea."

Petitioners' Substantiation of the Claimed Deductions

      Petitioners failed to provide substantiating documents requested by

respondent's counsel until after the trial had ended. On April 21, 2014, three days

after completion of the trial, petitioners moved for leave to supplement the record.

On May 27, 2014, the parties submitted a supplemental stipulation of facts that

largely addressed substantiation issues.12 Thereafter, petitioners withdrew their

motion.

                                     OPINION

I.    The Deductibility of Losses From the Jet Service Activity

      Respondent offers two rationales in support of his claim that petitioners

cannot deduct the losses they reported from Mr. Hoffmann's jet service activity in

      12
        The supplemental stipulation does not fully address the $218,082 of "other
expenses" claimed on the 2003 Schedule C for Mr. Hoffmann's jet service activity.
The parties stipulated $150,798 of other expenses paid by JobPlex and $10,780 of
other expenses paid by DHR, leaving unsubstantiated $56,504 ($218,082 !
$150,798 ! $10,780).
                                         - 16 -

[*16] 2003 and 2004. First, respondent argues the mortgage interest and repair

and maintenance expenses for which petitioners claimed deductions were actually

paid by JobPlex. Respondent also argues that the "other expenses" for which

petitioners claimed deductions were either paid by JobPlex or DHR or were

unsubstantiated. Therefore, respondent argues that petitioners failed to establish

that they paid the mortgage interest, repair and maintenance, and other expenses

for which they claimed deductions. Second, respondent argues that Mr. Hoffmann

did not engage in his jet service activity for profit.

      We agree with respondent that Mr. Hoffmann did not conduct his jet service

activity for profit during the years in issue. Because the deductions disallowed in

each year as a consequence of that determination exceed the amount that would be

disallowed by acceptance of respondent's first argument, we need not address that

argument.

      A.     Burden of Proof

      In general, a taxpayer bears the burden of proof. Rule 142(a)(1). However,

section 7491(a) shifts the burden of proof to the Commissioner in certain

situations if the taxpayer raises the issue, introduces credible evidence with respect

to any factual issue relevant to ascertaining the proper tax liability, complies with

all substantiation requirements, maintains required records, and cooperates with
                                         - 17 -

[*17] reasonable requests of the Internal Revenue Service "for witnesses,

information, documents, meetings, and interviews".

      Petitioners claim to have met the requirements to shift the burden of proof

to respondent under section 7491(a). Respondent denies that claim, noting, among

other things, petitioners' failure to provide requested substantiating documents

until after the trial ended, their failure to fully substantiate all claimed deductions

despite their submission of additional evidence after trial, and the lack of

credibility of several of petitioners' witnesses as demonstrated by the

inconsistency of that testimony with documentary evidence.

      We agree with respondent that petitioners failed to prove that they meet the

conditions specified in section 7491(a) to shift the burden of proof. In any event,

our assignment of the burden of proof would not affect our disposition of the case

because, for the reasons explained below, we find on a preponderance of the

evidence that, during the years in issue, Mr. Hoffmann did not engage in his jet

service activity for profit. See, e.g., Estate of Black v. Commissioner, 133 T.C.

340, 359 (2009); Estate of Bongard v. Commissioner, 124 T.C. 95, 111 (2005).
                                        - 18 -

[*18] B.     Section 183 For-Profit Requirement

             1.     Introduction

      Section 183(a) provides: "In the case of an activity engaged in by an

individual * * *, if such activity is not engaged in for profit, no deduction

attributable to such activity shall be allowed under this chapter except as provided

in this section." In general, section 183(b) allows deductions attributable to an

activity not engaged in for profit only to the extent of the gross income from the

activity. Section 183(c) provides: "For purposes of this section, the term 'activity

not engaged in for profit' means 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." Section 162 applies to trade or business expenses, while

section 212(1) and (2) allows a deduction, respectively, for expenses incurred "for

the production or collection of income" and for the management, conservation, or

maintenance of income-producing property.

      Section 1.183-2(b), Income Tax Regs., provides a nonexclusive list of nine

factors to be considered when ascertaining a taxpayer's profit intent. Those factors

are: (1) the manner in which the taxpayer carries on the activity, (2) the expertise

of the taxpayer or his advisors, (3) the time and effort expended by the taxpayer in

carrying on the activity, (4) the expectation that assets used in the activity may
                                         - 19 -

[*19] appreciate in value, (5) the success of the taxpayer in carrying on other

similar or dissimilar activities, (6) the taxpayer's history of income or losses from

the activity, (7) the amount of occasional profits, if any, earned by the taxpayer,

(8) the taxpayer's financial status, and (9) elements of personal pleasure or

recreation. No single factor is conclusive, and we may accord certain factors

greater weight than others. See Golanty v. Commissioner, 72 T.C. 411, 426

(1979), aff'd without published opinion, 647 F.2d 170 (9th Cir. 1981); Schlievert

v. Commissioner, T.C. Memo. 2013-239, at *18.

        Although Mr. Hoffmann testified that he intended to make a profit from his

jet service activity, we give more weight to the objective factors listed above in

determining whether he had the requisite profit objective and less to his "mere

statement of intent." See Keanini v. Commissioner, 94 T.C. 41, 46 (1990); Judah

v. Commissioner, T.C. Memo. 2015-243, at *32; see also sec. 1.183-2(a), Income

Tax Regs.

        On the basis of the record as a whole, taking into account the factors listed

in section 1.183-2(b), Income Tax Regs., we conclude that Mr. Hoffmann did not

engage in his jet service activity for profit during the years before us, and we so

find.
                                         - 20 -

[*20]         2.     Application of the Profit Factors

        As explained below, each of the nine factors listed in the regulations

supports respondent's position.

                     a.    Manner of Carrying On Activity

        The taxpayer's conduct of an activity in a businesslike manner may indicate

that the taxpayer is profit motivated. Sec. 1.183-2(b)(1), Income Tax Regs. To

make this determination, we can look to whether the taxpayer maintains complete

and accurate books and records, whether the activity is carried on in a manner

similar to other activities of the same nature that are profitable, and whether the

taxpayer has changed operating methods or abandoned unprofitable methods "in a

manner consistent with an intent to improve profitability". Id.

        The parties agree that Mr. Hoffmann initially carried out the jet service

activity in a businesslike manner but disagree on whether he continued to do so

during the years in issue. Respondent observes that, after DHR acquired the assets

of Original DHR in February 2001, Hoffmann Holdings did not invoice DHR for

its use of the aircraft and failed to formalize its arrangement with DHR in a written
                                         - 21 -

[*21] lease.13 Further, Mr. Hoffmann admitted that he "wasn't astute on the

recordkeeping" involved in allocating costs between business and personal use of

his aircraft.

       Petitioners attribute the failure to issue invoices to DHR for its use of the

aircraft to the close relationship between Mr. Hoffmann and the corporation.

Petitioners do not specifically address the absence of a formal lease agreement

with DHR concerning its use of Mr. Hoffmann's aircraft, but they suggest that, by

the years in issue, Mr. Hoffmann no longer viewed a written lease as important.

Petitioners note that Mr. Hoffmann's "focus in the years 2003 and 2004 was to

mitigate * * * losses" that they claim were unavoidable "because * * * [Mr.

Hoffmann] was locked into the NetJets contracts for five years, [and] he was

unable to extricate himself from that commitment".14 According to Ms. Lloyd,



       13
         Even if Original DHR's rights and obligations under its lease agreement
with Hoffmann Holdings transferred to EPS upon the latter's acquisition of
Original DHR's assets on December 14, 1998, and then transferred to Hoffmann
Acquisition upon its acquisition of those assets from EPS on February 6, 2001, the
lease would have expired by its terms on October 31, 2001. Petitioners provided
no evidence that, after DHR's acquisition of the assets of Original DHR, Hoffmann
Holdings or Mr. Hoffmann sought to extend the initial lease or enter into a new
aircraft lease with DHR.
       14
        Petitioners offered no explanation of why, if Mr. Hoffmann's focus in
2003 and 2004 was mitigating losses, he traded in Citation 2 on November 18,
2004, for a more expensive aircraft.
                                           - 22 -

[*22] Original DHR and Hoffmann Holdings executed their lease on the advice of

tax attorney Frank Bastian to demonstrate Hoffmann Holdings' profit motive in

acquiring and leasing the aircraft. Once Mr. Hoffmann's focus shifted from

earning profits to mitigating losses, he apparently no longer viewed the existence

of a formal lease agreement as critical.

      In assessing the manner in which Mr. Hoffmann carried on his jet service

activity, we find more important than any defects of recordkeeping his willingness

to incur avoidable losses. Just as abandoning unprofitable methods can indicate a

profit motive, sec. 1.183-2(b)(1), Income Tax Regs., a continuing and unexplained

failure to abandon an unprofitable activity evidences motives other than pursuit of

profit, see Heinbockel v. Commissioner, T.C. Memo. 2013-125, at *23-*24

(finding that jet leasing activity that continued after inability to earn profit became

clear was not conducted in a businesslike manner); Daugherty v. Commissioner,

T.C. Memo. 1983-188, 1983 Tax Ct. Memo LEXIS 602, at *20 ("[A]t some point

* * * [continued] losses * * * might justify a conclusion that * * * [the taxpayer]

abandoned any possible profit motive.").

      The evidence refutes Mr. Hoffmann's contention that his commitment to

NetJets forced on him losses that he could only mitigate but not avoid altogether.

The purchase agreements with NetJets, which Mr. Hoffmann acknowledged he
                                       - 23 -

[*23] had not read, allowed Hoffmann Holdings to cause NetJets to repurchase

Hoffmann Holdings' interest in the aircraft after 30 months. Although the

management agreements each provided for a general five-year term, each would

terminate earlier upon exercise of the repurchase option. Moreover, NetJets'

conduct suggests that it would not have strictly enforced the 30-month condition

on the repurchase option. NetJets was apparently willing to purchase both

Citation 1 and Citation 2 at Mr. Hoffmann's request in June 2000 and may actually

have purchased Citation 1 at that time.15 In addition, in response to Mr.

Hoffmann's request, NetJets agreed to repurchase the Gulfstream 200 just five

months after he acquired it by trading in Citation 2. In any event, even if NetJets

had insisted on strictly enforcing the 30-month condition to the repurchase option,




      15
         The statement by Dianne Mahaffey of NetJets in her email of November
16, 2004, that NetJets would not repurchase Citation 2 implies that it did
repurchase Citation 1 at Mr. Hoffmann's request. The application to the contract
for Citation 2 of the over flown hours incurred on Citation 1 is consistent with that
proposition. In addition, the parties submitted formal documentation of the
transfer of ownership of Citation 2 to Mr. Hoffmann after the dissolution of
Hoffmann Holdings on May 31, 2001, but introduced no such documentation in
regard to Citation 1. Finally, the loan prepayment charge of $153,196 reported on
the 2000 Schedule C for Mr. Hoffmann's jet service activity could be explained by
Hoffmann Holdings' early repayment of the loan it incurred to purchase Citation 1
after reselling that aircraft to NetJets.
                                        - 24 -

[*24] Mr. Hoffmann could have caused NetJets to repurchase Citation 2 any time

after October 20, 2002.16

      On the basis of Mr. Hoffmann's lax recordkeeping and, more importantly,

his willingness to incur substantial avoidable losses, we find that he did not carry

on his jet service activity in a businesslike manner during the years in issue.

                   b.       Expertise of the Taxpayer or His Advisors

      Preparation for an activity by extensive study or consultation with experts

may indicate a profit motive when the taxpayer carries on the activity as advised.

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

      Petitioners claim that Mr. Hoffmann "gathered information from those

experienced in the air transportation business" and that "studies were conducted".

They introduced no studies into evidence, however, and failed to describe the

content of any studies Mr. Hoffmann received. Petitioners claim that Mr.

Hoffmann sought counsel from Edward Ruberry, Anthony Barone, Jeff Goldman,

Frank Bastian, and unidentified members of Mr. Bastian's firm. There is no

      16
        Cathleen Lloyd acknowledged the possibility of reselling the aircraft to
NetJets but claimed that there would have been "significant penalties associated
with those options", apparently referring to the obligation to pay for over flown
hours. But her analysis determined that the over flown hours would be fully
absorbed by the payment of monthly management fees to NetJets through April
20, 2002. There is no evidence that exercise of the repurchase option for Citation
2 after April 20, 2002, would have resulted in any penalty.
                                        - 25 -

[*25] evidence, however, that any of these individuals had significant experience

in or particular expertise regarding the business of providing jet transportation

services.17 Mr. Hoffmann's professed "team of advisers", Ms. Lloyd, Gloria Seghi,

and Adam Morrison, were employees of or service providers to DHR who

reported to Mr. Hoffmann and assisted him in recordkeeping, allocating flight

costs on the basis of his instructions. Petitioners presented no evidence that any

member of that team offered advice regarding the jet service business or was

qualified to do so.

      More to the point, the advice Mr. Hoffmann claims to have received would

not address the critical inquiry in this case. Our concern is not why Mr. Hoffmann

began his jet service activity in 1999 but why he continued it during 2003 and


      17
         Mr. Hoffmann described his friend Mr. Goldman as a pilot and aircraft
owner. The record does not disclose, however, whether Mr. Goldman used his
aircraft in conducting a business or for personal purposes. Cf. Hillman v.
Commissioner, T.C. Memo. 1999-255, 1999 WL 558568, at *8 ("Expertise with
respect to the breeding and showing of horses is to be distinguished from expertise
in the economics of these undertakings."). According to Mr. Hoffmann, Mr.
Goldman had "experienced appreciation" in his own aircraft and advised Mr.
Hoffmann that he, too, could "expect to have some appreciation in the aircraft." It
does not appear, however, that any advice provided by Mr. Goldman to Mr.
Hoffmann regarding the potential of realizing a profit from appreciation took into
account the specific terms of the contracts with NetJets.
       Mr. Hoffmann characterized Mr. Barone as having "a certain degree of
experience" but offered no further description of any expertise Mr. Barone had
regarding the jet service business or any advice he received from Mr. Barone.
                                         - 26 -

[*26] 2004 when it had become clear that the activity could not be conducted

profitably. As noted above, petitioners defend Mr. Hoffmann's continuation of his

jet service activity during the years in issue not on the basis of advice from experts

but instead on his alleged inability to divest himself of his aircraft and terminate

his relationship with NetJets. Again, the evidence before us refutes petitioners'

claims that Mr. Hoffmann was "locked into" his relationship with NetJets

throughout the years in issue and thus forced to suffer losses that he could only

mitigate but not avoid.

      On the basis of Mr. Hoffmann's failure to present evidence of advice

received from persons knowledgeable regarding the jet transportation business, we

conclude that this factor, to the extent it is relevant to the issue before us, favors

respondent.

                    c.     Time and Effort Expended by the Taxpayer in Carrying
                           On the Activity

      The time and effort expended by the taxpayer in carrying on the activity

may indicate whether the taxpayer had a profit motive with respect to the activity,

particularly if there are no substantial personal or recreational elements associated

with it. Sec. 1.183-2(b)(3), Income Tax Regs.
                                         - 27 -

[*27] In their discussion of this factor in their briefs, petitioners focus primarily

on Mr. Hoffmann's efforts regarding EPS' planned IPO and the winding down of

EPS' business after the IPO failed. They argue that "the EPS business and the jet

service business should be considered together." But we need not address the

issue of whether Mr. Hoffmann's efforts on behalf of EPS and the leasing of his

aircraft comprise a single activity for purposes of section 183 because his

involvement with EPS ended before the years in issue.18 Therefore, the time Mr.

Hoffmann devoted to EPS, however extensive, does not support the proposition

that he conducted his jet service activity during the years before us with the

objective of making a profit.

      The record does not indicate how much time Mr. Hoffmann devoted to his

jet service activity during the years in issue. When asked to describe his duties in

regard to that activity, he referred only to his responsibility for approving

proposed uses of the aircraft. More generally, petitioners concede that Mr.

Hoffmann's focus during those years was mitigating losses. While petitioners

claim that the continuing losses Mr. Hoffmann incurred in his jet service activity

were unavoidable because of his inability to extricate himself from his obligations

      18
       There is no evidence that Mr. Hoffmann had any continuing involvement
with EPS after Hoffmann Acquisition repurchased the assets of Original DHR
from EPS on February 6, 2001.
                                        - 28 -

[*28] to NetJets, we have found otherwise. Efforts directed at mitigating

avoidable losses do not demonstrate an objective of making a profit.

      We conclude that this factor, as well, favors respondent.

                   d.     Expectation That Assets Used in Activity May
                          Appreciate

      An expectation that assets used in the activity will appreciate in value may

indicate a profit objective. See sec. 1.183-2(b)(4), Income Tax Regs. A profit

motive may be inferred in the absence of operating profits if reasonably expected

appreciation in the value of the assets used in the activity could exceed the

operating expenses. See id. The appreciation in value must be sufficient,

however, to recoup the accumulated losses of prior years. See Golanty v.

Commissioner, 72 T.C. at 427-428; Hillman v. Commissioner, T.C. Memo. 1999-

255, 1999 WL 558568, at *8.

      Petitioners argue that "Mr. Hoffmann was advised by knowledgeable

individuals that jet aircraft often appreciate in value." But the unremarkable

prospect that some aircraft appreciate would not establish that it was reasonable

for Mr. Hoffmann to expect appreciation in the undivided interests he held, along

with other coowners, in aircraft operated by NetJets.
                                        - 29 -

[*29] Petitioners introduced no evidence of an established market in undivided

interests in NetJets aircraft. As a practical matter, an owner's only realistic means

of selling its interest in the aircraft might well have been through exercise of the

repurchase option.

      Unless Mr. Hoffmann found a third-party transferee acceptable to NetJets,

he could have sold his interest in the aircraft only to NetJets, pursuant to the

repurchase option, at a price no greater than the original purchase price of the

interest paid by Hoffmann Holdings. In that case, the only profit he could have

earned would have reflected the recovery of prior depreciation.19 Because the

losses reported by Mr. Hoffmann from his jet service activity exceeded the

depreciation claimed on the aircraft used in that activity--his losses were economic

losses and not mere "paper" losses--resale of the aircraft at a price no greater than

the original purchase price would not have recouped those losses.

      Petitioners also refer to possible appreciation in the value of EPS stock held

by Mr. Hoffmann. Cf. Campbell v. Commissioner, 868 F.2d 833, 836-837 (6th

Cir. 1989) (taking into account shareholders' expectation of profit from

      19
        Because the allowance Mr. Hoffmann received when he traded in Citation
2 for a Gulfstream 200 did not exceed the $1,085,000 original purchase price of
Mr. Hoffmann's interest in Citation 2, any gain he may have realized on the
disposition of the plane would merely have recouped part, but not all, of the
depreciation previously claimed.
                                         - 30 -

[*30] corporation in finding that their leasing of an aircraft to the corporation was

also entered into for profit), aff'g in part, rev'g in part T.C. Memo. 1986-569.

Once again, petitioners' focus is misdirected. For starters, we find no evidence in

the record that Mr. Hoffmann owned stock in EPS.20 Moreover, an expectation of

profit from the EPS venture might have been a factor in Mr. Hoffmann's decision

to begin the jet service activity in 1999, but EPS failed before the years in issue.

Any expectation of profit from EPS cannot justify Mr. Hoffmann's continued

conduct of the jet service activity after EPS' failure.

      The absence of a reasonable expectation of appreciation sufficient to recoup

prior losses favors respondent in the sense that it eliminates a factor that might

explain the demonstrated string of losses that Mr. Hoffmann incurred in his jet

service activity.

                    e.     Success of the Taxpayer in Carrying On Other Similar or
                           Dissimilar Activities

      Section 1.183-2(b)(5), Income Tax Regs., provides that a taxpayer's prior

success in converting similar activities from unprofitable to profitable enterprises




      20
        Although Edward Ruberry and Mr. Hoffmann himself testified to his role
as an officer of EPS, neither of them described any ownership interest he had in
the corporation.
                                         - 31 -

[*31] "may indicate that he is engaged in the present activity for profit, even

though the activity is presently unprofitable."

      Petitioners point to Mr. Hoffmann's success in other ventures as evidence

that he had a profit motive in pursuing the jet service activity. Respondent

acknowledges Mr. Hoffmann's success in other ventures but argues that those

ventures are dissimilar to his jet service activity.

      We agree with respondent that, because of the dissimilarities between the

various activities, Mr. Hoffmann's success in unrelated ventures deserves little

weight in assessing whether he carried out his jet service activity during the years

in issue with the objective of earning a profit. This factor favors respondent in the

sense that it eliminates a claim that the losses Mr. Hoffmann incurred in his jet

service activity might be anomalous given his success in related activities. Cf.

McMillan v. Commissioner, T.C. Memo. 2015-109, at *21.

                    f.     Taxpayer's History of Income or Losses With Respect to
                           the Activity

      A record of substantial losses over several years after the startup period of

an activity, if not explainable as due to customary business risks or reverses, may

indicate the absence of a profit motive. Sec. 1.183-2(b)(6), Income Tax Regs.
                                        - 32 -

[*32] Mr. Hoffmann never reported a profit from his jet service activity.

Petitioners observe that the activity produced positive cashflow during its first

three years21 and that the continuing (and increasing) losses thereafter were

attributable to the failure of EPS' IPO. The losses incurred in Mr. Hoffmann's jet

service activity in 2003 and 2004, petitioners claim, "were a by-product or

aftermath" of "the attempted IPO for EPS." Again, petitioners invoke Mr.

Hoffmann's alleged inability to "extricate himself from the commitments he had

made to NetJets". We have already explained how the evidence refutes this claim

and demonstrates that Mr. Hoffmann could have caused NetJets to repurchase

Citation 2 at any time after October 20, 2002.

      The regulations provide that incurring losses from an activity "because of

unforeseen or fortuitous circumstances which are beyond the control of the

taxpayer" does not indicate that the activity is not engaged in for profit. Id. The

unforeseen failure of EPS may explain the losses incurred in the jet service activity

through 2002 but not the continuation of those losses in 2003 and 2004. As


      21
        The accuracy of this observation requires disregarding the loan
prepayment charge reported on the 2000 Schedule C for Mr. Hoffmann's jet
service activity. Although petitioners do not explain this charge, it could be
evidence that Mr. Hoffmann succeeded in selling Citation 1 back to NetJets in
2000, despite petitioners' claims that he was "locked into" a five-year deal. See
supra note 15.
                                         - 33 -

[*33] explained below, the evidence before us convinces us that Mr. Hoffmann's

retention of his interest in Citation 2 during the years in issue--and, indeed, his

trading up to a more expensive aircraft in November 2004--reflected his judgment

that the personal conveniences of travel by private jet, and perhaps the expected

tax benefits of using losses from his jet service activity to offset petitioners'

substantial income, justified the costs of maintaining his ownership of the aircraft,

at least until scheduling difficulties with NetJets greatly reduced those personal

conveniences.

                    g.     Amount of Occasional Profits, If Any, Which Are
                           Earned

      Section 1.183-2(b)(7), Income Tax Regs., provides:

      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. An occasional small profit from an
      activity generating large losses, or from an activity in which the
      taxpayer has made a large investment, would not generally be
      determinative that the activity is engaged in for profit. * * *

Conversely, substantial profits, even if only occasional, may indicate a profit

motive when the investment or losses are relatively small. Id. Finally, "an

opportunity to earn a substantial ultimate profit in a highly speculative venture is
                                         - 34 -

[*34] ordinarily sufficient to indicate that the activity is engaged in for profit even

though losses or only occasional small profits are actually generated." Id.

      Again, Mr. Hoffmann never reported a profit from his jet service activity.

In regard to this factor, petitioners offer essentially the same arguments they make

in regard to the prior factor: Mr. Hoffmann's jet service activity initially generated

positive cashflow, even if not a profit, and the potential profit that Mr. Hoffmann

could have earned from EPS' IPO supports finding a profit objective for his

conduct of the jet service activity. Again, neither point addresses the critical

question of why Mr. Hoffmann continued the jet service activity after the failure

of EPS' IPO. According to Ms. Lloyd's testimony, DHR did not pay Mr.

Hoffmann enough for its use of his aircraft to generate a profit. Therefore, as

petitioners' concede, "once EPS ceased being a customer, Hoffmann had no real

opportunity to charter the aircraft profitably."

      On the basis of Mr. Hoffmann's failure to report even occasional profits

from his jet service activity and his adherence to a course of conduct during the

years at issue that offered no possibility of earning a profit, we conclude that this

factor favors respondent.
                                        - 35 -

[*35]               h.     Financial Status of the Taxpayer

        Section 1.183-2(b)(8), Income Tax Regs., provides: "Substantial 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 especially if there are personal or recreational elements involved." See

also Sullivan v. Commissioner, T.C. Memo. 1998-367, 1998 WL 712432, at *13,

aff'd, 202 F.3d 264 (5th Cir. 1999).

        Petitioners acknowledge that they had substantial income from sources

other than Mr. Hoffmann's jet service activity and that the losses they claimed

from that activity reduced their taxable income. They seek to minimize the

adverse impact of this factor by claiming that "any personal or recreational

elements involved in Mr. Hoffmann's * * * [jet service activity] were de minimis".

        Contrary to petitioners' argument, for the reasons explained below, we find

that considerations of personal convenience played a significant role in Mr.

Hoffmann's decision to retain his interest in Citation 2 during the years in issue.

Petitioners claim that Mr. Hoffmann's "business savvy would most certainly not let

him intentionally throw away money just because he may be able to recover a

portion of it through tax deductions." We accept that Mr. Hoffmann was too

savvy a businessperson to throw money away intentionally. His retained
                                         - 36 -

[*36] ownership of Citation 2 after the failure of EPS' IPO and beyond the lapse of

the condition on his legal right to cause NetJets to repurchase the aircraft suggests

that he judged the pleasure and convenience of traveling by private jet rather than

on commercial flights worth the cost. We find it plausible that, in making that

calculation, Mr. Hoffmann took into account the tax savings he expected to

achieve from deducting at least part of the cost of maintaining his aircraft.

      We conclude that this factor also favors respondent.

                    i.       Elements of Personal Pleasure or Recreation

      Section 1.183-2(b)(9), Income Tax Regs., provides: "The presence of

personal motives in carrying on of an activity may indicate that the activity is not

engaged in for profit, especially where there are recreational or personal elements

involved." The existence of some "purposes or motivations other than solely to

make a profit", however, does not prevent an activity from being treated as

engaged in for profit. Id.

      Air travel by private jet rather than on a commercial flight, even in the case

of travel for business reasons, involves elements of personal consumption. The

availability of a private jet frees travelers from the strictures of commercial

carriers' schedules and thus offers significant convenience. Depending on the
                                        - 37 -

[*37] particular aircraft, a private jet may also offer more pleasurable

accommodations to the traveler.

      Petitioners ignore these realities in arguing that Mr. Hoffmann did not seek

personal pleasure or recreation in carrying out his jet service activity but instead

"was consumed with the business exigencies regarding the EPS IPO and the

subsequent liquidation and resolution of the business affairs."22 More to the point,

petitioners focus again on Mr. Hoffmann's motivations in commencing the activity

rather than on the reasons he continued the activity during the years in issue.

      The increasing losses Mr. Hoffmann incurred in his jet service activity after

EPS' demise show that DHR's needs for jet travel services were insufficient to

support the profitable conduct of that activity. DHR could meet its air travel needs

without resort to a private jet, as it in fact did after Mr. Hoffmann canceled his

contract with NetJets for the Gulfstream 200. Therefore, we infer that Mr.




      22
        Petitioners claim that Mr. Hoffmann "conscientiously attempted to make
sure that no personal charges were assumed as part of the ordinary and necessary
business expenses being incurred." We find this claim inconsistent with Mr.
Hoffmann's inability to explain the calculation of the amounts reported on the
2003 and 2004 Schedules C for his jet service activity. Despite petitioners'
reliance on others to prepare their tax returns, if Mr. Hoffmann had made
conscientious efforts to prevent the deduction of personal expenses, he ought to
have been able to describe at least the general method used in determining the
amounts deducted.
                                        - 38 -

[*38] Hoffmann continued his jet service activity during the years in issue for

reasons of personal convenience.

      Our inference is further supported by the reasons Mr. Hoffmann gave for

canceling the Gulfstream 200 contract. Mr. Hoffmann canceled the contract for

the Gulfstream 200, and thereby terminated his jet service activity, only when he

found that the personal convenience of travel by private jet no longer justified the

cost. From that we conclude that Mr. Hoffmann continued the activity after the

failure of EPS and throughout the years in issue primarily for reasons of personal

convenience and not for the purpose of making a profit. This factor, too, favors

respondent.

              3.    Weighing the Factors

      Because each of the nine factors listed in section 1.183-2(b), Income Tax

Regs., supports respondent's position, we have no need to weigh some factors

against others. Although the specified factors are nonexclusive, the record does

not present any other factors that would weigh against those listed in the

regulations. We therefore find that, during 2003 and 2004, Mr. Hoffmann did not

carry on his jet service activity to make a profit. Consequently, petitioners are

entitled to deductions attributable to that activity only to the extent allowed by

section 183(b).
                                        - 39 -

[*39] II.    Petitioners' Unreported Income

       Petitioners do not dispute respondent's increase in their gross income for

2004 to reflect DHR's reimbursement of $115,726 of repair and maintenance

expenses Mr. Hoffmann incurred. Petitioners argue, however, that the increase in

petitioners' income should result in a corresponding increase in the deductions

allowable from that activity under section 183(b). Respondent's disallowance of

the deductions claimed on the 2004 Schedule C for the jet service activity in

excess of the $78,061 of gross income reported on that schedule conflicts with his

determination that petitioners understated their income from that activity by

$115,726. Therefore, we agree with petitioners that the increase in the income

from Mr. Hoffmann's jet service activity for 2004 should result in a corresponding

increase in the deductions allowed in respect of that activity, thereby reducing the

amount of their deficiency.

III.   Accuracy-Related Penalties

       Section 6662(a) and (b)(1) provides for an accuracy-related penalty of 20%

of the portion of an underpayment of tax attributable to negligence or disregard of

rules and regulations. Section 6662(a) and (b)(2) provides for the same penalty on

the portion of an underpayment of tax attributable to "[a]ny substantial

understatement of income tax." Section 6662(d)(2)(A) defines the term
                                       - 40 -

[*40] "understatement" as the excess of the tax required to be shown on the return

over the amount shown on the return as filed. In the case of an individual, an

understatement is "substantial" if it exceeds the greater of 10% of the tax required

to be shown on the return or $5,000. Sec. 6662(d)(1)(A). An understatement is

reduced, however, by the portion attributable to the treatment of an item for which

the taxpayer had "substantial authority". Sec. 6662(d)(2)(B)(i). Section

6664(c)(1) provides an exception to the imposition of the section 6662(a)

accuracy-related penalty if it is shown that there was a reasonable cause for the

underpayment and the taxpayer acted in good faith.

      A.     Petitioners' Arguments

      Petitioners do not dispute that the deficiencies respondent determined

exceed the arithmetic threshold for "substantial" understatements. We have

already determined, however, that respondent overstated petitioners' deficiency for

their 2004 taxable year by failing to increase the allowable deductions from Mr.

Hoffmann's jet service activity to reflect the unreported income attributable to the

repair and maintenance expenses reimbursed by DHR. Whether petitioners'

deficiency for 2004 meets the arithmetic threshold for a substantial understatement

after correction of respondent's error is a computational matter.
                                         - 41 -

[*41] Petitioners argue that, even if the disallowance of deductions attributable to

Mr. Hoffmann's jet service activity results in a deficiency for each of 2003 and

2004 in excess of 10% of the tax they were required to show on their return for

that year, the disallowance of those deductions does not give rise to, or increase, a

substantial understatement because they had substantial authority to claim those

deductions. Petitioners also argue that "[t]he legal advice provided to Petitioner

by his seasoned attorneys and other advisors, to whom sufficient information was

presented, constitutes reasonable cause on his behalf" with regard to the accuracy-

related penalties respondent determined.23

      B.     Substantial Authority

      The determination of substantial authority requires a weighing of the

authorities that support the taxpayer's treatment of an item against the contrary

authorities. Sec. 1.6662-4(d)(3)(i), Income Tax Regs. A taxpayer can have

substantial authority for a position that is unlikely to prevail, as long as the weight

of the authorities in support of the taxpayer's position is substantial in relation to

      23
        Petitioners make no argument that they had substantial authority for their
treatment of the items they conceded before trial. Moreover, the only legal advice
they referred to in support of their claim to reasonable cause related to their
deduction of expenses attributable to Mr. Hoffmann's jet service activity.
Therefore, petitioners concede that "application of the penalties for the other
adjustments in the notice of deficiency which have been settled will be
computational."
                                        - 42 -

[*42] the weight of any contrary authorities. See id. subpara. (2) (substantial

authority standard is less stringent than the more likely than not standard). Section

1.6662-4(d)(3)(ii), Income Tax Regs., describes the required weighing as follows:

      The weight accorded an authority depends on its relevance and
      persuasiveness, and the type of document providing the authority.
      For example, a case or revenue ruling having some facts in common
      with the tax treatment at issue is not particularly relevant if the
      authority is materially distinguishable on its facts, or is otherwise
      inapplicable to the tax treatment at issue.

      After weighing the relevant authorities as required by the regulations, we

conclude that petitioners lacked substantial authority for claiming deductions from

Mr. Hoffmann's jet service activity in excess of the income generated by the

activity. Petitioners have not cited any authority that allows deductions in excess

of income from an activity continued by a taxpayer without reasonable explanation

when the activity no longer offers a realistic possibility of earning a profit. By

contrast, as previously noted, a taxpayer's continuation of an activity in those

circumstances demonstrates the absence of a profit motive. See Heinbockel v.

Commissioner, at *23-*24; Daugherty v. Commissioner, 1983 Tax Ct. Memo

LEXIS 602, at *20.

      Petitioners cite Cornfeld v. Commissioner, 797 F.2d 1049 (D.C. Cir. 1986),

rev'g T.C. Memo. 1984-105, Pryor v. Commissioner, T.C. Memo. 1991-109, and
                                         - 43 -

[*43] Rabinowitz v. Commissioner, T.C. Memo. 2005-188, 2005 WL 1763776,

for the proposition that losses attributable to unforeseeable changes in

circumstances do not preclude finding a profit motive. Each of those cases is

readily distinguishable from Mr. Hoffmann's situation. In contrast to Mr.

Hoffmann, the taxpayer in Cornfeld promptly abandoned his aircraft leasing

project after the event that called into question his ability to earn a profit from the

project.24 During the years at issue in Pryor, the taxpayer's sailboat chartering

activity remained in its startup phase. The record before us in that case did not

establish that the taxpayer's activity could not be conducted profitably in the

future. In Rabinowitz v. Commissioner, 2005 WL 1763776, at *13, despite

unforeseen safety problems with the model of aircraft the taxpayers used in their

jet charter activity, the resulting losses "generally decreased" and the taxpayers'

net cashflow from the activity "showed a general trend of increasing." The

activity's improving prospects "partially mitigate[d]" the taxpayers' "long history

      24
        Although we inferred a lack of a profit motive from the taxpayer's prompt
abandonment of his project, Cornfeld v. Commissioner, T.C. Memo. 1984-105,
1984 Tax Ct. Memo LEXIS 569, at *13 ("[Taxpayer's] abandonment of the [jet
leasing] project so soon after his ouster from IOS strongly suggests that he
actually believed he would have no use for the jet if he were not associated with
IOS."), rev'd, 797 F.2d 1049 (D.C. Cir. 1986), the Court of Appeals for the D.C.
Circuit disagreed. Cornfeld v. Commissioner, 797 F.2d at 1053 ("We fail to see
how * * * [the taxpayer's abandonment of the project] establishes the absence of
an honest profit objective.").
                                         - 44 -

[*44] of losses". Id. at *14. By contrast, petitioners failed to demonstrate

improving prospects for Mr. Hoffmann's jet service activity during the years in

issue. In fact, as noted above, petitioners concede that, after EPS' failure, Mr.

Hoffmann "had no real opportunity to charter the aircraft profitably." In short,

each of the authorities cited by petitioners is either "materially distinguishable on

its facts, or is otherwise inapplicable to the tax treatment at issue." Cf. sec.

1.6662-4(d)(3)(ii), Income Tax Regs. Consequently, those authorities are not

"particularly relevant". See id.

      Because petitioners lacked substantial authority for claiming deductions

from Mr. Hoffmann's jet service activity in excess of the income the activity

generated, petitioners' understatements are not reduced by section

6662(d)(2)(B)(i). Therefore, petitioners had a substantial understatement of

income tax for their 2003 taxable year. Whether they also had a substantial

understatement for 2004 raises a computational issue to be resolved by correction

for respondent's failure to allow additional deductions from Mr. Hoffmann's jet

service activity in that year because of the agreed amount of unreported income.

      C.     Negligence

      Because we find that the portion of petitioners' underpayment in each of the

years in issue attributable to the deductions claimed in respect of Mr. Hoffmann's
                                       - 45 -

[*45] jet service activity in excess of the amounts allowed by section 183(b) was

attributable to negligence, the section 6662(a) accuracy-related penalty applies to

that portion of the underpayment in each year regardless of whether it results in or

increases a substantial understatement within the meaning of section

6662(d)(1)(A).25

      Section 1.6662-3(b)(1), Income Tax Regs., provides that "negligence"

includes a "failure to make a reasonable attempt to comply with the provisions of

the internal revenue laws or to exercise ordinary and reasonable care in the

preparation of a tax return." See also Marcello v. Commissioner, 380 F.2d 499,

506 (5th Cir. 1967) ("Negligence is lack of due care or failure to do what a

reasonable and ordinarily prudent person would do under the circumstances."),

aff'g in part and remanding in part 43 T.C. 168 (1964), and T.C. Memo. 1964-299.

A "failure * * * to keep adequate books and records or to substantiate items

properly" also constitutes negligence. Sec. 1.6662-3(b)(1), Income Tax Regs.


      25
         Respondent's arguments in regard to petitioners' negligence relate solely to
their treatment of the expenses of Mr. Hoffmann's jet service activity. Therefore,
to the extent that respondent has not conceded the application of the negligence
penalty of sec. 6662(a) and (b)(1) to that portion of petitioners' underpayment for
2004 attributable to respondent's other adjustments, we conclude that respondent
has not met his burden of production under sec. 7491(c) of establishing the
appropriateness of that portion of the negligence penalty. Cf. Higbee v.
Commissioner, 116 T.C. 438, 446 (2001).
                                        - 46 -

[*46] Taking a "return position that has a reasonable basis" is not negligent. Id.

Section 1.6662-3(b)(3), Income Tax Regs., however, provides: "Reasonable basis

is a relatively high standard of tax reporting". Whether a position satisfies the

reasonable basis standard depends on the extent to which it is supported by

authorities of the type relevant in determining substantial authority, "taking into

account the relevance and persuasiveness of the authorities, and subsequent

developments". Id. A position that "is reasonably based on one or more of * * *

[those] authorities * * * will generally satisfy the reasonable basis standard even

though it may not satisfy the substantial authority standard". Id.

      Petitioners' position that Mr. Hoffmann had a profit motive in conducting

his jet service activity during the years at issue despite his acknowledged inability

to earn a profit rests on Mr. Hoffmann's unwarranted assumption regarding his

rights vis-a-vis NetJets. According to petitioners, the losses incurred from the

activity during those years were unavoidable because Mr. Hoffmann was "locked

into" his relationship with NetJets. Mr. Hoffmann acknowledged, however, that

his belief in that regard was based on an assumption. He confessed not to have

read the relevant documents. Moreover, his misunderstanding of his rights

demonstrates that he failed to seek the advice of a competent attorney regarding

the terms of those documents.
                                        - 47 -

[*47] A reasonable and ordinarily prudent person would read those documents

relevant to the propriety of deductions claimed on that person's tax return or at

least seek an explanation from legal counsel of what those documents provide.

Mr. Hoffmann's failure to do either thus constituted negligence. See Marcello v.

Commissioner, 380 F.2d at 506; sec. 1.6662-3(b)(1), Income Tax Regs. His

acknowledged laxity in recordkeeping and inability to explain the amounts

reported on the Schedules C for his jet service activity also show that he failed to

make a reasonable attempt to comply with the tax law and did not exercise

ordinary and reasonable care in reviewing those schedules. See sec. 1.6662-

3(b)(1), Income Tax Regs.; cf. Marcello v. Commissioner, 380 F.2d at 507 ("[A]

failure to keep books and documents necessary to form a rational basis for the

income reported and the expenses deducted [evidences negligence].").

      We have already concluded that the authorities petitioners relied on to

support their position that Mr. Hoffmann engaged in his jet service activity for

profit despite the absence of profit potential are "materially distinguishable" and

thus "not particularly relevant". Cf. sec. 1.6662-4(d)(3)(ii), Income Tax Regs. For

the same reason, we conclude that those authorities do not provide a reasonable

basis for petitioners' deduction of expenses incurred in that activity in excess of

the amounts allowed by section 183(b). Therefore, the strength of petitioners'
                                        - 48 -

[*48] legal position does not prevent a finding of negligence based on Mr.

Hoffmann's lack of due care.

      D.      Reasonable Cause and Good Faith

      As noted above, petitioners argue that they had reasonable cause for

deducting expenses in excess of income from Mr. Hoffmann's jet service activity

and acted in good faith in doing so on the basis of legal advice provided by Mr.

Hoffmann's "seasoned attorneys and other advisors".

      A taxpayer's reliance on the professional advice of an attorney or accountant

may constitute reasonable cause and good faith. As a general rule, "[t]he

determination of whether a taxpayer acted with reasonable cause and in good faith

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. In making that

determination, the "most important factor" is usually "the extent of the taxpayer's

effort to assess the taxpayer's proper tax liability." Id. Reliance on the advice of a

professional tax adviser may constitute reasonable cause and good faith "if, under

all the circumstances, such reliance was reasonable and the taxpayer acted in good

faith." Id.

      We have already concluded that Mr. Hoffmann failed to make a reasonable

effort to determine his proper tax liabilities. The evidence introduced provides no
                                         - 49 -

[*49] grounds to excuse Mr. Hoffmann's negligence on the basis of advice he

received from qualified advisers. Petitioners presented no evidence regarding the

substance of any advice Mr. Hoffmann received in support of the deductions in

issue. Thus, petitioners failed to demonstrate that they reasonably and in good

faith relied on the advice of a professional tax adviser. Because petitioners have

not shown reasonable cause for the portion of their underpayment attributable to

Mr. Hoffmann's jet service activity, section 6664(c)(1) does not preclude the

imposition of the accuracy-related penalty on that portion of their underpayment.

IV.   Conclusion

      For the reasons explained above, we find that Mr. Hoffmann did not engage

in his jet service activity for profit during the years before us. Consequently,

petitioners are entitled to deductions attributable to that activity only to the extent

allowed by section 183(b). Petitioners' income from that activity should include

the $115,726 Mr. Hoffmann received from DHR in 2004 in reimbursement of

repair and maintenance expenses, and that income should be taken into account in

determining the deductions allowable under section 183(b).

      We also conclude that petitioners lacked substantial authority for claiming

deductions from Mr. Hoffmann's jet service activity in excess of the income the

activity generated. Therefore, for the purpose of determining petitioners' liability
                                       - 50 -

[*50] for accuracy-related penalties under section 6662(a) for the years in issue,

their understatements for those years are not reduced by section 6662(d)(2)(B)(i).

       We also find that the portion of petitioners' underpayment for each of the

years in issue attributable to the deductions claimed in respect of Mr. Hoffmann's

jet service activity in excess of the amounts allowed by section 183(b) was

attributable to negligence and that petitioners failed to show reasonable cause for

that portion of the underpayment for each year.

       On the basis of those findings and conclusions, we sustain the deficiency

and accuracy-related penalty determined by respondent for petitioners' 2003 tax

year. The amounts of petitioners' deficiency and accuracy-related penalty for their

2004 tax year depend on the correction of respondent's error in failing to take into

account petitioners' unreported income for that year in determining the amount of

deductions allowable under section 183(b) in respect of Mr. Hoffmann's jet service

activity.


                                                     Decision will be entered under

                                                Rule 155.
