                  T.C. Summary Opinion 2003-124



                     UNITED STATES TAX COURT



                SHEILA MAE HOWARD, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 1853-02S.              Filed September 4, 2003.


     Sheila Mae Howard, pro se.

     Michael A. Pesavento, for respondent.



     ARMEN, Special Trial Judge:    This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect at the time that the petition was filed.1   The decision to

be entered is not reviewable by any other court, and this opinion

should not be cited as authority.


     1
        Unless otherwise indicated, all subsequent section
references are to the Internal Revenue Code in effect for the
taxable years in issue, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
                                  - 2 -

     Respondent determined deficiencies in petitioner’s Federal

income taxes and accuracy-related penalties as follows:

                                            Penalty
          Year       Deficiency           Sec. 6662(a)
          1996        $15,457              $3,091.40
          1997          9,377               1,875.40
          1998          4,100                 ---

     After concessions by the parties,2 the issues remaining for

decision are:

     (1) Whether petitioner is entitled to Schedule C, Profit or

Loss From Business, deductions for the taxable years at issue in

excess of the amounts allowed by respondent in the notice of

deficiency.   We hold that she is not.

     (2) Whether petitioner’s horse breeding activity was an

activity engaged in for profit within the meaning of section

183(a) for the taxable years at issue.        We hold that it was not.

     (3) Whether petitioner received unreported income during


     2
        Respondent concedes that petitioner incurred a capital
loss on the sale of a truck in 1998 in the amount of $1,009 as
claimed by her on Form 4797, Sales of Business Property.
     Respondent also concedes the amount realized by petitioner
in 1998 on the sale of a house that she built for sale.
Respondent further concedes that petitioner incurred a long-term
capital loss in 1998 with respect to the sale of this house but
in an amount ($13,910) less than that claimed by petitioner on
her 1998 return ($38,000). However, because of the $3,000
limitation on capital losses in sec. 1211(b), we need not decide
the exact amount of the loss because it will have no tax effect
in 1998, the latest of the taxable years in issue. See sec.
1212(b) regarding capital loss carryovers.
     Petitioner concedes that she received unreported interest
income in the amounts of $941, $32, and $1 during 1996, 1997, and
1998, respectively, and that she is entitled to a mortgage
interest deduction for 1998 in the amount of $4,909.
                               - 3 -

1996 and 1997.   Subject to respondent’s concessions and

adjustments, we hold that she did.

     (4) Whether petitioner is entitled to a dependency exemption

for Carl Collins for 1998.   We hold that she is not.

     (5) Whether petitioner is liable for accuracy-related

penalties under section 6662(a) for 1996 and 1997.    We hold that

she is to the extent provided herein.

     Adjustments relating to petitioner’s itemized deductions for

the taxable years at issue, self-employment taxes for 1996 and

1997, the earned income credit for 1996 and 1997, and the child

tax credit for 1998 are purely perfunctory matters, the

resolution of which is dependent on our disposition of the issues

above.

Background

     Some of the facts have been stipulated, and they are so

found.   Petitioner resided in Ocala, Florida, at the time that

her petition was filed with the Court.

     During the taxable years at issue, petitioner was employed

on a full-time basis as a paralegal.    Petitioner received wages

from employment in the amounts of $43,454, $46,277, and $42,443

during 1996, 1997, and 1998, respectively.3

     Petitioner has two children.    In addition to her own

children, petitioner helped raise Carl Collins, the child of a


     3
         All amounts are rounded to the nearest dollar.
                                 - 4 -

close family friend.     Carl began living with petitioner when he

was 11 months old.     Carl was not petitioner’s adopted child.

During 1998, Carl was about 11 years old and lived with his

grandmother.   Carl visited petitioner during 1998 on weekends,

holidays, and on his summer break from school.

     A.   Anchor Inn

     During the taxable years at issue, petitioner operated a

fish camp named the Anchor Inn.     Petitioner purchased the Anchor

Inn from her mother in or around 1990.       The Anchor Inn is

approximately 1.7 acres in size and is located on Lake Kerr.         The

Anchor Inn has six rental units and a boat ramp.       Each rental

unit has one bedroom and one bath.

     The majority of petitioner’s rentals were from February to

May each year.   Rentals were generally short-term, typically for

the day or weekend.     Petitioner rented each unit for

approximately $30 to $35 per night.       Guests were not charged for

use of the Anchor Inn’s boat ramp.       Petitioner requested a

minimal cash fee from nonguests for use of the boat ramp.

     In or around 1993, petitioner purchased the land and two

houses adjacent to the Anchor Inn from her mother.       During the

taxable years at issue, petitioner and her mother resided

separately in the two houses.

     B.   Horse Breeding Activity

     During the years at issue, petitioner operated a horse
                               - 5 -

breeding activity.   Petitioner had been raised around, and was

familiar with, horses.

     Prior to starting the horse breeding activity, petitioner

consulted horse trainers and breeders about the nature of horse

breeding.   Petitioner’s objective was to enter horses in

“cutting” competitions and then later breed the horses.4

     In or around 1995, petitioner purchased her first horse.

Later, petitioner purchased a second horse for use in the horse

breeding activity.   Petitioner hired a professional trainer for

the horses.   The horses were originally stabled and trained in

Georgia, about 265 miles from petitioner’s Florida residence.

Petitioner and her children would visit the stable approximately

three weekends each month.

     Petitioner did not prepare a written business plan with

respect to her horse breeding activity.     Petitioner’s records

consisted solely of canceled checks and a few receipts.

     C.   Petitioner’s Income Tax Returns

     Petitioner filed a Form 1040, U.S. Individual Income Tax

Return, for each of the taxable years at issue, and reported her

wages from her employment as a paralegal.     On her return for each

of the taxable years at issue, petitioner identified Carl as

either “child” or “son” and claimed a dependency exemption for



     4
        “Cutting” was described by petitioner as training a horse
to “cut” one cow from a herd of cattle.
                                 - 6 -

him.

       Petitioner reported income and expenses from the Anchor Inn

on her Federal income tax returns for 1996 through 1998 on

Schedules C as follows:

                  Gross               Total              Total
Year         Income Reported     Expenses Claimed    Losses Claimed

1996             $6,136                $37,215          $31,079
1997              6,045                 27,821           21,776
1998              8,586                 17,822            9,236

       Petitioner reported income and expenses from the horse

breeding activity on her Federal income tax returns for 1996

through 1998 on Schedules F, Profit or Loss From Farming, as

follows:

                  Gross               Total              Total
Year         Income Reported     Expenses Claimed    Losses Claimed

1996             $1,901                $11,037          $9,136
1997              1,576                 25,109          23,533
1998              2,300                 14,997          12,697

       D.   The Notice of Deficiency

       In the notice of deficiency, respondent determined that with

respect to the Anchor Inn, petitioner had not substantiated

Schedule C expenses for 1996, 1997, and 1998, in excess of

$25,305, $25,023, and $15,490, respectively.     Respondent also

determined that petitioner’s horse breeding activity was not an

activity engaged in for profit within the meaning of section 183

and disallowed all of her Schedule F deductions to the extent
                               - 7 -

they exceeded her gross receipts.5

     Further, using the bank deposits and cash expenditures

method of income reconstruction, respondent determined that

petitioner had unreported income in 1996 and 1997 of $45,719 and

$29,130, respectively.   Respondent now concedes that petitioner

received an additional $36,863 from nontaxable sources in 1996

and an additional $20,500 from nontaxable sources in 1997.

Respondent therefore now contends that petitioner had unreported

income in 1996 and 1997 of $8,856 and $23,767, respectively.6

     In addition, respondent disallowed petitioner’s claimed

dependency exemption for Carl for 1998.

     Finally, respondent determined that petitioner was liable

for accuracy-related penalties under section 6662(a) for 1996 and

1997 due to a substantial understatement of income tax.

Discussion

     In general, the determinations of the Commissioner in a

notice of deficiency are presumed correct, and the burden is on


     5
        Respondent allowed petitioner deductions on Schedules A,
Itemized Deductions, for interest and taxes without regard to
income from the horse breeding activity. Respondent allowed
petitioner miscellaneous itemized deductions on Schedules A for
the remaining expenses related to the horse breeding activity.
Respondent reclassified petitioner’s Schedules F gross income as
other income.
     6
        At trial, respondent asserted that petitioner’s deposits
for 1997 were erroneously understated in the notice of deficiency
and should be increased by $15,137. However, due to respondent’s
concession of additional nontaxable sources in 1997, respondent
does not seek an increased deficiency.
                                - 8 -

the taxpayer to show that the determinations are incorrect.     See

Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84

(1992); Welch v. Helvering, 290 U.S. 111, 115 (1933).7

     A.   Petitioner’s Schedule C Deductions

     We begin with several fundamental principles that serve to

guide the decisional process.

     First, deductions are a matter of legislative grace.      Deputy

v. duPont, 308 U.S. 488, 493 (1940); New Colonial Ice Co. v.

Helvering, 292 U.S. 435, 440 (1934).

     Second, a taxpayer bears the burden of proving that the

taxpayer is entitled to any deduction claimed.   Rule 142(a);

INDOPCO, Inc. v. Commissioner, supra; Welch v. Helvering, supra.

     Third, a taxpayer is required to maintain records sufficient

to substantiate deductions claimed by the taxpayer on his or her

return.   Sec. 6001; sec. 1.6001-1(a), (e), Income Tax Regs.

     Fourth, the fact that a taxpayer reports a deduction on the

taxpayer’s income tax return is not sufficient to substantiate

the deduction claimed on the return.    Wilkinson v. Commissioner,

71 T.C. 633, 639 (1979); Roberts v. Commissioner, 62 T.C. 834,

837 (1974).   Rather, a tax return is merely a statement of the

taxpayer’s claim; the return is not presumed to be correct.


     7
        Sec. 7491 does not apply in this case to shift the burden
of proof to respondent because petitioner neither alleged that
sec. 7491 was applicable nor established that she fully complied
with the requirements of sec. 7491(a)(2) with respect to any of
the issues before the Court.
                                - 9 -

Wilkinson v. Commissioner, supra at 639; Roberts v. Commissioner,

supra at 837; see also Seaboard Commercial Corp. v. Commissioner,

28 T.C. 1034, 1051 (1957) (a taxpayer’s income tax return is a

self-serving declaration that may not be accepted as proof for

the deduction or exclusion claimed by the taxpayer); Halle v.

Commissioner, 7 T.C. 245 (1946) (a taxpayer’s return is not self-

proving as to the truth of its contents), affd. 175 F.2d 500 (2d

Cir. 1949).

     At trial, petitioner did not introduce any documentary

evidence to support that she is entitled to deductions with

respect to the Anchor Inn in excess of the amounts allowed by

respondent.    Likewise, petitioner did not offer testimony at

trial in support of any of those deductions.

     Under certain circumstances, the Court may estimate the

amount of a deductible expense and allow the deduction to that

extent.    See Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir.

1930).    However, in the instant case, we have no basis whatsoever

on which to approximate any additional deductible expenses with

respect to petitioner’s operation of the Anchor Inn.    See Vanicek

v. Commissioner, 85 T.C. 731, 743 (1985).    In view of her failure

to substantiate, we hold that petitioner is not entitled to the

deductions claimed on her Schedules C with respect to the Anchor

Inn in excess of the amounts allowed by respondent in the notice

of deficiency.
                              - 10 -

     B.   Petitioner’s Horse Breeding Activity

     Under section 183(a), if an activity is not engaged in for

profit, then no deduction attributable to the activity shall be

allowed except to the extent provided by section 183(b).    In

pertinent part, section 183(b) allows deductions to the extent of

gross income derived from an activity that is not engaged in for

profit.

     Section 183(c) defines an activity not engaged in for profit

as “any activity other than one with respect to which deductions

are allowable for the taxable year under section 162 or under

paragraph (1) or (2) of section 212”.   Deductions are allowable

under section 162 or under section 212(1) or (2) if the taxpayer

is engaged in the activity with the “actual and honest objective

of making a profit”.   Ronnen v. Commissioner, 90 T.C. 74, 91

(1988); Dreicer v. Commissioner, 78 T.C. 642, 645 (1982), affd.

without opinion 702 F.2d 1205 (D.C. Cir. 1983).

     The existence of the requisite profit objective is a

question of fact that must be decided on the basis of the entire

record.   See Benz v. Commissioner, 63 T.C. 375, 382 (1974).     In

resolving this factual question, greater weight is accorded

objective facts than a taxpayer’s statement of intent.     See

Westbrook v. Commissioner, 68 F.3d 868, 875-876 (5th Cir. 1995),

affg. T.C. Memo. 1993-634; sec. 1.183-2(a), Income Tax Regs.     For

purposes of deciding whether the taxpayer has the requisite
                              - 11 -

profit objective, profit means economic profit, independent of

tax savings.   See Surloff v. Commissioner, 81 T.C. 210, 233

(1983).   The taxpayer bears the burden of proving that he or she

engaged in the activity with the objective of making a profit.

See Rule 142(a); INDOPCO, Inc. v. Commissioner, supra at 84;

Welch v. Helvering, supra at 115.

     The regulations set forth a nonexhaustive list of factors

that may be considered in deciding whether a profit objective

exists.   These factors are: (1) The manner in which the taxpayer

carries on the activity; (2) the expertise of the taxpayer or his

advisers; (3) the time and effort expended by the taxpayer in

carrying on the activity; (4) the expectation that the assets

used in the activity may 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 with

respect to the activity; (7) the amount of occasional profits, if

any, which are earned; (8) the financial status of the taxpayer;

and (9) any elements indicating personal pleasure or recreation.

See sec. 1.183-2(b), Income Tax Regs.

     No single factor, nor even the existence of a majority of

factors favoring or disfavoring the existence of a profit

objective, is controlling.   See id.    Rather, the relevant facts

and circumstances of the case are determinative.    See Golanty v.

Commissioner, 72 T.C. 411, 426 (1979), affd. without published
                              - 12 -

opinion 647 F.2d 170 (9th Cir. 1981).

     Based on all of the facts and circumstances in the present

case, we hold that petitioner has failed to prove that she

engaged in the horse breeding activity for profit within the

meaning of section 183.   See Rule 142(a); INDOPCO, Inc. v.

Commissioner, supra; Welch v. Helvering, supra.

     We do not analyze in depth all nine of the factors

enumerated in the regulation but rather focus on some of the more

important ones that inform our decision.

     The fact that a taxpayer carries on the activity in a

businesslike manner and maintains complete and accurate books and

records may indicate a profit objective.   Sec. 1.183-2(b)(1),

Income Tax Regs.   However, petitioner failed to develop a budget

or a formal or informal business plan to determine whether the

horse breeding activity could be operated profitably.   Other than

canceled checks and a few receipts, petitioner also failed to

keep any books and records with respect to the horse breeding

activity.   Petitioner did not keep the type of records that could

be used to increase the profitability of a business.    Petitioner

never prepared budgets or market projections that would outline

strategies for ensuring a profitable business venture and making

informed business decisions on a periodic basis.   Such lack of

information upon which to make educated business decisions tends

to belie a taxpayer’s contentions that an activity was pursued
                               - 13 -

with the objective of making a profit.    Dodge v. Commissioner,

T.C. Memo. 1998-89, affd. without published opinion 188 F.3d 507

(6th Cir. 1999).

     A taxpayer’s expertise, research, and study of an activity,

as well as his or her consultation with experts, may be

indicative of a profit objective.   Sec. 1.183-2(b)(2), Income Tax

Regs.    However, the fact that petitioner had some experience with

horses prior to entering into the horse breeding activity does

not alone show that the horse breeding activity was engaged in

with a profit objective.   See Glenn v. Commissioner, T.C. Memo.

1995-399, affd. without published opinion 103 F.3d 129 (6th Cir.

1996).

     Petitioner also sought general advice from other breeders

and trainers.   However, there is no evidence that petitioner

reviewed the records of other breeding operations or sought

specific advice as to how to make her operation profitable.

Petitioner did not point to any evidence that demonstrated how

she planned to reduce her losses and ultimately earn a profit

sufficient to recoup past losses.   See Burger v. Commissioner,

T.C. Memo. 1985-523, affd. 809 F.2d 355 (7th Cir. 1987).

     The devotion of a great deal of personal time and effort by

the taxpayer in carrying on an activity may indicate that it is

engaged in for profit, particularly if there are no substantial

personal or recreational elements associated with such activity.
                               - 14 -

Sec. 1.183-2(b)(3), Income Tax Regs.    However, petitioner was

employed full-time as a paralegal during the taxable years at

issue.   Petitioner also owned and operated the Anchor Inn.

Petitioner testified that she participated in the horse breeding

activity only on weekends.

     The fact that a taxpayer was able to convert an unprofitable

enterprise to a profitable one in the past may indicate that he

or she is engaged in the present activity for profit, even though

the activity is presently unprofitable.    Sec. 1.183-2(b)(5),

Income Tax Regs.   Petitioner has owned and operated the Anchor

Inn since about 1990.   During the taxable years 1996 through

1998, petitioner claimed total losses of $62,091 with respect to

the Anchor Inn.    Petitioner has not demonstrated the ability to

convert an unprofitable enterprise to a profitable one.

     A substantial profit, though only occasional, would

generally indicate that an activity is engaged in for profit.

Sec. 1.183-2(b)(7), Income Tax Regs.    Petitioner earned no

profits of any size at any time from her horse breeding activity.

     The fact that the taxpayer has substantial income from

sources other than the activity in question, particularly if the

losses from the activity generate substantial tax benefits, may

indicate that the activity is not engaged in for profit.   Sec.

1.183–2(b)(8), Income Tax Regs.    During the taxable years 1996,

1997, and 1998, petitioner reported wage income of $43,454,
                              - 15 -

$46,277, and $42,443, respectively.    During the same years,

petitioner reported Schedule F losses from the horse breeding

activity of $9,136, $23,533, and $12,697, respectively.

Petitioner used these losses to reduce her gross income by

approximately 21 percent for 1996, 51 percent for 1997, and 30

percent for 1998.   These reductions led to substantial tax

savings for petitioner.

     Considering all the facts and circumstances, we find that

petitioner’s horse breeding activity was not engaged in for

profit within the meaning of section 183(c).    Respondent’s

determination is therefore sustained.

     C.   Petitioner’s Unreported Income

     As previously noted, taxpayers are required to maintain

records sufficient to show whether they are liable for Federal

income taxes.   Sec. 6001; sec. 1.6001-1(a), (e), Income Tax Regs.

If a taxpayer fails to keep adequate records, the Commissioner

may reconstruct the taxpayer’s income by any method that is

reasonable under the circumstances.    See Petzoldt v.

Commissioner, 92 T.C. 661, 687 (1989).

     The bank deposits and cash expenditures method is recognized

as a reasonable method of reconstructing income.    See Parks v.

Commissioner, 94 T.C. 654, 658 (1990); Nicholas v. Commissioner,

70 T.C. 1057, 1065 (1978).   This method is premised on the

assumption that the taxpayer has disposed of unreported income by
                               - 16 -

depositing part of it into bank accounts and by making cash

expenditures of the other part.    Williams v. Commissioner, T.C.

Memo. 2003-216.

     The income reconstruction need not be exact, so long as it

is reasonable and substantially correct.     Petzoldt v.

Commissioner, supra at 693; Schroeder v. Commissioner, 40 T.C.

30, 33 (1963).    The Commissioner is not required to show that all

deposits constitute taxable income.     See Estate of Mason v.

Commissioner, 64 T.C. 651, 657 (1975), affd. 566 F.2d 2 (6th Cir.

1977); Gemma v. Commissioner, 46 T.C. 821, 833 (1966).

Consequently, in analyzing a bank deposits case, deposits are

considered income when there is no evidence that they represent

anything other than income.    See Price v. United States, 335 F.2d

671, 677 (5th Cir. 1964); United States v. Doyle, 234 F.2d 788,

793 (7th Cir. 1956).

     Respondent’s bank deposits and cash expenditures analysis

reflects that petitioner had unreported income during 1996 and

1997.    The bank deposit analysis was performed by first totaling

all of the deposits made to petitioner’s bank account.

Respondent then reduced the total amount of deposits by known

nontaxable sources8 and the income amounts reported on

petitioner’s tax returns to arrive at petitioner’s total net bank



     8
        Nontaxable sources included, for example, transfers from
other accounts and loan proceeds.
                                   - 17 -

deposits.     Finally, respondent then added petitioner’s identified

cash expenditures to total net bank deposits to determine

petitioner’s unreported income.

     At trial, petitioner did not question respondent’s

determination as to the amount of unreported income she received

in 1996 and 1997.     Petitioner has not alleged, nor have we

discovered, any error in respondent’s income reconstruction using

the bank deposits and cash expenditures method.     Petitioner

produced no evidence of any nontaxable sources for the

unexplained funds deposited in her bank account or the cash used

to make payments in any of the years in issue.    Accordingly, as

asserted by respondent at trial, we conclude that petitioner had

unreported income in the amounts of $8,856 in 1996 and $23,767 in

1997.

     D.     Dependency Exemption

        Section 151(c) allows a taxpayer to claim an exemption for

each dependent, as defined in section 152.     In order to qualify

as a dependent, an individual must be related to the taxpayer in

one of the ways enumerated in section 152(a)(1) through (8), or,

if the individual is unrelated to the taxpayer, the individual

must live with the taxpayer and be a member of the taxpayer’s

household throughout the entire taxable year of the taxpayer.

Sec. 152(a)(9); Trowbridge v. Commissioner, 268 F.2d 208 (9th

Cir. 1959), affg. 30 T.C. 879 (1958); Turay v. Commissioner, T.C.
                                - 18 -

Memo. 1999-315; Butler v. Commissioner, T.C. Memo. 1998-355;

sec. 1.152-1(b), Income Tax Regs.

     Although petitioner identified Carl as her son on her 1998

return, she is not related to him by blood or marriage, nor did

she adopt him.   Carl did not live with petitioner during all, nor

even the majority, of 1998.     Accordingly, we sustain respondent’s

determination that petitioner is not entitled to claim a

dependency exemption for Carl for 1998.

     E.   Section 6662(a)9

     The last issue for decision is whether petitioner is liable

for accuracy-related penalties pursuant to section 6662(a) for

1996 and 1997.   As relevant herein, section 6662(a) imposes a

penalty equal to 20-percent of any underpayment of tax that is

due to a substantial understatement of income.    See sec. 6662(a)

and (b)(2).   An individual substantially understates his or her

income tax when the reported tax is understated by the greater of

10-percent of the tax required to be shown on the return or

$5,000.   Sec. 6662(d)(1)(A).    As this threshold computation is

dependent on our previous conclusions, we leave for the parties

to determine as part of the Rule 155 computation whether there

was a substantial understatement for 1996 and/or 1997.    Assuming

     9
        Respondent has satisfied his burden of production under
sec. 7491(c) with respect to the accuracy-related penalty under
sec. 6662(a) and (b)(2). Sec. 7491(c); Rule 142(a); Higbee v.
Commissioner, 116 T.C. 438, 446-447 (2001).
                                - 19 -

that there was, we continue with our discussion of the accuracy-

related penalty.

     Tax is not understated to the extent that the treatment of

the item related thereto is based on substantial authority or is

adequately disclosed in the return or in a statement attached to

the return, and there is a reasonable basis for the tax treatment

of such item by the taxpayer.    Sec. 6662(d)(2)(B).     Further, no

penalty shall be imposed if it is shown that there was a

reasonable cause for the underpayment and the taxpayer acted in

good faith with respect to the underpayment.       Sec. 6664(c)(1).

     Petitioner makes no argument with regard to substantial

authority or adequate disclosure, and we think that no such

argument can be persuasively made.       Based on the record before

us, we also conclude that petitioner failed to establish that

there was reasonable cause for any portion of the understatements

in this case or that she acted with the requisite good faith.

Accordingly, we hold that petitioner is liable for accuracy-

related penalties for 1996 and 1997 to the extent that the Rule

155 computation demonstrates an underpayment of tax in each of

those years.

     Reviewed and adopted as the report of the Small Tax Case

Division.
                               - 20 -



     To reflect our disposition of the disputed issues, as well

as the parties’ concessions,

                                         Decision will be entered

                                    under Rule 155.
