                         T.C. Memo. 2012-59



                   UNITED STATES TAX COURT



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



Docket Nos. 27274-08, 10493-10.                 Filed March 5, 2012.



       R issued notices of deficiency determining deficiencies in
Federal income taxes for P’s 2005 and 2007 tax years and an I.R.C.
sec. 6662(a) accuracy-related penalty for 2007. The deficiencies stem
primarily from R’s determination that P could not deduct losses from
an activity reported on Schedule C.

      Held: P is liable for the deficiencies.

      Held, further, P is liable for the accuracy-related penalty
for 2007.
                                          -2-

      Douglas E. Klein, for petitioner.

      Jenny R. Casey, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


      WHERRY, Judge: These cases are before the Court on petitions for

redetermination of petitioner’s income tax deficiencies for 2005 and 2007 and

penalty for 2007 as determined by respondent. The issues for decision are:

      (1) whether petitioner is entitled to loss deductions claimed on Schedules C,

Profit or Loss From Business, of $80,345 and $84,240 for the 2005 and 2007 tax

years, respectively;1 and

      (2) whether petitioner is liable for a section 6662(a) accuracy-related penalty

for the 2007 tax year.2




      1
      An adjustment to petitioner’s student loan interest deductions for 2005 and
2007 and an adjustment to itemized deductions for 2007 are computational and will
depend on the outcome of this issue.
      2
       All section references are to the Internal Revenue Code of 1986, as amended
and in effect for the tax years at issue, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
                                           -3-

                                 FINDINGS OF FACT

       Some of the facts have been stipulated. The stipulated facts and the

accompanying exhibits are incorporated by this reference. At the time petitioner

filed his petitions, he resided in California. Petitioner did not testify at trial, and the

only evidence submitted at the trial consists of the stipulated facts and exhibits.3

       The Court has taken judicial notice of the State Bar of California records

reflecting that petitioner is an attorney and has been a member of the State Bar of

California since December 1992. Petitioner filed Forms 1040, U.S. Individual

Income Tax Return, for the 2005 and 2007 tax years, attaching to each a Schedule C

which listed his principal business as “International Consulting” and the business

name as “Intcom”. Petitioner incorporated IntCom, Inc., in California on July 29,

1997, by filing articles of incorporation with the California secretary of state.




       3
        At trial respondent objected to Exhibits 17-P, 20-P through 23-P, and 25-P.
Exhibit 17-P was rejected at trial on the grounds of relevance. Ruling on Exhibit
20-P was reserved; this Court overrules respondent’s objection and finds that the
exhibit was not being introduced for the truth of the matter, but rather, to show that
petitioner was exploring business options. Exhibit 21-P was rejected on the grounds
of relevance. The objection to Exhibit 22-P was overruled and Exhibit 22-P was
admitted at trial, and Exhibit 23-P was rejected.
                                         -4-

      For the 2003 through 2008 tax years petitioner reported on his Forms 1040

the following amounts of salary income, gross income from the activity, expenses

from the activity, net profit or from the activity, and gross income.

                               Gross                       Net profit or   Adjusted
               Salary      income from     Expenses of     (loss) from       gross
  Year        income          activity       activity        activity       income
  2003       $125,741            ---          $35,263        ($35,263)     $91,988
  2004         135,527           ---           70,892         (70,892)       67,268
  2005         137,069           ---           80,345         (80,345)       62,217
  2006         133,527           ---           88,578         (88,578)       49,606
  2007         138,750           ---           84,240         (84,240)       59,501
  2008         159,229           ---           88,184         (88,184)       77,329
   Total       829,843           ---          447,502        (447,502)     407,909

      On August 11, 2008, respondent issued petitioner a statutory notice of

deficiency determining an income tax deficiency of $10,845 for the 2005 tax year.

Petitioner timely filed a petition with this Court on November 10, 2008, at docket

No. 27274-08S.4 On February 18, 2010, respondent issued petitioner a statutory

notice of deficiency determining an income tax deficiency of $23,119 and a




      4
       On petitioner’s motion and following a hearing, this Court removed the sec.
7463 small case “S” designation by order on December 7, 2009, thereby converting
this matter to regular case status and changing the docket number to 27274-08.
                                         -5-

section 6662(a) penalty of $4,623.80 for the 2007 tax year. Petitioner timely filed a

petition with this Court on May 7, 2010, at docket No. 10493-10.

      On May 26, 2010, respondent filed a motion for leave to file an amendment

to answer in docket No. 27274-08 which was granted on June 7, 2010. Respondent

submitted an amendment to answer in docket No. 27274-08 which was filed June 7,

2010, asserting that petitioner’s activity reported on his 2005 Schedule C was not

entered into for profit and therefore under section 183 he was not entitled to deduct

any losses greater than that activity’s gross income. This answer increased the

determined 2005 deficiency to $21,908 and aligned respondent’s arguments in the

two cases. The two cases were consolidated for trial, briefing, and opinion on June

7, 2010.5 A trial was held in Los Angeles, California, on May 25, 2011.6

      5
       On brief, petitioner claims that the amounts in dispute are a deficiency of
$10,845 and a penalty of $12,848.61 for 2005 and a deficiency of $29,833.98 and a
penalty of $30,199.08 (including a proposed penalty of $4,623.80) for 2007. It is
unclear how petitioner arrives at these figures. Apparently he failed to use the
increased deficiency and penalty, and he perhaps added interest.
      6
       The case at docket No. 27274-08 was initially set for trial on December 7,
2009. On January 8, 2010, it was set for trial on June 14, 2010. It was again
continued on June 3, 2010, this time on respondent’s request. The two cases were
then consolidated on June 7, 2010, and set for trial on December 6, 2010. Petitioner
again requested a continuance on November 12, 2010, which was granted on
November 17, 2010. The consolidated cases were then set for trial on May 23,


                                                                        (continued...)
                                          -6-

                                      OPINION

I.    Burden of Proof

      The Commissioner’s determination of a deficiency is presumed correct, and

the taxpayer bears the burden of proving that the determination is improper. See

Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). However, pursuant to

section 7491(a)(1), the burden of proof as to a factual issue that affects the

taxpayer’s tax liability may be shifted to the Commissioner. Sec. 7491(a).

Petitioner did not argue that the burden should shift and, as we find below, failed to

maintain the required records or comply with the substantiation and cooperation



      6
        (...continued)
2011. On April 19, 2011, the Court issued an order for a joint status report, noting
“that absent a real emergency, it would not even consider a continuance, unless and
until the parties demonstrate significant progress toward either settlement or
preparing for trial.” On May 2, 2011, petitioner hand delivered another motion for
continuance explaining that in April 2011 he “was assigned a very sensitive and
extremely confidential project involving a highly complex transaction involving the
issuance of securities, a task that is expected to last through mid to late August
2011.” The motion was denied on May 5, 2011, because it “was filed less than 30
days before the scheduled calendar, and no sufficient cause for the delay is reflected
therein.” The Court did offer that “Petitioner may renew his motion for continuance
at the calendar call but, absent significant and meaningful progress towards
settlement or trial, it will again be denied absent true emergency.” At the calendar
call on May 23, 2011, petitioner renewed his motion for a continuance, which was
again denied. At trial on May 25, 2011, petitioner’s counsel again renewed this
motion because petitioner contended that he could not leave work at any time during
the scheduled trial session. The motion for continuance was again denied.
                                         -7-

requirements of section 7491(a)(2). Accordingly, the burden of proof remains on

petitioner. However, the increased deficiency for the 2005 tax year was not part of

the statutory notice of deficiency and is therefore a new matter within the meaning

of Rule 142(a) as to which respondent has the burden of proof.

II.   Section 183 “Hobby Loss”

      Respondent contends that the losses related to petitioner’s activity are not

deductible because the activity was not engaged in for profit within the meaning of

section 183. Section 183(a) generally disallows deductions attributable to activities

not engaged in for profit to the extent they would exceed the gross income from

such activity. 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.”

      The Court of Appeals for the Ninth Circuit, to which an appeal in these cases

would lie absent stipulation to the contrary, has held that an activity is engaged in

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

in the activity was to realize an economic profit independent of tax savings. Wolf v.

Commissioner, 4 F.3d 709, 713 (9th Cir. 1993), aff’g T.C. Memo. 1991-212.
                                          -8-

Section 1.183-2(b), Income Tax Regs., sets forth a nonexclusive list of factors to be

considered in determining whether an activity is engaged in for profit: (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 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 from the

activity; (8) the financial status of the taxpayer; and (9) elements of personal

pleasure or recreation.

      No single factor or set of factors is conclusive in determining whether an

activity is engaged in for profit, nor is the number of these factors for or against the

taxpayer necessarily conclusive in that respect. Golanty v. Commissioner, 72 T.C.

411, 426 (1979), aff’d without published opinion, 647 F.2d 170 (9th Cir. 1981); sec.

1.183-2(b), Income Tax Regs. All facts and circumstances with respect to the

activity must be taken into account. Sec. 1.183-2(b), Income Tax Regs.

      A.     The Manner in Which the Taxpayer Carries On the Activity

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

indicate that the activity is engaged in for profit. Sec. 1.183-2(b)(1), Income Tax
                                         -9-

Regs. Three common inquiries are considered in this context: (1) whether the

taxpayer maintained complete and accurate books and records for the activity; (2)

whether the taxpayer conducted the activity in a manner substantially similar to

those of other comparable activities that were profitable; and (3) whether the

taxpayer changed operating procedures, adopted new techniques, or abandoned

unprofitable methods in a manner consistent with an intent to improve profitability.

Giles v. Commissioner, T.C. Memo. 2005-28; sec. 1.183-2(b)(1), Income Tax Regs.

      Petitioner did not “prepare any business or profit plans, profit or loss

statements, balance sheets, or financial break-even analyses” for the activity. See

Dodge v. Commissioner, T.C. Memo. 1998-89, aff’d without published opinion,

188 F.3d 507 (6th Cir. 1999). The record does not contain any evidence as to the

type of business or whether it was conducted in a manner substantially similar to

those of other comparable activities that were profitable, nor whether petitioner

changed operating procedures or abandoned unprofitable methods. This factor

favors respondent.

      B.     The Expertise of the Taxpayer or His Advisers

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

economic, and scientific practices, or consultation with those who are expert
                                         - 10 -

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

on the activity in accordance with such practices.” Sec. 1.183-2(b)(2), Income Tax

Regs. There is little evidence relating to petitioner’s expertise in the activity. This

factor is neutral.

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

       The fact that the taxpayer devotes much of his personal time and effort
       to carrying on an activity, particularly if the activity does not have
       substantial personal or recreational aspects, may indicate an intention
       to derive a profit. A taxpayer’s withdrawal from another occupation to
       devote most of his energies to the activity may also be evidence that
       the activity is engaged in for profit. * * * [Sec. 1.183-2(b)(3), Income
       Tax Regs.]

       Petitioner did not devote a substantial amount of time to the activity.

Petitioner was a full-time attorney during the years at issue earning a significant

income. This factor favors respondent.

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

       “The term ‘profit’ encompasses appreciation in the value of assets, such as

land, used in the activity.” Sec. 1.183-2(b)(4), Income Tax Regs. The value of the

assets, if any, used in the activity and their anticipated appreciation or depreciation

were not discussed, nor was any evidence submitted on this issue. This factor is

neutral.
                                          - 11 -

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

       “The fact that the taxpayer has engaged in similar activities in the past and

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

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

unprofitable.” Sec. 1.183-2(b)(5), Income Tax Regs. Petitioner did not address this

factor, and there is no evidence that petitioner carried on any successful businesses

in a manner substantially similar to that of the Intcom activity. He has apparently

successfully run and operated a legal practice, some elements of which may be

similar to Intcom’s needs. This factor is neutral.

       F.     The Taxpayer’s History of Income or Losses With Respect to the
              Activity

       A series of losses during the initial or start-up stage of an activity may
       not necessarily be an indication that the activity is not engaged in for
       profit. However, where losses continue to be sustained beyond the
       period which customarily is necessary to bring the operation to
       profitable status such continued losses, if not explainable, as due to
       customary business risks or reverses, may be indicative that the activity
       is not being engaged in for profit. * * * [Sec. 1.183-2(b)(6), Income
       Tax Regs.]

       In the two years at issue petitioner claimed $164,585 in losses from an

activity that has never been profitable. Although we recognize that an activity may

sustain losses during the initial startup phase, this activity has lost significant
                                          - 12 -

amounts of money over a number of years. There is no indication that losses are

subsiding with time. Therefore, we find this factor favors respondent.

      G.     The Amount of Occasional Profits, If Any, From the Activity

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

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

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

Sec. 1.183-2(b)(7), Income Tax Regs. The activity has continued to lose large

amounts of money and was not profitable in either of the years at issue. We find

this factor favors respondent.

      H.     The Financial Status of the Taxpayer

      “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.” Sec. 1.183-2(b)(8), Income Tax Regs. Petitioner earns

substantial income from his full-time job as an attorney, and the losses from the

activity resulted in substantial tax benefits. During the years at issue petitioner

earned in excess of $137,000 a year from his outside job and deducted in excess of

$80,000 per year on his Federal income tax returns on account of losses related to

the activity. We find this factor favors respondent.
                                          - 13 -

      I.     Elements of Personal Pleasure or Recreation

      “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.” Sec. 1.183-2(b)(9), Income Tax Regs. However,

“We also note that a business will not be turned into a hobby merely because the

owner finds it pleasurable; suffering has never been made a prerequisite to

deductibility.” Jackson v. Commissioner, 59 T.C. 312, 317 (1972).

      Petitioner did not testify at trial to explain his personal views as to the

activity. Petitioner contends that he could not spare time to testify at his trial. If

that is true, it remains unexplained why no one else knowledgeable about the facts

appeared on his behalf. Perhaps there were none, although several years have

passed since the asserted business commenced. We note that petitioner’s failure to

introduce evidence “which, if true, would be favorable to him, gives rise to the

presumption that if produced it would be unfavorable”. See Wichita Terminal

Elevator Co. v. Commissioner, 6 T.C. 1158, 1165 (1946), aff’d, 162 F.2d 513 (10th

Cir. 1947). The activity required regular travel by petitioner; depending on the

nature of this travel it could have been for pleasure or it could have been for

business. This factor is neutral.
                                         - 14 -

       After considering all of the above factors as applied to the unique facts and

circumstances of these cases, and all other facts we consider relevant, we conclude

that the activity was not engaged in for profit within the meaning of section 183.

Therefore petitioner is not entitled to deduct expenses in excess of gross income

from the activity.7

III.   Section 6662(a) Penalty

       Respondent determined that petitioner is liable for a section 6662(a)

accuracy-related penalty for his 2007 tax year. Pursuant to section 7491(c), the

Commissioner has the burden of production with respect to a taxpayer’s liability for

a penalty and is, therefore, required to “come forward with sufficient evidence

indicating that it is appropriate to impose the relevant penalty.” See Higbee v.

Commissioner, 116 T.C. 438, 446 (2001).

       Subsection (a) of section 6662 imposes an accuracy-related penalty of 20% of

the portion of any underpayment attributable to causes specified in subsection (b).

Respondent determined that there was a substantial understatement of income tax

justifying the penalty. See subsec. (b)(2).



       7
        In addition to finding that the activity was not engaged in for profit, we find
that petitioner did not adequately substantiate his expenses related to the activity.
Petitioner never explained how his expenses related to his business purpose, nor for
which of the “assortment of different businesses” his specific expenses were
incurred.
                                        - 15 -

      There is a “substantial understatement” of income tax for any tax year where

the amount of the understatement exceeds the greater of (1) 10% of the tax required

to be shown on the return for the tax year or (2) in the case of an individual, $5,000.

Sec. 6662(d)(1)(A). Respondent met his burden of production, and petitioner did

not address the section 6662(a) penalty. Petitioner presented no evidence that he

had reasonable cause for any portion of any underpayment, and he is liable for the

penalty.

      The Court has considered all of petitioner’s contentions, arguments, requests,

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

meritless, moot, or irrelevant.

      To reflect the foregoing,


                                                       Decisions will be entered

                                                 under Rule 155.
