RONALD,AND SUSAN ROSENBLATT, Petitioners v .

RONALD,AND SUSAN ROSENBLATT, Petitioners v .

COMMISSION .R OF INTERNAL REVENUE, Responden t

Docket No . 17002-06S .

Filed

October

30,

2008 .

Elizabeth Opalkaj and Suzanne Meiners-Levy , for petitioners .

RUWE,

Judge : Ths case was'heard pursuant to the provisions

of section ~7463 ofthe internal Revenue Code in effect when the

petition was filed .' ursuant to section 7463(b), the decisio n

1 Unless otherwis indicated, all .section,references are t o

the Internal Revenue C de in effect . for the .years in issue, and

all Rule references ar to the Tax Court Rules of Practice an d

Procedure .

SERVE W OCT 3 0 2008

- 2 to be entered is not reviewable by any other court, and this

opinion shall not be treated as precedent for any other case .

Respondent determined deficiencies in petitioners' Federal

income taxes of $33,583 and $20,684 and section 6662 accuracyrelated penalties of $6,716 .60 and $4,136 .80 for the taxable

years 2.002 and 2003, respectively . The issues for decision are :2

(1) Whether petitioners' aircraft activity during 2002 and 2003

was engaged in for profit within the meaning of section 183 ; (2)

whether petitioners are entitled to deductions for worthless

stock and bad debts incurred in 2002 ; and (3) .whether petitioners

are liable for section 6662 accuracy-related penalties for 2002

and 2003 . 3

2 Before trial, petitioners' counsel submitted to the Court

a document entitled "Petitioners' Consolidated Pre-Trial Motion",

which the Court treated as petitioners' pretrial memorandum . At

trial, petitioners' counsel requested that the Court treat part

of their pretrial memorandum as a motion for partial summary

judgment (motion) . The Court obliged the request but,hdenied the

motion and declined to rule on petitioners' counsel's request to

shift the burden of proof . Petitioners failed to pursue some of

the arguments made in their motion at trial or in their posttrial briefs . Accordingly, we deem those arguments to have been

abandoned and will decide only the issues that petitioners'

counsel disputed in their posttrial briefs . See Nicklaus v .

Commissioner , 117 T .C . 117, 120 n .4 (2001) .

Respondent also determined that petitioners' itemized

deductions should be decreased by $2,534 in 2002 and $2,052 in

2003 . These are computational adjustments that depend on our

disposition of the other issues in this case .

3 Backgroun d

Some'facts'have been stipulated and are~so found . The

stipulation of facts and the attached exhibits are incorporated

by this reference . t the time : of filing the petition,

petitioners resided n Iowa .

Ronald Rosenbla t '(petitioner) is a graduate of'Columbia

University with a ba helor's . degree in art history, a minor i n

economics, and"a master's of art . Petitioner also holds a Ph .D .

in economics .from,the University of'Idaho . Petitioner work-ed'as

a professor and taugh economics for 7 years after he received

his Ph . D' .''

In 2002, petitio er was employed by Principal Residential

Mortgage ; Inc . (PRM), a subsidiary of`Principal Financial Group .

Petitioner' directly m naged°°six or seven people . Indirectly, he

managed approximately 500 people . Petitioner- .worked

approximately 50 hour' pe'rweek`in 2002, and he spent,most of his

work week in the offi es of PRM in downtown Des Moines- . Most°of

petitioner's incomea '2002 came from his position .at PRM .

Between 2002 and 003, -PRM .'"sold the division that petitioner

managed to American Ho e Mortgage (AHM) . In 2003, petitioner was

employed by AHM as an xecutive vice president of sales support

and development . Peti ioner's work hours and responsibilitie s

did not change very mu h between .2002 and 2003' . Petitioner Susa n

Rosenblatt (Mrs . Rosen latt) is an anchor reporter for the, local .

- 4 FOX news network in Des Moines, Iowa . Petitioners reported wages

on their Federal income tax-returns in excess of $593,000 for

2002 and $742,000 for 200 1 .

Petitioner always had an . interest in flying . Petitioner had

been interested in being a pilot since .his youth . In 1965, when

petitioner graduated from high school, he had an appointment to

the Air Force Academy, and he intended to become an Air Force

pilot . However, petitioner did not attend the Air Force Academy

because,his eyesight did not meet the requirements for him to

train as a pilot .

Petitioners' daughter Katie received flight instruction from

Executive One Aviation (EOA),

.beginning in 2001 . In the fall of

2001, petitioner also began taking flight training lessons from

EOA . On June 6, 2002, petitioner formed KAR RRR Aviation

Leasing, LLC (KAR RRR) . Mrs . Rosenblatt purchased a one-half

interest in KAR RRR on September 30, 2002 . Before Mrs .

Rosenblatt became a member of KAR RRR, petitioner was the sole

member, and they were the only two members thereafter .' Aside

from petitioners, KAR RRR had no employees .

' Petitioners apparently accounted for the aircraft activity

as a sole proprietorship on a Schedule C, Profit or Loss From

Business, until Mrs . Rosenblatt became a member of KAR RRR in

2002 . Thereafter, petitioners accounted for the aircraft

activity as a partnership on a Schedule E, Supplemental Income

and Loss .

In June 2002 ,

AR RRR purchased a Cessna~172 R (N3529D )

aircraft .( Cessna)`f om,EOA . Petitioner has never been a license d

pilot . Before the Cessna was purchased, petitioner had n o

experience in the'av ation industry other than being a "frequent

flyer" .

.Petitioner

escribed his decision to purchase- the Cessn a

"as a way of having

good new plane upon which to learn, and as

a way of starting a

ew business with the'plane .

KAR RRR finance

Petitioners paid 10

the Cessna with Cessna Finance Corp . (CFC) .

M ercent of the purchase price for the Cessna

as a down payment, a . d KAR RRR financed $144,350, the,balance'of

the purchase price f r the Cessna, through CFC . Petitione r

personally guarantee,

the loan from CFC to KAR RRR . The .Cessna

was hangared at Anke; y Regional Airport in Ankeny, Iowa .

On May 6, 2002,

before petitioner purchased the Cessna, EO A

provided a written projection of net income to petitioners

related to a purchase and leaseback of a Cessna . EOA projected

that if the Cessna wa rented out for 700 hours per year at $95

per Hobbs hour,' it c uld potentially generate $66,500 in gross

receipts .6 After sub racting expenses for insurance, hangar,

fuel, maintenance, on ine reserve, and management fees totalin g

5 A Hobbs meter ils .a device used to measure the amount of

time an'aircraft is operation .

6-Petitioners .had actual, gross receipts fromthe aircraft

activity of $21',645 i 2002 and $31,865 in 2003 .

- 6 $44,725 ,

EOA projected a net income of $21, 775 on a leaseback by

EOA of the Cessna .

Petitioner did not produce any other forma l

business , plan for KAR RRR . 7

EOA's projection did not include , finance expenses,

co mm issions ,

depreciation .

aircraft

legal and professional services expenses, :or

Reported expenses for petitioners '

2002 and 2003

activity were as follows :

2002 Expense s

Deductions

Repairs and

maintenanc e

Interest

Depreciation

(and sec . 179 )

Commissions

(and fees )

Fuel

Hangar

Insurance

Miscellaneous

Legal and professional

service s

Management fees

Total

Schedule C

Schedule E

Tota l

$1,210

$2,146

$3,35 6

1,777

73,447

1,777

5,924

3,55 4

79,37 1

1,595

1,160

; 2,75 5

3,513

375

2,495

-3,100

2,385

375

2,709

39

5,89 8

75 0

5,20 4

39

3,10 0

2,087

89,599

-16,515

2,08 7

106,11 4

Petitioner testified that he "worked off *

* *'[a] pro

forma and * * * [his] own notes about marketing and so on" and

that those materials indicated that, "given a certain, ; number of

hours per month of * * * lease that it would be profitable ."

Petitioner's "pro forma" and marketing notes were not offered

into evidence .

!p,

l

Repairs and aintenance $8,739

Interest

5,942, .

Depreciation (and 35,882

sec . 179 )

Commissions and fees) 4,282

Fuel

6,203

Hangar

1,500

Insurance

10,762

Miscellaneou

906

Legal and pr fessional .

1,50 0

service s

Instruction

591

Total

76,30 7

On June 14, 200, KAR RRR, CFC, and EOA entered into a .

"Consent to Lease"Agreement " ( lease agreement ), related to th e

Cessna . CFC require the lease agreement as a condition

precedent to obtaini g financing on the Cessna because the Cessna

would be rented out o the general public . Under the leas e

agreement, KAR RRR was designated the "Lessor" and .EOA was,

designated the "Lessee" . The lease agreement stated in pertinent

part : "Neither Lesso [KAR RRR] nor Lessee

lease the * * *

.[EOA] shall furthe r

[Cess "-a] or assign the Lease . without firs t

obtaining the prior w itten consent of CFC ,

which consent may be

withheld at the sole iscretion of CFC . "

KAR RRR and EOA lso entered i nto an " Aircraft Marketing

Agreement " ( marketing agreement ),

which stated as folio s :,

drafted by Advocate Consulting,

.

.

AIRCRAFT .MARKETI G AGREEMENT

This agreement, ade .on .this 14th day of . June, 2002 by .,

and between KAR RR Aviation Leasing, LLC ., hereinafter

- 8

referred to as the Owner, and * * *

referred to as the Agent .

[EOAJ,

hereinafter

WITNESSET H

WHEREAS, Owner is the owner of one (1) Cessna 172R,

Registration Number N3529D ;

WHEREAS, Agent in the ordinary course of business

develops relationships with prospective customers for

owner seeking to rent aircraft ;

i

WHEREAS, Agent is willing to serve as marketing and

compliance agent on a ,non-exclusive basis upon the

terms and conditions herein set forth .

NOW, THEREFORE, in consideration of the mutual

covenants and agreements herein contained, the parties

hereto do hereby agree as follows ;

1) Aircraft : Owner hereby authorizes Agent to

serve as a nonexclusive marketer for the aircraft

outlined on Exhibit A .

2) Terms of Agreement : The term of this agreement

shall be for a period of seven (7) days commencing on

the date hereof, and automatically renew each seven (7)

days thereafter . This agreement shall be subject to

termination by either the Owner or Agent for any reason

whatsoever upon five (5) days advance written notice

given to the other party .

3) The aircraft will be based at the Ankeny

Airport, and the owner will assume all responsibility

for storage fees in the amount of $125 .- per month for

heated, community hangar space .

4) Owner has had the aircraft inspected b y

[EOA], verifying that the aircraft meets the standards

required by the Federal Aviation Regulations and that a

valid Airworthiness Certificate exists in respect

thereto, and that all other requirements and paperwork

are in good order and effect .

5) The fees payable by Owner to Agent for the

rental of said aircraft shall be calculated at the rate

of 15% of the gross Hobbs rental charge . At the start

of this agreement, said hourly rate shall be $90'..00,

11

- 9 and may be adj sted with approval of both parties . The

rent shall b .e aid within ten days after the end o f

each calendar onth, based upon the hours rented during

each prior mon h . . Agent agrees to waive charges for'

the use of the aircraft by Owner : .. Owner agrees to

follow scheduling procedures established by Agent for

the reservat'io s of aircraft . and to return aircraft

with full fuel to the Agent .

6) Owner s

satisfactorily

thereby meeting

Aviation Admin i

all maintain the aircraft t o

etain its airworthiness certificate

the requirements of the Federal

tration .

7) .Owner s

fuel, oil, lubr

the .operation . o

by Agent to Own

cents below the

all shop labor

current list an

cost, plus frei

required & rout

* * * [EOA] mai

to Owner .

all furnish at their own expense all

cants and other materials necessary fo r

8) Renters

12 hours total

Approved Curren

this aircraft .

this aircraft s

all times .

force and effect

shall be writte n

parties and nami

Lienholder as in

of the Owner, Ag

risk is covered

the Owner shal l

said aircraft . Fuel shall be price d

r at the leaseback-rate of twenty (20)

then current retail . rate . In addition

hall be priced at $5 per'hour belo w

parts shall : be charged at 15% above

ht or other added charges . Al l

ne maintenance may be performed by the

tenance facility without prior notic e

shall-be required at a minimum to have

ime plus a sign-off from an FA A

Flight Instructor in order to solo

Other than for maintenance down time ,

all . be available .for scheduled rent a t

at their own expense . Such insuranc e

by an underwriter satisfactory to all

g the Owner, Agent and Curren t

ured, and shall protect the interest s

nt and Current Lienholder . If'the

y the insurance policy of the Agent,

repay Agent'the amount , of suc h

insurance at th e first of each calendar month and Agent

shall provide Ow er evidence of such Insurance coverage-in force and sat sfactory,to the Owner and Current Lien

holder . Agent s all be responsible for deductible if

the aircraft is

amaged while hangared at * * * [EOA] ,

if such damage i

caused by an * * * [EOA] employee o r

by a customer re ting the aircraft through * * *. [EOA] .

- 10 -

10) The term of this agreement shall be 5 years,

commencing on the below mentioned execution date . '

Owner may terminate this agreement for any reason upon

thirty (30) days written notice to Agent .

lu

Petitioner provided documents (logs) indicating his

'l

involvement with KAR RRR during 2002 and 2003 . These logs sho w

that petitioner spent approximately 197 .058 and 208 .25 hours o n

KAR RRR activities in 2002 and 2003, respectively .9 Petitione r

prepared these logs himself, though he admits they are!''

incomplete . Much of the time reflected in petitioner's .. logs

represents time during which he participated in flight

instruction, ground school, and test flights .

Petitioners relied on the services of EOA for taking

reservations for the Cessna, providing storage for the'iCessna,

and providing : licensed flight instructors to fly the Cessna . The

customers who rented the Cessna did not enter into written leas e

II'

agreements, but they did sign a document ensuring that the peopl e

who flew the Cessna were licensed pilots . These agreements were

maintained by EOA . The people who flew the Cessna included both

flight instruction students and private pilots . KAR RRR's Cessn a

8 The total time on petitioner's log for 2002 is listed as

191 .3 hours but actually adds up to 197 .05 hours .

The logs separate petitioner's "Business Time" and "Travel

Time" spent on KAR RRR . In 2002, petitioner's log reflects 52 .75

hours of travel time and 144 .3 hours of business time .` In 2003,

petitioner's log reflects 41 hours of travel time and 167 .2 5

hours of business time .

- 11

was one of three o r four aircraft available to rent at•the_ .Ankeny

Regional Airport-in 2002 . and 2003 .

Benefit Techn o ogies, Inc . •(BTI), is a research and

development business specializing in full flexible benefit plan s

for small to midsiz e

founder of BTI and ils still actively involved with BTI . BTI '

filed for chapte r

ankruptcy .protection in February 2001,'

shortly after BTI d e aulted on a $250,000 interest payment to a

venture capital fir m on January 15, 2001 . Sometime after filin g

for bankruptcy, . BTI '

bankruptcy proceedings were converted from

chapter 7 to chapte r

11 .

Petitioner own e

.

BTI stock, lent money to BTI', and served o n

BTI's board of direc

BTI . Petitioner wa s

having attended occaIional board meetings . Petitioners claime d

2002 relating to the alleged worthlessness

d loans that :petitioner made to BTI .

Discussio n

Generally, the ommissione•r's determinations in a notice of

deficiency are presumed correct, and the,taxpayer'bears the

burden . of proving that the determinate ns are incorrect . "Rule

- 12 I .

Claimed Losses From Aircraft Activit y

Pursuant to section 183(b), deductions with respect to an

activity "not engaged in for profit!' generally are limited to the

amount of gross income derived 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 . "

Deductions are allowed under section 162 for the ordinar y

and necessary expenses 'of carrying on an activity whic h

constitutes the taxpayer's trade or business . . Deductions are

allowed under section 212 for expenses paid or incurred•in

connection with an activity engaged in for the-production or

collection of income, or for . the management, conservation, or

maintenance of property held .for the production of income . With

respect to either section, however, the taxpayer must demonstrate

a profit objective for the activities in order to deduct

associated expenses .

Dreicer v . Commissioner , 78 T .C . 642, 644-

645 (1982), affd . without published opinion 702 F .2d 1205 (D .C .

Cir . 1983) ;

Warden v . Commissioner , T .C . Memo . 1995-176, affd .

without published opinion 111 F .3d 139 (9th Cir . 1997) ;--sec .

1 .183-2(a), Income Tax Regs . In order to meet the required

profit objective, "the taxpayer's primary purpose for engaging in

the activity must be for income or profit ."

Commissioner v .

13

Groetzinger ,, 480 U- c . 23, 35 (1987) ; Bot v . Commissioner , 353

F .3d 595, 599 (8th ir . 2003), affg . 118 T .C . 138 (2'002) ;

Am .

Acad . of Family Ph icians v. . United States, 91 F .3d 1155,

1157-

1158 . (8th Cir . 1996) .

Section 1 .183-2(b) ., Income Tax Regs ., provides factors to be

considered when determining whether an activity is engaged in for

profit as-follows :

(b), .-Relevant factors .--In determining-whether an

activity .is engaged in for profit, all facts and

circumstances with respect to the activity are to be

taken into accont . No one factor is determinative in

making this det rmination . In addition, . .it is not'

intended that oily the factors described in this

paragraph are t -be taken into account .in making the

determination, r that a determination is to be made on

the basis that he number of factors (whether or . not

listed in this aragraph) indicating a lack of profit

objective excee s the number of factors indicating a

profit objective , or vice versa . * * *

Nine nonexclusive factors are set forth in the regulations

which are to be considered when determining profit intent . Those

factors are : (1) .Th manner in which the taxpayer carried on the

activity ; (2) the ex ertise of the taxpayer or his advisers ; (3 )

the time and effort ~xpended by the taxpayer in-carrying on th e

activity ; (4) the exLectation that assets used in the activit y

may appreciate in value ; (5) the success of the taxpayer in

carrying on other si ilar or dissimilar activities ; (6) the

taxpayer's history of income or losses with respect to th e

activity ; (7) the amount of occasional profits, if any, which ar e

earned ; (8) the financial status of the taxpayer ; and (9) whether

14 elements of personal pleasure or recreation exist .

Id ..

Not all

of the factors are applicable in every case, and no one factor is

controlling . See Abramson v . Commissioner , 86 T .C . 360, 371

(1986) ; sec . 1 .183-2(b), Income Tax Regs . We begin by applying

each of these factors to the facts relating to petitioners'

aircraft activity .

The fact that a taxpayer carries on an activity in~ .a

businesslike manner and maintains, complete and accurate books and

records may indicate that the activity was engaged in for profit .

See Engdahl v . Comm issioner , 72 T .C .

.

2(b)(1), Income Tax Regs .

659, 666

(1979) ;

sec . 1 .183-

During the years at issue, petitione r

kept logs noting his involvement with KAR RRR, but he admitted

that those logs were incomplete . The logs were not made

contemporaneously with the activities petitioner noted therein .

Much of the time memorialized in the logs is attributable to

travel time and time that petitioner spent on his own flight

training activities and classes .

Petitioner failed to develop a formal business plan .

Although petitioner testified that he used a "pro forma", it wa s

not produced at trial . EOA's financial projections overestimate d

the profitability of renting the Cessna, and the projecte d

expenses did not include finance expenses ,

sales tax, o r

registration fees and did not take into account actua l

depreciation of the Cessna .

- 15 Petitioner tes_ified that he was active in advertising the

Cessna throughout the community, but he failed to adequatel y

corroborate : that tes

imony with evidence of such marketin g

activities . •Petitio er also did bookkeeping for KAR'RRR,

including=the estab i

account . However,

shment and maintenance of the'company bank

p titioners relied on . the services of EOA for e

the day-to--day. renta

of the Cessna ,

reservations for the Cessna ,

including takin g

providing storage for the Cessna,

and providing licens

d flight instructors to fly the Cessna .

Moreover, the mainte

ance,ren.tal of the aircraft,-and collection

of rental receipts w re performed by either .EOA or the flight

instructors associa t d .with the rental flights .. Petitione r

explained at'trial t

at student pilots and renters would'pay .EOA

directly for the use

of the Cessna at the end of the renta l

period . EOA would t en credit the account of KAR RRR for the feegenerated . At the e

d of the month, EOA wou .ld ;deduct :thei r

commission and : other expenses , such as fuel and maintenance .

Petitioner was not quIalified to perform th e maintenance on th e

Cessna necessary to k ep it airworthy . Petitioner reviewed :some

of these activities b t did not perform them himself and .

otherwise had limite d involvement`in the day-tb-day,activitie s

involving the Cessna ..

Consequently, consideration of the first

factor weighs against

the finding of a profit objective .

.

- 16 A taxpayer's expertise or that of his advisers is 'a factor

in determining profitability . Sec . .1 .183-2(b)(2), Income Tax

Regs . Before his purchase of the Cessna, petitioner had no

relevant experience in the aircraft industry . Petitioner spent

time "going on the FAA's website" to understand what rules and

regulations governed private aviation . He also researched

Cessna's advisories about his type of aircraft to determin e

"whether there were recalls or anything like that ."

i

Petitioner sought advice in selecting the appropriate

aircraft for the activity, relying in part on the knowledge of

local flight instructors . Otherwise, petitioner relied on EOA,

the seller of the Cessna, and Advocate Consulting . Before the

purchase of the Cessna, petitioner was informed by EOA's

president that the Cessna could be rapidly depreciated,i!for tax

purposes . At the same time, employees of EOA informed petitioner

that Advocate Consulting could structure the purchase of the

Cessna in a tax-advantageous manner . Petitioner's independent

research-'on Advocate .. Consulting entailed going online and trying

"to get a little background on the * * * company ." Petitioner

did not know anyone else who was referred to Advocate Consulting .

Petitioner testified that Advocate Consulting agreed to represen t

petitioners before the IRS as part of their agreement ;, with KA R

RRR .

17 Petitioners'-retained the services of Advocate Consulting on

a yearly basis . Petitioners sought the advice of Advocate

Consulting because a rcraft-leasing "was a field that

[petitioner] really idn't know in terms of-legal or tax issues .'

When asked at trial if he ever thought that the tax advice he

received was too goo to be true, petitioner responded that if

he's "paying for their advice and ' their . counsel tells me that

this is the way it is,-then *•* I believe them .

As we have alrea y noted,, EOA provided a written projection

of,net income that di not include finance expenses, commissions,

legal and professiona services expenses, or tax depreciation

expenses related to t e Cessna . Given petitioner's educationa l

background in economi :s and his discussions with- employees of EOA'

and Advocate Consulti g about structuring the purchase of the

Cessna in~a tax-advan ageous manner, it is reasonable to assume

that petitioner recog ized the significant distortions these

omissions would create between the projected profits and the

profits or-losses from the aircraft activity that petitioners

would report on their tax returns . In preparing for an'activity,

a taxpayer need not m ke a formal market'study, but might be

a

expected to undertake a basic investigation of the factors that

would affect profit . Westbrook v . Commissioner, T .C . Memo . 1993634, affd . 68 F .3d 868-(5th Cir . 1995) . Yet petitioner failed to

seek an objective opinion about the profit potential of•such a n

- 18 undertaking . and relied heavily on parties with their on

subjective interest in the transaction . Under the circumstances,

petitioner's independent research of profitability . of the

aircraft activity was insufficient . Consequently, the'secon d

factor weighs against a finding of a profit objective .

The fact that a taxpayer devotes much of his personal time

and effort to carrying on an activity, particularly if .there are

no substantial personal or recreational elements, may indicate a

profit motive . Sec . 1 .183-2(b)(3), Income Tax Regs . Much of the

time that petitioner spent on the aircraft activity involved his

own flying lessons . Petitioner and his daughter, had decided to

learn how to fly, and petitioner purchased the Cessna as a way to

do that . Petitioner had long wanted to learn to fly airplanes,

having attempted to join the Air Force when he was younger .

.Petitioner created logs documenting hi,s activities related to th e

Cessna . The logs, though incomplete, indicate that petitioner

spent approximately 197 .05 and 208 .25 hours on KAR RRR activities

in 2002 and 2003, respectively . Much of that time represents

petitioner's own flying instruction . While the logs . petitioner

kept indicate some activity that could be construed as business

related, it could also be construed as a genuine interest in

a

recreational activity . Regardless, the relatively small amount

of time spent on this activity that was substantiated in the

record does not outweigh the evidence indicating that petitioner

f

- 19 had a significant in terest in the recreational elements of th e

activity . Consequently, the third factor does not support a

finding of a profit objective .

An expectation that the assets used in the activity will

appreciate in value ight indicate a_profit objective ;. Sec .

1 .183-2(b)(4),

Incom Tax Regs . It is unlikely that petitioner

expected the Cessna, , the only asset owned by KAR RRR, to

appreciate in value . Additionally, absent extenuating

circumstances, none of which were established in this case, the

regular-wear and tea on a Cessna would likely cause economic

depreciation . Accordingly, the fourth factor weighs against

finding-a profit-obj ctive .

The fact that t e taxpayer has engaged in similar activitie s

in the past and cony rted 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 .

.183-2(b)(5), Income Tax Regs . Petitioner

had no previous'expe ience in, the aircraft-industry, and provided

no evidence that he had engaged in any similar activities for

profit . Consequently, the fifth factor is neutral .

.

A series of :;losses'during'the initial or startup stage of an

activity may not necessarily be an indication that the activity .

is not engaged in for profit . Sec . 1 .183-2(b)(6), Income Tax

Regs . However,,where losses continue to be sustained beyond the

20

period that 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 .

Id .

Ultimately, a taxpayer must demonstrate an ability to make a

profit in the long term to offset any startup losses . See

Bessenyey v . Commissioner , 45 T .C . .261 (1965), affd . 379 F .2d 252

(2d Cir . 1967) .

There was no prior history . of either profits or losses from

petitioner's aircraft activity because the years at issue were

the first 2 years in which petitioner's aircraft activity

existed . In neither 2002 nor 2003 did the aircraft activity

generate a profit .10 Petitioner testified and submitted evidence

indicating that in the years following the years at issue,

several flight instructors who had used petitioner's Cessna to

give lessons decided to start their own flight instruction

business using petitioner's Cessna at Des Moines International

Airport . Petitioner explained that he became very involved in

the marketing and organization of this new business and had plans

to merge his aircraft activity with the flight instructors' .

business . However, petitioner failed to submit evidence

regarding the profitability of the aircraft activity in the year s

to The aircraft activity generated losses of $84,469 for

2002 and $44,442 for 2003 .

- 21 after 2003 . Without) any proof of profitability in later years ,

the sixth factor is•ieutral .

The amount of occasional profits earned in relation to the

amount of losses incurred may provide useful criteria in

determining the tax .p yer's intent . Sec . 1 .183-2(b)(7), Income -Tax Regs .- A-s . we hav established, there is no history of the

aircraft activity's eing profitable . Consequently, the "sevent h

factor is neutral .

Substantial income from sources other than the activity may

indicate that the activity is not engaged in for profit,

especially if there are personal or recreational elements

involved .- Sec .

1 .1813-2(b) ' (8),

Income Tax Regs . Petitioner

worked approximately 50 hours per week in 2002, and he spent most

of his work week in he offices'ofPRM in downtown Des Moines .

Most of petitioner's income came .from his position at•PRM .`

Petitioner's hours a rd responsibilities did not change 'very much

between 2002 and 200--" . Petitioners . reported salaries in`excess

of $593,000 in-2002 and $742,000 in 2003 . The losses created 'by

the aircraft activit , if found to be deductible, would offset

some of petitioners" substantial salaries and generate~a

significant tax savings in the years at issue . Consequently', the

eighth factor weighs against a profit objective . '

Finally, the presence of personal motives in carrying on an

activity may indicate that the activity is not engaged in for

- 22 profit, especially where there are recreational or personal

elements involved . Sec . 1 .183-2(b)(9), Income Tax Regs""i .

Petitioners' daughter Katie received flight instruction from EOA

beginning in 2001 . In the fall of 2001, petitioner also began

taking flight training lessons from EOA . Before taking flying

lessons, petitioner always had an interest in flying . Being a

pilot had been a long-term interest of .petitioner since his

youth . Petitioner acknowledges the purchase of the Cessna as "a

way of having a good new plane upon which to learn" .

Consequently, the ninth factor weighs against a finding of a

profit objective .

When considering whether a taxpayer engaged in an activity

for profit, greater weight must be given to the objective facts

than to a taxpayer's mere statement of intent .

Beck v . .

Commissioner , 85 T .C . 557, 570 (1985) . While some of

petitioner's efforts could support an argument in favor of a

profit objective, they could also be construed as a genuine

interest in and an effort to contribute to an activity that

provided personal pleasure in the form of a hobby . Regardless,

petitioner's testimony and the evidence on =record in favor of

petitioners' argument are insufficient to overcome the weight of

the objective facts indicating that petitioners were not engaging

23 in the activity pri m rily for profit ." Accordingly, we will .,

sustain .respondent '

determination with regard to th e

s created by the .aircraft activity . '

II .

Claimed Loss fr m Worthless Stock and Loan s

On ` .their 2002

F deral income tax return, petitioners claimed

losses of $432,34 6

lating to the alleged worthlessness of their

BTI stock and loans

etiti.oner made to B .I . On-petitioners'-2002

.T

Schedule D, Capita l

ains and Losses, they reported a short-term

capital loss of $3.3 2 346 . related to BTI, which contributed .to a

total net short-ter m loss of $412,,033 reported for that year .

Petitioners also rep

rted a $100,000 long-term ; capital los s

related 'to BTI on . .t h it ScheduleD for 2002, which contributed to

a total net long-te r

capital loss of $26,245 . -Petitioners were

limited by section- 1 11(b) :.(1)`to a recognized capital loss o f

$3,OQO on their 200 2 Federal income, tax return . Petitioner s

carried forward a s h

rt-term capital loss of $409,033 and a long-

term capital loss of $26,245 . to 2003 . .

Respondent dis a lowed petitioners', claimed capital losses ,

relating to BTI . H o

ever,, respondent .concedes that afte r

application . of the . s ction 1211(b)(1) capital loss limitation i n

2002, petition'ers'

' Because we

F deral'income tax return,for 2002 reflecte d

.f i

not engaged in with

decide whether petit

activity losses subj

469 .

d that petitioners' aircraft activity wa s

he required profit objective, we need not

oners ' losses were nondeductible . passive

ct to the limitations imposed under sec .

- 24 the appropriate amount of capital losses (i .e ., capitaliloss of

$3,000) . Accordingly, the disallowance of the reported loss with

respect to BTI affects only petitioners' taxable income for 2003 .

Petitioners argue that the BTI stock became worthless and

that their loans to BTI became nonbusiness bad debt when BTI "ran

out of opportunities to sell the company" in 2002 . Respondent

argues that neither the stock nor the loans became worthless in

2002 .

In order for a taxpayer to claim a loss for worthless

securities in a taxable year, the security must .become worthless

in that taxable year . Sec . 165(g)(1 .) . A loss shall be treate d

as sustained during the taxable year in which the loss occurs a s

evidenced by closed and completed transactions and as fixed by

identifiable events occurring in such taxable year . Sec . 1 .1651(d)(1), Income Tax Regs . Total worthlessness of the security is

required for the deduction . Sec . 1 .165-4,, Income Tax Regs . N o

loss deduction is allowed for partial worthlessness or for mer e

decline in value . Sec . 1 .165-5, Income Tax Regs . Stock becomes

worthless and the loss is sustained only when the stock has no

liquidating value and there is no reasonable hope and expectation

that at some future point in time it will become valuable .

Duncan v . Commissioner , T .C . Memo . 1986-122 . The burden is on

the taxpayer to establish the worthlessness of the stock and the

year in which it became worthless .

Id .

(citing

Boehm v .

Commissioner , 326 U

established"satisfa c only only by some "identifiable event" i n

the corporation's li

expectation of revit

business operations, ,

appointment of a re c fiver for it .

Morton v . Commissioner , 3 8

B .T .A . 1270, 1279 (1 38), affd . 112 F .2d 320 (7th Cir . 1940) . .

In the case,-o f

taxpayer other than a corporation, wher e

any nonybusiness deb t

the loss resulting t erefrom shall be considered a loss from the .

sale or exchange, du

held for not more-t h

nonbusiness debt is

debt has become tota

ly worthless . Sec . 1 .166-5(a)(2), Incom e

Tax Regs . The burde

worthlessness of the

worthle-ss .

Crown ,.v . IComm i

is generally accepte d that-the year of worthlessness is to be

fixed by identifiabl e

events which form the basis of reasonable ,

grounds for abandoni n

hope of recovery .

Id .

Whether petition is loans-made to BTI should be evaluate d

for fitting the,defin .tion of worthless securities or nonbusines s

bad debt depends on w~ether the debt is evidenced by a security

- 26 as defined in section 165(g)(2) (C) .12 Sec . 166(e) . ; However,

each of these alternatives requires petitioners to show that, at

the end of 2002, there was no reasonable prospect for recovery .

See Boulafendis v . Commissioner , T .C . Memo . 1984-321 (citing

Boehm v . Commissioner ,

supra at

598), .

supra ,at 291-292 ;

Crown v . Commissioner ,

Accordingly, we begin our analysis by addressin g

this issue .

Mr . Hyman testified that BTI owned furniture, fixtures, an d

a patent on the use of linear programming at, the time it file d

for bankruptcy in 2001 . He testified that BTI had substantia l

value at that time . Almost immediately after the bankruptcy

filing, the venture capital firm on whose interest payment BTI

defaulted and another company submitted .separate bids to purchase

the assets of BTI for $2 million ., Mr . Hyman testified that if a .

sale had occurred in 2001, BTI shareholders would have benefited .

However, Mr . Hyman believed that BTI could be .sold for, and the

assets were worth, significantly more than $2 million . According

to Mr . Hyman, that is the reason that BTI's bankruptcy truste e

turned down both of the $2 million offers .

P;

Mr . Hyman testified that it was reasonable for petitioner to

believe that he could get something for his investment in BTI a t

12 Sec . 165(g) (2) (C) defines a "security" as "a bond,

debenture, note, or certificate, or other evidence of

indebtedness, issued by a corporation or by a government or

political subdivision thereof, with interest coupons or in

registered form ."

- 27 the end of 2001, eve after it filed for bankruptcy . At that

time, Mr . Hyman was,iopeful .that a sale was going to occur . . Mr .

Hyman testified that, .when no sale occurred, the company was "pu t

into cold storage "

th the goal-of-trying to raise money . . BTI' s

bankruptcy proceedi n

was later,converted-from chapter 7 to

chapter 11 . .-BTI i s

resently operating as a business in chapte r

11, and Mr . Hyman to tified that "there's activity now startin g

to try to . raise capi al within the chapter 11 environment to b e

able to, to bring t h

company . potentially . out of . chapter 1 1 and

operate * **"-the co pang ."

The evidence . p r sented at trial, combined with Mr . . Hyman' s

testimony, indicates

that BTI had value at all times in 2002 an d

still has value . Pe

itioners_havewfailed to . carry their burde n

of proof to show that there was no reasonable prospect of

recovery for their s ock .and loans .in 2002 . Accordingly, we hold

that petitioners . are not entitled to deductions for worthless

securities or nonbus'ness bad debt .

III . .

AccuracV-Related Penalt y

With respect to the accuracy-related penalty under section

66 .62(a), the Commissioner has the burden of production ., Sec .'

7491(c) . To prevail, the Commissioner must'produce sufficient

evidence that it is a propriate to apply the penalty to the

taxpayer .

.'Higbee v . ommissioner, 116 T .C .438, 446 (2001) .

Once the Commissioner meets his burden of °production, the

- 28

taxpayer bears the burden of supplying sufficient evidence to

persuade the Court that the-Commissioner's determination is

incorrect .

Id .

at 447 .

Section 6662(a) and (b)(1) provides accuracy-related

penalties equal to 20 percent of the underpayment of tax required

to be ; .shown on a return if the underpayment is due to negligence

or disregard of rules or regulations .13 For purposes of section

6662, the term "negligence" includes "any failure to make a

reasonable attempt to comply with the provisions of * * * [the

Code], and the term `disregard' includes any careless, reckless,

or intentional disregard ." Sec . 6662(c) . "Negligence" also

includes any failure by a taxpayer to keep adequate books and

records or to substantiate items properly . Sec . 1 .6662-3(b)(1),

Income Tax Regs .

An accuracy-related penalty is-not imposed with respect to

any portion of the underpayment as to which the taxpayer acted

with reasonable cause and in good faith . Sec . 6664(c) :,!(l) ; see

Higbee v . Commissioner ,

supra at 448 . This determination is made

based on all the relevant facts and circumstances .

Commissioner ,

Higbee v .

supra at 448 ; sec . 1 .6664-4(b)(1), Income Tax Regs .

13 Sec . 6662 can also apply when there is a substantial

.

understatement of tax . See sec . 6662(b) .(2) . However ; since the

only reason given in the notice of deficiency for . imposing the

penalty was negligence or intentional disregard of rules and

regulations, and respondent did not raise sec . 6662(b)(2) until

after trial, we will only consider the issue raised in the notice

of deficiency .

- 29

Relevant factors°inc ude the taxpayer's efforts to assess his

proper tax liability .

While we have h ld that petitioners did not have profit as

their primary object've for entering into the aircraft activity,

we believe that they had both personal and profit objectives in

the sense that they actually hoped that their activity might

produce a profit . S le Warden v . Commissioner , T .C . Memo . 1995176 . Sometimes it i difficult to determine which of two motive s

for engaging in an a~tivity is primary . That is one of the basi c

reasons for using ob ective facts to determine subjective intent .

But a finding that p ofit was not the primary motive does not

automatically result in a conclusion that petitioners were

negligent or intenti nally disregarded the rules and regulations .

See Bernardo v . Co mm issioner, T .C . Memo . 2004=199 ;

Sherman v .

Commissioner , . T .C . Memo . 1989-269 . On the basis of the

previously stated facts, we find that petitioners' reporting of

their aircraft activity was not due to negligence and that they

are not liable for the penalties with respect to the portions of

the underpayments due to their aircraft activity . Likewise, we

find that petitioners are not liable for the penalty on the

portion of the 2003 u derpayment due to their claimed losses from

worthless stock and l ans . The determination of worthlessness i n

the situation describ d in this case is not without some`doubt ,

and while we have fouLd that petitioners have not proven

- 30 worthlessness, we believe that they honestly believed that their

stock and loans were worthless in 2002 .19 We therefore hold that

petitioners are not liable for the section 6662 penalties .

To reflect the foregoing,

Decision will be entered

for respondent as to th e

deficiencies and fo r

petitioners as to th e

accuracy-related penalties .

1a In petitioners' posttrial brief, they requested the

following finding of fact :

62 . Dr . Rosenblatt believes his investments in Benefit

Technologies became worthless in 2002 because during

that year the bankruptcy trustee ran out of

opportunities to the [sic] sell the company .

In his answering brief, respondent had no objection to this

proposed finding of fact .