# UNITED STATES TAX COURT > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3Acd43905431684e54 ## Record - **Collection:** Agency decision - **Document type:** Agency decision ## Text T.C. Memo. 2012-96 UNITED STATES TAX COURT F. LEE BAILEY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent F. LEE BAILEY AND ESTATE OF PATRICIA S. BAII!EY, F. LEE BAILEY, PERSONAL R£PRESENTATIVE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket Nos. 3080-08, 3081-08. Filed April 2, 2012. P, a lawyer, represented a criminal defendant who was cooperating with the Federal Government by facilitating the transfer of his foreign assets as restitution. In 1994 P entered into an unusual unwritten agreement with the Government, pursuant to which he would use an existing foreign account of his own to hold $6 million of the client's stock and make expenditures to faóilitate the client's plan. P sold some of the stock and borrowed against the remainder, using some of the proceeds for the client's business but also transferring some to other accounts from which he made personal expenditures of his own. He later repaid the funds he had spent for himself. P conducted a yacht rental activity and an airplane remanufacturing activity through a wholly owned S corporation. ! SERVED APR - 2 2012 -2Most of the use of the yacht was personal. The airplane remanufacturing activity was devoted to developing a plane as a prototype, including the expensive process of obtaining FAA approval for remanufacturing multiple planes for sale. Neither of the activities ever generated a profit, and P claimed pass-through losses from his S corporation on his individual income tax returns. P failed to report all of his income on his returns, wrongly reported some income he did not receive, claimed some deductions he could not substantiate, and failed to deduct certain amounts that he did expend. Held: P realized income not when he received the stock, sold it, or borrowed against it, but only when he transferred sale proceeds to other accounts from which he later made personal expenditures. Held, further, the yacht rental activity was not engaged in for profit under I.R.C. sec. 183 during any of the tax years at issue; but the airplane remanufacturing activity was engaged in for profit from 1993 until April 1996. Held, further, for the 1993 through 1995 and 1997 through 2000 tax years, P is liable for the accuracy-related penalty under I.R.C. sec. 6662. F. Lee Bailey, for himself. Carina J. Campobasso, Thomas R. Thomas, Frances F. Regan, and Janet F. Appel, for respondent. CONTENTS FINDINGSOFFACT ............................................... 8 Mr.Bailey's careerand business ventures .......................... 8 Mr. Bailey's representation of Claude Duboc . . . . . . . . . . . . . . . . . . . . . . . 9 Mr. Bailey's unwritten agreement with the Government . . . . . . . . . . . . . . . 9 Theterms oftheunwritten agreement ............................ 10 Payments under the unwritten agreement . . . . . . . . . . . . . . . . . . . . . . . . . . 12 The use of Mr. Bailey's existing Credit Suisse account . . . . . . . . . . . . . . . 14 Mr.Bailey's workunderthe agreement ........................... 15 Mr.Bailey's financialtransactions ............................... 16 Accounting for and return of stock . . . . . . . . . :. . . . . . . . . . . . . . . . . . . . 19 Repayment of unapproved expenditures and personal loans . . . . . . . . . . . 21 Subsequent proceedings L . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Mr.Bailey's subchapter S corporationk v.......................... 24 Mr.Bailey'srecords ...-... ................................... 25 Mr.Bailey'sairplanerentalactivity ............:.:............... 26 Mr.Bailey'syachtrentalactivity ................................27 Mr. Bailey's airplane remanufacturing activity . . . . . . . . . . . . . . . . . . . . . 30 Project288income andexpenses ................................ 37 Preparation of Mr. Bailey's Forms 1040 and 1120S . . . . . . . . . . . . . . . . . 38 Filing of Mr. Bailey's Forms 1040 and 1120S . . . . . . . . . . . . . . . . . . . . . . 39 Mr. Bailey's cooperation with the IRS's examination . . . . . . . . . . . . . . . . 45 Destructionofrecords .......................................... 47 Noticesofdeficiency.......................................... 47 OPINION........................................................ 48 I. Background evidentiary principles . . . . . . . . . . . . . . . . . . . . . . . . . . 48 A. BurdenofProof .....O.. ......'.:..................48 1. . Providing IRS access to records . . . . . . . . . . . . . . . . . 49 a. Taxpayers are required to keep their own records................................. 50 -4b. Taxpayers are required to retain their records as long as they may become material for tax purposes. . . . . . . . . . ... . . . . . . . . . . . . . . 51 B. II. Burden shift under section 7491(a) . . . . . . . . . . . . . . . 52 3. 4. Alleged animus . . . ... . . . . . . . . . . . . . . . . . . . . . . . . . . 53 New matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 Collateralestoppel .................................. 56 Income from wrongful appropriations . . . . . . . . . . . . . . . . . . . . . . . 60 A. B. C. D. III. 2. Taxable income includes wrongful appropriations. . . . . . . . . 60 A trustee realizes income from the trust corpus when he actually misappropriates it. . . . . . . . . . . . . . . . . . . . 62 Mr. Bailey realized income when he transferred stock sale proceeds from the advance account. . . . . . . . . . . . 64 Mr. Bailey did not realize income when he transferred loan proceeds from the advance account. . . . . . . . . . . . . . . . 66 Due process and Mr. Bailey's income from the Broderlitigation ........................................ 74 IV. Whether activities are engaged in for profit: generalprinciples ........................................ 78 V. Analysis of Mr. Bailey's yacht rental activity . . . . . . . . . . . . . . . . . 80 A. Lack of profit motive for yacht refurbishing activity . . . . . . 81 1. 2. Manner in which the activity is conducted . . . . . . . . . 82 Expertise of the taxpayer and his advisers . . . . . . . . . . 83 3. Time and effort expended . . . . . . . . . . . . . . . . . . . . . . 83 4. 5. Expectation that assets may appreciate in value . . . . . 84 Taxpayer's success in similar or dissimilar activities ........................... 84 - 5- B. 6-7. History of income or loss, amount of 8. occasionalprofits ............................. 84 Financial status of the taxpayer . . . . . . . . . . . . . . . . . . 84 9. Elements of personal pleasure . . . . . . . . . . . . . . . . . . . 85 10. Conclusion .................................. 86 Equitableestoppel ................................. 87 1. 2. VI. Alleged agreement ............................ 87 Allegedmisleading............................ 88 C. Lack of nexus between yacht refurbishing and D. yachtrental .......................................90 Tax consequences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 Analysis of Mr. Bailey's airplane remanufacturing activity . . . . . . 92 A. Profitmotiveundersection183 ....................... 92 1. 2. Manner in which the activity is conducted . . . . . . . . . 92 Expertise of the taxpayer and his advisers . . . . . . . . . . 94 3. Timeandeffortexpended ...................... 95 4. 5. Expectation that assets may appreciate in value . . . . . 96 Taxpayer's success in similar or dissimilar activities . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 B. 6-7. History of income or loss, amount of 8. 9. 10. occasionalprofits ............................. 97 Financial status of the taxpayer . . . . . . . . . . . . . . . . . . 98 Elements of personal pleasure . . . . . . . . . . . . . . . . . . . 98 Conclusion .................................. 99 Timingofdeductions .....m........................ 100 1. The Commissioner's alternative contention . . . . . . . 100 2. 3. 4. Start-up expenditures . . . . . . . . . . . . . . . . . . . . . . . . . 101 Capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . 103 Analysis ................................... 103 -6VII. Miscellaneousadjustments ................................ 106 A. B. Mr.Bailey's position .............................. 106 Analysis ......................................... 108 1. 2. .. . Incomeitems ............................... 109 Deductions ................................. 121 VIII. Failure-to-file additions to tax under section 6651(a)(1) . . . . . . . . 138 IX. Accuracy-related penalty under section 6662 . . . . . . . . . . . . . . . . 139 A. B. Negligence ...................................... 140 Defenses ........................................ 141 Conclusion ....................................................... 143 MEMORANDUM FINDINGS OF FACT AND OPINION GUSTAFSON, Judge: The Internal Revenue Service ("IRS") issued to petitioner F. Lee Bailey1 two statutory notices of deficiency on November 6, 2007, pursuant to section 6212,2 showing the IRS's determinations of the following IFor the years 1993 and 1994, the IRS issued a notice of deficiency to Mr. Bailey and his wife, Patricia S. Bailey, who died in 1999. Mr. Bailey is the personal representative of the Estate of Patricia S. Bailey. For the years 1995 through 2001, the IRS issued a notice of deficiency to Mr. Bailey alone. 2Unless otherwise indicated, all citations of sections refer to the Internal Revenue Code (26 U.S.C.), and all citations of Rules refer to the Tax Court Rules of Practice and Procedure. -7deficiencies in income tax and failure-to-file additions to tax and accuracy-related penalties under sections 6651(a)(1) and 6662, respectively, for the 1993 through 2001 tax years: Addition to tax Penalty sec. 6662 $35,364 427,581 34,843 --43,623 125,842 26,152, 13,262 Year 1993 1994 1995 1996 1997 1998 1999 2000 Deficiency $176,818 2,137,907 174,217 511,444 218,116 629,209 130,758 66,309 sec. 6651(a)(1) ----------$94,381 19,530 9,946 2001 82,191 --- . --- The issues for decision are: (i) whether and when Mr. Bailey realized income from Biochem Pharma stock held in his investment account at Credit Suisse Bank; (ii) whether Mr. Bailey's yacht rental activity and airplane remanufacturing activity were engaged in for profit pursuant to section 183; (iii) whether and to whalextent his Íncome was fully reported or over-feported; (iv) whether and to what extent his deductions are substantiated and deductible; and (v) whether he is liable for the addition to tax under section 6651(a)(1) and the accuracy-related penalty under section 666Z Éo 041 any portions of the deficiencies. -8FINDINGS OF FACT Some of the facts have been stipulated and are so found. The parties' stipulations of facts are incorporated herein by this reference. At the time that he filed his petitions, Mr. Bailey resided in Massachusetts. Mr. Bailey's career and business ventures During the tax years at issue, Mr. Bailey was an attorney who was well known for his defense of high-stakes, high-profile criminal cases. Mr. Bailey tried cases in almost every State and in five foreign countries. He was also a speaker and author. During the years at issue Mr. Bailey's average gross income from those activities exceeded $1 million a year. Before his graduation from law school in 1960 and his subsequent career as an attorney, Mr. Bailey served as a pilot in the U.S. Marine Corps. As a Marine he flew many types of aircraft, and he developed an interest in small airplanes. In March 1954 Mr. Bailey received his commercial license to fly aircraft, and he began to fly small airplanes for personal pleasure and recreation. In 1960, when he began his law practice, Mr. Bailey purchased a small airplane and used it to fly himself to and from the locations of his various court cases. In 1971 Mr. Bailey bought a helicopter manufacturing company named Enstrom Helicopter Corp. and owned it for 10 years before selling it. The record -9does not show Mr. Bailey's precise role in Enstrom or the extent of the company's profitability. The record does not show that Mr. Bailey was involved in any other ventures related to remanufacturing, refurbishing, leasing, buying, or selling aircraft (or other luxury vehicles;such as boats). Mr. Bailey's representation of Claude Duboc In 1994 Claude Duboe, who was accused of importing marijuana into the United States on a huge scale, retained Mr. Bailey to negotiate a plea arrangement and to assist Mr. Duboc in cooperating with the Federal Government's seizure of his many foreign assets, including multiple pieces of high-value residential real estate. To influence the prosecutors and the court to,reduce his sentence, Mr. Duboc wanted to maximize the amounts paid over to the Government, but the Government's seizure of his assets presented legal, diplomatic, and practical difficulties. - Mr. Bailey's unwritten agreement with the Government Because of those difficulties, the Government entered into a vague and unusual agreement with Mr. Bailey, under which)Mr. Bailey would perform services to facilitate Mr. Duboc's forfeiture of his assets, and Mr. Duboc would transfer 602,000 shares of Biochem Pharma stock to Mr. Bailey, to provide funds - 10 that Mr. Bailey could use to maintain and transfer Mr. Duboc's foreign assets 3 Thomas Kirwin, an Assistant U.S. Attorney who worked for the Government on the Duboc case (and who later became a U.S. Attorney) testified at trial that the Duboc case was important and complex and that the nature of the work that Mr. Bailey undertook to do was "extraordinary". Nonetheless, the agreement was completely unwritten. Bailey v. United States, 54 Fed. Cl. 459, 465 (2002) (Bailey II). The terms of the unwritten agreement As described by Mr. Kirwiri in his testimony in these cases, the unwritten agreement called for Mr. Bailey to-liquidate the properties, maintain them, you know, worry about the mechanic's lien, worry about the zoning things, getting all of those 3Some of the facts pertinent to the Biochem Pharma stock issue were determined in litigation between Mr. Bailey and the Government on two prior occasions: In United States v. Duboc, No. 94-01009 (N.D. Fla. Oct. 23, 1997), aff'd in part, rev'd and remanded in part sub nom. United States v. Bailey 175 F.3d 966, 967-968 (11th Cir. 1999) (Bailey I), a forfeiture proceeding in District Court, the Government successfully claimed the right to Mr. Duboc's 602,000 shares of Biochem Pharma stock, reduced only by expenditures approved by the district court. In Bailey v. United States, 40 Fed. Cl. 449 (1998), 46 Fed. Cl. 187 (2000), 54 Fed. Cl. 459 (2002) (Bailey II), a contract suit in the Court of Federal Claims, Mr. Bailey unsuccessfully claimed a contractual right to the appreciation in value that the Biochem Pharnga stock experienced after it was transferred to his Credit Suisse account. The parties are here collaterally estopped from disputing the facts set out in part I.B. below that were found in those prior cases. -11 things ready so that thesé houses could be sold and the money repatriated to the United States. The asset that was to be used to cover both Mr. Bailey's fees and the other expenses generated by Mr. Bailey's work-both for Mr. Duboc's defense and for repatriation of his foreign assets--was Mr. Duboc's Biochem Pharma stock. If the stock had instead been forfeited immediately to the Government, the Government's only practical option would have been to sell it promptly; but flooding the market with that quantity of stock would have yielded diminished sale proceeds and might have damaged the company. It was therefore in the common interest of Mr. Duboc (who wanted as large a forfeiture as possible), Mr. Bailey (who wanted a source for payment of his fees4), and the Government (which wanted a well-managed repatriation and as large a forfeiture as possible) to leave the Biochem Pharma stock out of the Government's hands and to let Mr. Bailey manage it. 4Mr. Bailey believed that nder fhe agreemenf he became entitled to any appreciation in the value of the Biochem Pharma stock, see p. 12 below; and that was an additional subjective reason for him to favor the transfer of the stock to himself. However, the Court of Federal Claims held in Bailey II that the unwritten agreement did not entitle him to the appreciation. - 12 Therefore, under the unwritten agreement, Mr. Bailey was to hold the Biochem Pharma stock in trust for the Government,5 and he was to have the discretion to sell the stock or to borrow against it as he saw fit. Mr. Bailey was at risk that, if the Biochem Pharma stock depreciated, there would be no source from which to pay his attorney's fees. He maintained that, on the other hand, he was entitled to any appreciation in the value of the Biochem Pharma stock; but the Court of Federal Claims held to the contrary in Bailey II, and that holding estops any dispute of the matter here. Under the agreement . Mr. Bailey was not entitled to the Biochem Pharma stock's appreciation. However, Mr. Bailey's contrary belief conditioned some of his decisions in managing the repatriation, as we will show below. In particular, expecting appreciation in value, he often borrowed against the stock when funds were needed, rather than selling it; and, in addition to using the stock as collateral, he assumed personal liability for the loans. Payments under the unwritten agreement The repatriation expenses that were incurred under the agreement (including property maintenance expenses and Mr. Bailey's travel expenses) could be 5The parties are collaterally estopped from disputing this finding of the District Court. See pt. I.B.2. below. _13 _ reimbursed as incurred. The defense expen 541es would include costs (other than attorney's fees) that defense counsel would incur on the case, and those defense costs could be reimbursed to counsel as incurred. The defense expenses would also include attorney's fees for Mr. Bailey and the other attorneys working with him, Bailey II, 54 Fed. Cl. at 463-466, 491, 492, 505, 506, 508, which the Government personnel acknowledged might amount to as much as $3 million,id. at 463, but there was confusion about the permissible timing óf the payment20f attorney's fees; Mr. Bailey thought that the agreement.allowed him.to withdraw fees as earned (subject to making a subsequent accounting to the court),6 but the Government personnel did not agree to such a provision; and the U.S. District Court for the Northern District of Florida eventually held that Mr. Bailey did not have this right (and that some of his withdrawals had therefore been improper). The Government änd Mr: Bailey were both clear that, at the conclusion of the criminal case, Mr. Bailey would make an accounting to the District Court. See, e.g., Bailey II, 54 Fed. Cl. at 468, 492. The Court of Federal Claims found, see id. at 468, that Mr. Bailey explicitly acknowledged in 1994, at the conference 6See Bailey II, 54 Fed. Cl. at 468 ("Mr. Bailey and * * * [his co-counsel] agreed that under the .arrangement they could take fees as they were necessary or earned"). - 14 between counsel and the court in which the Biochem Pharma arrangement was approved, that Mr. Bailey-would account for the $6 million value of the stock transferred to him, and present an application for payment of fees to Chief Judge Paul at the end of the case and not on an interim basis, although Mr. Bailey and * * * [his co-counsel] agreed that under the arrangement they could take fees as they were necessary or earned. The use of Mr. Bailey's existing Credit Suisse account Mr. Bailey had an investment account at Credit Suisse in which he held investments, and he had a linked account (called an "advance account") into which cash from transactions involving those investments was deposited and from which expenditures or cash transfers could be made. In 1994 Mr. Bailey's own funds totaling $53,397 were in the advance account, apart from the Biochem Pharma transfers. For receiving and holding the Biochem Pharma stock, Mr. Bailey did not open a new account. Rather, the "Government attorneys understood that MriBailey possessed * * * a Swiss bank account", Bailey II, 54 Fed. Cl. at 464, and by agreement it was Mr. Bailey's own account at Credit Suisse that was used for the Biochem Pharma transactions, id. at 486, 505. On April 26, 1994, 602,000 shares of Biochem Pharma stock, then worth $5,891,352, were transferred to Mr. Bailey's Credit Suisse account. Mr. Bailey - 15 did not report income from his receipt of that stock on any income tax return for any year. Mr. Bailey's work under the agreement From April 1994 until late 1995, Mr. Bailey worked very intensively on the Duboc matter. He made frequent trips to Europe, maintained and sold Mr. Duboc's properties, paid European creditors with claims against the properties, dealt with complications of foreign law, negotiated with foreign prosecutors and customs officials who had their own interest in Mr. Duboc's assets, dealt with a French magistrate.who froze certain of the assets, did most of the work in a joint effort with Government counsel to obtain a necessary order from the District Court, and visited regularly with Mr. Duboc in a prison in the rural United States. Mr. Kirwin acknowledged that Mr. Bailey's work on the repatriation of Mr. Duboc's assets was very good; and the Court of Federal Claims found that his work was "far more than usual for a defense attorney". Bailey II, 54 Fed. Cl. at 484. - 16 Mr. Bailey's financial transactions In 1994 and 1995, Duboc-derived funds came into the Credit Suisse advance account from three sources--(1) sales of Biochem Pharma stock, (2) loans collateralized by Biochem Pharma stock, and (3) sales of other stock owned by Mr. Duboc. First, Mr. Bailey made two sales of Biochem Pharma stock in his Credit Suisse account: In October 1994 he sold 150,000 shares for $1,550,850; and in April 1995 he sold 52,000 shares for $850,005. The two sales thus yielded total proceeds of $2,400,855. Second, in 1994 and 1995 Mr. Bailey borrowed a total of $3,013,4637 from Credit Suisse against the remaining 400,000 shares. Mr. Bailey was personally liable for the loans, but he used the Biochem Pharma shares as collateral. Third, at the request of the U.S. Marshals overseeing the forfeiture, Mr. Bailey received and sold $730,000 worth of other stock owned by 7By eliminating the stock sale proceeds, the Commissioner concludes that the remainder of the transferred funds were borrowings and amounted to $550,041 in 1994 and $2,500,230 in 1995, totaling $3,050,271. Mr. Bailey objects to this analysis only by asserting that "[t]he fees of two other clients were deposited in the Credit Suisse account during 1994 (as the records show) and were included in the transfers as earned". We infer that the "records" must be Exhibit 5-J (Credit Suisse statements) and that the two non-Duboc deposits are for $17,169.96 on October 28 and $19,637.63 on December 21, totaling $36,807.59. We accept the Commissioner's analysis subject to that correction, so that the 1994 loans were $513,233 and the two-year total was $3,013,463. Because we find that loan proceeds are not income to Mr. Bailey, the precise amounts of the loans are not necessary to our decision. - 17 Mr. Duboc (in Obayashi Corp. and Pasco Corp.), to facilitate the forfeiture of the proceeds. From the Duboc-derived proceeds in the Credit Suisse advance account (i.e., sale proceeds of $2,400,855 plus loan proceeds of $3,013,463, totaling $5,414,318), Mr. Bailey both made expenditures for the benefit of Mr. Duboc and for the repatriation of his assets (hereinafter, "Duboc-related expenditures") and made transfers to his money market account at Barnett Bank (hereinafter, "the Barnett account"); and from the Barnett account he both made Duboc-related expenditures and made transfers to his personal checking account. These cascading transactions were as follows: From the Credit Suisse advance account, Mr. Bailey made Duboc-related expenditures8 that totaled $931,698 in 1994 and $302,454 in 1995; and he made transfers of Biochem Pharma stock sale and loan proceeds to the Barnett account totaling $688,2709 in 1994 and $2,750,249 in 1995 (totaling $3,475,327), of which 8From this account Mr. Bailey also made a $57,487 personal purchase of stock. This stock purchase was apparently made from Mr. Bailey's own money in the account, which, according to Arthur Andersen, consisted of an opening balance of $5,526 and non-Duboc-related depo 541its of $49,006 and $17,170. 9The parties stipulated that the 1994 transfers from the Credit Suisse account to the Barnett account totaled $725,078. Of this amount, $688,270 was from Duboc-derived funds, and the remaining $36,808 was from fees paid by other (continued...) - 18 the sale proceeds constituted $175,037 in 1994 and $250,019 in 1995 (totaling $425,056) and loan proceeds constituted the remainder of $3,013,463.1° Mr. Bailey also transferred from the Credit Suisse account to the Barnett account the $730,000 in proceeds from the sales of the Obayashi and Pasco stock. From the Barnett account, Mr. Bailey paid $730,000 in 1995 to the U.S. Marshals, for the Obayashi and Pasco stock. (The record shows no complaint at that time from the U.S. Marshals that this $730,000 payment was made from the Barnett account rather than directly from the Credit Suisse advance account, and we find that his use of this account did not result in any appropriation by . Mr. Bailey.) Mr. Bailey also made transfers from the Barnett account to his personal checking account totaling $2,863,000 in 1995 (including the $425,056 that constituted Biochem Pharma sale proceeds, rather than loan proceeds). From the Barnett account Mr. Bailey also made substantial personal expenditures, both in 1994 and 1995, but they were evidently made from his non-Duboc-related 9(...continued) clients. 1°These expenditures and transfers of Biochem Pharma-derived funds from the Credit Suisse advance account total only $4,672,671, whereas the gross totals of Biochem Pharma-derived funds credited to the Credit Suisse advance account (from sales and loans) was $5,414,318. The difference of $741,647 apparently consists of amounts paid back to Credit Suisse from time to time during 1994 and 1995. - 19 personal funds in the account, which were adequate to cover those expenditures. The record does not show that Mr. Bailey regarded the funds in the Barnett account as subject to any restrictions on their use resulting from his agreement with the Federal Government. From the personal checking account (which had received $2,863,000 of Duboc-derived funds from the Barnett account in 1995 (including the $425,056 in sales proceeds)), Mr. Bailey made $35,705 in Duboc-related expenditures, apparently in 1995. He spent the remainder of the Duboc-derived funds (more than $2.8 million) on non-Duboc-related matters. When the money was in that personal checking account, Mr. Bailey treated it (and spent it) as his own. Accounting for and return of stock In late 1995 or early 1996, Mr. Duboc replaced Mr. Bailey with another lawyer. For the prior year and a half, the Government had not inquired about the Biochem Pharma stock. However, Mr. Duboc's retention of new counsel focused attention on the situation at a time when the stock had more than quadrupled in value (from under $10 per share in the spring of 1994 to abóut $44 in February 1996). The 400,000 unsold shares had thus increased in value by about $34 per share, so that appreciation of $13.6 million was at stake. At the Government's request, the District Court ordered Mr. Bailey to transfer the - 20 400,000 unsold Biochem Pharma shares to the Federal Government. At that time, however, Mr. Bailey owed $2,332,743 for loans that had been made against 236,000 of the remaining 400,000 unsold shares (and he had spent the proceeds); and Credit Suisse would not make any transfer of the shares until the loans were repaid. Mr. Bailey therefore did not immediately comply with the District Court's order, and the court found him in contempt in March 1996 and ordered him incarcerated. Mr. Bailey had induced Credit Suisse to transfer 164,000 of the unsold shares to the Federal Government in February 1996. However, because the remaining 236,000 of those unsold shares served as collateral for the loans of about $2.3 million, Mr. Bailey had to repay those loans before Credit Suisse would transfer those shares to the Government. He did repay the Credit Suisse loans (from funds he borrowed from others); but the difficulty of borrowing such amounts from third parties (accomplished while Mr. Bailey was incarcerated for contempt) accounted for his delay in complying with the District Court's order. After Mr. Bailey repaid the Credit Suisse loans, Credit Suisse transferred the remaining 236,000 shares to the Government in April 1996. See Bailey I, 175 F.3d at 968. - 21 Repayment of unapproved expenditures and personal loans Having thus paiél off the Credit Suisse loans, Mr. Bailey then had to account to the District Court for (and inake up the balance of) the $2;400,855 in proceeds of his sales of 202,000 shares in 1994 and 1995. "The district court determined that Bailey incurred $1,221,177.06E"1 in legitimate, reimbursable expenses," Bailey I, 175 F.3d at 968,.apparently leaving $1,179,678 that the court ordered him to repay. . Of that amount, $700,000 was repáid in April 1997. That $700,000 payment was from an amount due to Mr. Bailey in unrelated litigation he had against Aaron J. Broder. Pursuant to court order, Mr. Broder paid that amount to trustees who had been appointed by the District Court in the Duboc case, toward Mr. Bailey's obligations in that case. In 1998 the remainder of the Broder lawsuit was settled for $1,100,000 (in addition to the $700,000 paid in 1997); however, $829,639.01 of that $1,100,000 in settlement payments from Mr. Broder was paid not to Mr. Bailey himself but to third parties." Specifically, $150,000 of the "As we have foùnd, Mr. Bailey had paid Duboc-related expenses from the Biochem Pharma proceeds totaling $1,269,857 (i.e., from the advance account, $931,698 in 1994 and $302,454 in 1995; and from the personal checking account, $35,705 in 1995). "The $1,100,000 in settlement payments from Mr. Broder consisted of (i) a (continued...) - 22 $829,639.01 was paid to Mr. Bailey's attorneys for legal fees, which the Commissioner concedes is deductible under section 162, and the remaining . $679,639;01 was paid to Mr. Bailey's creditors, who had lent to Mr. Bailey in April 1996 to enable him to pay off the Credit Suisse loans and obtain release of the 236,000 shares of Biochem Pharma stock. Mr. Bailey did not include, in the income he reported on his tax returns, the payments totaling $1,650,00013 that Mr. Broder made to him or to his creditors on his behalf in 1997 and 1998. The $700,000 payment from Mr. Broder in April 1997 left a balance of $479,678 of disapproved expenditures that Mr. Bailey was required to repay. Two and a half years later, the unpaid balance was only $423,237.77, so that the "(...continued) $100,000 check to Michael Armstrong for legal fees, (ii) a $485,000 check to Wayne Smith for loan repayment, (iii) a $50,000 check to Fishman, Ankner & Horstmann for legal fees, (iv) a $270,360.99 check to Mr. Bailey, and a wire transfer of $194,639.01 to Truman Bank for loan repayment, totaling $465,000. "In his response to a request for admissions, Mr. Bailey admitted that he did not include the $700,000 payment from Mr. Broder to the trustees, the $485,000 payment from Mr. Broder to Mr. Smith, and the $194,639.01 payment from . Mr. Broder to Truman Bank in the income he reported on his tax returns. In that response, Mr. Bailey denied that he failed to include the $270,360.99 payment from Mr. Broder to himself. However, the IRS included that amount as unreported income for 1998 in the notice of deficiency, and Mr. Bailey had the burden to prove that he reported that amount on his tax returns. Since Mr. Bailey failed to do so, we find that he did not include any of the $1,650,000 in the income he reported on his tax returns. - 23 difference--$56,440--was evidently paid sometime before then. Since the record does not show exactly when, and Mr. Bailey has the burden of proof, we assume that a $56,440 payment was made in 1999 and not earlier. Mr. Bailey repaid the remaining balance of $423,237.77 by two additional payments in late 1999. Subsequent proceedings As a result of his handling of the Duboc matter and the Biochem Pharma stock, Mr. Bailey was disbarred.14 Notwithstanding the District Court's orders, Mr. Bailey still claimed that he was entitled to the Biochem Pharma stock appreciation that had occurred after April 1994, but in Bailey II the Court of Federal Claims rejected that claim. As a result, Mr. Bailey was left with none of the proceeds of the Biochem Pharma stock. He was reimbursed only for the pörtion of his out-of-pocket expenditures that the District Court approved, and he was not paid any fee for his services. Nonetheless, the IRS issued a notice of deficiency on November 6, 2007, in which it determined, inter alia, that Mr. Bailey received income of $5.9 million 14The court orders concerning Mr. Bailey's disbarment are, of course, public records. See In re Bailey, 2005 WL 2901885 (D. Mass. Nov. 1, 2005), aff'd, 450 F.3d 71 (1st Cir. 2006); Florida Bar v. Bailey, 803 So.2d 683 (2001); In re Bailey, 786 N.E.2d 337 (Mass. 2003). However, the Commissioner did not attempt to bind Mr. Bailey to any findings reflected therein, and we do not derive facts from them nor attempt to reconcile our findings with them. - 24 when the Biochem Pharma stock was transferred in 1994 to Mr. Bailey's Credit Suisse account. Mr. Bailey's subchapter S corporations During the tax years at issue, Mr. Bailey was the sole owner of a subchapter S corporation known as Palm Beach Roamer, Inc. (PBR). During 1993 and part of 1994, Mr. Bailey was also the sole owner of an S corporation known as Bahamas Enterprises, Inc. (BEI). Through these S corporations Mr. Bailey conducted three activities--yacht rental, airplane rental, and airplane refurbishing. Mr. Bailey admits that none of these activities ever turned a profit. We discuss those activities in detail below and explain here the corporate structure. In 1993 BEI held title to a number of small airplanes, which Mr. Bailey rented to the general public. In 1994 Mr. Bailey merged BEI into PBR and renamed it Roamer Aircraft Division for accounting purposes. After the merger, Mr. Bailey sold off most of the small airplanes and ceased to rent airplanes to the general public. Mr. Bailey incorporated PBR in 1987. PBR was a calendar year taxpayer and used the accrual method of accounting. PBR purchased and refurbished a yacht, which PBR chartered from 1993 to 1996 and sold in 1998. - 25 In 1993 Mr. Bailey decided to use PBR to remanufacture airplanes rather than yachts. In 1994 PBR purchased a used airplane and began the airplane remanufacturing activity, which continued until 1996. In sum, through BEI and PBR Mr. Bailey was engaged in three distinct activities:" the airplane rental activity (through BEI from 1993, until he merged BEI into PBR in 1994); the yacht rental activity (through PBR from 1993 to 1996), and the airplane remanufacturing activity (through PBR from 1994 to 1996). Mr. Bailey's records The record does not show the type ror quality of the records that Mr. Bailey kept for BEI and PBR (or the three activities that he conducted through them). Mr. Bailey initially stored all of his records for BEI and PBR at his law offices in Palm Beach, Florida. In 2000 he moved those records to an airplane hangar at the Palm Beach County Park Airport in Lantana, Florida ("the Lantana hangar"), which he had used for the conduct of the airplane rental and manufacturing activities. (As we explain below, these records were destroyed sometime after June 2002.) 15See note 42 below. - 26 Mr. Bailey used "Quicken" software to maintain registers for his several personal and business accounts and to generate various summaries and reports of the information in those registers. Using this software, he or his staff entered deposits and expenditures, coded according to source or category, and various reports could thereafter be printed out using these data. Our record includes Quicken printouts of registers and summaries for three of the years (1996, 1999, and 2000), and the data they show appear to correspond generally to the amounts reported on Mr. Bailey's returns for those years. Mr. Bailey's airplane rental activity Mr. Bailey rented small airplanes to the general public through BEI during 1993 and part of 1994--an activity the IRS contends was not engaged in for profit. Mr. Bailey generally stored those airplanes in the Lantana hangar. After Mr. Bailey merged BEI into PBR in 1994, he sold off most of the small airplanes and ceased the rental activity. On his returns for 1993 and 1994, Mr. Bailey reported losses from this activity. On audit, the only portions of the claimed losses that the IRS disallowed were for expenses of $6,425 in 1993 and $3,850 in 1994 that cannot be substantiated. - 27 Mr. Bailey's yacht rental activity In 1989 PBR purchased a used Chriseraft Roamer yacht from a bank in Rhode Island. Mr. Bailey christened the yacht the Spellbound, and PBR refurbished it, with the services of Dennison Marine (a yacht manufacturing company and a client of his law practice) and the Roscioli Yachting Center. Mr. Bailey hoped to use the Spellbound as a prototype to refurbish and sell other used yachts, but at trial he did not prove how serious that hope was, nor how critical it was to his purchase and refurbishing of the yacht. During the refurbishing process, the Spellbound's plumbing, electronics, and heating and airconditioning systems were all replaced. With the help of Ann Dennison, a decorator at Dennison Marine, Mr. Bailey personally redesigned the interior layout of the Spellbound. He fitted the yacht with new carpeting, wall coverings, and furniture. When the Spellbound was fully refurbished (before the years at issue), it was built to Mr. Bailey's specifications, and he considered it beautiful. In 1993 Congress repealed the luxùry tax (which had applied to new yachts, and not refurbished yachts),l' and Mr:Bailey concluded that the price advantage 16See Omnibus Budget Reconciliation Act of 1993, Pub.;L. No. 103-66, sec. 13161, 107 Stat. at 449 (repealing the luñury tax-on the first retail sale of boats). Mr. Bailey testified that the"luxury tax was important to his idea of selling refurbished used yachts. He said he began the venture believing that the (continued...) - 28 of used yachts over new yachts was now insufficient for his yacht refurbishing activity to be profitable. He therefore abandoned his idea of refurbishing and reselling used yachts (and dëcided to use PBR as a vehicle to remánufacture and sell used airplanes, as is discussed below)." Although running a yacht rental business had not ever been one of PBR's objectives, and although Mr. Bailey had no expertise in yacht rental, he decided to rent the Spellbound to help to cover the cost of its dockage fees until he sold it. Mr. Bailey did not expect that the Spellbound would appreciate in value but believed on the contrary that yabhts generally depreciate very quickly. 16(...COntinued) 10 percent tax that was imposed by section 4002 on sales of new yachts would work to his advantage by increasing the prices of new yachts as compared to used yachts, but that the repeal frustrated his original plan. However, the tax was enacted in 1990, after he purchased the Spellbound. See Omnibus Budget Reconciliation Act of 1990, Pub. L. No. 101-508, sec. 11221(a), 104 Stat. at 1388-438 (imposing a 10% luxury tax, effective January 1, 1991, on the first retail sale of passenger vehicles, boats, aircraft, and furs and jewelry). His trial testimony was sincere but evidently mistaken about.this almost 20-year-old sequence. "Despite the fact that PBR exitedsthe yacht refurbishing business in 1993 and never intended to enter the yacht rental business, it purchased a 22-foot ski boat in 1995, which Mr. Bailey christened the Glacier Bay. Mr. Bailey kept the Glacier Bay docked at his personal residence, and concedes that the principal.use of PBR's ski boat was personal. - 29 Mr. Bailey did not personally expend any time or effort in renting the Spellbound. Instead, PBR hired Jim Hunter and his wife, Cynthia Walsh, to sail and maintain the Spellbound as its captain and crew. From 1993 to 1996, PBR sporadically chartered the Spellbound to members of the general public, but most of the use of the Spellbound was by Mr. Bailey's family and friends. Mr. Bailey's summaries of the revenue and expenses for the yacht rental activity indicate that the activity generated 10 times more expenses than charter fees. We conclude that the activity consistently generated losses and that Mr. Bailey's nonbusiness use of the Spellbound exceeded the rental use. The crew of the Spellbound kept timesheets for·1995," and those timesheets show that in that year the crew devoted only 106.5 hours to paid charters but devoted 320 hours to personal trips. The timesheets also show that the Spellbound was used for business reasons on only 34 days but was used for personal or unpaid trips on 71 days. Most of the use of the Spellbound was personal during the tax years at issue. Other than the few records discussed here, Mr. Bailey failed to offer into evidence any logs, books, records, business plans, profit analyses, or market The record does not include any copies of timesheets kept by the crew of the Spellbound for other years. - 30 studies with respect to the yacht rental activity. Mr. Bailey testified that he kept, in the Lantana hangar, logs and other records for PBR that would have demonstrated a profit objective and would have substantiated the business use of the Spellbound in his rental activity; but as is discussed below, Mr. Bailey discarded those records after he stopped renting the Lantana hangar in June 2002. The yacht rental activity ended in April 1996. Mr. Bailey was incarcerated for contempt on March 6, 1996, and remained in prison for 44 days.. Shortly thereafter, the Government took control of the Spellbound as a condition of Mr. Bailey's release. In April 1996 PBR dismissed the captain and crew and ceased to charter the Spellbound. PBR sold the Spellbound in March 1998. PBR received modest amounts of gross income from the yacht rental activity (reported as $5,707 in 1993, $7,364 in 1994, $56,396 in 1995, $68,998 in 1996) and $39,449 of capital gain in 1994 from the sale of an airplane (presumably obtained from BEI); but the activity turned no profit. We need not verify the precise amounts of the yacht-related expenses to know that they swamped the yacht-related income in every year. Mr. Bailey's airplane remanufacturing activity In 1993 Mr. Bailey decided to use PBR as a vehicle to remanufacture and sell used airplanes. Mr. Bailey determined to purchase, repair, and modify used - 31 airplanes, and then to sell them at about half the price of comparable new airplanes. Mr. Bailey planned first to re 041anufacture a single airplane as a prototype and then to remanufacture and sell other used airplanes. Mr. Bailey considered two similariairplane models--the Piper PA-30 Twin Comanche and the Beechcraft Baron--for PBR to modify and resell. Piper Aircraft's production of the Twin Comanche had ceased in 1972, whereas Beechcraft's production of the Baron was ongoing. Mr. Bailey ultimately chose the Twin Comanche over the Beechcraft !Baron after consulting with Robert A. Hoover, an air show and test pilot; Charlës B. Cusick, an aeronautical engineer and former executive with Narco (an avionics manufacturer for small aircraft) and Cessna Aircraft Co.; and LeRoy Patrick LoPresti, an aeronautical engineer and former executive with Beechcraft and Pijer Aircraft, Inc. All three men favored Piper's Twin Comanche and advised against remanufacturing Beechcraft's Baron--an airplane model that was still in production--since to do so would involve direct competition with a major nianufacturer and might prompt the manufacturer to pressure suppliers into denying him good prices on the parts that he would need to remanufacture the used planes. Piper's Twin Comanche was also favored because (i) it was readily available in large numbers on the secondary market, (ii) it was originally manufactured with a zinc chromate coating on both - 32 the inside and outside of the hull to prevent corrosion, and (iii) it was a relatively fuel-efficient airplane at a time when fuel prices were rising. In 1994 PBR purchased a used Twin Comanche and began the airplane remanufacturing activity. The plane he purchased had the serial number 30-288, and Mr. Bailey therefore dubbed his remanufacturing activity "Project 288". PBR also purchased two more used Twin Comanches between the years 1994 and 1996. All three of the airplanes were stored at the Lantana hangar. Project 288 principally consisted of repairing and modifying one of the three used Twin Comanches for use as a prototype, which Mr. Bailey dubbed the "Bailey Bullet". The activity also involved (i) obtaining approval from the Federal Aviation Administration (FAA) to modify the Tvéin Comanche for resale; and (ii) promoting.the sale of PBR's line of modified Twin Comanches by displaying the Bailey Bullet at trade shows and meetings for aviation enthusiasts. 042 During the remanufacturing process, PBR disassembled the airframe, engines, and moving parts of the Bailey Bullet and reconstructed it using å number ofnew and reconditioned parts. The Bailey Bullet was cleaned, repainted, and reconstructed with a new interior, new upholstery, and new engines. When the process was complete, the Bailey Bullet was equipped with all of the most up-todate features, and Mr. Bailey considered it "better than new". - 33 . Mr. Bailey, as the sole owner and president of PBR, personally chose the features that were added to the Bailey Bu let. iHowever, PBR hired about a dozen employees to disassemble añd reconstruct the airplanes. Mr. Bailey's son, Scott Bailey, served as the vice president of PB!R and was the highest paid employee in Project 288. After interviewing with Scott Bailey, Douglas Vasco was hired as the chief inspector and director of maintenanòe-for Project 288 in1May 1995. During the tax years at issue, Mr. Vasco was an F:AA-certified designated airworthiness representative. In that capacity he.was authorized to perform examination, inspection, and testing services for Project 288 that were necessary in order to obtain FAA permission to modify Twin Comanches. See 14 C.F.R. sec. 183.33 (1996). During his tenure at PBR, Mr. Vasco had about nine employees working under him in Project 288, two of which were FAA-certified airframe and powerplant mechanics. In addition to PBR's employees, Project 288 contracted for the services of Bill Wall. Mr. Wàll wore twö håts with respecTtó Project 288. During the tax years at issue, Mr. Wall served as the president of East Coast Aerospace, an aircraft engineering dompany. In that capacity, he helped to develop modifications to the Twin Comanche design arid install those modifications^on the Bailey Bullet. Mr. Wall also served as the administratór of East Coast Avionics, an FAA- - 34 certified designated alteration station. In that capacity, he was authorized to issue supplemental type certificates on behalf of the FAA to approve modifications to aircraft designs.19 See id. sec. 21.451. On September 21, 1995, Mr. Wall issued to PBR five supplemental type certificates that approved a number of the modifications that he helped to develop for Project 288. The approved modifications to the Twin Comanche design included the conversion of its 14-volt electrical system to a 28-volt electrical system with dual alternators, as well as the installation of various avionics systems.and engine instruments, an instrument panel, and a heating and air-conditioning system. As Mr. Bailey's expert witness, 19The FAA is charged by.Congress with promoting air safety. See 49 U.S.C. sec. 106(g)(1)(A) (1994). When the FAA approves an aircraft design, the FAA issues a type certificate. See id. sec. 44704(a). Modifications to an FAAapproved aircraft design must also be FAA approved. Id. The FAA may issue a field approval to approve a minor modification to one serial numbered aircraft, see FAA Order 8900.1 (2009), or a supplemental type certificate to approve a modification to an aircraft design, see 14 C.F.R. sec. 21.113 (1995).. As Mr. Vasco testified, the process for obtaining a "multi-use" supplemental type certificate to modify an aircraft design is considerably more difficult and expensive than obtaining a "one-off" field approval to modify a single aircraft. - 35 John Whiting Olcott,20 credibly testified, obtaining a supplemental type certificate is a sophisticated and costly process that hobbyists do not engage in. By 1995 the Bailey Bullet was fully remanufactured and airworthy. In that year, PBR rented booth space at the Annual Meeting and Convention of the National Business Aviation Association (¡"NBAA")--a civil aviation trade show-to display the Bailey Bullet. Mr. Olcott, ivho was the president of the NBAA at the time and presided over the conventiori, testified that the NBAA rented booth space only to commercial venders--never(to hobbyists. He also testified that at the convention the Bailey Bullet generated "a lot of interest" from serious aviators. We find that by this time-1995--Project 288 was an active trade or business. Despite the positive receptiori of thé Bailey Bullet at the NBAA convention, the airplane remanufacturing activity ended abruptly in April 1996, as we have explained. Mr. Bailey ¿vas incarcerated for contempt on March 6, 1996, and 20Mr. Olcott currently serves as pre¼ident of General Aero Co., Inc., a business aviation consulting firm. From 1992 to 2003, he served as president of the National Business Aircraft Association, a trade organization for corporate aviation. From 1973 to 1992, he served as an editor for two aviation magazines-FLYING and Business & Commercial. Aviation--published by Ziff Davis Publishing Co. From 1974 to 1986, Mr. Ólcott served on advisory committees for the National Aeronautics and Space Administration. He is a licensed.transport pilot and holds a bachelor's and a master's degree in aeronautical engineering from Princeton University and a master's degree in business administration from Rutgers University. - 36.remained in prison for 44 days until he was able to raise over $2 million to comply with the District Court's order to return the remaining shares of Biochem Pharma stock. While he was in prison, Mr. Bailey had his son, Scott Bailey, call Mr. Vasco to tell him that Project 288 was being shut down indefinitely. In response, Mr. Vasco left Project 288 in April 1996. By the time that Mr. Bailey raised the money to comply with the District Court's order and was released from prison, he had no funding to continue the airplane remanufacturing activity and all of his employees, with the exception of his son, had left Project 288.- Mr. Bailey's son was on PBR's payroll until the end of 1996. Beginning in 1996 PBR tried to sell its one remanufactured plane, the . Bailey Bullet. However, PBR had mortgaged the Bailey Bullet "right to the hilt" (over $400,000) to raise money for Project 288, and it was unable to sell the remanufactured airplane for a high enough price to satisfy the mortgagor. In the absence of better evidence, we use this to conclude that Mr. Bailey's cost basis in the Bailey Bullet was $400,000. At some point after the tax years at issue, PBR was dissolved and Mr. Bailey became the direct owner of the Bailey Bullet. Although at the time of trial the Bailey Bullet was still subject to the mortgage, the mortgagor had yet to foreclose, and Mr. Bailey remained in possession of the airplane. - 37 The Bailey Bullet was the only used Twin Comanche that Project 288 fully remanufactured. In 1996 PBR sold the tivo other Twin Comanches that Project 288 had purchased and had begun to disassemble. When beginning Project 288 Mr. Bailey had no expectation that the Bailey Bullet or the other used Twin Comanches held by PBR would appreciate. However, Mr. Bailey did expect the "multi-use" supplemental type certificates that Mr. Wall issued on behalf of the FAA to appreciate, since they were in effect the licenses that would permit PBR to install i|n Twin Comanches thé modifications permitted by those certificates, which PBlì would sell in increasing numbers as he promoted the Bailey Bullet (for example, Åt events like the NBAA convention). Mr. Bailey failed to submit into evidence any logs, books, records, business plans, profit analyses, or market studies viith respect to the airplane remanufacturing activity. When Mr. Bailey discontinued rental of the Lantana hangar, he discarded any records there that might have demonstrated a profit objective. Project 288 income ànd expenses PBR never realized aný ordinary inbome from Pi.óject 288, although it did realize capital gain of $59,203 in 1996 from the sale of two airplanes. PBR's - 38 expenses incurred in connection with Project 288 totaled $424,787 in 1994,21 $456,286 in 1995, and $125,694 in 1996. Approximately $339,814 of PBR's expenses were for the building of the Bailey Bullet prototype,22 presumably about half in 1994 and half in 1995. Preparation of Mr. Bailey's Forms 1040 and 1120S Mr. Bailey hired Mary C. Dunay, a certified public accountant, to prepare his Forms 1040, U.S. Individual Income Tax Return, for 1993, 1994, and 1995. Mr. Bailey filed joint returns with his wife for 1993 and 1994 and filed separate returns for the other years at issue. Mr. Bailey self-prepared his Forms 1040 for 1996 through 2000. Then Mr. Bailey hired Richard Paladino, an attorney, to prepare his Form 1040 for 2001. The record does not show whether Mr. Bailey or 2iFor 1994, when both the yacht activity and the airplane remanufacturing activity were underway, PBR's reported cost of goods sold ($427,166) and deductions ($200,657) totaled $627,823, of which the yacht-related expenses totaled $203,036, leaving the difference--$424,787--attributable to Project 288. 22PBR purchased three Twin Comanches in 1994; and if we assume that PBR's entire increase in capital in that year ($180,599) is allocated among the three planes that PBR acquired, then $60,186 was the capital cost of acquiring the plane that PBR then remanufactured. The remainder of the Bailey Bullet's $400,000 presumed cost and value (i.e., $400,000 - $60,186 = $339,814) was therefore incurred by PBR in 1994 and 1995 (i.e., $169,907 in each year). The imprecision of these assumptions is obvious; but as we explain below, the Commissioner has the burden of proof on alternative contentions for which the amounts attributable to the plane itself are relevant, and in the absence of such proof we therefore make assumptions favorable to Mr. Bailey. - 39 anyone else prepared a Form 1120S, U.S. Income Tax Return for an S Corporation, for BEI for either 1993 or 1994. Mr. Bailey prepared the Forms 1120S for PBR for 1993 through 1998 with help from his daughter-in-law, Lainey Bailey. Mr. Bailey hired Mr. Paladino to prepare the Form 1120S for PBR for 1999. No one prepared a Form 1120S for PBR for 2000 or 2001. Printouts of reports from Mr. Bailey's "Quicken" database were evidently used for preparing the income tax returns at issue, but our record includes contemporaneous printouts for only three years, 1996, 1999, and 2000. In August 1998 Mrs. Bailey was diagnosed with pancreatic cancer. In July 1999 Mrs. Bailey was hospitalized and required Mr. Bailey's almost constant presence at her bedside. Mrs. Bailey died on September 9, 1999, a month after the 1998 return was due (on an extension to August 15, 1999). Mr. Bailey filed the return 50 days after Mrs..Bailey's death on October 19, 1999. Filing of Mr. Bailey's Forms 1040 and 1120S On the dates given in the table belåw, Mr. Bailey and his S corporations filed their required returns," the IRS con menced examination on those returns; and the IRS issued notices of deficiency. The record does not show whether BEI filed a Form 1120S for 1993 or 1994, but it does show that PBR failed to file Forms 1120S for 2000 and 2001. - 40 Year Form Filina date Notice of deficiency 1993 1040 1120S (PBR) Oct. 17, 1994 Undated Nov. 6, 2007 1994 1040 1120S (PBR). Oct. 15, 1995 Sept. 15, 1995 Nov. 6, 2007 1995 1040 1120S (PBR) Octc21, 1996 Oct. 13, 1996 Nov. 6, 2007 1996 1040 1120S (PBR) Oct. 22, 1997 Sept. 15, 1997 Nov. 6, 2007 1997 1040 1120S (PBR) Oct. 16, 1998 Sept. 15, 1998 Nov. 6, 2007 1998 1040 1120S (PBR) Oct. 19, 1999 Undated Nov. 6, 2007 1999 1040 042 1120S (PBR) - Oct. 16, 2000 . Oct. 19, 2001 Nov. 6, 2007 2000 1040 Oct. 22, 2001 Nov. 6, 2007 2001 1040 Oct. 22, 2002 Nov. 6, 2007 For the nine years at issue (1993 through 2001) Mr. Bailey reported income and losses from his law practice and related speaking services on Schedule C, Profit or Loss From Business, of his Forms 1040. His reported gross income for the nine-year period was $10.1 million, and his reported expenses were $9.5 million. For four years he reported iet income and in five years net loss. On Schedules E, "Supplemental Income and Loss", attached to those Forms 1040, Mr. Bailey claimed net losses from BEI nd PBR. We find as follows concerning Mi Bailey's re'porting of specific items of income he had received and deductions lie had claimed.24 In the years at issue, Mr. Bailey received the following additiònal items of income (not discussed above) that were not reported on his tax returns: Year Item Amount 1993 Barnett Bank interest income Pension income $207 1,951 1994 Fees deposited to Credit Suisse 86,808 1995 Deposits to offibe account California State income tax refund Interest from thkee sources 3,955 1,469 389 1996 Mathematical eiTor Speaking income Boston fees 100,000 15,700 58,374 1997 Deposits to offi e account Fees from client McCorkle 33,696 26,713 1998 Fees from client Vidu Speech income Fees from client McCorkle 7,280 20,000 110,000 24These miscellan eous items are discussed in p art VII below. . - 42 Deposits to office account Payment from Phoenix 9,257 11,288 1999 Wages from Entertainment Partners Interest from Principle Life 1,541 . 61- 2000 Fees from client Dubey Deposits to office account Royalty income Deposits to N. Bailey's account 63,473 7,526 26,500 38,333 2001 Unexplained items 16,561 Pension income Pass-through income from Tel-Share 69,527 2,423 . (We do not sustain the following adjustments for additional income that were included in the IRS's notice of deficiency: $10,183 of barter income in 1995; $106,758 of checks returned·to Credit Suisse in 1995; and royalty income of $20,000 in 1999.) Mr. Bailey did not receive the following items of income that were mistakenly reported on his tax returns: Year Item Amount 1995 Reimbursed income Twice-included income $1,300 40,394 1996 Three adjustments by IRS 23,017 - 43 For the years at issue, Mr. Bailey claimed on his tax returns deductions for the following items that he did not substàntiate or to which he was otherwise not entitled: Year Amount Item Charitable ded etion (Aventura) $13,383 2,750 1,558 3,447 1 161 12,976 6,425 1,000 1994 Dues and publi ations Legal and accounting fees (Sch. C) Office expense (computers) Office expenses (billed but not paid) Flow-through loss from BEI 10,200 2,289 5,457 3,322 3,850 1995 Contract labor Credit Suisse interest Double-deduct d expenses Travel & entertainment 1,974 5,741 215,612 48,199 1996 Boston office e pense 202,082 Travel & entertainment Mortgage inter st Real estate taxes 22,080 14,244 2,362 1993 Dues and publications Legal and acco nting fees (Sch. C) Telephone expense Travel expense (Tel-Share) Means & entertainment Travel expenses Flow-through lpss from BEI 1997 Household maintenance Travel & entertainment Office expense Mortgage interest . 24,000 20,480 206,484 14,986 - 44 Real estate taxes 11,327 1998 Travel & entertainment Office expense 45,201 579,098 1999 Travel & entertainment Office expense 25,229 533,191 2000 Travel & entertainment Office expense Nine miscellaneous items 23,408 30,519 133,421 2001 Household expenses Life insurance premiums Payment to attorney 735 19,660 1,150 Mr. Bailey substantiated the following deductions that were disallowed in the notice of deficiency: $15,852 to Republic Bank in 1995; a greater portion of the office expen 541e in 1996; and hangar expenses of $5,751 and $19,469 in 2001. Mr. Bailey is entitled to the following additional deductions that he did not claim on his returns: Year Item Amount 1993 Tax preparation (Sch. A) $2,750 1994 Computer depreciation Tax preparation (Sch. A) Charitable contribution 273 2,250 10,000 1995 Computer depreciation 1,091 1996 Computer depreciation 1,091 - 51997. Computer depreciation 1998 Computer depreciation , . . 1,091 818 Mr. Bailey's cooperation with the IRS's examination The IRS opened examinations of . Bailey's Forms 1040 for 1993 in December 1994, for 1994.in February 1996; for 1995 in December 1996, and thereafter for 1996 through 2001. In 1996 the IRS assigned Revenue Agent James J. Tabor to conduct the examination of Mr. Bailey's tax returns. Beginning in May 1997, Revenue Agent Tabor partnered with Revenue Agent Bobbie Kay Campbell to issue to PBR a series of at least 29 information document requests (IDRs) with respect to the . airplane rental activity, the yacht rental activity, and the airplane remanufacturing activity. The latest of these IDRs is date April 5, 2002. The IDRs request, inter alia, (i) records to substantiate PBR's gross income and expenses; (ii) a breakdown of the expenses for the airplane rental activity,·yacht rental activity, and airplane remanufacturing activity; (iii) copies of ány ads purchased by PBR to promote the sale or rental of boats or airplanes; (iv) PBR's bank records; (v) market studies or records that indicate the airplane remanufacturing activity:was "economically . viable"; (vi) records to show the project d sales price of the airplanes and "per plane profit" in the airplane remanufacturing activity; and (vii) "[a]ny records not - 46 previously provided that show efforts made to increase profitability of Palm Beach Roamers' businesses". The last five IDRs in the record, dated April 5, 2002, made requests with respect to the "profitability" of Mr. Bailey's activities. Those same IDRs gave Mr. Bailey until May 6, 2002, to respond. The record includes five letters from Mr. Bailey's counsel, Mr. Paladino, to Revenue Agent Tabor, which appear to respond to a number of IDRs that are not in the record. The record also includes a "breakdown" of the revenue and expenses of PBR's three activities for 1995 and 1996; it is addressed from Lainey Bailey to Revemie Agent Tabor in response to "IDR #19". Mr. Bailey failed to fully comply with the IDRs, and he repeatedly failed to provide the IRS with requested information. In 2002 Mr. Bailey's representative did provide printouts of his Quicken reports for 1996, 1999, and 2000 to-the IRS's examining agent and of workpapers generated during the preparation of the returns. The agent did a painstaking analysis of the data Mr. Bailey provided, correlated them to the tax returns as filed, and identified income items and deductions not reported on the returns. The audit adjustments reflected in the notice of deficiency (described below) are largely based on that analysis. · - 47 Destruction of records By 2002 the cost of renting the Lantana hangar became burdensome to Mr. Bailey. He notified the IRS that he ould discard his records for BEI and PBR when he stopped renting the Lantana hangar, and he invited the IRS's representatives to visit the hangar and make copies of his records. Revenue Agents Tabor and Campbell and their su ervisor visited the hangar and met with Mr. Bailey and his attorney, Richard Paladino, on June 24, 2002. The record does not show what records, if any, the IRS re iewed or copied. At some point thereafter, Mr. Bailey discarded his recor s at the Lantana hangar. Notices of deficiency In the notices of deficiency? the IRS (i) determined that Mr. Bailey had numerous items ofunreported income from his law practice and speaking services, (ii) determined to disallow some, but notlall, of Mr. Bailey's deductions for his "By stipulation and on brief, both parties have resolved several of the issues raised in the notices of deficiency. Mr. Bailey concedes that he had additional interest income of $207 under section 61(a)(4) from Barnett Bank of Palm Beach County in 1993. The Commissioner concedes that Mr. Bailey is entitled to an additional depreciation deduction under section 167 in the amount of $273 in 1994 with respect to the cost of two computers. The Commissioner also concedes the adjustment to Mr. Bailey's 1996 Form 1040 with respect to a $365,000 malpractice insurance policy payment made by the Home Insurance Co. on his behalf. Although this payment is includible in income under section 61(a), the Commissioner agrees that Mr. Bailey is entitled to a corresponding deduction in the same amount pursuant to section 162(a). - 48 expenses from those businesses, (iii) largely disallowed the net losses from BEI and PBR that Mr. Bailey claimed on his Forms 1040, and (iv) made numerous other miscellaneous adjustments to Mr. Bailey's reported income and deductions on his Forms 1040 for the 1993 through 2001 tax years.26 OPINION I. Background evidentiary principles A. Burden of Proof Generally, the Commissioner's determinations set forth in a notice of deficiency are presumed correct, and the taxpayer generally bears the burden of proving the determinations are erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Moreover, deductions are a matter of legislative grace, and the taxpayer bears the burden of proving that he is entitled to any deduction claimed. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). Mr. Bailey makes three attempts to shift the overall burden of proof to the Commissioner. Each of these attempts is unsuccessful, but we do find that the Commissioner bears the burden of proof in one respect. 26During trial and on brief the parties collectively referred to the miscellaneous adjustments as "Issue C" or "the 'C' issues". - 49 1. Providing IRS access to records Mr. Bailey stored all of his records for BEI and PBR in the Lantana hangar where he conducted the airplane rental and remanufacturing activities. The record does not show the type or quality of those records. Mr. Bailey testified and contended on brief that those records could have substantiated his profit motive for all three activities. Mr. Bailey notified the IRS that h would discard his records after he lost access to the Lantana hangar, and he invited its representatives to visit the hangar to review and copy his records. Reven Agents Tabor and Campbell, and their supervisor, visited the hangar on June 2 , 2002, but the record does not show what records, if any, they reviewed or copied. At somÈ point thereafter, Mr. Bailey discarded his records at the Lantana han ar. Mr. Bailey now protests that his I ek of records is the IRS's fault, because it should have copied his records or should have warned him, before he discarded his records, that he might need them. Hi contention is not well founded. - 50 a. Taxpayers are required to keep their own records. Even assuming arguendo that the Lantana hangar once contained sufficient records to substantiate Mr. Bailey's expenses and 15rofit motive," his attempt to shift the burden of proof on this basis must fail. The record-keeping requirements for the income tax are set forth in section 6001, which requires thatEvery person liable for any tax imposed by this title, or for the collection thereof, shall keep such records, render such statements, make such returns, and comply with such rules and regulations as the Secretary may from time to time prescribe. * * * [Emphasis added.] Taxpayers are thus required to keep sufficient records to substantiate their gross income, deductions, credits, and other tax attributes. See also 26 C.F.R. sec. 1.6001-1(a), Income Tax Regs. There is no provision in section 6001 or the regulations thereunder that imposes a record-keeping requirement on the IRS or that allows a taxpayer, like Mr. Bailey, to obligate the IRS to store his records. The fact that he offered to let the IRS review and copy his records before discarding them does not absolve him of that requirement or shift the burden of proof in these cases. "The record does not show the type or quality of records that Mr. Bailey kept in the hangar, and the Commissioner disputes Mr. Bailey's contention that those records were sufficient to substantiate his profit motive. - 51 b. Táxpayers are required to retain their records as long as they may become material for tax purposes. Even assuming arguendo that before the date on which he discarded his records, the IRS gave Mr. Bailey no indication that it would challenge his profit motive,28 that supposed lack of notice did not shift the burden of proof. There is no provision in section 6001 or the regulations thereunder that excuses taxpayers from retaining their records if the IRS fails to notify them of an imminent challenge. Instead, taxpayers are required to retain their books and records as long as they may become material: (e) Retention of records.--The books or records required by this section shall be kept at all times available for inspection by authorized internal revenue officers or employees, and shall be retained so long as the contents thereof may become material in the administration of any internal revenue law. [Emphasis added.] 26 C.F.R. sec. 1.6001-1(e), Income Tax Regs. A taxpayer's books and records for a given tax year "may become material" for purposes of section 6001 as long as the period of limitations on assessment for that year remains open under section 6501. Since the period of limitations is still open with respect to the tax 28The record contradicts Mr. Bailey's contention that he was given no notice that the IRS might challenge his profit m tive. Revenue Agent Tabor issued five IDRs to Mr. Bailey in April 2002 that each made requests with respect to the profitability of his activities--well before June 2002, when Mr. Bailey gave the IRS a final opportunity to review and copy his records before he discarded them. - 52 years at issue,29 Mr. Bailey was required to retain his books and records with respect to those years, whether or not the IRS gave Mr. Bailey notice of a possible challenge to his profit motive. 2. Burden shift under section 7491(a) Under certain circumstances, the burden of proof as to factual matters may shift pursuant to section 7491(a) from the taxpayer to the Commissioner, but only if the taxpayer introduces credible evidence regarding a factual matter affecting his liability and only if he has complied with substantiation requirements, has maintained all required records, and has cooperated with the IRS's reasonable requests. Sec. 7491(a)(1) and (2). Mr. Bailey contends that section 7491(a) shifts the burden of proof to the Commissioner. However, in general Mr. Bailey has not introduced credible evidence raising factual questions about his liabilities (rather, he has made conclusory arguments without supporting references to exhibits in the record); he did not comply with substantiation or record-keeping requirements (rather, he discarded his records); 29The period of limitations for assessment was open with respect to all seven of the tax years at issue on November 6, 2007, when the IRS issued the notices of deficiency to Mr. Bailey, because he signed Forms 872, Consent to Extend the Time to Assess Tax, by which he agreed to extend the period of limitations on assessment. See sec. 6501(c)(4). The period of limitations for assessment will remain open for a minimum of 60 days after the decision of this Court becomes final. See secs. 6213(a), 6503(a). - 53 and he did not fully cooperate with the IRS, specifically with Revenue Agent Tabor's requests for information about BEI and PBR (rather, it appears that Mr. Bailey was unresponsive to a series of IDRs). Accordingly,-section 7491(a) does not shift the burden to the Commissioner, and Mr. Bailey therefore retains the burden of proof with respect to the d ficiencies. See Rule 142(a)(1). 3. Alleged animus Another contention that Mr. Bailey makes to assail the notice of determination is a recurring observation that the agent's notes (on which the notices of deficiency are based) include erasures: Mr. Bailey perceives that in 2001, after the judge in~Bailey II made remarks encouraging to Mr. Bailey, the IRS agent's "investigation took a hard reversal in direction. Friendly communication stopped, and [the IRS] Agent * * * started changing his notes to favor the government." From this timing, and from erasures and revisions in the revenue agent's workpapers, Mr. Bailey infers that the prosecutors influenced the revenue ' agent. Mr. Bailey speculates that these e asures reflect changes that occurred after developments adverse to the Governmen in their litigation concerning the Duboc stock. Mr. Bailey believes that the agent made these changes not because of his bona fide conclusions about Mr. Bailey's income and deductions but cynically at the behest of the Government's attorneys. For issues as to which the agent's notes - 54 include erasures, Mr. Bailey implicitly contends that the burden of proof should shift to the Government. However, Mr. Bailey's only evidence to support this timeline and this scenario is his own perception of a change in the agent's attitude. . The agent . . contradicted Mr. Bailey's contention and testified that he was "not in communication with other branches of the government". We found him credible. Having observed the agent's testimony, including under cross-examination by Mr. Bailey, we find no basis for Mr. Bailey's speculation. Moreover, the issue of the Biochem Pharma stock (the subject of Mr. Bailey's litigation with the Government) has little relation to this argument of Mr. Bailey's, even if the argument were well grounded. . The agent's notes pertain principally to substantiation issues, whereas the Biochem Pharma issue was conspicuous and well known apart from anything the agent might have done, and the parties have stipulated or broadly agreed about the basic facts of the stock transfers, loans, and expenditures that are pertinent to that issue. But even if there were reason (there is none, we stress) to be suspicious about the agent's sincerity in the adjustments he made, such suspicion would not affect the burden of proof. As a general rule, we do not look behind the notice to examine the motives of the IRS in making its adjustments to a taxpayer's liability. -55Graham v. Commissioner, 82 T.C. 299 (1984), aff'd, 770 F.2d 381 (3d Cir. 1985). This is not an instance in which the tax ayer alleges that he was selected for audit on the basis of an impermissible criterion, such as ethnicity, see Greenberg's Express, Inc. v. Commissioner, 62 T.C. 24, 328 (1974), or that the statutory notice is based on illegally seized evide ce, see Suarez v. Commissioner, 58 T.C. 792, 813-814 (1972), overruled in part, Guzzetta v. Commissioner, 78 T.C. 173, 184 (1974). To the extent that the IRS's adjustments are supported not by reason or evidence but only by ill motive, then the taxpayer's burden to prove his actual liability "should be concomitantly easie ", cf. Church of Spiritual Tech. v. United States, 20 Cl. Ct. 762, 765 (1990), so that the IRS's motive for the adjustments is unimportant. 4. 042 New matters The notice of deficiency disallowed Mr. Bailey's deduction of expenses attributable to Project 288 on the groùnd that the activity was not engaged in for profit. We have found, however, that th activity was engaged in for profit. The Commissioner contends in the alternativ that the expenditures either were startup expenses under section 195 or were expenditures for the creation of a capital asset (i.e., the Bailey Bullet). However, as an exception to the general rule, Rule 142(a)(1) provides that "in respect of any new matter * * * pleaded in the - 56 answer,® it [the burden of proof] shall be upon the respondent." The Commissioner's two alternative coritentions are "new matter[s]", and the Commissioner therefore has the burden of proving that substantiated Project 288 expenditures were capital expenses or start-up expenses. B. Collateral estoppel In connection with the Biochem Pharma stock issue, the Court previously advised the parties, in an order dated March 26, 2009, t'that the Court-will consider sua sponte (see Monahan v. Commissioner, 109 T.C. 235, 250 (1997)) the preclusive effect of those prior decisions"--i.e.,.Bailey I and Bailey II. The rule of collateral estoppel provides that "[w]hen an issue of fact or law is actually litigated and determined by a valid and final judgment, and the determination is essential to the judgment, the determination is conclusive in a subsequent action between the parties, whether on the same or a different claim.". 1 Restatement, Judgments 2d, sec. 27 (1982); see also Allen v. McCurry, 449 U.S. 90, 94 (1980) ("Under collateral estoppel, once a court has decided an issue of fact or law necessary to its judgment, that décision may preclude relitigation of the issue in a suit on a "Altfiough these alternative contentions were not pleaded in the Commissioner's answer, they were addressed at trial without objection.by Mr. Bailey and were therefore tried by consent. We therefore treat them as pleaded and do not require the Commissioner to file a motion to amend his answer, which motion we would grant. - 57 different cause of action"); Montana v. United States, 440 U.S. 147, 153-154 (1979). The nature and terms of Mr. Bailey's agreement with the Federal Government were "actually litigated" b Mr. Bailey and the Federal Government in those prior cases, in which cases the issues were "essential to the judgment". See 1 Restatement, supra,.sec. 27. Consequently, the findings of those prior cases are "conclusive" in these subsequent cas s, though these cases are founded on a "different claim" (i.e., assignment of error in,the IRS's determination of deficiencies). . . Mr. Bailey objects to the application of collateral estoppel here, although it is not completely clear why he does so. This Court has no jurisdiction to award Mr. Bailey the attorney's fees for his rep esentation of Mr. Duboc that the District Court denied him, nor to hold that he is ntitled to the Biochem Pharma stock's appreciation that the Court of Federal Claims denied him. One reason that Mr. Bailey resists collateral estoppel is.to make the contentions discussed in part III below (i.e., that a denial of due process in the District Court should undo . his liability for tax on income that the court seized), but we show there that his due process contentions are unavailing. Mor over, the findings that we import here by way of collateral estoppel--e.g., that Mr. 3ailey received the stock in trust (rather than as payment)--are largely favorable to Mr. Bailey. -58 In any event, Mr. Bailey's objection to the application of collateral estoppel--in particular, his contention that the issue of whether he held the Biochem Pharma stock "in trust" was not fully and fairly litigated in the prior proceedings--is not well founded. Mr. Bailey's claims about his ownership of the stock were the focus of the litigation in Bailey I, in which the District Court issued an order of January 12, 1996, that directed Mr. Bailey to make a-full accounting of the monies and properties held in trust by him for the United States. * * * This should include * * * a full accounting of the 602,000 shares of stock in Biochem Pharma, Inc., that was delivered to Bailey to be held in trust for the United States. [Emphasis added.] Order of Contempt (Feb. 3, 1996) at 1. In addressing Mr. Bailey's appeal from the decision of the District Court, the Court of Appeals for the Eleventh Circuit observed: At one time, Bailey contested ownership of the Biochem Pharma stock. He argued that the government had given him the stock in fee simple and not in trust: Bailey dismissed that claim in May 1996. Bailey I, 175 F.3d at 967. Thus, Mr. Bailey's dispute of the trust character of his stock holding was decided by the District Court and was not overturned on appeal. There can thus be ño doubt that the issue was litigated. However, Mr. Bailey evidently contends that the issue was not fully and fairly litigated because of defects in the District Court proceedings--chiefly, that - 59 the trial judge had prejudged Mr. Bailey's claims, and Mr. Bailey "was never able to remove him from the case". This cornplaint about the judge was raised (as it must have been) on appeal from the jud e's ruling. If the Court of Appeals erred in that regard, Mr. Bailey's remedy was to petition for a writ of certiorari from the Supreme Court, not to attack the decision collaterally in this Court. The Court of Federal Claims did later entertain in Bailey II Mr. Bailey's dispute on the trust issue, but only long enough to determine that it was only a "semantic" dispute, since the Government contended that Mr. Bailey held the Biochem Pharma stock "in trust", 54 Fed. Cl. at 466, 471, 500, while Mr. Bailey contended that the arrangement was "in he nature of a trust", id. at 472, 501. This semantic dispute--"trust" vs. "in the nature of a trust"--is not material in these cases. Since Bailey I clearly held at least that the Biochem Pharma stock when transferred to Mr. Bailey was for specifi uses for which he must give an accounting, and Bailey II held that Mr. Bailey was not entitled to the subsequent appreciation, the parties are precluded fr m relitigating those issues here, and we find that Mr. Bailey held the Biochem P1 arma stock not on his own account but for others. - 60 II. Income from wrongful appropriations The IRS determined that Mr. Bailey received $5.9 million in income in 1994 when his client Claude Duboc transferred Biochem Pharma stock to Mr. Bailey's investment account at a Swiss bank." Mr. Bailey contends, on the other hand, that none of the $5.9 million was ever income to him, since he eventually had to transfer the stock and its proceeds to the Federal Government. A. Taxable income includes wrongful appropriations. Under section 61(a), "gross income means all income from whatever source derived". Money received may be income even when the recipient has no right to it--even when the recipient misappropriated it--and is obliged to pay it back. The Supreme Court "has given a liberal construction to the broad phraseology of the 'gross income' definition statutes in recognition of the intention of Congress to tax all gains except those specifically exempted." James v. United States, 366 U.S. 213, 219 (1961) (citing Commissioner v. Jacobson, 336 U.S. 28, 49 (1949), and Helvering v. Stockholms Enskilda Bank, 293 U.S. 84, 87-91 (1934)). In James, The IRS determined that the $5.9 million was income in .1994 when Mr. Bailey received the stock and allowed subsequent deductions for his reimbursement of sale proceeds and his return of the unsold stock. Since Mr. Bailey fully reimbursed and repaid those amounts, the Commissioner acknowledges that his income in 1994 is fully offset by deductions in later years; but under the Commissioner's approach Mr. Bailey still may be liable for interest, additions to tax, and penalties for tax year 1994. - (1 366 U.S. at 219-220, the Supreme Court held that "wrongful appropriations" are includible in gross income. For that reason, Mr. Bailey's principal position--that he realized no income from the stock simply because he was eventually required to return it--must be rejected. It does not carry the day for Mr. Bailey to prove (as he easily can, in light of Bailey I and Bailey II) that he never truly owned the beneficial interest in the stock. Rather, a ounts that were misappropriated and then later returned can nonetheless be ta able income in the year of the misappropriation if the taxpayer had dominion and control over those amounts. The Supreme Court has defined gross in ome under section 61 "to encompass all 'accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.'" James, 366 U.S. at 219 (quoting Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955)). In James, the Supreme Court applied this standard to conclude that "w ongful appropriations" (but not "loans") are "within the broad sweep of 'gross income'". Id. The Commissioner's principal pos tion here, in reliance on those principles, is that Mr. Bailey received income of $5.9 million when the Biochem Pharma stock was first transferred to his Credit S aisse investment account in 1994, pointing out that Mr. Bailey had completb dominion and control over the stock at that time. If Mr. Bailey had prevailed in Bailey I (or maybe even in Bailey II), - 62 then the Commissioner's position would have much to commend it; but in light of the holdings in those opinions, that position, too, must be rejected. Given that the Government proved that the stock was not Mr. Bailey's and that he held it only in trust-and especially given that the Government persuaded the District Court to jail Mr. Bailey until he lived up to the terms of that trust--the Commissioner's principal position is not tenable.32 B. A trustee realizes income from the trust corpus when he actually misappropriates it. Not every remittance of funds is income to the recipient. Bank deposits are not income to the bank; a bailment is not income to the bailee; and funds received in trust by a trustee are excludible from gross income when those funds are subject to a restriction that they be expended for a specific purpose, and the taxpayer does not profit, gain, or benefit in spending the funds for the stated purpose. Ford Dealers Adver. Fund, Inc. v. Commissioner, 55 T.C. 761, 771 (1971) (citing Seven-Up Co. v. Commissioner, 14 T.C. 965 (1950), aff'd, 456 F.2d 255 (5th Cir. "Because the IRS treated the receipt of the $5.9 million of stock as income, it allowed, in subsequent years, deductions for the return of the stock and the reimbursement of the sale proceeds. To the extent we hold that Mr. Bailey did not realize income from the Biochem Pharma stock, the corresponding deductions are not allowable and the adjustments therefor in the notice of deficiency must be reversed. However, under section 1341 Mr. Bailey may deduct his repayment of amounts of Biochem Pharma stock sale proceeds that we conclude were income to Mr. Bailey. - 63 1972), Broad. Measurement Bureau, In . v. Commissioner, 16 T.C. 988 (1951), Angelus Funeral Home v. Commissioner, 47 T.C. 391 (1967), aff'd, 407 F.2d 210 (9th Cir. 1969), and Dri-Powr Distrib. Ass'n Trust v. Commissioner, 54 T.C. 460 (1970)). On the other hand, it is true that funds held in trust by a trustee do become includible in his gross income once he has misappropriated them. Webb v. IRS, 15 F.3d 203, 207 (1st Cir. 1994) Adams v. Commissioner, T.C. Memo. 1970-104 (1970). The question whether income has been misappropriated in a given instance is a question of fact. See, e.g., BancInsure, Inc. v. BNC Nat'l Bank, N.A., 263 F.3d 766, 771 (8th Cir. 2001) ("'where an individual's conduct falls somewhere between the two extremes of embezzlement and simple poor judgment, intent becomes a question of fact'") (quoting FDIC v. Oldenburg, 34 F.3d 1529, 1540 (10th Cir. 1994)); United States v. Wall ce, 300 F.2d 525, 532 (4th Cir. 1962) ("Whether funds were embezzled is a qu stion of fact"). The mere fact that Mr. Bailey had dominion and control over the Biochem Pharma stock--to such an extent that he had discretion to sell it--does not compel the conclusion that it was income to him, since "[d]iscretion to sell stock is consistent with a requirement for a full accounting", Bailey II, 54 Fed. Cl. at 495, and therefore consistent with the - 64 fiduciary arrangement. As a result, facts beyond "dominion and control" must be consulted. C. Mr. Bailey realized income when he transferred stock sale proceeds from the advance account. If a fiduciary commingles trust funds with his own money (as Mr. Bailey did in the Credit Suisse accounts, the Barnett account, and the personal checking account), then in certain circumstances this fact would suggest that he had abandoned his fiduciary role, was now treating and using the funds as his own, and therefore realized income. However, in these cases the commingling cannot be decisive of the point. Mr. Bailey's agreement with the Government explicitly contemplated that he would use his existing Credit Suisse account for the Biochem Pharma stock. Consequently, the transfer of the shares to his Credit Suisse investment account and of the loan and sale proceeds to his Credit Suisse advance account did not constitute an appropriation of those proceeds. The relatively small personal expenditures he made from that advance account (to purchase other stock for himself) were in amounts consistent with the amounts of his own funds that were already in that advance account; and when the Government asked that he use his existing account for the Biochem Pharma stock, such commingling was made - 55 inevitable and did not affect the tru 541t chtracter ofthe funds placed there for the repatriation and legal defense expenditures. In 1995 Mr. Bailey transferred funds from the Credit Suisse advance account to two other accounts of his-th Barnett money market account and the personal checking account. The Governnient had not agreed that he should use these accounts, and from these accounts Mr. Bailey made substantial personal expenditures totaling $2.8 million. The use of the Barnett money market account was arguably consistent with the trust character of the funds, since (a) the Government may have implicitly approved the use of the account by acquiescing to its use for the repatriation of the proceeds from the Pasco and Obayashi stock (whereas there is no basis for suggesting that the Government acquiesced in his putting the funds in his personal checking account), and (b) from the Barnett account Mr. Bailey's personal expenditu:es were covered by his personal funds in the account (whereas from the personal checking account he made substantial personal expenditures from Biochem Plurma-derived proceeds). For those reasons, our prior order dated April 29, 2009, found that a genuine issue of material fact precluded the resolution of his point on summary judgment. At trial, however, Mr. Bailey bore the burden to prove that in transferring the funds to his Barnett account he did not depart from h s fiduciary role, and he did not carry that - 66 burden. The record does not show that he regarded the funds in the Barnett account as subject to restrictions on their use. We therefore hold that Mr. Bailey wrongly appropriated Biochem Pharma stock sale proceeds when he made transfers thereof to his Barnett money market account in the amounts of $175,037 in 1994" and $250,019 in .1995 (totaling $425,056) and that he received income for those amounts in those years. . D. · Mr. Bailey did not realize income when he transferred loan proceeds from the advance account. The sale proceeds of $425,056, discussed above, constituted only about an eighth of the transfers of Biochem Pharma-derived funds from the Credit Suisse advance account. The remainder--slightly more than $3 million--was the proceeds not of sales but of loans that Mr. Bailey had taken out, using the Biochem Pharma stock as collateral. The Commissioner contends in the alternative that if the 602,000 shares of stock were not income to Mr. Bailey when he first received them in 1994, then the loan proceeds, like the sale proceeds, were income to Mr. Bailey when he actually appropriated them. The Commissioner argues that, if the Court holds that Mr. Bailey realized income only when he actually Mr. Bailey did not actually spend any of the sale proceeds on personal expenditures until 1995, but we hold that he nonetheless realized the income when he appropriated the funds by transferring them to an account on which he acknowledged no restrictions. - 57 appropriated the funds, then the computation of that income should take into account the fact that Mr. Bailey could borrow up to only 25 percent of the value of the stock. The Commissioner argues that Mr. Bailey's $3 million of loans in fact employed $12 million of stock value, and $12 million of income should therefore be imputed to him from the value of the atock. This valuation argument, however, is upside down. The Commissioner would value the $3 million of cash that Mr. Bailey received in loans by the $12 million worth of collateral that he had to use to obtain it, and would impute $12 million in income-but this reverses the economics of the situation. The question should be: How much income did Mr. Bailey actually realize from his use of $12 million of Biochem Pharma stock? The answer to that question is easy: He was actually able to obtain $3 million (in loans); and $3 million was therefore the value to him of the use of the stock a d is therefore the amount of income that would be imputed to him if loan proceed were income to him. The Commissioner's second alternative argument is that Mr. Bailey realized income in the actual amounts of the loan proceeds (about $3 million) when he received them. Mr. Bailey denies that these-amounts constituted income. He personally guaranteed the loans, and witl great difficulty he borrowed from others and repaid the loans in 1996. He therefo e invokes a basic tax principle: "[I]t is - 68 settled that receipt of a loan is not income to the borrower." Commissioner v. Indianapolis Power & Light Co., 493 U.S. 203, 207 (1990). This principle is correct; but when Mr. Bailey previously made this contention in a motion for summary judgment, the Court denied his motion because the issue is complicated by Mr. Bailey's use of the Biochem Pharma stock as collateral for those loans, and this use of the stock generated factual issues that could not be resolved under Rule 121. After a trial, we can now decide this question. In these cases, as in Webb v. IRS,,15 F.3d at 205, the loan-proceeds-asmcome issue-is centered at the confluence of two fundamental principles of federal tax law. On the one hand, bona fide loan proceeds are not gross income to the borrower, see Commissioner v. Indianapolis Power & Light Co., 493 U.S. 203, 207-08, 110 S.Ct. 589, 592-93, 107 L.Ed.2d 591 (1990), because the contemporaneous economic benefit realized upon receipt of the loan proceeds is counterbalanced by the borrower's legal obligation to repay the loan. See McSpadden v. Commissioner, 50 T.C. 478, 491, 1968 WL 1490 (1968). The factual determination as to whether a particular transaction is a bona fide loan turns on whether there are sufficient indicia of the parties' intention that the monies advanced were to be repaid. See Crowley v. Commissioner, 962 F.2d 1077, 1079 (1st Cir. 1992); Moore v. United States, 412 F.2d 974, 978 (5th Cir.1969). At the same time, a line of Supreme Court cases indicates that monies and other property acquired by misappropriation must be reported as income in the year of their receipt. See James v. United States, 366 U.S. 213, 221, 81 S. Ct. 1052, 1056, 6 L. Ed.2d 246 (1961) (embezzlement proceeds); Rutkin v. United States, 343 U.S. 130, 137-38, 72 S.Ct. 571, 575-76, 96 L.Ed. 833 (1952) (extortion proceeds). - 69 Aided by the Court of Appeals for the First Circuit's analysis in Webb,34 we hold that the Credit Suisse loan proceeds were not income to Mr. Bailey. In Webb, a trustee misrepresentec the eligibility of his solely owned Massachusetts business trust for a storm disaster loan from the U.S. Small Business Administration (SBA) and diverted a portion of the loan proceeds from the trust for his personal use. Id. at 204. The IRS determined that the trustee had unreported embezzlement income in the amount of the diverted loan proceeds and the District Court granted summary judgment to the IRS. Id. at 205. On appeal, the trustee argued (i) that the divertediloan proceeds constituted a de facto loan from the SBA to him, and (ii) that loan proceeds are not income under James v. United States, 366 U.S. 213 (1961). Webb, 15 F.3d at 206-207. Although the Court of Appeals for the First Circuit agreed that loan proceeds are not income, it upheld the IRS's determination and affirmed the District Court because it found that the diverted loan proceeds were not a loan under the so-called James "consensual recognition" test. Id. at 207-208. Under the James test, a loan is recognized as su h for tax purposes if there is "the consensual recognition, express or impli d, of an obligation to repay" the loan. 34Under section 7482(b)(1)(A), an appeal from a decision in these cases would be made to the Court of Appeals for the First Circuit. - 70 James, 366 U.S. at 219. The Court of Appeals found that the only borrower with a "consensual recognition" of an obligation to repay the SBA was the trust, and further found that there was no proof of any loan or obligation between the trust and the trustee. Webb, 15 F.3d at 207-208. However, the facts of Webb are very unlike those of the instant cases. There is no dispute (i) that Credit Suisse made directly to Mr. Bailey the loans that were collateralized by the Biochem Pharma stock, (ii) that he was personally liable for those loans, (iii) that he intended to repay Credit Suisse, (iv) that Credit Suisse insisted that he repay the loans-even when he became incarcerated--before it would release the collateral, and (v) that he actually repaid Credit Suisse in 1996. On those facts and in the absence of any evidence to the contrary, we find that there was a "consensual recognition" of Mr. Bailey's obligation to repay the loans to Credit Suisse. Under the James test, the loan proceeds from Credit Suisse were the product of a loan to Mr. Bailey, and thus, are not includible in his gross mcome. However, the Commissioner contends that Mr. Bailey must nonetheless recognize the loans from Credit Suisse as income, because he misappropriated the value of the Biochem Pharma stock by using it as collateral for those loans. We disagree. The receipt of a loan is not income to the borrower where the borrower - 71 uses another person's property as collateral to obtain that loan--even where the collateral is obtained under false preten es or is otherwise misappropriated--as long as there is a "consensual recognitio " that the borrower will repay the loan. See Kreimer v. Commissioner, T.C. Me o. 1983-672 (holding that loan proceeds were not income to taxpayers who borrowed money through a series of shell companies and fraudulently issued bonds in another corporation's name to secure those loans, because the taxpayers treated the loans as bona fide debt and the facts showed a "consensual recognition" of all parties involved that the loans would be repaid). Even though Mr. Bailey received most of the alleged income as loan proceeds, the Government argues here ti at it was income to him because his use of the Biochem Pharma stock as collateral was a knowing misappropriation that they criticize in no uncertain terms. It is inde:d clear--with the benefit of hindsight-that Mr. Bailey was not entitled to use the Biochem Pharma stock as collateral to secure loans for his personal use, and we certainly do not condone Mr. Bailey's failure to draw clear lines between his personal financial interests and the other interests he was bound to promote; but v)ewing Mr. Bailey as a taxpayer, we find that the Government entered into a "vague and unusual" agreement with Mr. Bailey under which: he was given ti;e broadest possible discretion to sell the - 72 stock or use it as collateral; he and his co-counsel were led to believe that their compensation might amount to as much as $3 million; he and his co-counsel believed (wrongly) that they could take fees as they earned them (subject to a later accounting); he bore the risk (eventually realized) of zero compensation; he performed very substantial services for the Government's benefit" for which he was never paid; and his belief that he owned the right to any appreciation in the value of the stock, though mistaken, survived two dispositive motions in the Court of Federal Claims36 and was eventually decided only after a nine-day trial, after which the court, though holding against Mr. Bailey, stated that it found him to be one of the three "most consistently credible of the witnesses testifying at the trial." Bailey II, 54 Fed. Cl. at 463. In these cases the Court asked Mr. Kirwin "Why was this arrangement not reflected in a written agreement?", and Mr. Kirwin answered candidly: 35The Court asked U.S. Attorney Thomas Kirwin, "How many of your criminal defense attorneys end up taking on responsibilities of the sort that Mr. Bailey took on?" Mr. Kirwin answered, "in my experience, almost none. But, this case is different than many of our cases." Mr. Kirwin acknowledged that he has never heard of any other case in which a criminal defense attorney agreed with the Government to manage assets, to postpone for years any payment of his fees, and to risk complete nonpayment of fees if the assets' value declined. 36See Bailey II, 40 Fed. Cl. 449 (denying motion to dismiss for lack of jurisdiction); Bailey II, 46 Fed. Cl. 187 (denying motion to dismiss for lack of jurisdiction and for failure to state a claim). - 73 Well, I ask myself that question about every three months, your Honor. You know, it should have been. It absolutely should have been. That is a huge mistake that Nas made. * * * I just don't think anybody thought about the need tc put it in writing. The Government thus admits that its failure to reduce to writing its agreement with Mr. Bailey was a mistake; and we find tl at part of the Government's mistake was its failure to make clear the restrictions t at it intended about Mr. Bailey's use of the stock. On the record before us we fi d that Mr. Bailey did not know he was violating the agreement when he used the Biochem Pharma stock as collateral for his loans from Credit Suisse. Rather, he borrowed the money from Credit Suisse in good faith, in his own name, and with a full expectation of paying it back (which he did). However, even if Mr. Bailey had intentionally misappropriated the stock as collateral (more like the taxpayers in Kreimer), that fact would not convert bona fide loans into misappropriation income so long as Mr. Bailey and Credit Suisse had a "consensual recognition" th t he would repay the loans. There is no exception to the James test for loans that were secured by another person's collateral"--no matter how it was obtaine d--and "any broader reading of the In our prior order dated April 29, 2009, denying the parties' cross-motions for summary judgment, we overstated the significance of the Biochem Pharma stock as collateral, suggesting that "here the borrower's legal obligation to repay' (continued...) - 74 language in James would be unwarranted on the basis of the facts of that case and all subsequent decisions which have considered the issue." Kreimer v. Commissioner, T.C. Memo. 1983-672. IIL Due process and Mr. Bailey's income from the Broder litigation Among the items of income that Mr. Bailey did not report in the years at issue, and that the IRS attributed to him, was the $1,650,000 from Mr. Broder that, Mr. Bailey says, constituted "fees due him", but part of which was paid to the District Court on Mr. Bailey's behalf in 1997 and the remainder of which was paid in 1998 to third parties who had lent Mr. Bailey money in 1996 to repay Credit Suisse's advances to Mr. Bailey so that Credit Suisse would release his collateral, the Biochem Pharma stock, and the Broder payments were used to repay their loans in 1998. It is true that Mr. Bailey did not get to keep any of the Broder payments, and that the payment made directly to the District Court was compelled by that court; but income earned by a taxpayer is taxable to him, even if he directs that it be paid to someone else, see Lucas v. Earl, 281 U.S. 111 (1930), or if it is "(...continued) was overwhelmed by the fact that the lender held highly marketable collateralcollateral that did not belong to the borrower-which would satisfy the unpaid loan." In so saying we implied a standard not acknowledged in Webb or James and contradicted in Kreimer. The existence of collateral (to protect the lender), whether rightly obtained or wrongly obtained, does not undermine the borrower's obligation. applied to satisfy his debt, Old Colony Trust Co. v. Commissioner, 279 U.S. 716, 729 (1929) ("The discharge by a third peeson of an obligation to him is equivalent to receipt by the person taxed"); Tuckeræ. Commissioner, 69 T.C. 675, 678-679 (1978). Mr. Bailey argues, however, that these Broder payments should not be treated as income to him because of violttions of the Fifth Amendment to the U.S. Constitution, which provides that "No person shall * * * be deprived of life, liberty, or property, without due process of law". Mr. Bailey contends that he was denied due process" when the Government contrived a debt he did not really owe (i.e., the Biochem Pharma stock) and forced him to satisfy it with the Broder "Mr. Bailey also seems to invoke the takings clause of the Fifth Amendment ("nor shall private property be taken for public use, without just compensation") when he asserts, "There i s no question but what the government 'took'" the Broder payments. However, when the Goverhment takes a person's property not "for public use" but rather to pay the person's private debt, that is not a Fifth Amendment "taking". See Skillo v. United States, 68 Fed. Cl. 734, 743 (2005) ("'This Court and other courts have routinely held that the lawful exercise of the Government's collection powers does not amount to a prohibited Fifth Amendment "taking".'") (quoting Kerrigan v. Unite'd States, 1997 WL 685275, at *5 (Fed. Cl. Apr. 30, 1997)). Moreover, this Court has not been granted jurisdiction to adjudicate a Fifth Amendment "taking" claim. Rather, such claims must be litigated in the Court of Federal Claims (under 28 U.S.C. sec. 1491(a)(1) (2006)) or in Federal District Court (under 28 U.S.C. sec. 1346(a)(2) (2006)). - 76 payments.39 This due process argument stumbles at the starting block, for two related reasons. First, these allegations concern supposed defects in prior judicial proceedings, which were (or could have been) reviewed on appeal from those proceedings 4° The Tax Court does not sit as a court of review of the decisions of other courts. Second, these allegations ultimately dispute a holding--i.e., that Mr. Bailey did not acquire rights to the Biochem Pharma stock in 1994 and was therefore required to return the stocli and its proceeds--that Mr. Bailey is collaterally estopped from disputing, for the reasons explained above in part I.B. 39Specifically, Mr. Bailey alleges that in Bailey I he was wrongly denied the ownership of the Biochem Pharma stock; that he was denied compensation for his labor in repatriating Duboc's assets; that by misrepresentations the Department of Justice induced the Federal District Court to demand immediate return of the Biochem Pharma stock in 1996; that the Federal District judge refused to hear some of his arguments and evidence and refused to recuse himself though he ought to have been a witness; that Mr. Bailey was unjustly jailed until he,could come up with $2.3 million; that the appellate court "missed or avoided the central argument"; and that the Department of Justice held up the renomination of the Court of Federal Claims judge who was handling Bailey II, thereby prompting an adverse outcome that denied him the appreciation on the Biochem Pharma stock. 4°In Bailey I, decisions of the District Court for the Northern District of Florida had to be appealed to the U.S. Court of Appeals for the Fifth Circuit, 042 28 U.S.C. secs. 1291, 1294(1), and decisions of the Court of Appeals for the Fifth Circuit had to be appealed to'the U.S. Supreme Court, 28 U.S.C. sec. 1254. In ~ · Bailey II, decisions of the Court of Federal Claims had to be appealed to the U.S. Court of Appeals for the Federal Ciròuif. 28 U.S.C. sec. 1295(a)(3). 41Mr. Bailey also alleges that the Department of Justice violated due process 042 (continued...) - 77 Mr. Bailey was held by the District Court to be obliged to reimburse the Government for the stock sales; and he Ldmits that he was personally obliged to repay the Credit Suisse loans, which in t2rn were paid by third parties whom he was then liable to pay. That being the cLse, the Broder payments made to the District Court and to these third parties satisfied obligations of Mr. Bailey, and they are income to him even if he never had the money in hand. Mr. Bailey's last due process argument is that pressure from the Department of Justice fomented errors in the notice of deficiency. It certainly is in our jurisdiction to review the notice of deficiency, and we do have the power to remedy any errors in it. However, this contention is little more than a repetition of Mr. Bailey's argument that IRS animus should affect the burden of proof. As we stated in part I.A.3. above, there is no warrant here to look behind the notice of deficiency and examine the IRS's motiveis. If the evidence shows that adjustments in the IRS's notice of deficiency cannot i e sustained, then the Commissioner could not prevail by proving that the agerit was sincere; likewise, if the evidence (...continued) by engineering his disbarment. Of cours , the Tax Court does not have (and Mr. Bailey does not suggest that we have) jur sdiction to review his disbarment proceedings or the power to reinstate his license to practice law. And even if we could determine that he had been unjustly disbarred, we could not remedy that wrong by excusing him from tax liability on income that we find he did receive. - 78 shows that the adjustments were correct, Mr. Bailey could not prevail by proving that the agent was prejudiced. The issue here is not the agent, the agency, or the audit but rather Mr. Bailey's tax liability. IV. Whether activities are engaged in for profit: general principles Next at issue is Mr. Bailey's entitlement to deductions for the 1993 through 2001 tax years that arose from the yacht rental activity and the airplane remanufacturing activity" that he conducted through his two wholly owned S corporations. A taxpayer who is carrying on a trade or business may deduct ordinary and necessary expenses incurred in connection with the operation of the business. Sec. 162(a). However, a taxpayer generally may not deduct expenses incurred in connection with a hobby or other nonprofit activity to offset taxable income from other sources. Sec. 183(a). 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 "The regulations provide that "all the facts and circumstances" must be taken into account to determine the activity or activities of the taxpayer. 26 C.F.R. sec. 1.183-1(d)(1), Income Tax Regs. On the basis of all the facts and circumstances, we find that Mr. Bailey conducted the airplane rental activity, yacht rental activity, and airplane remanufacturing activity as (three) separate activities for purposes of section 183. See Keanini v. Commissioner, 94 T.C. 41, 46 (1990). Mr. Bailey conducted the three activities as separate activities for accounting purposes. He also hired a different set of employees to manage and carry out each activity. - 79 (1) or (2) of section 212." An activity constitutes a "trade or business" within the meaning of section 162--and it escapes t2e limitation of section 183--if the taxpayer's actual and honest objective is to realize a profit. Osteen v. Commissioner, 62 F.3d 356, 358 (11th Cir. 1995), aff'g in part and rev'g in part T.C. Memo. 1993-519. The expectation of profit need not have been reasonable; however, the taxpayer must have entered into the activity, or continued it, with the objective of making a profit. Hulter v. C mmissioner, 91 T.C. 371, 393 (1988); 26 C.F.R. sec. 1.183-2(a), Income Tax R gs. Whether the requisite profit objective exists is determined by looking at all the surrounding facts and circumstances. Keanini v. Commissioner, 94 T.C. 41, 46 (1990); 26 C.F.R. sec. 1.183-2(b). Greater weight is given to o jective facts than to a taxpayer's mere statement of intent. Thomas v. Commissioner, 84 T.C. 1244, 1269 (1985), aff'd, 792 F.2d 1256 (4th Cir. 1986); 26 C.F.R. sec. 1.183-2(a). Section 1.183-2(b) of the regulatio:1s provides a list of factors to be considered in the evaluation of a taxpáyer's profit objective: (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 expendec by the taxpayer in carrying on the activity; (4) the expectation that assets us d in the activity may appreciate in value; (5) the success of the taxpayer in c irrying on other similar or dissimilar - 80 activities; (6)-the taxpayer's history of income or losses with respect to the_ activity; (7) the amount of occasional profits, if any, from the activity; (8) the financial status of the taxpayer; and (9) elements of personal pleasure or recreation. This list is nonexclusive, and the number of factors for or against the taxpayer is not necessarily determinative. Rather, all facts and circumstances must be taken into account, and more weight may be given to some factors than to others. Id.; see Dunn v. Commissioner, 70 T.C. 715, 720 (1978), äff'd, 615 F.2d 578 (2d Cir. 1980). We now address these nine factors with respect to the yacht rental activity and the airplane remanufacturing activity. V. Analysis of Mr. Bailey's yacht rental activity . Mr. Bailey conducted the yacht rental activity through PBR from 1993 until the Government took control of the Spellbound in 1996. Mr. Bailey concedes that he never intended to profit from yacht rentals per se, and we therefore do not analyze that activity for a profit motive. Rather, Mr. Bailey contends that the yacht rental activity was really the continuation and winding down of his previous yacht refurbishing activity, which (he alleges) was engaged in for profit. Mr. Bailey also contends that the Commissioner is estopped by a settlement agreement from contesting his profit motive for the yacht rental activity. - 81 Even if Mr. Bailey's ya ht rental activity is viewed as a continuation of his previous yacht refurbishing activity, we find that it was not engaged in for profit during tax years 1993 though 1996.* We also find that'the Commissioner is not estopped from contesting Mr. Bailey's p ofit motive. A. Lack of profit motive for yacht refurbishing activity Mr. Bailey contends that the yacht rental activity was really the continuation and winding down of his previous yacht hefurbishing activity. He contends that the yacht refurbishing activity was enga ed in for profit (i) before the tax years at issue, when he attempted to use the Spellbound as a prototype to refurbish and-sell other used yachts, and (ii) during the tax years at issue, when he was winding down the yacht refurbishing activity. As Mr.'Bailey correctly notes, a taxpayer does not lack a profit motive merely because his business fails and he takes a reasonable time to unwind it and minimi e his losses.44 "Mr. Bailey contends that he is entitled to deduct "yacht-based expenses" from 1993 until PBR sold the Spellbound in 1998. We find that the yacht rental activity was not engaged in for profit. Se pt. V.C. below. In addition, we find that the record provides even less support for Mr. Bailey's contention that his attempts to sell the Spellbound during the 1996 through 1998 tax years constitute an activity that was engaged in for profit. Accordingly, we hold that Mr. Bailey lacked the requisite profit motive for the yacht rental and sale activities during all of the tax years at issue. 44See Helmick v. Commissioner, T. . Memo. 2009-220, slip op. at 27-28 (continued...) - 82 However, if the deductibility of the suit-years' yacht-related expenditures depends on the for-profit character of the pre-suit-years' yacht refurbishing activity, then it was incumbent on Mr. Bailey to prove that for-profit character. He did not do so, as the following consideration of the nine factors listed above shows. 1. Manner in which the activity is conducted Mr. Bailey kept his records for the yacht activity in the Lantana hangar before discarding them, but the record contains only Mr. Bailey's general claims about the adequacy of the records, and does not provide needed details about their type or quality. Mr. Bailey discarded those records (after giving the IRS an opportunity to review and copy them). Mr. Bailey thus failed to prove whether he kept records for the activity in a business-like manner. Mr. Bailey does not allege, nor does the record show, that he changed his operating methods to improve the profitability of the yacht refurbishing activity. This factor--the manner in which the activity is conducted--is strongly in the Commissioner's favor. (...continued) (after "a catastrophic loss that could never be recouped," a taxpayer who "thereafter expected to generate an overall prospective profit * * * could not be said to lack a profit objective after the disaster merely because he would never recoup the prior loss"). - 83 2. Expertise of the taxpa er and his advisers Mr. Bailey was an aviator, a lawye , a speaker, an author, and a past owner of a helicopter company; but when he ac uired the Spellbound he had no prior experience in yacht selling or refurbishing. Mr. Bailey did hire experts--Dennison Marine and the Roscioli Yachting Center-to-execute his plans to refurbish the Spellbound; but he offered no evidence 0:her than his own general testimony to show that they actually collaborated with or advised him in establishing a business of which the Spellbound was to be a prototype. We are not convinced that he was much more than a retail customer of Demtison Marine and the Roscioli Yachting Center. This factor--expertise--is in the Commissioner's favor. 3. Time and effort expendéd Mr. Bailey did not establish how much time or effort he spent in refurbishing the Spellbound or develbping a plan to sell yachts. Instead, Mr. Bailey was otherwise employed with his law practice. This factor--time and effort--is in the Commissioner's favor. - 84 4. Expectation that assets may appreciate in value Mr. Bailey testified that he did not expect the Spellbound to ap [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3Acd43905431684e54. Public record. Not legal advice.