Friday, December 30, 2011
Wayne L. Wilmot v. Commissioner, TC Memo 2011-293 , Code Sec(s) 162; 183.
WAYNE LASIER WILMOT, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent .
Code Sec(s): 162; 183
Docket: Docket No. 18296-08.
Date Issued: 12/22/2011
Judge: Opinion by MORRISON
Reference(s): Code Sec. 162; Code Sec. 183
Official Tax Court Syllabus
Wayne Lasier Wilmot, pro se.
James C. O'Leary, for respondent.
Opinion by MORRISON
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent (the IRS) issued a notice of deficiency to petitioner, Wayne Lasier Wilmot (Wilmot), determining an income-tax deficiency of $14,666 for the year 2004. The IRS reduced the deficiency to $14,303 after correcting a computational error in the notice. Wilmot timely filed a petition under section 6213(a) for redetermination of the deficiency. 1 We have jurisdiction under section 6214.
The primary issue for decision is whether Wilmot's photography activity was an “activity not engaged in for profit” within the meaning of section 183. We find that Wilmot did not engage in his photography activity for profit. Thus he cannot deduct any of the photography expenses he reported. 2
FINDINGS OF FACT
Some facts have been stipulated, and they are so found. Wilmot resided in Maryland when he filed the petition.
Wilmot earned a B.S. in electrical engineering in 1964 and a Ph.D. in oceanography in 1972. From 1972 to 1984, he conducted oceanographic research at various universities, institutes, and government agencies; he also taught graduate-level courses. This work took place in Scandinavia—primarily in Sweden.
In 1984, Wilmot returned to the United States and started Wilmot & Associates, an oceanographic-consulting business. By his account, the business was relatively successful.
In 1985, Wilmot began working full time for the National Oceanic and Atmospheric Association (NOAA) as an oceanographer. He also continued his oceanographic-consulting business, Wilmot & Associates. By the 1990s, however, Wilmot & Associates was dormant.
In 1992, while still working for NOAA, Wilmot earned an M.S. from Johns Hopkins University. The degree was in “Technical Management: Project Management and Systems Engineering”.
In 1992, after earning his M.S., Wilmot began teaching part time at Johns Hopkins while continuing to work at NOAA. 3
In 2001, Wilmot began taking photography classes at Montgomery College in Rockville, Maryland. His coursework included color photography, black-and-white photography, electronic photography, portrait and fashion photography, and business practices and portfolio development.
Around 2001, Wilmot became interested in starting a photography business. He hoped to pursue advertising, commercial photography, and environmental photography. 4
In 2002, while working full time for NOAA and part time for Johns Hopkins, Wilmot began engaging in a photography activity that he characterized as a for-profit business. On his tax returns, he began reporting the expenses from this activity under the name Wilmot Environmental Technology. He used the same name to report expenses from oceanographic consulting, an activity he resumed in 2002. For the two years that Wilmot conducted both photography and oceanographic consulting (2002 and 2003), it is unclear how much of the expenses he reported for Wilmot Environmental Technology were oceanographic-consulting expenses.
In 2004 (the year in issue), Wilmot stopped working as an oceanographic consultant. He continued to engage in photography and remained a full-time employee of NOAA and a part-time employee of Johns Hopkins. His combined wages in 2004 from NOAA and Johns Hopkins totaled $119,127.36.
In 2004, Wilmot made three trips to Europe to take photos. He used these trips to build a portfolio—a set of sample photos that photographers use to seek work. The first trip took place from December 17, 2003 to January 21, 2004, the second trip from March 9 to 22, 2004, and the third trip from July 1 to August 11, 2004. On the first and second trips, Wilmot took photos exclusively in the Czech Republic. On the third trip, he again took photos in the Czech Republic, but also brought one model, Hana Strangfeldova, to Sweden for seaside photos.
During portions of each trip, Wilmot staged multiple all-day photo shoots. The shoots consisted of photographing models in fashionable clothing and swimwear. In the Czech Republic, the shoots took place at local photo studios and at various other locations. Pavel Danel, a Czech photographer and studio owner, coordinated the logistics for many of the shoots: he lent Wilmot his studio; he provided equipment; and he hired models, makeup artists, and photo assistants. 5 In Sweden, Wilmot and Strangfeldova stayed at a summer home owned by the family of Wilmot's former domestic partner. Wilmot took seaside photos of Strangfeldova on the surrounding land and islands.
After the photo shoots, Wilmot either processed the photos himself or sent them to a professional lab for processing. He then used the photos to compile a portfolio. 6
In 2006, Wilmot earned an associate of applied science degree in photography from Montgomery College. He continued engaging in his photography activity until at least 2007. 7 He continued teaching part time at Johns Hopkins until 2009, and he continued working for NOAA until he retired in 2010.
On his 2004 tax return, Wilmot claimed $57,691.60 of photography expenses on Schedule C, Profit or Loss From Business: 8
Amount Claimed Expense Car and truck $185.00 Legal and professional services 12,836.26 Office 11,048.74 Repairs and maintenance 247.31 Supplies 10,204.33 Travel 20,949.86 Meals and entertainment 1,495.95 Utilities 724.15
Total 57,691.60 “consulting & photography”, but as Wilmot testified, the activity reported on his 2004 Schedule C consisted solely of photography; thus all his Schedule C expenses in 2004 were photography expenses. Wilmot reported no gross receipts from his photography activity. He thus claimed a $57,691.60 Schedule C loss, which reduced his gross income by $57,691.60.
At trial, Wilmot submitted into evidence two binders of documents to substantiate his photography expenses (binder documents). The documents include receipts, invoices, ticket stubs, bank statements, credit card statements, and utility bills. They indicate payments for: books, meals, travel, lodging, entertainment, women's clothing, women's swimwear, makeup supplies, utilities, photo equipment, storage equipment, digital equipment, postal services, photographic services, and miscellaneous items.
To prepare his 2004 tax return, Wilmot created handwritten workpapers based in part on the binder documents. The handwritten workpapers are not in evidence. The amounts on Wilmot's Schedule C (see table above) did not correspond to the amounts on the binder documents. One reason was that he lacked receipts for some expenses and thus relied on his personal knowledge of those expenses. Another reason was that he sometimes used the U.S. Department of State per diem rates instead of his actual expenses.
During audit, Wilmot created Excel spreadsheets that detail how he calculated his expenses when preparing his 2004 tax return. The Excel spreadsheets are electronic versions of the handwritten workpapers that Wilmot used to prepare his 2004 tax return. The spreadsheets divide his photography expenses into categories (the same categories used on his 2004 tax return) and list the date, payee, amount, and purpose of each expense. Although we excluded the spreadsheets as hearsay, the parties agreed to treat the spreadsheets as if Wilmot had testified to the information contained in them. We thus ordered that the spreadsheets be treated as if their information was reflected in Wilmot's sworn testimony.
I. The Parties' Positions
Wilmot contends that he engaged in his photography activity for profit and is thus entitled to deduct his photography expenses as business expenses under section 162. He argues that the profit-motive factors in section 1.183-2(b), Income Tax Regs., show that he had a profit motive. Citing the same factors, the IRS argues that Wilmot did not engage in his photography activity for profit.
The IRS also argues that even if Wilmot intended to earn a profit from photography, his photography expenses should be amortized as startup expenses because he was not actively engaged in a photography activity in 2004. See ,,secs. 195(a), (b), (c)(1), 162(a); Jackson v. Commissioner, 86 T.C. 492, 514 (1986) (no deduction under section 162 unless ongoing business), affd. 864 F.2d 1521 [63 AFTR 2d 89-539] (10th Cir. 1989). We need not address this argument because, as we explain, we find that Wilmot did not conduct his photography activity for profit; thus he could not amortize his expenses as section 195 startup expenses. See ,sec. 195(b)(1), (c)(1)(A) (amortization allowed only for expenses incurred to create new trade or business); Commissioner v. Groetzinger, 480 U.S. 23, 35 [59 AFTR 2d 87-532] (1987) (profit motive required to have trade or business).
Wilmot contends that he gave the IRS full substantiation of his photography expenses during audit and that the IRS failed to conduct a “proper audit” of his 2004 tax return. He requests that we order the IRS to conduct a complete audit. But even if the audit was incomplete, the proper remedy is for us to determine Wilmot's correct tax liability. See, e.g., Greenberg's Express, Inc. v. Commissioner, 62 T.C. 324, 327-328 (1974).
Wilmot also argues that when the IRS audited his 2006 tax return, it agreed that he had conducted his photography activity for profit. But this is irrelevant. The IRS's failure to propose adjustments to one year does not estop it from proposing adjustments to another year. See, e.g., Rose v. Commissioner, 55 T.C. 28, 31-32 (1970).
II. Burden of Proof
In the notice of deficiency, the IRS determined only that Wilmot failed to substantiate his photography expenses. The IRS raised the issue of profit motive before trial, and the parties agreed to try this issue even though it was not raised in the notice of deficiency or the answer. Because the issue was not raised in the notice of deficiency, the IRS has the burden of showing, by a preponderance of the evidence, that Wilmot did not engage in his photography activity for profit. See Shea v. Commissioner, 112 T.C. 183, 190-197 (1999) (placing burden of proof on IRS for new matter tried by consent of parties under Rule 41(b)); Estate of Gilford v. Commissioner, 88 T.C. 38, 51 (1987) (party satisfies burden of proof by demonstrating merits of claim by preponderance of evidence).
III. Whether Wilmot Engaged in His Photography Activity for Profit Under section 183(a), 9 no deduction is allowed for an “activity *** not engaged in for profit”, except as provided in section 183(b). 10 Section 183(c) defines an “activity not engaged in for profit” as any activity other than one for which deductions are allowable under section 162 or 212(1) or (2). Expenses are deductible under section 162 (the section Wilmot claims is applicable) only if the taxpayer is engaged in a trade or business. In other words, the taxpayer must engage in the activity continuously and regularly, and the taxpayer's primary Commissioner v. Groetzinger, supra at 35 purpose must be profit. (defining “trade or business”).
Courts determine whether an activity is engaged in for profit by examining the facts and circumstances. Sec. 1.183-2(a), Income Tax Regs.; see also Hendricks v. Commissioner, 32 F.3d 94, 97 [74 AFTR 2d 94-5841]-98 (4th Cir. 1994), affg. T.C. Memo. 1993-396 [1993 RIA TC Memo ¶93,396]. The taxpayer must have a good faith profit motive, but need not have a reasonable expectation of profit. Sec. 1.183-2(a), Income Tax Regs.; see also Hendricks v. Commissioner, supra at 97-98; Dreicer v. Commissioner, 78 T.C. 642, 645 (1982), affd. without opinion 702 F.2d 1205 (D.C. Cir. 1983). In determining profit motive, “greater weight is given to objective facts than to the taxpayer's mere statement of his intent.” Sec. 1.183-2(a), Income Tax Regs.; see also Hendricks v. Commissioner, supra at 98.
Section 1.183-2(b), Income Tax Regs., provides nine factors that courts typically consider in determining whether an activity is engaged in for profit: (1) “Manner in which the taxpayer carries on the activity”; (2) “The expertise of the taxpayer or his advisors”; (3) “The time and effort expended by the taxpayer in carrying on the activity”; (4) “Expectation that assets used in activity may appreciate in value”; (5) “The success of the taxpayer in carrying on other similar or dissimilar activities”; (6) “The taxpayer's history of income or losses with respect to the activity”; (7) “The amount of occasional profits, if any, which are earned”; (8) “The financial status of the taxpayer”; and (9) “Elements of personal pleasure or recreation”. 11 See, e.g., Hendricks v. Commissioner, supra at 98.
A. Manner in Which the Taxpayer Carries On the Activity
The following facts can indicate a profit motive: (1) the
taxpayer conducts the activity "in a businesslike manner and
maintains complete and accurate books and records", (2) the
taxpayer conducts the activity "in a manner substantially
similar" to profitable activities of the same nature, and (3) the
taxpayer attempts to improve the activity's profitability by
changes in operating methods. Sec. 1.183-2(b)(1), Income Tax
Regs.; Engdahl v. Commissioner, 72 T.C. 659, 666-667 (1979).
Wilmot did not conduct his photography activity in a businesslike manner. He lacked a separate bank account for the activity and a written business plan. 12 See Keating v. Commissioner, 544 F.3d 900, 905 [102 AFTR 2d 2008-6638] (8th Cir. 2008), affg. T.C. Memo. 2007-309 [TC Memo 2007-309]. Although he kept detailed records of his expenses, it seems he did so solely to substantiate tax deductions. See id. (records do not indicate profit motive when kept only to “memorialize for tax purposes the existence of the subject transactions”); Bush v. Commissioner, T.C. Memo. 2002-33 [TC Memo 2002-33] (records do not indicate profit motive if “maintained primarily to support tax deductions”), affd. without published opinion 51 Fed. Appx. 422 [90 AFTR 2d 2002-7500] (4th Cir. 2002). There is no evidence that Wilmot used his records to make business decisions or improve operations. See Golanty v. Commissioner, 72 T.C. 411, 430 (1979), affd. without published opinion 647 F.2d 170 (9th Cir. 1981).
Wilmot's meager efforts at promotion and advertising fall far short of what the owner of a profitable business would have done. See Keating v. Commissioner, supra at 905 (paltry advertising efforts can indicate lack of profit motive). Wilmot relied on word of mouth to promote his activity even though he had few contacts and no established reputation in the photography industry. He claimed that he had contacted several potential clients in 2004, but we find that he contacted only three potential clients; and of these, only one was a realistic prospect. 13 He even turned down work that he thought undesirable: he declined to work on photography jobs with another Montgomery College student who did personal portraits and wedding photography. We are skeptical that a fledgling for-profit photographer would have behaved this way.
Wilmot did not make significant efforts to improve profitability. Only belatedly did he shift from film to digital photography. Even this transition—which ended several years after 2004—was unlikely to materially improve profitability. See Golanty v. Commissioner, supra at 431 (operational changes not meaningful when they cannot significantly improve profitability). For clients who preferred digital photography, Wilmot was still an unknown photographer because he did not advertise.
For the above reasons, the manner in which Wilmot conducted his photography activity does not indicate a profit motive.
B. The Expertise of the Taxpayer or His Advisors Preparation for an activity “by extensive study of its accepted business, economic, and scientific practices” or by consultation with experts in these practices may indicate a profit motive where the taxpayer conducts the activity “in accordance with such practices”. Sec. 1.183-2(b)(2), Income Tax Regs.
This factor is neutral. Wilmot's coursework at Montgomery College gave him extensive knowledge of photographic techniques. But he lacked adequate knowledge of the business aspects of See Golanty v. Commissioner, supra at 432 photography. (expertise should include knowledge of business aspects of activity); Giles v. Commissioner, T.C. Memo. 2005-28 [TC Memo 2005-28] (same). He testified that his courses at Montgomery College taught him the business aspects of photography, but only one of these courses covered business practices. He also claimed that he had received advice from professional photographers. But he received only general advice on which fields to pursue from a photography professor at Montgomery College. And he did not receive business advice from the other photographers with whom he worked; he simply paid them for services and studio space. Even if Wilmot did glean business knowledge from his courses or from other photographers, we doubt whether he applied it given his lackluster efforts at cost cutting and promotion. See supra part III.A.
C. The Time and Effort Expended by the Taxpayer in
Carrying On the Activity
If the taxpayer devotes “much of his personal time and effort” to conducting an activity, this may indicate a profit motive, particularly if the activity lacks “substantial personal or recreational aspects”. Sec. 1.183-2(b)(3), Income Tax Regs.
This factor is neutral. Wilmot spent a significant amount of time on his photography activity. 14 The time spent, however, included substantial personal and recreational aspects, see infra part III.I., which severely detract from the significance of the time commitment, see sec. 1.183-2(b)(3), Income Tax Regs.; Giles v. Commissioner, T.C. Memo. 2006-15 [TC Memo 2006-15]. Wilmot also would have done many tasks, like taking photos and purchasing equipment, regardless of whether photography was a hobby or a business. See Giles v. Commissioner, T.C. Memo. 2006-15 [TC Memo 2006-15].
D. Expectation That Assets Used in Activity May Appreciate
A profit motive may exist if the taxpayer expects that assets used in the activity will appreciate in value, such that even if current income is insufficient to realize a profit, the activity will generate an overall profit when the assets are sold. Sec. 1.183-2(b)(4), Income Tax Regs.
This factor favors the IRS. Wilmot testified that his photos were assets that could appreciate in value and earn him royalty-like income when leased to stock photography companies, but we do not find this testimony credible. 15 Wilmot admitted that he did not seriously pursue stock photography. There is also no evidence that Wilmot's photos would appreciate in value. He never earned any income from his photography activity, and we have no samples of his work and no credible market-value estimates; thus we have no way of gauging any potential See Hendricks v. Commissioner, 32 F.3d at 100 appreciation. (mere expectation of asset appreciation, without probative foundation, is insufficient to support profit motive).
E. The Success of the Taxpayer in Carrying On Other
Similar or Dissimilar Activities
If the taxpayer has profitably conducted similar activities, this may indicate a profit motive. Sec. 1.183-2(b)(5), Income Tax Regs. This factor favors the IRS. Although Wilmot successfully ran an oceanographic-consulting business, the skills he developed were not readily transferable to a photography activity. See, e.g., Giles v. Commissioner, T.C. Memo. 2005-28 [TC Memo 2005-28] (success in dental practice had no bearing on ability to conduct horse activity).
F. The Taxpayer's History of Income or Losses With Respect
to the Activity
If the taxpayer sustains losses beyond the customary startup period for the activity, this may indicate a lack of profit motive. Sec. 1.183-2(b)(6), Income Tax Regs. Losses during the startup stage or losses that are explainable “as due to customary business risks or reverses”, however, might not indicate a lack Losses due to circumstances outside the of profit motive. Id. taxpayer's control, such as natural disasters or depressed market conditions, do not indicate a lack of profit motive. Id.
This factor favors the IRS. Wilmot's photography losses generally worsened over the years. See Golanty v. Commissioner, 72 T.C. at 427. As reflected in his Schedules C, Wilmot lost $29,674.63 in 2002, $37,665.79 in 2003, $57,691.60 in 2004 (the year in issue), $73,066.68 in 2005, $70,971.64 in 2006, and $69,937.86 in 2007—a 6-year total of $339,008.20 of losses. 16
Wilmot claims that his history of losses is not so severe. First, he argues that we should not consider losses from 2002 and 2003 because those years precede the year in issue, 2004. This argument is invalid. Section 1.183-2(b)(6), Income Tax Regs., directs us to examine the “history” of losses, which includes losses from prior years. Second, Wilmot argues that we should not examine years after 2004 (i.e., 2005, 2006, and 2007). We need not decide whether these post-2004 years are outside our frame of reference. Even without these years, we conclude that Wilmot's history of losses suggests he lacked a profit motive. Three straight years of losses (2002, 2003, and 2004) is sufficient because the magnitude of the losses far outstrips the See Smith v. Commissioner, T.C. Memo. 1997-503 [1997 RIA TC Memo ¶97,503], affd. revenue. without published opinion 182 F.3d 927 [83 AFTR 2d 99-2549] (9th Cir. 1999); see also Miller v. Commissioner, T.C. Memo. 1998-463 [1998 RIA TC Memo ¶98,463], affd. without published opinion 208 F.3d 214 [86 AFTR 2d 2000-5968] (6th Cir. 2000). Wilmot earned no gross receipts, and this poor performance was caused by his method of operation, not by the newness of his “business”.
G. The Amount of Occasional Profits, If Any, Which Are
The earning of substantial profits, even if the profits are sporadic, generally indicates a profit motive if the taxpayer's investment or losses are relatively small. Sec. 1.183-2(b)(7), Income Tax Regs. The mere opportunity to earn a substantial profit may also indicate a profit motive. Id. In contrast, an occasional small profit generally indicates a lack of profit motive if the taxpayer's investment or losses are relatively large. Id.
This factor favors the IRS. Wilmot earned no income from his photography activity and never made a profit. See Wesley v. Commissioner, T.C. Memo. 2007-78 [TC Memo 2007-78] (analogous situation). He claims that he persisted in his photography activity because he hoped to make a profit, but objectively, he had little hope of the activity ever becoming profitable given his lack of clients, advertising, reputation, business records, and flexibility See Giles v. Commissioner, T.C. Memo. regarding type of work. 2005-28 (hope of speculative profit must be supported by record).
H. The Financial Status of the Taxpayer If the taxpayer lacks substantial income from sources other than the activity, this may indicate a profit motive. Sec. 1.183-2(b)(8), Income Tax Regs. If, on the other hand, the taxpayer has substantial income from other sources—particularly if the losses from the activity generate substantial tax benefits—this may indicate a lack of profit motive, especially if the activity involves personal or recreational elements. Id.
This factor favors the IRS. Wilmot earned $119,127.36 in 2004 from his work at NOAA and at Johns Hopkins. He claimed $57,691.60 of photography losses, which reduced his gross income by $57,691.60. His photography activity also involved personal and recreational elements, as explained below. See infra part III.I.
I. Elements of Personal Pleasure or Recreation The “presence of personal motives” in conducting an activity may indicate a lack of profit motive, especially if the activity involves personal or recreational elements. Sec. 1.183-2(b)(9), Income Tax Regs. Making a profit, however, need not be the An activity is not classified as taxpayer's sole objective. Id. a hobby simply because the taxpayer finds it pleasurable. Jackson v. Commissioner, 59 T.C. 312, 317 (1972).
This factor favors the IRS. It is true, as Wilmot suggests, that he did not visit family during his three trips to Europe. But this fact does not convince us that his photography activity lacked personal and recreational elements. First, we believe that photography had a significant recreational aspect for Wilmot. Second, it is difficult to conceive why, if Wilmot did not enjoy photography, he would continue the activity given its complete lack of revenue. See, e.g., Miller v. Commissioner, supra. Third, many of Wilmot's activities involved foreign travel, dining, and entertainment. 17
J. Conclusion Wilmot did not engage in his photography activity for profit. He earned no income from the activity and incurred increasing losses that he was unlikely to recoup. He did not conduct the activity in a businesslike manner or in a manner similar to a profitable business. He did not keep records that helped him make business decisions, nor did he significantly attempt to improve profitability. He had no genuine expectation that his photos would appreciate in value. His previous success in oceanography did not increase his odds of success in photography. And lastly, he used photography losses to offset income from other sources and derived substantial pleasure from traveling and taking photos. His expertise in photographic techniques and his large time expenditure are insufficient to outweigh these factors. Because we find that Wilmot did not conduct his photography activity for profit, he cannot deduct any of his photography expenses under section 162 or section 183. For this reason, we need not determine whether Wilmot substantiated his expenses.
We have considered all arguments, and contentions not addressed are meritless, irrelevant, or moot.
To reflect the foregoing, Decision will be entered for respondent.
All section references are to the Internal Revenue Code as in effect for the year in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.
The notice of deficiency reflected that the disallowed photography deductions increased Wilmot's income, thus resulting in computational adjustments to his tuition and fees deduction and his miscellaneous itemized deductions. Wilmot argues that his tuition and fees expenses were genuine expenses. But he misunderstands the IRS's adjustment. Though he may have incurred tuition and fees expenses, his modified adjusted gross income (as increased by the notice of deficiency) exceeds the threshold for the tuition and fees deduction.
Wilmot generally taught two courses per year—one in the spring and one in the fall.
Environmental photography (in Wilmot's parlance) consists of taking staged photos of people in their work environments. These photos are then used in promotional brochures or advertising.
Wilmot paid Danel for studio and equipment rental. Danel also set the fees for the models, makeup artists, and photo assistants (whom Wilmot paid directly) and received a 25-percent commission on their earnings.
Wilmot's portfolio is not in evidence. Nor are any of his photos.
The manner in which Wilmot conducted his photography activity underwent little change in the years after 2004. As discussed infra pt. III.A., the only change Wilmot made was a shift from film to digital photography.
The Schedule C stated that Wilmot's principal business was
Sec. 183 applies only to individuals and S corporations. Sec. 183(a).
Sec. 183(b) provides two exceptions, neither of which applies to Wilmot. Sec. 183(b)(1) allows certain types of deductions that do not require a profit motive. Sec. 183(b)(2) allows deductions that would otherwise require a profit motive, but only to the extent that gross income from the activity exceeds the total deductions under sec. 183(b)(1). All of Wilmot's photography-expense deductions are the type that require a profit motive, see secs. 162 and 183(c), and he earned no gross income from his photography activity. Thus he does not qualify for deductions under sec. 183(b).
These factors are not exclusive, and no one factor is dispositive. Sec. 1.183-2(b), Income Tax Regs.; Hendricks v. Commissioner, 32 F.3d 94, 98 [74 AFTR 2d 94-5841] (4th Cir. 1994).
Wilmot's “unwritten business plan” was supposedly to build up his photography activity to provide additional retirement income. Wilmot also claims that he chose his photo-shoot locations to lower costs, but there is no written evidence of cost comparisons. His two binders of documents merely show that he incurred certain expenses at the locations he chose.
Wilmot could only name three contacts. He interviewed with an office-workspace company in Rockville, Maryland, but did not get the job. He also sent unsolicited mailings to Nordstrom and H&M (two large clothing companies) offering his services. But we do not believe these mailings created realistic work opportunities.
Wilmot estimates that he spent 1,520 hours on his photography activity in 2004, or about 30 hours a week. The IRS argues that this estimate is implausible. We disagree. As Wilmot testified, a combination of his annual leave, his holidays, his flexible work schedule at NOAA, and the seasonal nature of his work at Johns Hopkins allowed him to devote time to photography.
Stock photography companies acquire photos and let clients use the photos for a fee. The companies then remit a portion of this fee to the photographer.
It is possible that the 2002 and 2003 figures reflect some losses from Wilmot's consulting activity. But we find that most of Wilmot's Schedule C losses for 2002 and 2003 were photography losses.
Of the $57,691.60 of photography expenses, $20,949.86 was for travel, and $1,495.95 was for meals and entertainment. Wilmot's receipts indicate that his photography expenses included a trip to Gröna Lunds Tivoli, a Swedish amusement park, and the purchase of a Harry Potter DVD in the Czech Republic.
Thursday, December 29, 2011
CARLSON v. U.S., Cite as 108 AFTR 2d 2011-7444, 12/12/2011 , Code Sec(s) 6701; 7121; 7122; 6494; 7422
Frances CARLSON, PLAINTIFF v. UNITED STATES OF AMERICA, DEFENDANT.
Code Sec(s): 6701; 7121; 7122; 6494; 7422
Court Name: U.S. District Court, Middle Dist. of Florida,
Docket No.: Case No. 8:10-cv-900-T-24-TGW,
Date Decided: 12/12/2011.
Disposition: Decision for Govt. in part.
1. Penalties for aiding and abetting understatement of tax liability—settlements—collection due process—refunds—return preparers—summary judgment. Return preparer was partly denied summary judgment on her Code Sec. 6701 penalties refund complaint: although IRS agent initially agreed in letter incident to intervening CDP hearing to abate some penalties and reduce others, it wasn't clear whether such resulted in binding settlement as preparer argued or whether agent lacked authority to enter such settlement at time she allegedly did. Also, preparer was off base insofar as arguing that Code Sec. 6701 was meant to apply only to material advisors and that applying same to return preparers would render Code Sec. 6694 's own preparer provisions superfluous; she was also off base in claiming that her due process rights were violated either because she was “forced” to file lawsuit within 30 days of refund claim disallowance notice and forego administrative appeal or by IRS's failure to notify her that it was reassessing penalties; and govt., by presenting testimony and other evidence that she prepared false client returns claiming fabricated deductions or other items, raised sufficient material fact questions to rebut preparer's claims that there was no justification for imposing penalties on approximately 40 client returns, save for 3 which govt. conceded.
Reference(s): ¶ 67,015(15) ; ¶ 71,215.07(5) ; ¶ 74,225.06(100) Code Sec. 6701; Code Sec. 7121; Code Sec. 7122; Code Sec. 6494; Code Sec. 7422
UNITED STATES DISTRICT COURT MIDDLE DISTRICT OF FLORIDA TAMPA DIVISION,
Judge: SUSAN C. BUCKLEW United States District Judge
This cause comes before the Court on Plaintiff Frances Carlson's Motion for Summary Judgment (Doc. No. 31). The United States has filed a response in opposition (Doc. No. 46). At issue is a series of penalties that the Internal Revenue Service (“IRS”) levied against Carlson pursuant to 26 U.S.C. § 6701. For the reasons stated herein, Carlson's Motion for Summary Judgment is granted in part and denied in part.
The following facts are undisputed:
A. Carlson's Work at Jackson Hewitt
From 2002 through 2006, Carlson worked for two companies owned by Daniel Prewett 1 : JH Accounting, Inc. and Simple Financial Solutions, Inc., doing business as Jackson Hewitt (collectively, “Jackson Hewitt”). While working for Prewett, Carlson prepared income tax returns, both for business entities and for individuals, and provided bookkeeping services for some clients.
B. Carlson's Interactions with the IRS
In 2007, the United States sued Prewett, Carlson, and others to enjoin them from acting as federal tax return preparers and from engaging in activity that is subject to a penalty under § 6701 (i.e., aiding or assisting in the preparation of any portion of a tax document, knowing that portion would result in an understatement of tax liability). In May 2009, Carlson consented to the injunction. In September 2009, the IRS assessed $148,000 in penalties against Carlson under § 6701, related to approximately forty income tax returns that the IRS alleged Carlson prepared between 2002 and 2006. After paying 15% of the penalties, Carlson challenged the assessment by filing a refund claim with the IRS.
On March 23, 2010, the IRS informed Carlson that her refund claim was denied in full. In its notification, the IRS explained that Carlson had the option of filing suit in district court, and that “[t]he time for filing suit without paying additional funds is 30 days after the date of [pg. 2011-7445] this letter or 6 months and 30 days from the date you filed your claim[,] whichever date comes first.” (Doc. No. 3, Ex. 1 at 15.) Carlson timely filed suit, thereby initiating this action, on April 19, 2010.
Meanwhile, Carlson had also requested a Collection Due Process (“CDP”) hearing under 26 U.S.C. § 6330. The IRS appeals officer assigned to Carlson, Betty Landau, reviewed Carlson's CDP application, and between April and June 2010, Landau and Carlson's attorney discussed the penalties. On June 7, 2010, Landau sent Carlson's attorney a letter confirming her determination that the penalties for 2002 would be removed and that the remaining penalties would be reduced to the amounts that would have been assessed under 26 U.S.C. § 6694. Carlson's IRS Account Transcript indicates that, for each of the relevant years, her penalties under § 6701 were abated.
By letter dated September 2, 2010, having learned that Carlson had commenced this lawsuit, Landau informed Carlson's attorney that she had changed her determination to one that upheld all of the penalties assessed against Carlson. Thereafter, Carlson's penalties under § 6701 were restored.
C. The Present Lawsuit
In this action, Carlson seeks a judgment in the amount of the return preparer penalties assessed and collected from her for the years 2002 through 2006. Additionally, she asserts a denial of due process claim, in which she alleges that she was denied the ability to pursue an administrative appeal and file the instant lawsuit without paying the entire penalty amount. On September 23, 2010, the United States filed its answer and a counterclaim seeking a judgment for the full amount of the penalties against Carlson. (Doc. No. 10).
II. Standard of Review
Summary judgment is appropriate “if the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law.” Fed. R. Civ. P. 56(a). The Court must draw all inferences from the evidence in the light most favorable to the non-movant and resolve all reasonable doubts in that party's favor. Porter v. Ray, 461 F.3d 1315, 1320 (11th Cir. 2006). The moving party bears the initial burden of showing the Court, by reference to materials on file, that there are no genuine issues of material fact that should be decided at trial. Id. Summary judgment must be entered “against a party who fails to make a showing sufficient to establish the existence of an element essential to that party's case, and on which that party will bear the burden of proof at trial.” Johnson v. Bd. of Regents, 263 F.3d 1234, 1243 (11th Cir. 2001) (quotation omitted).
When a moving party has discharged its burden, the non-moving party must then go beyond the pleadings, and by its own affirmative evidence, designate specific facts showing there is a genuine issue for trial. Porter, 461 F.3d at 1320. In determining whether there is a “genuine” issue, the inquiry is “whether the evidence presents a sufficient disagreement to require submission to a jury or whether it is so one-sided that one party must prevail as a matter of law.” Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 251–52 (1986).
 Carlson argues she is entitled to summary judgment for three reasons. First, she argues summary judgment is appropriate based on what she contends is a binding settlement agreement between herself and the United States. Second, Carlson contends that penalties under § 6701 2 were inapplicable to her because she never materially advised her clients; instead, if penalties are warranted at all, they [pg. 2011-7446] must be assessed under § 6694. 3 Third, she maintains that she is entitled to summary judgment because the United States deprived her of due process, or in the alternative abused its discretion, by failing to allow her an administrative appeal and failing to give her notice that the IRS was reassessing penalties against her. In the alternative, Carlson argues she is entitled to partial summary judgment on several of the specific penalties at issue. The Court will address each of these arguments in turn.
A. Is Summary Judgment Warranted Based on a Binding Settlement Agreement?
 Carlson argues that she is entitled to judgment as a matter of law by virtue of a binding settlement agreement with the United States that removed her penalties for 2002 in full, and reduced the penalties for 2003 through 2006 to amounts that would have been assessed under § 6694. She contends that in the course of her attorney's correspondence with Landau, the two parties reached a binding settlement agreement, confirmed in writing by Landau, and governed by the principles of contract law. The United States disputes that an agreement was formed, but even assuming Carlson and Landau did reach an agreement, the United States contends that agreement is not binding on the United States because Landau did not have authority to compromise with Carlson.
Pursuant to 26 U.S.C. § 7122(a), “[t]he Secretary [of the Treasury] may compromise any civil or criminal case arising under the internal revenue laws prior to reference to the Department of Justice for prosecution or defense; and the Attorney General or his delegate may compromise any such case after reference to the Department of Justice for prosecution or defense.” The United States is not bound by an agreement entered into by one of its agents unless that agent is acting within the limits of his or her actual authority. Creel v. Comm'r of Internal Revenue, 419 F.3d 1135, 1141 [96 AFTR 2d 2005-5487] (11th Cir. 2005); United States v. Walcott, 972 F.2d 323, 326–27 (11th Cir. 1992) (applying this concept with respect to the Small Business Administration). Furthermore, “[i]t is well settled that persons dealing with a governmental agent must take notice of the agent's authority and that any unauthorized acts taken by the agent do not bind the government.” Creel, 419 F.3d at 1141.
Carlson has not presented undisputed evidence that Landau had authority to settle Carlson's refund claim at the time of the June 7, 2010 letter. Because the record is inconclusive as to when this matter was actually referred to the Department of Justice, and by extension, whether Landau had authority to compromise at the time of the purported settlement agreement, the Court finds that a genuine issue of material fact remains as to this argument.
Furthermore, release is a defense that must be affirmatively pled. See Fed. R. Civ. P. 8(c)(1). Because Carlson did not raise the affirmative defense of release from liability by virtue of Landau's letter in her response to the government's counterclaim, the argument is waived, and Carlson may not claim release of liability as a ground for summary judgment. Accordingly, summary judgment is denied on this ground.
B. Is Summary Judgment Warranted Based on the Scope of § 6701?
Carlson argues that summary judgment is appropriate because the United States cannot produce any evidence that she was a “material advisor” to her Jackson Hewett clients. Carlson contends that § 6694 is intended to apply to tax preparers, while § 6701 is intended to apply to those who materially advise taxpayers. To apply § 6701 to individuals “who do nothing more than prepare returns,” Carlson argues, would render § 6694 completely superfluous, contrary to the basic principles of statutory construction: that, if possible, courts should give effect to every clause and word of a statute, and avoid rendering superfluous any statutory language. Carlson urges the Court to consider [pg. 2011-7447] the statutory titles, the IRS's internal forms, and the IRS Manual as support for her argument that § 6694 applies to tax return preparers, while § 6701 applies only to those who materially advise taxpayers. The Court rejects these arguments.
To establish that a § 6701 penalty should be imposed against an individual, the government must prove: (1) that person aided in the preparation of any portion of a tax-related document; (2) that person knew, or had reason to believe, that portion would be used in connection with a material matter relevant to the internal revenue laws; and (3) that person knew that portion would result in an understatement of tax liability for another person or entity. 26 U.S.C. § 6701(a). Section 6701 plainly provides for assessment of this penalty against “any person” who committed the proscribed conduct. Id.
Section 6694(a), by contrast, penalizes tax return preparers for preparing any return that results in an understatement of liability by virtue of a position for which the preparer knew or reasonably should have known did not have a realistic possibility of being sustained on the merits. 26 U.S.C. § 6694(a) (1989). Section 6694(b) penalizes tax return preparers for preparing a return, of which any part of any understatement of liability is due either to a willful attempt to understate liability, or to any reckless or intentional disregard of the rules or regulations. Id. at § 6694(b).
Courts must give effect to overlapping statutes in the absence of a “positive repugnancy” between them. See Conn. Nat'l Bank v. Germain, 503 U.S. 249, 253 (1992). There is no such positive repugnancy here. 4Section 6701 is aimed at different conduct than is § 6694; specifically, § 6701 is not aimed at simply preparing a tax return, but instead, it focuses on aiding, assisting, procuring, or advising “with respect to, the preparation or presentation of any portion of a return, affidavit, claim, or other document.” 26 U.S.C. § 6701(a)(1); see also Mattingly v. United States, 924 F.2d 785, 788 [67 AFTR 2d 91-494] (8th Cir. 1991) (noting that before the enactment of § 6701, “there was no civil penalty to punish aiding and abetting conduct” in the internal revenue laws). Moreover, § 6701 is applicable, not only to tax return preparers (to whom § 6694 applies), but to any person whose conduct exposes him or her to liability under the statute. 26 U.S.C. § 6701(a). Finally, and perhaps most importantly, Congress acknowledged that certain conduct could violate both §§ 6694 and 6701, because § 6701 specifically disallows assessing a penalty under § 6694 with respect to any document for which a penalty has already been assessed under § 6701. See 26 U.S.C. § 6701(f)(2).
The plain language of § 6701 does not require that the person penalized be a “material advisor.” Additionally, Carlson has not cited, and the Court has not found, any case in which that requirement was read into that statute, and the Court declines to do so now. Accordingly, Carlson is not entitled to summary judgment on this ground.
C. Is Summary Judgment Warranted Based on Lack of Due Process?
1. Denial of Administrative Appeal
Carlson argues that she was denied the opportunity to administratively appeal the IRS's assessment of the penalties because she was forced to file this suit within 30 days of being notified that her refund claim had been disallowed; Carlson alleges this was a denial of due process. Carlson argues that the Treasury Regulations provide that taxpayers assessed penalties under § 6701 are entitled to a post-assessment administrative appeal. Thus, she submits that the proper course of action would have been to give her an opportunity to administratively appeal the IRS's disallowance of her refund claim, and to have the statutory period for filing the refund suit begin to run only after the disallowance became final.
Ordinarily, full payment of a tax assessment is required before bringing suit in federal court. See Flora v. United States , 357 U.S. 63, 72 [1 AFTR 2d 1925]–75 (1958). Section 6703 5 provides an exception to that requirement by allowing an individual who is levied pursuant to [pg. 2011-7448] §§ 6700 or 6701 to file suit after paying only 15% of that penalty. 26 U.S.C. § 6703(c); see Dalton v. United States, 800 F.2d 1316, 1318 [58 AFTR 2d 86-5775] (4th Cir. 1986). If the individual seeking a refund fails to initiate a lawsuit within 30 days of receiving notice that his or her claim for a refund has been denied by the IRS, then that individual can proceed to district court only by paying the full amount of the penalty assessed and filing suit within the two-year limitation period. 26 U.S.C. § 6703(c); see Dalton, 800 F.2d at 1318–19; see also Thomas v. United States, 755 F.2d 728, 729 [55 AFTR 2d 85-1094]–30 (9th Cir. 1985).
In its March 23, 2010 notice that Carlson's refund claim had been denied, the IRS explained that Carlson had the option of filing suit in district court, and that “[t]he time for filing suit without paying additional funds is 30 days after the date of this letter ....” (Doc. No. 3, Ex. 1 at 15.) Even assuming that Carlson had a right to an administrative appeal, there is no evidence on the record demonstrating that she could not have, first, pursued an administrative appeal, and then — having exhausted administrative appeals — filed the instant lawsuit after paying the full penalty amount. Accordingly, summary judgment is denied on this ground.
2. Lack of Notice
In her motion for summary judgment, Carlson contends that the IRS compounded its denial of her due process rights by failing to give her notice that her § 6701 penalties were being reassessed after they were first abated by virtue of her purported settlement agreement with Landau. Alternatively, Carlson asks the Court to find that the IRS abused its discretion in failing to give Carlson notice under 26 U.S.C. § 6303.
The United States does not offer evidence that the IRS notified Carlson of the restoration of her § 6701 penalties; instead, it responds that “Ms. Carlson's lack-of-notice argument fails because when the IRS fails to give proper notice of a penalty under [Internal Revenue Code] § 6303, the only consequence is that the IRS may not invoke administrative remedies to collect it; civil actions brought by the United States to collect the penalties are not barred.” (Doc. No. 46 at 9).
Pursuant to § 6303 (by virtue of 26 U.S.C. § 6671), as soon as practicable, and within 60 days, after a penalty is assessed under § 6701, the Secretary of the Treasury must give notice to the person liable. See 26 U.S.C. §§ 6303, 6671. Carlson has not argued that the IRS failed to give her timely notice of the § 6701 penalties when they were originally assessed; her argument concerns only the IRS's reassessment of those penalties in November 2010. However, Carlson has not directed the Court to any case law showing that failure to give notice of a reassessment or restoration of penalties can form the basis for a due process claim. Furthermore, Carlson has not specifically alleged in her complaint that her due process claim is based on the IRS's failure to give her notice of the reassessment. 6 Therefore, the Court finds that Carlson has not met her burden, and denies summary judgment on this claim.
D. Is Partial Summary Judgment Warranted Based on the Penalties Specified in Carlson's Motion?
Carlson argues that if the Court does not grant her motion for summary judgment based on the arguments discussed above, then the Court should grant partial summary judgment as to a number of the specific penalties imposed against her. 7 She presents four basic arguments with respect to these penalties: (1) the United States has no evidence that Carlson prepared any document related to a claim; (2) the United States has no evidence that any such document resulted in any understatement of liability; (3) the United States has no evidence that Carlson knew that any such document would result in an understatement; and (4) the United States has no evidence that Carlson was a “material advisor” to the taxpayer. The Court rejects these arguments.
The United States has presented sufficient evidence to raise a genuine issue of material fact as to whether Carlson's remaining § 6701 penalties were justified. For example, the government provided affidavit testimony from a former Jackson Hewitt co-worker of Carlson's that outlined the following: (1) Carlson's awareness that receipts were forged or fabricated for purposes of thwarting IRS audits; (2) Carlson's preparation of federal income tax returns that claimed false home office deductions; and (3) Carlson's concerns about Prewett's business practices and acknowledged [pg. 2011-7449] doubts about their lawfulness. (Doc. No. 46, Ex. 7).
The United States also provided affidavit testimony from a former Jackson Hewett client explaining: (1) that Carlson assisted Prewett in forming, without the client's direction, a corporation for the client's personal yacht; (2) that Carlson never discussed with the client how the yacht would be used or what types of deductions might be available for the yacht; and (3) that Carlson regularly took possession of the client's credit card and bank statements, which contained a mix of personal and business expenses, said she would separate them for him to claim only proper deductions, and never contacted him with questions about expenses or other tax-related information. (Doc. No. 46, Ex. 15).
Viewing the record evidence in the light most favorable to the United States, the Court finds that a genuine issue of material fact exists as to whether Carlson prepared documents knowing that those documents, if used, would understate another person's tax liability. Accordingly, Carlson is not entitled to summary judgment on the penalties specified in her motion, except as to the penalties related to returns filed by Frank and Ellen Kaman, Dain and Kasie Carlson, and Kent and Susan Messner.
Accordingly, Carlson's Motion for Summary Judgment (Doc. No. 31) is GRANTED with respect to the penalties relating to the returns of Kaman, Carlson, and Messner. Otherwise, the motion is DENIED. DONE AND ORDERED at Tampa, Florida, this 12th day of December, 2011.
United States District Judge
In 2008, Prewett was convicted of four federal counts related to drug distribution and money laundering. He is currently serving 18 years in prison.
Section 6701 provides, in pertinent part:
Penalties for aiding and abetting understatement of tax liability
((a)) Imposition of penalty. --Any person--
((1)) who aids or assists in, procures, or advises with respect to, the preparation or presentation of any portion of a return, affidavit, claim, or other document,
((2)) who knows (or has reason to believe) that such portion will be used in connection with any material matter arising under the internal revenue laws, and
((3)) who knows that such portion (if so used) would result in an understatement of the liability for tax of another person,
shall pay a penalty with respect to each such document in the amount determined under subsection (b).
((b)) Amount of penalty. --
((1)) In general.--Except as provided in paragraph (2), the amount of the penalty imposed by subsection (a) shall be $1,000.
((2)) Corporations.--If the return, affidavit, claim, or other document relates to the tax liability of a corporation, the amount of the penalty imposed by subsection (a) shall be $10,000.
26 U.S.C. § 6701.
The version of § 6694 applicable during the relevant time period provides, in pertinent part:
Understatement of taxpayer's liability by income tax return preparer
((a)) Understatements due to unrealistic positions. --If--
((1)) any part of any understatement of liability with respect to any return or claim for refund is due to a position for which there was not a realistic possibility of being sustained on its merits,
((2)) any person who is an income tax return preparer with respect to such return or claim knew (or reasonably should have known) of such position, and
((3)) such position was not disclosed as provided in section 6662(d)(2)(B)(ii) or was frivolous,
such person shall pay a penalty of $250 with respect to such return or claim unless it is shown that there is reasonable cause for the understatement and such person acted in good faith.
((b)) Willful or reckless conduct.--If any part of any understatement of liability with respect to any return or claim for refund is due--
((1)) to a willful attempt in any manner to understate the liability for tax by a person who is an income tax return preparer with respect to such return or claim, or
((2)) to any reckless or intentional disregard of rules or regulations by any such person,
such person shall pay a penalty of $1,000 with respect to such return or claim. With respect to any return or claim, the amount of the penalty payable by any person by reason of this subsection shall be reduced by the amount of the penalty paid by such person by reason of subsection (a).
26 U.S.C. § 6694 (1989).
Indeed, were such a positive repugnancy to exist, § 6694 (the earlier-enacted statute) would ordinarily be deemed repealed by § 6701 (the later-enacted statute). See generally Posadas v. Nat'l City Bank of N.Y., 296 U.S. 497, 501–04 (1936).
Section 6703 provides, in pertinent part:
(c) Extension of period of collection where person pays 15 percent of penalty. --
((1)) In general.--If, within 30 days after the day on which notice and demand of any penalty under section 6700 or 6701 is made against any person, such person pays an amount which is not less than 15 percent of the amount of such penalty and files a claim for refund of the amount so paid, no levy or proceeding in court for the collection of the remainder of such penalty shall be made, begun, or prosecuted until the final resolution of a proceeding begun as provided in paragraph (2). Notwithstanding the provisions of section 7421(a), the beginning of such proceeding or levy during the time such prohibition is in force may be enjoined by a proceeding in the proper court. Nothing in this paragraph shall be construed to prohibit any counterclaim for the remainder of such penalty in a proceeding begun as provided in paragraph (2).
((2)) Person must bring suit in district court to determine his liability for penalty.--If, within 30 days after the day on which his claim for refund of any partial payment of any penalty under section 6700 or 6701 is denied (or, if earlier, within 30 days after the expiration of 6 months after the day on which he filed the claim for refund), the person fails to begin a proceeding in the appropriate United States district court for the determination of his liability for such penalty, paragraph (1) shall cease to apply with respect to such penalty, effective on the day following the close of the applicable 30- day period referred to in this paragraph.
26 U.S.C. § 6703(c).
The Court acknowledges that the IRS reassessed Carlson's penalties after she filed her complaint. However, if she intended to seek relief for the IRS's failure to give her notice of the reassessment, she should have filed an amended complaint.
The Court notes that the United States has conceded the disputed penalties related to returns filed by Frank and Ellen Kaman, Dain and Kasie Carlson, and Kent and Susan Messner. (Doc. No. 31 at 20–21; Doc. No. 46, Ex. 5). Accordingly, Carlson is entitled to summary judgment as to the penalties imposed for these three returns.
Wednesday, December 28, 2011