John A. Sernett v. Commissioner,
TC Memo 2012-334 , Code Sec(s) 183; 7491.
JOHN A. SERNETT, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent .
Case Information:
Code Sec(s):
183; 7491
Docket: Docket
No. 25295-10.
Date Issued:
12/3/2012
HEADNOTE
XX.
Reference(s): Code Sec. 183; Code
Sec. 7491
Syllabus
Official Tax Court Syllabus
Michael J. Dwyer, Ward Rollin
Anderson, and Rebecca S. Christensen, for petitioner.
II. Whether Sternett Motorsports
Was Operated for Profit A. Section 183
Generally 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) and (b). Section 183(c) defines an “activity
not engaged in for profit” as “any activity other than one with respect to
which deductions are allowable for the taxable year under section 162 or under
paragraph (1) or (2) of section 212.” An activity constitutes a “trade or
business” within the meaning of section 162 if it is conducted with continuity,
regularity, and for the primary purpose of realizing income or profit.
Commissioner v. Groetzinger, 480 U.S. 23, 35 [59 AFTR 2d 87-532] (1987). The
U.S. Court of Appeals for the Eighth Circuit, to which an appeal in this case
would lie absent a stipulation to the contrary,see, sec. 7482(b)(1)(A), (2),
has stated that "[a]n activity is engaged in for profit if the taxpayer
has an actual, honest profit objective, even if it is unreasonable or
unrealistic.” Keating v. Commissioner, 544 F.3d 900, 904 [102 AFTR 2d
2008-6638] (8th Cir. 2008), aff'g [*11]
T.C. Memo. 2007-309 [TC Memo 2007-309]; see also sec. 1.183-2(a), Income
Tax Regs. Whether the requisite profit objective exists is determined by
looking at all the facts and circumstances, Evans v. Commissioner, 908 F.2d
369, 373 [66 AFTR 2d 90-5500] (8th Cir. 1990), rev'g T.C. Memo. 1988-468
[¶88,468 PH Memo TC]; sec. 1.183-2(a), Income Tax Regs., and greater weight is
given to objective facts than to a taxpayer's statement of intent,Thomas v.
Commissioner, 84 T.C. 1244, 1269 (1985), aff'd, 792 F.2d 1256 [58 AFTR 2d
86-5138] (4th Cir. 1986); sec. 1.183-2(a), Income Tax Regs.
Section 1.183-2(b), Income Tax
Regs., provides a list of factors to be considered in the evaluation of a taxpayer'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
expended by the taxpayer in carrying on the activity; (4) the expectation that
assets used in the activity may appreciate in value; (5) the success of the
taxpayer in carrying on 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, 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. See Dunn [*12] v.
Commissioner, 70 T.C. 715, 720 (1978), aff'd, 615 F.2d 578 [45 AFTR 2d 80-683]
(2d Cir. 1980); sec. 1.183-2(b), Income Tax Regs.
B. Petitioner's Racing Activity
We apply the factors listed in
section 1.183-2(b), Income Tax Regs., as follows.
1. The Manner in Which Petitioner
Conducted the Activity In deciding whether a taxpayer has conducted an activity
in a businesslike manner we consider whether the taxpayer: (1) maintained
complete and accurate books and records; (2) conducted the activity in a manner
substantially similar to other activities of the same nature that were
profitable; and (3) changed operating methods, adopted new techniques, or abandoned
unprofitable methods in a manner consistent with an intent to improve
profitability. See Engdahl v. Commissioner 72 , T.C. 659, 666-668 (1979); sec.
1.183-2(b)(1), Income Tax Regs.
Petitioner contends that he
operated Sernett Motorsports in a businesslike manner by (1) investing heavily
in capital assets, (2) analyzing his performance after each season, (3)
consulting with various advisers, (4) racing only in races offering significant
prize money, (5) maintaining accurate records, and (6) maintaining a separate
checking account for Sernett Motorsports. Respondent contends that Sernett
Motorsports was not operated in a businesslike manner [*13] because petitioner
(1) failed to maintain comprehensive books and records for evaluating his
racing activity, (2) lacked a written or credible business plan, (3) commingled
his personal funds with his business funds in Sernett Motorsports' checking
account, and (4) failed to take steps to reduce costs or to increase
profitability.
Although petitioner invested heavily
in capital assets, such investment is consistent with respondent's theory that
petitioner's racing activity was simply an expensive hobby. Petitioner kept
accurate records, but he seemingly did so to satisfy the Code's recordkeeping
requirements rather than as a tool to achieve profitability. See Golanty v.
Commissioner, 72 T.C. 411, 430 (1979), aff'd without published opinion, 647
F.2d 170 (9th Cir. 1981); Nissley v. Commissioner, T.C. Memo. 2000-178 [TC Memo
2000-178], 79 T.C.M. (CCH) 2105, 2110 (2000). Similarly, petitioner testified
that he consulted with his C.P.A. regarding various tax matters but he could
not testify with specificity regarding any financial advice that his C.P.A. may
have provided. We find, however, that there is no indication that he commingled
his personal funds with those of his racing activity.
Petitioner obtained marketing
materials from a professional design firm to help secure corporate sponsorships
for Sernett Motorsports. These materials indicate that he operated Sernett
Motorsports in a businesslike manner. [*14] Petitioner did not have a written
business plan during the years in issue. Petitioner's lack of a written
business plan indicates that he did not operate Sernett Motorsports in a
businesslike manner.
We find credible petitioner's
testimony that he tried to minimize expenses and maximize his chances of
winning races. However, this is also consistent with respondent's theory that
petitioner's racing activity was an expensive hobby. Sprint car racing is a
competitive sport, and petitioner, no doubt, did whatever he could to win races
and minimize his expenses.
In short, petitioner conducted
Sernett Motorsports in a manner consistent both with the operation of a
profit-seeking enterprise and with the enjoyment of an expensive hobby.
Accordingly, this factor is neutral.
2. The Expertise of Petitioner or
His Advisers Preparation for an activity by an extensive study of its accepted
business, economic, and scientific practices, or consultation with those who
are experts therein, may indicate a profit objective. Engdahl v. Commissioner ,
72 T.C. at 668; sec. 1.183-2(b)(2), Income Tax Regs. Efforts to gain experience
and a willingness to follow expert advice may also indicate a profit objective.
See, e.g., Dworshak v. Commissioner, T.C. Memo. 2004-249 [TC Memo 2004-249], 88
T.C.M. (CCH) 403, 406 (2004). [*15] Petitioner contends that his expertise and
the expertise of those with whom he consulted are indicative of a profit
motive. Respondent contends that petitioner lacked expertise with respect to
creating a profitable racing enterprise and failed to seek advice from experts
on making Sernett Motorsports profitable.
Petitioner has a bachelor's degree
in business administration from Creighton University and is a successful
salesperson. He managed a racing team for C.L. Boyd during the early 1980s and
raced sprint cars for others for 15 years before starting his own sprint car
racing activity. Since then petitioner has been racing for and managing Sernett
Motorsports. Petitioner regularly consulted with a close network of sprint car
racing enthusiasts, frequented racing supply shops, and attended the
Performance Racing Industry Trade Show in Orlando, Florida. We are satisfied
that petitioner had the requisite expertise to run a sprint car racing
business. Accordingly, this factor favors petitioner.
3. Petitioner's Time and Effort
Devoted to the Activity The fact that a taxpayer devotes personal time and
effort to carry on an activity may indicate an intention to derive a profit,
particularly where there are no substantial personal or recreational elements
associated with the activity. Sec. 1.183-2(b)(3), Income Tax Regs. [*16]
Petitioner contends that he spent significant time racing and preparing to race
and reduced the hours he worked for NACR during the racing season. Respondent
contends that petitioner's testimony with respect to the amount of time he
spent on his racing activity is uncorroborated and self-serving and that it is
anyway insufficient to show that his racing activity was conducted with a
profit motive.
Petitioner credibly testified that
he spent 15-20 hours during the week before a racing event preparing for the
event. Petitioner explained that he disassembled the cars after each race and
then cleaned, inspected, and replaced various parts, as required. He credibly
testified that, during the years in issue, he raced between 10 and 16 weekends
per racing season 6 and that he traveled to events up to five hours away from
his shop in Lakeville, Minnesota. Petitioner also credibly testified that he
reduced the number of hours that he spent working for NACR from 40-50 per week
during the off-season to 20-25 per week during the racing season.
Although, as we find infra pp.
26-27, petitioner enjoys racing, we find that petitioner also spent significant
personal time and effort preparing his cars for [*17] racing events. See Foster
v. Commissioner, T.C. Memo. 2012-207 [TC Memo 2012-207], slip op. at 18.
Additionally, petitioner significantly reduced the hours he spent working his
lucrative, fully commissioned job for NACR so that he could prepare his cars
for racing events. Accordingly, this factor favors petitioner.
4. Expectation That Assets Used in
the Activity May Appreciate An activity may produce an overall economic profit,
even if there is no operational profit, when appreciation of the assets of the
activity is taken into account. Sec. 1.183-2(b)(4), Income Tax Regs.
Petitioner contends that his
equipment should not have to appreciate for him to show a profit motive.
Respondent contends that petitioner introduced no evidence that his equipment
appreciated, and the record supports an inference that petitioner's equipment
was not appreciating.
Petitioner has introduced no
evidence that any of his racing equipment or assets appreciated. See Rule
142(a)(1). However, the absence of asset appreciation does not indicate that
petitioner lacked a profit motive. See Foster v. Commissioner, slip op. at 19.
Accordingly, this factor is neutral. [*18] 5. Success in Carrying On Similar or
Dissimilar Activities The fact that a taxpayer engaged in similar activities
and converted them from unprofitable to profitable enterprises may indicate
that the taxpayer is engaged in the present activity for a profit, even though
the activity is presently unprofitable. Sec. 1.183-2(b)(5), Income Tax Regs.
To support his contention that he
had success in carrying on similar activities, petitioner merely points to his
experience in the racing industry. Respondent contends that petitioner produced
no evidence showing that he successfully operated similar activities.
Petitioner has introduced no
evidence showing that he engaged in similar activities and converted them from
unprofitable to profitable enterprises. See Rule 142(a)(1). Accordingly, this
factor is neutral. See Pirnia v. Commissioner, T.C. Memo. 1989-627 [¶89,627 PH
Memo TC], 58 T.C.M. (CCH) 740, 743 (1989).
6. Petitioner's History of Income
or Loss From the Activity A taxpayer's history of income or loss with respect
to an activity may indicate the presence or absence of a profit objective. See
Golanty v. Commissioner, 72 T.C. at 426; sec. 1.183-2(b)(6), Income Tax Regs.
However, a series of startup losses or losses sustained because of unforeseen
circumstances beyond the control of the taxpayer does not necessarily indicate
a lack of profit [*19] motive. Engdahl v. Commissioner 72 T.C. at 669; Kahla v.
Commissioner, , T.C. Memo. 2000-127 [TC Memo 2000-127], 79 T.C.M. (CCH) 1846,
1852 (2000), aff'd without published opinion, 273 F.3d 1096 [88 AFTR 2d
2001-6055] (5th Cir. 2001); sec. 1.183-2(b)(6), Income Tax Regs.
Respondent contends that (1)
petitioner's racing activity has produced persistent and significant losses
since 1992 and (2) petitioner's use of his racing activity to boost his sales
performance with NACR contradicts his claim of a profit motive for his racing
activity.
Sernett Motorsports lost money
from 1992 through 2009. From 2000 through 2007 Sernett Motorsports had gross
receipts of $199,963, total expenses of $770,677, and total losses of $570,714.
This history of significant, sustained losses is persuasive evidence that
petitioner did not operate Sernett Motorsports with a profit motive. See
Golanty v. Commissioner, 72 T.C. at 427. 7 [*20] To rebut this evidence
petitioner points to his success as a salesperson for NACR, arguing that some
of this success is attributable to his operation of Sernett Motorsports. 8titioner
credibly testified that part of his success as a salesperson was attributable
to his operation of Sernett Motorsports. Petitioner explained that he used
Sernett Motorsports as a “marketing, promotional, bonding vehicle” and that he
used the racing activity to build long-term relationships with his telephone
equipment buyers. Petitioner introduced emails showing that he used Sernett
Motorsports as a marketing tool, and NACR's president and CEO, Thomas M. Roles,
wrote in a letter dated April 29, 2008, that “Sernett Motorsports has a direct
contribution to *** success in the telephone equipment business from a
marketing standpoint and is an important part of his overall success as a sales
representative”. We therefore find that petitioner continued operating Sernett
Motorsports, at least in part, because Sernett Motorsports helped him succeed
in his job as a salesperson for NACR.
Although Sernett Motorsports may
have increased petitioner's income from NACR, the significant, sustained losses
that it produced indicate that petitioner did [*21] not operate Sernett
Motorsports with a profit motive. See Morken v. Commissioner, T.C. Memo.
1986-535 [¶86,535 PH Memo TC], 52 T.C.M. (CCH) 969, 972 (1986). To the
contrary, petitioner's belief that his racing activity increased his income
from NACR lessened his concern about his losses from Sernett Motorsports. See
id. 9 Moreover, petitioner's generalized belief that his racing activity helped
increase his income as a salesperson is insufficient to overcome the objective
evidence of significant, sustained losses from 1992 through 2009, particularly
when petitioner could not quantify the effect of the racing activity on his
commission income.
Petitioner does not contend, and
the record does not suggest, that Sernett Motorsports' significant, sustained
losses were startup losses or losses sustained because of unforeseen
circumstances beyond his control. Accordingly, this factor favors respondent.
7. Amount of Occasional Profits
The amount of profits earned in
relation to the amount of losses incurred, the amount of the investment, and
the value of the assets in use may indicate a profit objective. See sec.
1.183-2(b)(7), Income Tax Regs. The opportunity to earn substantial profits in
a highly speculative venture may be sufficient to [*22] indicate that the
activity is engaged in for profit even though only losses are produced. See id.
Petitioner contends that he had
opportunities to earn significant profit from prize money and sponsorship
contracts. Respondent contends that petitioner's claimed expectations for
earning significant profit were unrealistic. a. Prize Money Sernett Motorsports
earned $31,430 in prize money during the years in issue. The $15,000 purse
structure that petitioner typically raced for had a top prize of $2,250 and a
second prize of $1,750. Petitioner testified that, had he placed higher in the
events, he could have earned between $225,000 and $350,000 in prize money
during the years in issue. 10 However, petitioner testified that, before the
years in issue, he raced in the Knoxville Nationals for a top prize of $140,000
but that he had stopped racing in that event because he did not feel that he
was “competitive enough to make money at that event.” Petitioner also testified
at trial, in March 2012, that he expected to earn prize money of approximately
$25,000 in 2012. [*23] As petitioner's reason for not competing in the
Knoxville Nationals during the years in issue and petitioner's more modest
expectations for the then-upcoming 2012 racing season show, petitioner is
capable of rationally judging his competitiveness. Additionally, we find that
petitioner could not have rationally expected that Sernett Motorsports would
earn significantly more prize money than it earned during the years in issue.
b. Sponsorships Sernett Motorsports earned $6,050 in corporate sponsorships
from two local businesses during the years in issue. Petitioner testified that
he also sought more lucrative sponsorships but was ultimately unsuccessful.
Petitioner testified with some detail regarding two of his proposals.
With respect to the first
proposal, petitioner testified that he pursued a $125,000, three-year
sponsorship from Tires Plus in May 2004. Petitioner further testified that he believed
that he had a good chance of obtaining the sponsorship from Tires Plus and that
the proposal was dropped when Bridgestone acquired Tires Plus in fall 2004.
However, in a summary of his solicitations of corporate sponsorships for
Sernett Motorsports, petitioner wrote that he met with Tires Plus in April
2003. Additionally, the written proposal for the sponsorship from Tires Plus
states that petitioner was then employed as a national account manager for
[*24] Progressive, and NACR acquired Progressive in 2003. The written proposal
also states that petitioner had 25 years of racing experience. Petitioner
started racing in 1975, giving him 25 years experience by 2000. The proposal
also has several dated quotes, and all of them predate 2000. 11 Accordingly,
although we are satisfied that petitioner proposed a sponsorship to Tires Plus,
the record does not reliably establish when this proposal was made.
With respect to the second
proposal, petitioner testified that he pitched a corporate sponsorship proposal
to Jack Links in Laurens, Iowa, in September 2005. The division manager at Jack
Links, Karl Paepke, was impressed and arranged for petitioner to meet with Jack
Links' marketing director, Peachy Hall, in Minong, Wisconsin, in May 2006. Jack
Links ultimately decided not to sponsor Sernett Motorsports because Sernett
Motorsports' demographics did not correspond with Jack Links' target
demographics at the time. Petitioner did not testify regarding the terms of the
proposed Jack Links sponsorship. [*25] We note that even if petitioner had
secured a three-year sponsorship along the lines of the unsuccessful Tires Plus
proposal for the years in issue, Sernett Motorsports would still have lost
money. There is no credible evidence in the record that any of petitioner's
other proposals would have brought Sernett Motorsports close to returning a
profit. Accordingly, we find that there was little or no likelihood that
Sernett Motorsports would earn significantly more sponsorship money than it
earned during the years in issue.
Because there is no credible
evidence that the substantial losses sustained by Sernett Motorsports were
likely to be offset by greater amounts of prize money and sponsorship income
during the years in issue, this factor favors respondent.
8. Petitioner's Financial Status
The fact that a taxpayer does not
have substantial income or capital from sources other than the activity in
question may indicate that the activity is engaged in for profit. See sec.
1.183-2(b)(8), Income Tax Regs. Substantial income from sources other than the
activity (especially if the losses from the activity would generate substantial
tax benefits) may indicate a lack of profit motive, particularly where elements
of personal pleasure or recreation are involved. See id.
Petitioner contends that his
success selling telecommunications equipment for NACR depends on his
involvement with Sernett Motorsports and sprint car [*26] racing. Respondent
contends that petitioner's financial status indicates that he did not operate
Sernett Motorsports with a profit motive because he received significant
compensation from his employment with NACR during the years in issue and
Sernett Motorsports' losses generated large tax savings.
During the years in issue,
petitioner earned a significant income as a fully commissioned salesperson for
NACR. The losses petitioner incurred from operating Sernett Motorsports
provided substantial tax benefits. And, as we findinfra pp. 26-27, petitioner
enjoyed racing. Accordingly, this factor favors respondent.
9. Elements of Personal Pleasure
or Recreation The existence of personal pleasure or recreation relating to an
activity may indicate the absence of a profit objective. See sec.
1.183-2(b)(9), Income Tax Regs. However, an activity is not treated as an activity
not engaged in for profit merely because the activity may have recreational or
pleasurable elements. Id.
Petitioner contends that he no
longer enjoys racing as he once did and that he raced solely for profit during
the years in issue. Respondent contends that the record shows that petitioner's
lifelong involvement in sprint car racing is motivated, not by a desire to make
a profit, but by his love of the sport. [*27] Petitioner testified that
maintaining his cars has become a chore and that “the thrill is basically
gone”. Petitioner further testified that he continues racing because “it makes
me money”. We do not find petitioner's self-serving, uncorroborated testimony
to be credible. See Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). Accordingly,
this factor favors respondent.
10. Conclusion
Of the nine factors listed in
section 1.183-2(b), Income Tax Regs., four favor respondent, two favor
petitioner, and three are neutral. Because Sernett Motorsports was a mature
activity during the years in issue, we place particular emphasis in our
analysis on its history of significant, sustained losses and on petitioner's
inability to reduce Sernett Motorsports' expenses or increase its income. See
Golanty v. Commissioner, 72 T.C. at 427 (history of sustained losses is
persuasive evidence of activity not entered into with profit motive). After
considering the factors, and the facts and circumstances of this case, we
conclude that petitioner did not have an actual, honest profit objective in
operating Sernett Motorsports during the years in issue. Accordingly,
petitioner's deductions for expenses incurred with respect to Sernett
Motorsports are subject to the limitations of section 183. [*28] We have
considered the parties' remaining arguments, and to the extent not discussed
above, conclude those arguments are irrelevant, moot, or without merit.
To reflect the foregoing and
respondent's concession,
www.irstaxattorney.com (212) 588-1113 ab@irstaxattorney.com
No comments:
Post a Comment