Donald E. Swanson ( 2023 )

United States Tax Court
T.C. Memo. 2023-81DONALD E. SWANSON,
Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
—————
Docket No. 21701-18. Filed June 29, 2023.
—————
Christopher S. Crago, Andrew Simister (student), and Greg Spurgetis
(student), for petitioner.
Adriana E. Vargas, Daniel G. Kempland, and Melissa D. Lang, for
respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
PUGH, Judge: Respondent determined the following deficiencies,
additions to tax, and accuracy-related penalties with respect to Donald
Swanson’s federal income tax for years 2014–16 (years in issue):
Additions to Tax / Penalties
Year Deficiency
§ 6651(a)(1) § 6662(a)
2014 $16,135 $4,034 $3,227
2015 38,762 9,691 7,752
2016 4,299 — 860
Deficiencies resulted largely from respondent’s determination
that Mr. Swanson’s fishing charter activity was not a business for profit
Served 06/29/23
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[*2] within the meaning of section 183 1 and that he was not entitled to
business expense deductions. Respondent also made various other
income adjustments and reduced or disallowed some itemized
deductions.
In the Second Stipulation of Facts the parties conceded certain
adjustments for each year in issue.
Tax Year 2014
Respondent conceded that Mr. Swanson (1) is not liable for an
accuracy-related penalty of $3,227 and (2) is entitled to a noncash
charitable contribution deduction of $199. Mr. Swanson conceded that
he is not entitled to (1) a tax expense deduction of $2,288 (admitting that
his deduction is $1,306 as determined in the notice of deficiency) and
(2) a car and truck expense deduction of $1,993.
Tax Year 2015
Respondent conceded that Mr. Swanson is not liable for an
accuracy-related penalty of $7,752. Respondent also conceded that Mr.
Swanson is entitled to (1) a noncash charitable contribution deduction
of $200; (2) a cash charitable contribution deduction of $1,362; (3) a
supplies expense deduction of $1,389; and (4) an insurance expense
deduction of $1,259. Mr. Swanson conceded that he is not entitled to (1) a
mortgage interest expense deduction of $9,777; (2) a car and truck
expense deduction of $1,250; (3) a utilities expense deduction of $600;
and (4) an advertising expense deduction of $640. Mr. Swanson also
conceded that his gross receipts reported on Schedule C, Profit or Loss
From Business, should be increased by $155 for income received for tax
preparation services he provided.
Tax Year 2016
Respondent conceded that Mr. Swanson is not liable for an
accuracy-related penalty of $860. He also conceded that Mr. Swanson is
entitled to (1) a cash charitable contribution deduction of $670; (2) an
insurance expense deduction of $1,244; (3) an advertising expense
1 Unless otherwise indicated, statutory references are to the Internal Revenue
Code, Title 26 U.S.C., in effect at all relevant times, regulation references are to the
Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times, and
Rule references are to the Tax Court Rules of Practice and Procedure. We round all
monetary amounts to the nearest dollar.
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[*3] deduction of $2,256; and (4) an other expense deduction of $8,487.
Mr. Swanson conceded that he is not entitled to (1) a charitable
contributions carryover of $3,724; (2) a medical and dental expense
deduction of $409; (3) a car and truck expense deduction of $1,714; and
(4) a meals and entertainment expense deduction of $74.
In his Opening Brief respondent stated that after concessions, the
issues for consideration are whether Mr. Swanson: (1) engaged in a
fishing charter activity with the objective of making a profit within the
meaning of section 183; (2) is entitled to deductions for expenses
reported on the Schedules C attached to his federal income tax returns
for the years in issue; (3) is entitled to deductions reported on Schedules
A, Itemized Deductions, attached to his federal income tax returns for
the years in issue; (4) had income in excess of the amounts reported on
his federal income tax returns for the years in issue; (5) had capital gains
from the sale of real property in excess of the amounts reported on his
federal income tax return for 2015; (6) is entitled to charitable
contribution deductions in amounts greater than allowed by respondent
for the years in issue; (7) is entitled to expense deductions reported on
Schedules E, Supplemental Income and Loss, in amounts greater than
respondent allowed for 2014 and 2015; and (8) is liable for section
6651(a)(1) additions to tax for failure to timely file federal income tax
returns for 2014 and 2015.
The two issues that Mr. Swanson challenged at trial and in his
posttrial briefs are whether his fishing charter trip activity was a
business or a hobby within the meaning of section 183 and whether he
is entitled to deductions for certain expenses related to his activity in
2015 (boat and airplane expenses) and 2016 (boat expenses). Because
one of the issues involves unreported income, on which respondent bears
the burden of proof, we must decide whether respondent has met his
burden. Respondent has the burden of production as to the additions to
tax. See § 7491(c). We deem Mr. Swanson to concede all other issues
because he did not challenge them at trial or in his briefs, and we sustain
respondent’s determinations with respect to those issues. We make no
separate findings of fact related to those conceded issues.
FINDINGS OF FACT
The facts we find are derived from the pleadings, the trial
testimony, and the documents admitted into evidence and include the
stipulated facts and documents. Mr. Swanson resided in Alaska when
he timely filed his Petition.
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[*4] I. Happy Jack Charters
Mr. Swanson is an avid fisherman and has been fishing in Alaska
for more than 30 years. In 2010, after retiring from two jobs (loading
cargo and driving a city bus), he decided to establish Happy Jack
Charters and acquired a boat designed to fish for halibut. Mr. Swanson
wanted to show people where to fish and how to fish. His boat, a 22-foot
Boulton Sea skiff, was made in Oregon.
During the years in issue Mr. Swanson lived in Anchorage,
Alaska, but his plan was to take people on halibut fishing trips in
Homer, Alaska. His life partner’s children lived in Homer, and they let
Mr. Swanson store his boat, camper, truck, and other things on their
property. This allowed Mr. Swanson to reduce his expenses. He hoped
to retire eventually, buy a cabin, and fish in Homer. In 2015, to shorten
his travel time between Anchorage and Homer, Mr. Swanson acquired
a plane. Although he also wanted to use the plane to transport
customers, he was not allowed to do that during the years in issue
because he had only a student license.
Mr. Swanson did not own a commercial fishing permit for halibut
fishing but rented one in 2015 and 2016. The State of Alaska requires
fishermen to maintain a detailed log of fish caught daily. Because Mr.
Swanson did not have a commercial fishing license in 2014, he did not
take any fishing charter trips and did not file fishing logs with the
Alaska Department of Fish and Game for that year. In 2015 and 2016
Mr. Swanson filed fishing logs with the Alaska Department of Fish and
Game reporting five fishing charter trips in 2015: on June 10 and 14,
and on July 15, 21, and 25; and six fishing charter trips in 2016: on July
2, 12, 14, 16, and 22, and on August 18. Mr. Swanson also took his boat
for personal fishing trips. During the years in issue he sometimes used
the personal fishing trips to photograph people catching fish for
advertisements to promote Happy Jack Charters. The halibut fishing
season lasts from May to September.
A cancer diagnosis and treatment restricted Mr. Swanson’s
physical activities in 2013, but during the years in issue he did not have
to travel for cancer treatments. In 2015 he suffered a knee injury in an
automobile accident, but he was able to perform the duties of a captain
after the injury. A boat fire in 2016 took his boat out of service for the
week or two that the repairs took to complete.
5
[*5] Mr. Swanson did not rely on the income from operating Happy
Jack Charters. His main sources of income for the years in issue were
Social Security, pension, and rental income from his two real estate
properties. He did not have a separate bank account, accounting or
recordkeeping system, or income and expense journals for Happy Jack
Charters for the years in issue. But he did keep expense receipts for tax
purposes.
In 2014 the Internal Revenue Service (IRS) audited Mr.
Swanson’s 2010 federal income tax return. Mr. Swanson explained that
during the audit the IRS agent told him that he did not have “the right
kind of insurance” and “the right kind of license.” Following the audit,
Mr. Swanson purchased “commercial insurance” and a “commercial
license.” 2 In addition, he started using an application called “Square” to
track his business income, and he joined the Chamber of Commerce.
During the years in issue Mr. Swanson traveled to several trade
shows hoping to attract customers for his fishing charter activity. He did
not land any customers from the shows in the years in issue, but he still
hoped that they would come later.
II. Business Expenses (Schedule C)
Mr. Swanson produced copies of receipts for boat and airplane
expenses for 2015 and 2016:
2015 Boat Expenses 2015 Airplane Expenses 2016 Airplane Expenses
Petro Marine $174.06 Avionics $95.00 Missionary $55.44
Petro Marine 126.03 No Li Avionics 56.30 Smon 77.61
Petro Marine 164.51 No Li Avionics 99.90 Northern Lights 78.65
Petro Marine 125.43 No Li Avionics 32.05 Northern Lights 7.55
Petro Marine 8.22 No Li Avionics 12.95 Ace 73.38
Petro Marine 75.97 No Li Avionics 55.90 Ace 80.77
Petro Marine 107.12 No Li Avionics 39.90 Ace 69.27
Petro Marine 142.13 No Li Avionics 678.45 Crowley Fuels 62.92
Petro Marine 92.89 Ace 35.06 Crowley Fuels 44.82
Petro Marine 115.99 Ace 48.10 Ace 38.44
Petro Marine 47.22 Ace 70.27 Crowley Fuels 50.53
Petro Marine 82.23 Ace 44.16 Ace 35.75
Petro Marine 58.54 Ace 26.12 Ace 63.66
2 The record does not indicate when Mr. Swanson bought the insurance, but
we infer that it was after the IRS audit and before the years in issue.
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[*6]
Petro Marine 81.41 Ace 48.66 Ace 57.75
Petro Marine 158.56 Ace 58.31 Ace 84.45
Petro Marine 29.71 Ace 64.03 Ace 40.81
Petro Marine 111.74 Ace 53.42 Ace 68.59
Petro Marine 90.96 Ace 39.20 Ace 41.17
Petro Marine 20.18 Ace 53.78 C2 Aviation 55.19
Petro Marine 39.53 Missionary 76.74 Seaplanes North 52.50
— — Ace 52.28 Ace 55.55
— — Ace 84.39 Crowley Fuels 46.44
— — Ace 61.21 Crowley Fuels 49.00
— — Ace 38.75 Crowley Fuels 9.28
— — C&J 20.00 Pathfinder 74.90
— — Ace 54.27 State of Alaska 210.00
— — Smokey Bay 45.49 LASA 165.00
— — Petro Marine 47.22 Sky Airports 35.00
— — Sky Airparts 61.68 Stoddards 8.00
— — Municipality 100.00 LASA 165.00
— — Bieg Big Studios 680.00 T&B Aircraft 715.00
— — Gary M 600.00 Seaplanes North 1,052.48
— — AMA 371.00 Seaplanes North 761.59
— — Ron Stafford 565.00 Seaplanes North 14.70
— — AMA 557.00 Seaplanes North 129.85
— — — — Seaplanes North 36.00
— — — — Seaplanes North 65.56
— — — — Avemco 612.75
— — — — Aviation Med. 173.40
— — — — Ron Stoffono 450.00
Total $1,852 $5,027 $5,969
III. Rental Income
Mr. Swanson owned two rental properties in Anchorage. He
received rental income during the years in issue from these properties.
In 2015 Mr. Swanson sold one of the properties for $279,900.
IV. Bank Deposits Analysis
Respondent’s revenue agent (RA) conducted a bank deposits
analysis for the years in issue. For 2014 the RA reviewed the Denali
Alaskan Federal account ending in 5879 (account 5879), the Alaska USA
Federal account ending in 1643 (account 1643), and the Alaska USA
Federal account ending in 1629 (account 1629). To determine Mr.
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[*7] Swanson’s gross receipts for the years in issue the RA used only
accounts 5879 and 1643 because account 1629 is a joint account. The RA
determined that in 2014 the total amount of bank deposits in the two
accounts was $116,435. In 2014 Mr. Swanson reported $75,785 of
income on his federal income tax return; therefore, the RA concluded
that in 2014 Mr. Swanson had unreported income of $40,650.
The RA determined that in 2015 the total amount of bank
deposits was $265,919. In 2015 Mr. Swanson reported $241,966 of
income; therefore, the RA concluded that in 2015 Mr. Swanson had
unreported income of $23,953. The RA classified the unreported income
into three categories: (1) unexplained unreported income of $18,983;
(2) income reportable on Schedule E, Line 3, Rents Received, of $4,820;
and (3) income reportable on Schedule C for income earned as a tax
professional of $150.
The RA determined that in 2016 the total amount of bank
deposits was $68,988. In 2016 Mr. Swanson reported $53,042 of income;
therefore, the RA concluded that in 2016 Mr. Swanson had unreported
income of $15,946. An error in the bank deposits analysis for 2016
resulted in an erroneous increase of $290 in the total deposits.
Mr. Swanson admitted that he received rental income and was
paid as a tax professional for helping his friend to prepare a tax return
on one occasion.
V. Federal Income Tax Returns
Mr. Swanson filed Forms 1040, U.S. Individual Income Tax
Return, for 2014 and 2015 on August 15, 2017. He filed Form 1040 for
2016 on June 5, 2017.
For 2014 Mr. Swanson reported $1,500 of gross receipts and
$1,993 of business expenses from his fishing charter activity. For 2015
he reported $2,345 of gross receipts and $36,960 of business expenses
from his fishing charter activity. And for 2016 Mr. Swanson reported
$3,709 of gross receipts and $25,631 of business expenses from his
fishing charter activity. Mr. Swanson filed federal income tax returns
reflecting income and business expense deductions for his fishing
charter activity for 2010 and 2012 through 2016. He reported net
business losses for each of those years, totaling $131,105.
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[*8] OPINION
The main issue in this case is whether during any of the years in
issue Mr. Swanson entered into or carried on his fishing charter activity
for profit and whether the associated deductions were proper.
I. Burden of Proof
Generally, the taxpayer bears the burden of proving that the
Commissioner’s determinations are erroneous. Rule 142(a); Welch v.
Helvering, 290 U.S. 111, 115 (1933). Under section 7491(a)(1), “[i]f, in
any court proceeding, a taxpayer introduces credible evidence with
respect to any factual issue relevant to ascertaining the liability of the
taxpayer for any tax imposed by subtitle A or B, the Secretary shall have
the burden of proof with respect to such issue.” See Higbee v.
Commissioner, 116 T.C. 438, 442 (2001). Mr. Swanson does not contend
that the burden of proof should shift to respondent under section
7491(a), and we conclude that section 7491(a) does not apply here.
In cases involving unreported income, the Commissioner must
establish an evidentiary foundation connecting the taxpayer to the
income-producing activity, Weimerskirch v. Commissioner, 596 F.2d
358, 361 (9th Cir. 1979), rev’g 67 T.C. 672 (1977), or demonstrate that
the taxpayer actually received income, Edwards v. Commissioner, 680
F.2d 1268, 1270–71 (9th Cir. 1982). Once the Commissioner has met this
threshold burden, the burden shifts to the taxpayer to show that the
Commissioner’s determination of income was arbitrary or erroneous.
Hardy v. Commissioner, 181 F.3d 1002, 1004–05 (9th Cir. 1999), aff’g
T.C. Memo. 1997-97.
II. For-Profit Business
Taxpayers are generally allowed deductions for business and
investment expenses. See §§ 162, 212. Under section 183(a), individuals
are not allowed a deduction attributable to an activity “if such activity
is not engaged in for profit” except to the extent provided by section
183(b). Section 183(b) allows deductions that would have been allowable
had the activity been engaged in for profit but only to the extent of gross
income derived from the activity (reduced by deductions attributable to
the activity that are allowable without regard to whether the activity
was engaged for profit).
Section 183(c) defines an activity not engaged in for profit as “any
activity other than one with respect to which deductions are allowable
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[*9] for the taxable year under section 162 or under paragraph (1) or (2)
of section 212.” For expenses to be fully deductible under section 162 or
212, taxpayers must show that they are engaged in the activity with the
primary objective of making a profit. Wolf v. Commissioner, 4 F.3d 709,
713 (9th Cir. 1993), aff’g T.C. Memo. 1991-212; see also Westbrook v.
Commissioner, 68 F.3d 868, 875 (5th Cir. 1995), aff’g T.C. Memo. 1993-
634.
The expectation of a profit need not be reasonable, but the
taxpayer must conduct the activity with the actual and honest objective
of making a profit. Keating v. Commissioner, 544 F.3d 900, 904 (8th Cir.
2008), aff’g T.C. Memo. 2007-309. Greater weight is given to objective
facts than to the taxpayer’s self-serving statement of intent. King v.
Commissioner, 116 T.C. 198, 205 (2001); Treas. Reg. § 1.183-2(a) and (b).
The regulations provide a nonexhaustive list of nine factors that
should be considered: (1) the manner in which the taxpayer carries on
the activity; (2) the expertise of the taxpayer or the taxpayer’s advisers;
(3) the time and effort expended by the taxpayer in carrying on the
activity; (4) the expectation that assets used in the activity may
appreciate in value; (5) the success of the taxpayer in carrying on other
similar activities; (6) the taxpayer’s history of income or loss 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) whether
elements of personal pleasure or recreation are involved. Treas. Reg.
§ 1.183-2(b). Neither a single factor, nor the existence of even a majority
of the factors is controlling; rather all the facts and circumstances should
be evaluated. See Golanty v. Commissioner, 72 T.C. 411, 426–27 (1979),
aff’d without published opinion, 647 F.2d 170 (9th Cir. 1981).
A. Manner in Which the Taxpayer Carries on the Activity
Carrying on an activity in a businesslike manner, as by
maintaining complete and accurate books and records, conducting the
activity in a manner similar to other activities of the same nature that
are profitable, and making changes in operations to adopt new
techniques or abandon unprofitable methods, is a factor that may
indicate a profit objective. Treas. Reg. § 1.183-2(b)(1). Businesslike
conduct is characterized by carefully and thoroughly investigating the
profitability of a proposed venture, monitoring the venture’s progress,
and attending to problems that arise over time. See Ronnen v.
Commissioner, 90 T.C. 74, 93 (1988); Taube v. Commissioner, 88 T.C.
464, 481–82 (1987). An important indication of whether an activity is
10
[*10] being performed in a businesslike manner is whether the taxpayer
implements methods for controlling losses, including efforts to reduce
expenses and generate income. See Foster v. Commissioner, T.C. Memo.
2012-207, 2012 WL 3000350, at *6; Dodge v. Commissioner, T.C. Memo.
1998-89, 1998 WL 88175, at *5, aff’d, 188 F.3d 507 (6th Cir. 1999).
For section 183 purposes, the key question is not whether the
taxpayer keeps records, but whether the taxpayer uses his records to
improve profitability and take steps to control expenses and increase
income. See Golanty, 72 T.C. at 430. Mr. Swanson explained that he kept
various receipts for tax purposes that he would hand to his accountant
at the end of the year “to figure it out.” Mr. Swanson did not have a
separate bank account for Happy Jack Charters; instead, he used
Square to track his income from the fishing charter activity. Mr.
Swanson did not explain whether and how he used the data about his
income and expenses to make his activity profitable. Neither did he keep
complete records of his Happy Jack Charters activity. His maintenance
of receipts of various expenses is insufficient. See Keating, T.C. Memo.
2007-309 (holding that complete and accurate books and records are
more than the mere maintenance of lists of, and receipts for, expenses).
And we are skeptical about the accuracy of Mr. Swanson’s income
tracking using Square as respondent’s bank deposits analysis
demonstrated significant discrepancies between his reported income on
his federal income tax returns and his deposits into his bank accounts.
Mr. Swanson did not have a business plan and made no
significant changes to reduce expenses and generate income the entire
time he operated Happy Jack Charters. He experienced significant
losses not only during the years in issue but from the beginning of his
fishing charter activity in 2010.
Mr. Swanson explained that he implemented some changes after
respondent’s audit of his 2010 federal income tax return. He explained
that he obtained a fishing license and commercial insurance, started
using Square, and engaged in advertising with the Chamber of
Commerce. He also attended trade shows hoping eventually to land new
clients. Some of these changes had nothing to do with increasing
profitability or reducing expenses but instead were necessary to comply
with applicable laws and regulations (maintaining a valid fishing license
and commercial insurance). Advertising generally indicates a profit
motive, but Mr. Swanson’s explanation of how advertising helped him
increase profitability of Happy Jack Charters was vague and
unpersuasive. He mentioned that his first client from trade show
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[*11] advertising was in 2017. During the three years in issue Mr.
Swanson had only 11 fishing trips. Despite the apparent lack of clients
and income, Mr. Swanson purchased an airplane and incurred
significant expenses related to storing, maintaining, and operating it.
Over the seven years of operating Happy Jack Charters, Mr. Swanson
never made changes that enhanced his prospect for making a profit.
Because Mr. Swanson did not maintain complete business
records, did not have a business plan, and did not respond to losses by
changing how he conducted his fishing charter activity, we find that he
did not conduct the activity in a businesslike manner. Therefore, this
factor weighs against Mr. Swanson.
B. The Expertise of the Taxpayer or His Advisers
The taxpayer’s expertise, research, and study of an activity, as
well as his consultation with experts, may be indicative of a profit
motive. Treas. Reg. § 1.183-2(b)(2). The type and quality of advice that
a taxpayer seeks is important to the analysis of the taxpayer’s
consultation with experts. See Engdahl v. Commissioner, 72 T.C. 659,
668 (1979) (noting that informal and continuous consultations with
experts in the field demonstrate an intent to engage in a business for
profit).
We do not doubt Mr. Swanson’s fishing expertise, but he did not
demonstrate to us that he had any expertise in running a business,
much less a fishing charter business. When he first started, he did not
have a commercial fishing license or commercial insurance; only after
the IRS audit did he rectify these omissions. Mr. Swanson did not
demonstrate how he prepared for running a fishing charter business,
whether he did any research or study, or whether he consulted with
experts or received any other advice about operating a fishing charter
business.
Mr. Swanson testified that he joined the Chamber of Commerce
but did not explain whether or how it better equipped him to run a
profitable fishing charter business. He testified only that he viewed it as
another avenue for advertising.
Because Mr. Swanson lacked expertise in running a fishing
charter business and did not consult any advisers to compensate for his
lack of business expertise, this factor weighs against him.
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[*12] C. The Time and Effort Expended by the Taxpayer in Carrying
On the Activity
The taxpayer’s devotion of much of his personal time and effort to
carrying on an activity may indicate a profit motive, particularly if the
activity does not involve substantial personal or recreational enjoyment.
Treas. Reg. § 1.183-2(b)(3).
Mr. Swanson did not take any charter fishing trips in 2014 and
had only five and six trips in 2015 and 2016, respectively. He testified
that health issues restricted his physical activities in 2013 but did not
indicate how his health problems affected his activities in the years in
issue. Rather, the main reason Mr. Swanson did not take any fishing
trips in 2014 was that he did not have a commercial fishing license or
commercial insurance. Mr. Swanson did not explain why he had only 11
trips in 2015 and 2016.
The limited time that Mr. Swanson spent on fishing charter trips
in the years in issue indicates a lack of intent to make a profit from the
fishing charter activity. We find that this factor weighs against Mr.
Swanson.
D. Expectation that Assets Used May Appreciate in Value
An expectation that assets used in an activity will appreciate may
indicate a profit motive even if the taxpayer derives no profit from
current operations. Id. subpara. (4).
Mr. Swanson did not address this factor at trial or in posttrial
briefs, and offered no other evidence to show any assets used in the
fishing charter activity will appreciate in value. Accordingly, this factor
is neutral.
E. The Success of the Taxpayer in Carrying On Similar or
Dissimilar Activities
If a taxpayer has previously engaged in similar activities and
made them profitable, this success may show that the taxpayer has a
profit objective, even if the current activity is unprofitable currently. Id.subpara. (5).
Mr. Swanson did not address this factor at trial or in posttrial
briefs, and offered no other evidence to establish his success in other
businesses. Respondent notes that Mr. Swanson engaged in the
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[*13] management of rental properties which also generated losses for
all years in issue. We find that this factor weighs against Mr. Swanson.
F. The Taxpayer’s History of Income or Losses with Respect to
the Activity
A history of continued losses in an activity may indicate the lack
of a profit motive. Id. subpara. (6). While a series of losses during the
startup stage of an activity may not necessarily indicate a lack of profit
motive, a record of large losses over many years is persuasive evidence
that a taxpayer did not have that motive. See Golanty, 72 T.C. at 426.
Mr. Swanson started Happy Jack Charters in 2010 and
experienced a loss for every year through 2016. Over the course of these
seven years he reported more than $130,000 in losses. Mr. Swanson
contends that unforeseen circumstances caused him to experience
losses.
We sympathize with Mr. Swanson’s setbacks, but we do not think
that those issues were the main reason his fishing charter activity was
unprofitable. Mr. Swanson testified that despite his health problems he
was able to perform the duties of a boat captain and that he did not have
to travel for treatment during the years in issue. The 2015 automobile
accident also did not keep Mr. Swanson from performing his fishing
charter activity. He testified that despite the accident, he was able to
work that season. Lastly, the 2016 boat fire interrupted Mr. Swanson’s
fishing charter activity for only a week or two, the time it took to make
the necessary repairs.
Mr. Swanson’s continuous and significant losses indicate a lack of
a profit motive, and this factor weighs against him.
G. The Amount of Occasional Profits, if Any, Which Were
Earned
A taxpayer’s generation of some profits from an otherwise money-
losing venture may support the existence of a profit motive. Treas. Reg.
§ 1.183-2(b)(7).
Mr. Swanson did not address this factor at trial or in posttrial
briefs, and he stipulated that Happy Jack Charters experienced losses
for the seven years from its launch through the years in issue. Neither
did he attempt to show that there is potential for significant profit in the
future. We find that this factor weighs against Mr. Swanson.
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[*14] H. The Financial Status of the Taxpayer
Substantial income from sources other than the activity may
indicate that the activity is not engaged in for profit. Id. subpara. (8).
Mr. Swanson did not rely on income from Happy Jack Charters
as his main source of income, although he hoped that one day he would.
Mr. Swanson received income from a retirement pension, Social Security
retirement, and rental properties. He used his purported losses from the
fishing charter activity to reduce his income from other sources. Because
Mr. Swanson did not receive substantial income from his fishing charter
activity, he was spending his income from other sources to fund it. This
factor also weighs against Mr. Swanson.
I. Elements of Personal Pleasure or Recreation
The presence of personal motives for conducting an activity may
indicate lack of a profit objective, especially if the activity involves
personal or recreational aspects. Id. subpara. (9). An activity is not
classified as a hobby simply because the taxpayer finds it pleasurable.
Jackson v. Commissioner, 59 T.C. 312, 317 (1972). The analysis does not
require that the activity be engaged in with the exclusive intent of
deriving a profit or even maximizing profit. Treas. Reg. § 1.183-2(b)(9).
That said, “where the possibility for profit is small . . . and the possibility
for gratification is substantial, it is clear that the latter possibility
constitutes the primary motivation for the activity.” Dodge v.
Commissioner, 1998 WL 88175, at *7 (quoting Burger v. Commissioner,
T.C. Memo. 1985-523, aff’d, 809 F.2d 355 (7th Cir. 1987)).
We have no doubt that Mr. Swanson finds fishing pleasurable.
Mr. Swanson used his boat for personal fishing trips. He denied some
personal use and admitted some too. He could not adequately explain
the number of times that he had to refuel the boat that had no
corresponding charter booking. In addition Mr. Swanson testified that
his retirement plan has been to retire to Homer and fish.
A review of the entire record and the testimony at trial persuades
us that Mr. Swanson’s personal motives and the recreational or personal
aspects of his fishing charter activity outweighed his desire for profit.
This factor weighs against Mr. Swanson.
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[*15] J. Conclusion
While Mr. Swanson testified credibly about the time he spent on
Happy Jack Charters and the obstacles he faced, he did not demonstrate
that his fishing charter activity was more than a retirement hobby.
Considering the evidence as a whole, we are convinced that Mr. Swanson
wanted his fishing charter activity to succeed and he devoted time to it,
but he was not operating it as a business.
We therefore find that during the years in issue Mr. Swanson did
not operate his fishing charter activity with the requisite profit intent.
Consequently, he is entitled to deductions attributable to that activity
only to the extent allowed by section 183(b).
III. Unreported Income: Bank Deposits Analysis
Gross income includes “all income from whatever source derived.”
§ 61(a). A taxpayer must maintain books and records establishing the
amount of his gross income. § 6001. If a taxpayer fails to maintain and
produce the required books and records, the Commissioner may
determine the taxpayer’s income by any method that clearly reflects
income. See § 446(b); Petzoldt v. Commissioner, 92 T.C. 661, 693 (1989);
Treas. Reg. § 1.446-1(b)(1). The Commissioner’s reconstruction of
income “need only be reasonable in light of all surrounding facts and
circumstances.” Petzoldt, 92 T.C. at 687.
The bank deposits method is a permissible method of
reconstructing income. See Clayton v. Commissioner, 102 T.C. 632, 645
(1994); see also Kudo v. Commissioner, T.C. Memo. 1998-404, aff’d, 11
F. App’x 864 (9th Cir. 2001). Bank deposits constitute prima facie
evidence of income. See Tokarski v. Commissioner, 87 T.C. 74, 77 (1986).
The Commissioner need not show the likely source of a deposit treated
as income but “must take into account any nontaxable source or
deductible expense of which [he] has knowledge” in reconstructing
income using the bank deposits method. Clayton, 102 T.C. at 645–46. He
need not follow any “leads” suggesting that a taxpayer has deductible
expenses. DiLeo v. Commissioner, 96 T.C. 858, 872 (1991), aff’d, 959 F.2d
16 (2d Cir. 1992). After the Commissioner reconstructs the taxpayer’s
income and determines a deficiency, the taxpayer bears the burden of
proving that the bank deposits analysis is unfair or inaccurate. See
Clayton, 102 T.C. at 645; see also DiLeo, 96 T.C. at 883. The taxpayer
must prove that the reconstruction is in error and may do so by proving
that all or part of a deposit is not taxable. See Clayton, 102 T.C. at 645.
16
[*16] Because Mr. Swanson did not maintain books and records
sufficient to establish his income and expenses, the RA reconstructed
Mr. Swanson’s income using the bank deposits method. To support the
analysis, respondent produced bank records. Further, respondent
proved at least a few likely sources of income—Mr. Swanson admitted
that he received rental income as well as one payment for preparing a
friend’s tax return. Respondent’s analysis is well supported, and we
accept the reconstruction of income and expenses as reasonable and
accurate. Thus, we conclude that respondent has met his burden of
proof.
Mr. Swanson did not argue that respondent’s reconstruction was
unfair or inaccurate and thus did not meet his evidentiary burden. We
therefore sustain respondent’s determinations with respect to
unreported income for the years in issue.
IV. Additions to Tax
Respondent determined additions to tax under section 6651(a)(1)
for 2014 and 2015. Respondent bears the burden of production with
respect to additions to tax and must produce evidence that they are
appropriate. See § 7491(c); Higbee, 116 T.C. at 446–47.
Section 6651(a)(1) imposes an addition to tax for failure to file a
return on or before the due date (including extensions) unless the
taxpayer can establish that such failure was “due to reasonable cause
and not due to willful neglect.” To demonstrate reasonable cause, a
taxpayer must show that he exercised ordinary business care and
prudence but was nevertheless unable to file on time. United States v.
Boyle, 469 U.S. 241, 246 (1985); Treas. Reg. § 301.6651-1(c)(1).
Respondent produced evidence of late filing, which Mr. Swanson
did not dispute. Neither did he argue that the failure to timely file his
2014 and 2015 tax returns was due to reasonable cause. Thus, we
conclude that respondent met his burden of production with respect to
the additions to tax.
To reflect the foregoing and respondent’s concessions,
Decision will be entered under Rule 155.