Tax_Research_Paper_Iii

Tax Research Assignment – Project III To: Jennifer Woods From: L. Bromfield Date: July 8th, 2012 Re: Expense deduction for AGI against winnings of prize money and sponsorship income. Facts: You have been employed for the last six years as a manager by Ski USA, a distributor of ski equipment and boots. In the past two years you have participated in over 50 races annually as a professional bicycle racer and incurred annual expenses that exceeded your annual income. You worked lighter schedule during the racing season by utilizing your vacation time and has been ranked in two events by the National Biking Association. You have worn full-face helmet, chest protector, knee protection, elbow pads, goggles and heavy duty clothing in both events ranked by the NBA Issues: Whether you were correct in deducting the total expenses incurred from your bicycle racing activities as a deduction for AGI against the prize money and sponsorship income received from races. Rule: Section 183(a) provides generally that, if an activity is not engaged in for profit, no deduction attributable to such activity shall be allowed except as provided in section 183(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." The U.S. Court of Appeals for the Ninth Circuit, to which an appeal in this case would lie, has held that for a deduction to be allowed under section 162 or section 212(1) or (2), a taxpayer must establish that he engaged in the activity with the primary, predominant, or principal purpose and intent of realizing an economic profit independent of tax savings. See Wolf v. Commissioner, 4 F.3d 709, 713 (9th Cir.1993), affg. T.C. Memo.1991-212; Indep. Elec. Supply, Inc. v. Commissioner, 781 F.2d 724, 726 (9th Cir.1986), affg. Lahr v. Commissioner, T.C. Memo.1984-472. Analysis: The expectation of profit need not have been reasonable, but it must be bona fide. See Golanty v. Commissioner, 72 T.C. 411, 426 (1979), affd. without published opinion 647 F.2d 170 (9th Cir.1981); sec. 1.183-2(a), Income Tax Regs. Whether the requisite profit objective exists is determined by looking to all the surrounding facts and circumstances. Golanty v. Commissioner, supra at 426; sec. 1.183-2(b), Income Tax Regs. Greater weight is given to objective facts than to a taxpayer's mere after-the-fact statement of intent. Indep. Elec. Supply, Inc. v. Commissioner, supra; Thomas v. Commissioner, 84 T.C. 1244, 1269 (1985), affd. 792 F.2d 1256 (4th Cir.1986); sec. 1.183-2(a), Income Tax Regs. Petitioners bear the burden of proof. Rule 142(a). 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 other similar or dissimilar activities; (6) the taxpayer's history of income or loss 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 but rather all facts and circumstances must be taken into account, and more weight may be given to some factors than to others. See sec. 1.183-2(b), Income Tax Regs.; cf. Dunn v. Commissioner, 70 T.C. 715, 720 (1978), affd. 615 F.2d 578 (2d Cir.1980). The facts submitted here establishes that your primary, predominant, or principal motive for engaging in the bicycle racing activity was not for profit. A. Manner in Which the Activity Is Conducted While you did keep records, they did not your intent of actually conducting a business therefore making a profit was not your sole intent. Even though you had records reporting substantial losses, you never developed a written business plan or made a budget. Your participation in multiple races over the past two years earning sponsorship income and prize money and does not constitute a business plan. B. Expertise of Petitioners and Their Advisers You have been ranked in two events by the National Biking Association and had indicated that you have extensive experience in bicycle racing by training on a daily basis however you have also demonstrated that your main source of income was your full time job as a manager at Ski USA. Not once have you mentioned your intent to enter bicycle racing as a means earning income. C. Time and Effort Expended by Petitioners You claimed that you trained extensively on a daily basis which cannot be substantiated. You worked a full time job which is considered 8 hours per day 40 hours per week. Other than your self- serving, conclusory statements, there is no evidence to support this assertion. See Wood v. Commissioner, 338 F.2d 602, 605 (9th Cir.1964), affg. 41 T.C. 593 (1964); Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). This factor also weighs against you. D. The Activity's History of Income or Loss A record of substantial losses over several years may be indicative of the absence of a profit motive. Golanty v. Commissioner, 72 T.C. at 426. As was noted by the facts, you have incurred expenses that far exceeded you’re your annual income – a combination of your regular job, prize money and sponsorship income. Furthermore, petitioners' history of losses belies any notion that it was operated for profit. While a person may start out with a bona fide expectation of profit, even if it is unreasonable, there is a time when, in light of the recurring losses, the bona fides of that expectation must cease. See Filios v. Commissioner, 224 F.3d 16 (1st Cir.2000), affg. T.C. Memo.1999-92. This factor also weighs against you. E. Petitioners' Financial Status You continued to work and maintained your hours at your regular job throughout the time and when necessary you used your agreed vacation hours as time off. Therefore substantial income from sources other than the activity in question, particularly if the activity's losses generate substantial tax benefits, may indicate that the activity is not engaged in for profit. Sec. 1.183-2(b)(8), Income Tax Regs. From 1991 through 1998, petitioners' net profit from Dr. Prieto's medical practice averaged $638,253. This factor weighs against you as well. F. Elements of Personal Pleasure The absence of personal pleasure or recreation relating to the activity in question may indicate the presence of a profit objective. Sec. 1.183- 2(b)(9), Income Tax Regs. You have established that you enjoy what you do and has derived substantial amounts of pleasure from the cycling. You trained hard, worked lighter schedules and utilized your vacation time to enter these activities. Based on the facts, we find that this factor weighs against you. G. Additional Facts The following additional facts also support our conclusion that the bicycle racing activity was not entered with the primary, predominant, or principal purpose of making a profit. The evidence established that you were ranked in two events – the duly slalom and downhill races for which you wore full face helmet, chest protector, elbow pads, goggles and heavy duty clothing. While these gears were necessary, they could be considered as featured advertisement for participating sponsors. H. Conclusion After reviewing the entire record, I conclude that you did not engage in the bicycle racing activity with the primary, predominant, or principal purpose and intent of making a profit within the meaning of section 183. Therefore I have concluded that you had participated in these activities as a Hobby. If you lose money pursuing a hobby, you cannot deduct your hobby loss from your other income on your tax return, but you can deduct your expenses up to the amount of your hobby income on your tax return. A hobby loss is a miscellaneous tax deduction on your tax return, though, and limited by the 2% of AGI threshold. 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 is engaged in for profit if the taxpayer’s “predominant, primary or principal objective” in engaging in the activity was to realize an economic profit independent of tax savings. Wolf v. Commissioner, 4 F.3d 709, 713 (9th Cir. 1993), affg. T.C. Memo. 1991-212. The expectation of making a profit need not be reasonable. Beck v. Commissioner, 85 T.C. 557, 569 (1985); Dreicer v. Commissioner, 78 T.C. 642, 644-645 (1982), affd. without published opinion 702 F.2d 1205 (D.C. Cir. 1983); sec. 1.183-2(a), Income Tax Regs. [A]n activity is not engaged in for profit, then no deduction attributable to that activity is allowed except to the extent provided by section 183(b). In pertinent part, section 183(b) allows those deductions that would have been allowable had the activity been engaged in for profit 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 in for profit). You can generally deduct hobby expenses, but only up to the amount of hobby income. A hobby is not a business because it is not carried on to make a profit. See IRS Publication 535.