Antonides v. C.I.R.

• Decision Date: 11 January 1990
• Docket Number: 89-2634 and 89-2699,Nos. 89-2632,s. 89-2632
• Citation: 893 F.2d 656
• Parties: -521, 90-1 USTC P 50,029 Gary ANTONIDES, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. David SMITH; Mary Diane Smith, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Richard HERDENDORF; Phyllis Herdendorf, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Fourth Circuit

Page 656

893 F.2d 656

65 A.F.T.R.2d 90-521, 90-1 USTC P 50,029

Gary ANTONIDES, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

David SMITH; Mary Diane Smith, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Richard HERDENDORF; Phyllis Herdendorf, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Nos. 89-2632, 89-2634 and 89-2699.

United States Court of Appeals Fourth Circuit.

Argued Nov. 2, 1989.

Decided Jan. 11, 1990.

John J. Mullenholz (Thomas J. O'Rourke, Neill, Mullenholz & Shaw, on brief) for petitioners.

Thomas Richard Lamons (Shirley D. Peterson, Asst. Atty. Gen., Gary R. Allen, and Gilbert S. Rothenberg, Tax Div., Dept. of Justice, on brief) for respondent.

Before CHAPMAN and WILKINS, Circuit Judges, and WINTER, Senior Circuit Judge.

WILKINS, Circuit Judge.

Gary Antonides, David and Mary Diane Smith, and Richard and Phyllis Herdendorf (the taxpayers) appeal the decision of the Tax Court that their yacht chartering venture was an activity not engaged in for profit. I.R.C. Sec. 183 (West Supp.1989). Antonides also appeals the decision of the Tax Court that he is liable for an addition to tax because of a substantial understatement of tax liability. I.R.C. Sec. 6661 (West 1989). We affirm.

I.

David Smith ¹, Antonides, and the Herdendorfs are avid sailors, all of them either owning or having access to sailboats. In 1979 Smith became interested in acquiring a sailboat for use in the charter business. He studied boating and investment periodicals and determined that sailboats had been appreciating in value significantly since the mid-1970's. Although his research revealed that a charter business would not immediately realize a positive cash flow, he concluded that in the early years he could concentrate on building a client base and that favorable tax laws and the expected appreciation in the value of the boat would offset early losses.

In 1981 Smith approached Antonides, a Naval Academy classmate, and the Herdendorfs, Smith's sister and brother-in-law, and proposed that they purchase a boat for use in the charter business. Smith, Antonides, and the Herdendorfs formed a partnership in which Smith and Antonides each held a one-third interest and the Herdendorfs jointly held a one-third interest. ² The partnership purchased a boat through a sale-leaseback agreement from Nautilus Yacht Sales (Nautilus) for $94,790. The sale-leaseback agreement provided that the boat was leased to Nautilus for three years for a total of $18,958, with this amount treated as a down payment on the boat. The remainder of the purchase price was financed with a full recourse loan at 17 percent interest over a period of five years. Nautilus provided financing, insurance, charter management, and documentation services. Nautilus also provided advertising that the partners hoped would assist in building a client base.

The partnership was capitalized with an initial contribution of $414.33 from each partner. The partners agreed to share losses and profits equally. Each partner was entitled to personal use of the boat for seven days each year. The partners inspected the boat regularly and made minor repairs in an effort to save money. After one year, Smith evaluated the performance of the business and concluded that, if necessary, they could sell the boat at the end of the three-year lease term and break even.

In 1983 the partners refinanced the boat to obtain a more favorable interest rate. An appraisal of the boat reported that its value had declined to $78,500. On December 31, 1983, Antonides sold his partnership interest to the other partners. He reported a gain on the sale and recaptured unused investment tax credit.

The tax return of the partnership for the 1982 tax year showed income of $6,320, interest expense of $12,801, operating expenses of $2,580 and depreciation of $20,854 for a total tax loss of $29,915. ³ The Herdendorfs reported all of the income and one-third of the partnership's deductions. Antonides and Smith each reported one-third of the partnership's deductions. The Commissioner of Internal Revenue determined: (1) that the partners should share the partnership income equally; (2) that the operating expense and depreciation deductions of the partnership were disallowed because the charter business was not an activity engaged in for profit; (3) that there was a deficiency in the taxpayers' income tax for 1982; (4) that Antonides was liable for an addition to tax for negligence, I.R.C. Sec. 6653(a) (West 1989); and (5) that Antonides and the Smiths were each liable for an addition to tax because of a substantial understatement of tax, I.R.C. Sec. 6661. The taxpayers petitioned the Tax Court for a redetermination of the deficiency. The Tax Court sustained the Commissioner's determinations disallowing the deductions from the partnership and imposing the substantial understatement penalty on Antonides, determined that Antonides was not liable for the negligence penalty, and determined that the Smiths had not made a substantial understatement of tax. See Antonides v. Commissioner, 91 T.C. 686 (1988).

II.

Section 183(c) of the Internal Revenue Code defines an "activity not engaged in for profit" as an activity other than one with respect to which deductions are allowable under section 162 or sections 212(1) or (2). ⁴ I.R.C. Sec. 183(c). If the activity is not engaged in for profit, section 183(a) disallows deductions attributable to the activity except for those deductions specifically allowed under section 183(b). I.R.C. Sec. 183(a). Section 183(b)(1) allows only those deductions that would be allowable without regard to whether the activity is engaged in for profit. I.R.C. Sec. 183(b)(1). Section 183(b)(2) allows all other deductions that would be allowable if the activity were engaged in for profit, but only to the extent that gross income from the activity exceeds the deductions allowable under section 183(b)(1). I.R.C. Sec. 183(b)(2). The Tax Court determined that because the partnership was not engaged in the charter activity for profit, section 183 disallowed the deductions from the activity except for the interest expense, which during 1982 was a deduction allowable without regard to whether the activity was engaged in for profit. Because the interest expense exceeded the gross income from the charter activity, no other deductions were allowed under section 183(b)(2).

Section 6661 imposes on the taxpayer a penalty of twenty-five percent of the amount of any underpayment of tax attributable to a substantial understatement in the amount of income tax liability. I.R.C. Sec. 6661(a). An understatement is the excess of the amount of tax required to be shown on a return over the amount of the tax which is actually shown on the return. I.R.C. Sec. 6661(b)(2)(A). To be substantial, the amount of the understatement must exceed the greater of ten percent of the tax required to be shown on the return or $5,000. I.R.C. Sec. 6661(b)(1)(A). The amount of the understatement is reduced, however, by the portion of the understatement that is attributable to the taxpayer's position with respect to an item if there is substantial authority to support the taxpayer's position or if the relevant facts respecting the tax treatment of the item are adequately disclosed in the return. ⁵ I.R.C. Sec. 6661(b)(2)(B). Authorities for a reporting position include the Internal Revenue Code, other statutes, regulations, judicial decisions, revenue rulings and procedures, tax treaties, and legislative history. Treas.Reg. Sec. 1.6661-3(b)(2) (1985). There is substantial authority "only if the weight of the authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary positions." Treas.Reg. Sec. 1.6661-3(b)(1). The Tax Court found that there was not substantial authority for the position that the losses arising from the partnership activity were deductible. The partners did not contend that they had made an adequate disclosure of the relevant facts. Therefore, the Tax Court held that the penalty was applicable. ⁶

III.

We review the decision of the Tax Court under the clearly erroneous standard unless "there has been an erroneous interpretation of the applicable legal standard." Faulconer v. Commissioner, 748 F.2d 890, 895 (4th Cir.1984). The taxpayers contend that the Tax Court applied the wrong legal standard by ruling that an activity is not engaged in for profit for purposes of section 183 unless there is a predominant purpose and intention to make a profit. In Faulconer we specifically declined to decide whether section 183 requires a primary or predominant purpose of making a profit. Id. at 895-96 n. 10. We did note, however, that the profit motive required by section 183 was the same as the profit motive required by sections 162 and 212. Id. at 893. The Supreme Court has held that for deductions to be allowable under section 162, the primary purpose for engaging in the activity must be for profit. Commissioner v. Groetzinger, 480 U.S. 23, 35, 107 S.Ct. 980, 987, 94 L.Ed.2d 25 (1987); see Thomas v. Commissioner, 792 F.2d 1256, 1259 (4th Cir.1986) ("The major premise for the allowance of [section 162] deductions is that they arise out of a venture whose primary objective is to make a profit."). Additionally, other circuits have held that section 212 also requires a predominant purpose and intention to make a profit. See Simon v. Commissioner, 830 F.2d 499, 500-01 (3d Cir.1987) (deductions claimed under section 212 must meet the requirements of section 162 except that the taxpayers need not be in a trade or business); Bolaris v. Commissioner, 776 F.2d 1428, 1432 (9th Cir.1985); Snyder v. United States, 674 F.2d 1359, 1364 (10th Cir.1982). Here, the Tax Court required the taxpayers "to show that they engaged in their boat chartering activity with the objective of making an economic profit." Because this was not an erroneous interpretation of...