Westbrook v. C.I.R.
| Citation | 68 F.3d 868 |
| Decision Date | 30 October 1995 |
| Docket Number | No. 94-40652,94-40652 |
| Parties | -7397, 95-2 USTC P 50,587 Billie R. WESTBROOK and Madeline M. Westbrook, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. |
| Court | United States Courts of Appeals. United States Court of Appeals (5th Circuit) |
Robert I. White, Shelley Cashion, Chamberlain, Hrdlicka, White, Williams & Martin, Houston, TX, for appellants.
Andrea R. Tebbets, Richard Farber, Washington, DC, Gary R. Allen, Chief, Appellate Section, Tax Division, Dept. of Justice, Washington, DC, David L. Jordan, Acting Chief of Counsel, IRS, Washington, DC, for appellee.
Appeal from the United States Tax Court.
Before KING and JONES, Circuit Judges, and KAZEN *, District Judge.
Billie R. Westbrook and Madeline M. Westbrook appeal the United States Tax Court's affirmance of the Commissioner's determination of deficiencies and additions to tax for negligence and for substantial understatement of tax liability for the tax years 1984-1987. Finding no error, we affirm.
Billie R. Westbrook ("Dr. Westbrook") has been a veterinarian since 1955. He and Madeline M. Westbrook ("Mrs. Westbrook") were married in 1952. In 1962, Dr. Westbrook founded the Spring Branch Veterinary Clinic (the "Clinic"), at which he worked on a full time basis during the years at issue 1984-1987. Dr. Westbrook worked at the Clinic from 8 a.m. to 6 p.m. on weekdays, and on Saturday and Sunday mornings, and he was on call for emergencies twenty-four hours a day, seven days a week. During the years in issue, the Clinic's average gross revenues approximated $725,000, and the Westbrooks reported annual income from the Clinic ranging from $114,828 to $224,343.
Mrs. Westbrook has performed services for the Clinic without compensation since its inception. Her primary role has been in marketing the Clinic, although she has also served as the receptionist and "kennel person." Mrs. Westbrook also handled public relations for the Texas Veterinary Medical Association, through which she was able to obtain free advertising for the Clinic by using animals owned by the Westbrooks. Mrs. Westbrook's public relations activities included bringing animals to schools and nursing homes.
In October 1976, the Westbrooks purchased Burton Farm, a 299.2 acre farm, with its mineral rights, located in Lee County, Texas. In 1976 and 1977, after investigating the cattle business, the Westbrooks commenced a cattle-raising operation by purchasing twenty Angus cows and one Angus bull. The Westbrooks did not have a business plan for their cattle-raising operation, and they did not keep detailed records of the venture. In April 1983, the Westbrooks sold their herd and ceased the cattle operation. During the years at issue, 1984-1987, the Westbrooks neither kept animals nor performed farming activities at Burton Farm. Nevertheless, they reported net losses for farming operations at Burton Farm from 1976 through 1987.
In the late 1970s, oil was discovered on Burton Farm, and the Westbrooks commenced oil and gas production in commercial quantities. On August 16, 1983, the Westbrooks entered a lease agreement giving WCS Petroleum Co. ("WCS") the exclusive right to explore, drill, and produce oil and gas at Burton Farm. In return, the Westbrooks received a royalty interest--a fractional share of oil production, free of development and operational expenses. During 1984-1987, the Westbrooks reported net income from oil and gas production on Burton Farm, although they reported net losses from farming operations on Burton Farm for those years.
The Westbrooks arranged for Danny Nowell, a production manager with WCS, to reside at Burton Farm and look after the Burton Farm property and the oil wells. Nowell lived at Burton Farm from 1983 or 1984 until sometime between 1985 and 1987. Nowell repaired the perimeter fence in order to keep cattle inside, but he did not upgrade the fence in a manner designed to deter oil theft. No oil was stolen from Burton Farm during the time that WCS was lessee. The Westbrooks made no written claims to WCS for reimbursement for physical damage to the property, as the lease required, because they incurred no covered damages.
The Westbrooks purchased a 211-acre farm in Austin County, Texas known as Billenbrook Farm in 1980. The Westbrooks did not calculate the number of years that it would take to recoup their investment in the farm or in the livestock they planned to keep at the farm, but their son did prepare a "preliminary business outline" stating: "The purpose of this venture is to build capital assets with the limited physical involvement of the principals [the Westbrooks and their son]."
The Westbrooks' activities on Billenbrook Farm generally consisted of raising cattle and miniature horses. First, they investigated and then engaged in "embryo transplant" cattle-raising from 1982 to 1984. Although the Westbrooks investigated the process of embryo transplants and examined existing operations, they failed to obtain appraisals or make income projections. The Westbrooks never calculated how much it would cost to achieve their professed goal of building a purebred herd, nor did they calculate the cost of production for each embryo-transplant calf. In 1982, they purchased two Angus heifers to use in the embryo transplant process, and, during 1984, they maintained 14-16 head of cattle on Billenbrook Farm. The Westbrooks kept cattle on Billenbrook Farm until 1987, but they discontinued the embryo transplants in 1986 because they were losing money from that operation.
In 1983, the Westbrooks investigated the miniature horse business and purchased twenty-seven miniature horses. They did not make any written financial projections regarding the miniature horses, or calculate how long it would take to recoup their investment in the horses. The Westbrooks did not insure the horses except when they moved them. They failed to keep fertility records or to perform pregnancy tests on the horses. They never mated any of their mares with another owner's stud, nor offered their stallion's stud services to horses owned by others. The Westbrooks never sold any miniature horses. In August 1985, the Westbrooks donated their entire herd of miniature horses to a tax-exempt, charitable organization.
The Westbrooks reported net losses from operations at Billenbrook Farm in each year from 1980 to 1987. Starting in 1984, they reduced their time spent at Billenbrook Farm out of concern for the profitability of the Clinic. The Westbrooks finally ceased operations at Billenbrook Farm when oil and gas production began at Burton Farm, causing a "drastic change" in their lives.
On January 18, 1982, the Westbrooks formed Billenbrook Farms, Inc., a subchapter S corporation with its principal place of business on Billenbrook Farm. Dr. Westbrook owned 100% of the stock of Billenbrook Farms, Inc. during 1984-1987 and all expenses incurred by the corporation were funded by cash provided by the Westbrooks, either as a contribution or a loan. Billenbrook Farms, Inc. engaged in the activities of breeding and raising purebred dogs and maintaining pygmy goats. In February 1985, Billenbrook Farms, Inc. sold its entire stock of dogs and ceased the dog operation, after determining that success would require a larger stock of dogs and a greater percentage of Dr. Westbrook's time than the Westbrooks were willing to commit. Billenbrook Farms, Inc. also raised pygmy goats, although it failed to maintain breeding records for the goats or sell any of them. The goats were treated as an ancillary operation to Billenbrook Farm's miniature horses, and they were taken by Mrs. Westbrook to nursing homes, schools, and petting zoos as part of her public relations efforts for the Clinic. In September 1985, the Westbrooks donated their entire stock of pygmy goats to a tax-exempt, charitable organization. Billenbrook Farms, Inc. reported net losses on its income tax returns in each year from 1983 through 1986.
Except for Billenbrook Farm, for which the Westbrooks' son created a brief preliminary business outline, the Westbrooks did not make formalized business plans for any of their activities. The Westbrooks maintained one checking account, from which they paid the expenses for the Clinic, Burton Farm, and Billenbrook Farm. Billenbrook Farms, Inc. maintained a separate account. Dr. Westbrook annotated each check with a description of the relevant activity, such as "Burton" or "Billenbrook," and he then sent copies of the checks to his accountant, John Braden. Relying upon Dr. Westbrook's annotations, Mr. Braden entered the check information into a computer program under the designated activity, and the program created an income statement and a balance sheet for each of the Clinic, Burton Farm, and Billenbrook Farm. Braden also used this program to create financial statements for Billenbrook Farms, Inc.
Dr. Westbrook and his staff made some errors in annotating the checks and in disbursing funds from the wrong checking account; therefore, the financial statements created by Braden contained errors that the Westbrooks subsequently failed to correct. As a result, some expenses related to the Westbrooks' individual federal income tax returns were reported and deducted on the Billenbrook Farms, Inc. federal income tax return, while some expenses incurred by Billenbrook Farms, Inc. were deducted on the Schedules F of Burton Farm or Billenbrook Farm, which were part of the Westbrooks' individual return.
On June 27, 1991, the Commissioner mailed the Westbrooks a Notice of Deficiency informing them of the Commissioner's determination of additional tax liabilities for the years 1984 through 1987. Following a trial, on December 29, 1993, the tax court sustained the Commissioner's determination of additional tax liability...
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