Gallegos v. Commissioner
T.C. Memo. 2021-25

On March 2, 2021, the Tax Court issued a Memorandum Opinion in the case of Gallegos v. Commissioner (T.C. Memo. 2021-25). The primary issue presented in Gallegos v. Commissioner was whether the team roping expenses the petitioner claimed on his Schedule C as business losses were business or personal in nature.

Giddy-up, ya’ll…

Setting the Stage for Gallegos v. Commissioner

First, this is a Judge Holmes opinion, so you know it’s going to be gold.

Second, it involves competition team roping, which might even make for an entertaining opinion if it were authored by Judge Gustafson, who is a rather straight-laced jurist.

How many sentences will Judge Holmes be able to write without a pun?


One sentence.

I am so excited…like, Jessie Spano on caffeine pills excited.

Background (on Roping Steers)

The petitioner grew up on the “largest ranch” in the largest town in New Mexico.  “But it was not on horses that he rode to success.”  Second sentence – first pun.  Game on Judge Holmes, game on.  The petitioner started a marketing business with his wife specializing in Medicare Advantage policies, and the business became “a galloping success.”  A little cheap, but we’ll allow it.  The petitioner showed great acumen at finding talent, and once “he roped them in” to a training program, he shared in their commissions.

Despite his success, or perhaps because of it, the petitioner shifted his focus from wrangling talent and leads back to his first love – team roping – which he began competing in during the first iteration of Van Halen.  What is “team roping” you may ask?  Well, Judge Holmes is a step ahead of you “equine challenged” (his words, not mine) folks.

See, there are two cowboys – a “header” and a “heeler,” of which the petitioner was the prior.  As you might guess, the header ropes the head of the steer, and the heeler, the heels (or hooves, as it were).  Once the steer is roped on both ends, the cowboys “dally” (but do not dilly) and stop the steer in its proverbial tracks.  The Tax Court acknowledges that this is a “very simplified” explanation. “There are a multitude of rules on timing, positioning of the riders, and ‘legal head captures.’”

The sport is pay-to-play and requires fairly hefty entry fees, which fees have increased with the popularity of team roping.  According to the petitioner, you therefore “have to be prepared if you’re going to put that kind of investment in.” The goal is to perform well enough to at least win back your entry costs.  With the concomitant costs of travel (for the rider and his horse), etc., the expenses add up rather quickly.

Meanwhile, Back at the Ranch…

Sorry, too easy…

In 2009, the petitioner decided to begin reporting income and losses from the roping activities on the Schedules C of the joint tax returns that he prepared with his wife.  It was only then that they decided “to make [roping] his business and not just his pastime.”  By this time, the petitioner had his doubts about his insurance business, and he even considered buying a Subway franchise to make ends meet.  “But neither of the Gallegoses had restaurant experience, and team roping looked better.”

Their “business plan” was simple: They would earn a profit by having the petitioner “get better” at team roping, by winning team-roping competitions, and also by selling (and possibly breeding) successful team-roping horses. In the petitioner’s own words, he “wanted to get better, put more effort into it, more time into it, and win.”  According to this theory of business planning, he should have just wished for a goose that laid golden eggs, and he would have had it made.  Nonetheless, the petitioner purchased a trailer with living quarters for both the horses and the riders (no kidding), and he pursued his roping dream…at some expense.

From 2009 to 2011, the petitioner has a net loss of over $170,000.  He also failed to maintain a separate bank account.  He also failed to have a “budget” or, it seems, a “plan” for actually making money – other than “getting better.”

Nevertheless, “[l]ike a mountain lion sniffing out a herd of mustangs, the [IRS] detected this consistent pattern of losses and began circling his prey.”

Solid gold, maestro.  Solid gold.

The Audit and Trial

The petitioner may have been bad at roping, but he was worse at reporting his roping expenses.  He underreported the large entry-fee expense of $45,000 by around $6,000; underreported his gross receipts by about the same amount; and failed to claim deductions for car and truck expenses, travel, and meals. What he reported for 2010 and 2011 was only slightly different from his true expenses, but still inaccurate across nearly all reported items. And he incorrectly reported certain of these amounts on the same Schedule C as he did his insurance business’ items of income and expense for 2009.  Part of this can be blamed, one assumes, on getting hit on the head one too many times by a steer’s ass.

I’m just guessing here.

The parties settled many issues before trial, and they left to the Tax Court only the issue of whether the petitioner engaged in team roping with the intent to earn a profit in 2009-11.

Reining in the Issues

I’m not sorry for the puns.  I’m not sorry, not ashamed—hell, I’m not even saddled with guilt.

Under what circumstances could the petitioner claim Schedule C losses?  The answer can be found in three separate but related Code sections.  First, IRC § 162(a) permits deductions for ordinary and necessary expenses paid or incurred in carrying on any trade or business. Second, IRC § 212(1) and IRC § 221(2) generally allow a taxpayer to deduct all the ordinary and necessary expenses paid or incurred for the production or collection of income and for the management, conservation, or maintenance of property held for the production of income.  Surprisingly, this is not the first rodeo (or team roping case, as it were) for the Tax Court.  See Estate of Brockenbrough v. Commissioner, T.C. Memo. 1998-454; Haun v. Commissioner, T.C. Memo. 1998-349.

Even if there is no trade or business, a deduction for expenses relating to investment activities may be allowable under IRC § 212. See, e.g., Thomason v. Commissioner, T.C. Memo. 1997-480, *6. Nevertheless, IRC § 183(a) bars taxpayers from claiming deductions for activities that are not “engaged in for profit” (except as provided under IRC § 183(b)). The test of profit motive is a subjective one—a taxpayer must show that he undertook the challenged activity with an “actual and honest objective of making a profit.” See Dreicer v. Commissioner, 78 T.C. 642, 645 (1982), aff’d, 702 F.2d 1205 (D.C. Cir. 1983). The taxpayer’s expectation of profit doesn’t have to be reasonable, but it must be genuine. Indeed, Treas. Reg. § 1.183-2(a) notes that it may be sufficient that there is a small chance of making a large profit. See also Elliott v. Commissioner, 90 T.C. 960, 970 (1988), aff’d 899 F.2d 18 (9th Cir. 1990). A taxpayer bears the burden of proving his motive, which must be to make an economic profit and not just to cut his tax bill. Westbrook v. Commissioner, 68 F.3d 868, 876 (5th Cir. 1995), aff’g T.C. Memo. 1993-634.

The Treasury Regulations provide guidance, observing that courts should apply objective standards to discern a taxpayer’s intent, taking into account all facts and circumstances.  See Treas. Reg. § 1.183-2(a).  To this end, the Treasury Regulations provide nine factors to consider, with no one factor being determinative. See Treas. Reg. § 1.183-2(b).  Courts may look to other factors, and a determination should not be made based on the number of factors indicating a lack of profit motive and vice versa. Id.

The nine factors include the following:

  • the manner in which the taxpayer carries on the activity;
  • the expertise of the taxpayer or his advisers;
  • the time and effort expended by the taxpayer in carrying on the activity;
  • the expectation that assets used in the activity may appreciate in value;
  • the success of the taxpayer in carrying on other similar or dissimilar activities;
  • the taxpayer’s history of income or losses with respect to the activity;
  • the amount of profits earned, if any;
  • the financial status of the taxpayer; and
  • any elements of personal pleasure or recreation.
Manner in Which the Activity Is Conducted

The first factor examines how the taxpayer carries on the activity. A taxpayer who works in a “businesslike manner” and “maintains complete and accurate books and records” is more likely to have a profit motive than one who merely seeks to “get better” and “win” and who fails to adequately keep separate books and records, as in the present case. See Treas. Reg. § 1.183-2(b)(1). Profit motive may also be found “where an activity is carried on in a manner substantially similar to other activities of the same nature which are profitable.” Id.

Without adequate recordkeeping, it is quite difficult for a taxpayer to evaluate economic performance and ways to improve profitability. See Burger v. Commissioner, T.C. Memo. 1985-523, aff’d, 809 F.2d 355 (7th Cir. 1987).  (At this, the Tax Court “bridled” at finding the petitioner’s business plan, which apparently both rewarded mediocrity and also sought to “get better”—concepts which the Tax Court found at odds with one another.  “Given what the record shows, team roping is the unusual activity in which the route to profitability might more clearly lie in staying mediocre.”) Also, the Tax Court observes, “winning” is not an actual business plan – much to the chagrin of the petitioner, Charlie Sheen, and the hashtag that will long outlive both of them.  #Winning.  Ultimately, the Tax Court found that “winning” team roping competitions was more of a hope than a real business plan. See Kneels v. Commissioner, T.C. Memo. 2017-152, *15.

Expertise of Taxpayers or Advisers

Next, the factors look to whether there was preparation for the activity by extensive study of its accepted business, economic, and scientific practices or consultation with experts, both of which suggest a profit motive. Treas. Reg. § 1.183-2(b)(2). While a taxpayer needn’t make a formal market study in preparation for a trade or business, he’s expected to undertake a basic investigation of the factors that would affect his profit. Heinbockel v. Commissioner, T.C. Memo. 2013-125, *24-*25. Technical knowledge of the activity itself, apart from its economics, is insufficient. Metz v. Commissioner, T.C. Memo. 2015-54, *44. Favoring technical knowledge over practical knowledge of an activity’s economics reveals a skilled hobbyist and not a businessman. See Golanty v. Commissioner, 72 T.C. 411, 432 (1979), aff’d, 647 F.2d 170 (9th Cir. 1981).

Time and Effort Expended on the Activity

The fact that the taxpayer devotes much of his personal time and effort to carrying on an activity, particularly if the activity does not have substantial personal or recreational aspects, may indicate an intention to derive a profit. Treas. Reg. § 1.183-2(b)(3). A taxpayer’s choice to leave another job to spend most of his time on the activity may be very convincing evidence of his intention to turn a profit, but it is not, itself, dispositive. See Metz, T.C. Memo. 2015-54, at *46-*47.

Activities with substantial personal or recreational aspects neutralize this factor. Indeed, the Tax Court has previously held that the time and effort factor is “neutral” for taxpayers who “also derived substantial recreational benefit from the time they spent with their horses,” even given the work associated with the activity.  See Dodge v. Commissioner, T.C. Memo. 1998-89, 1998 WL 88175, at *5-*6), aff’d, 188 F.3d 507 (6th Cir. 1999); Giles v. Commissioner, T.C. Memo. 2006-15, 2006 WL 237503, at *13.

Expectation That Assets Used in Activity May Appreciate in Value

An expectation that assets will appreciate in value can suggest a profit motive even if the taxpayer derives no profit from current operations. See Treas. Reg. § 1.183-2(b)(4).  The Tax Court will only infer a profit motive if a taxpayer expected that the asset’s appreciation would exceed their operating expenses, such that the eventual gain on sale would allow them to recoup their losses. See Bronson v. Commissioner, T.C. Memo. 2012-17, *8, aff’d, 591 F. App’x 625 (9th Cir. 2015).

Success in Carrying on Other Similar Activities

A taxpayer’s previous success in similar activities may show that he has a profit objective, even if the activity is currently unprofitable. See Treas. Reg. § 1.183-2(b)(5).  Curiously, success in the insurance industry does not correlate to success in team roping events—so said the Tax Court.

History of Income or Loss

A series of losses during the startup stage of an activity may not necessarily prove that an activity is not engaged in for profit. See Treas. Reg. § 1.183-2(b)(6). However, where losses continue to be sustained beyond the period which customarily is necessary to bring the operation to profitable status, losses may indicate that the activity was not undertaken for profit. Id.

Amount of Occasional Profits, if Any

Occasional profits can show a profit motive, but the size and frequency of profits relative to losses are what matter. See Treas. Reg. § 1.183-2(b)(7). Further, an occasional small profit from an activity generating large losses, or from an activity in which the taxpayer has made a large investment, would not generally be determinative that the activity is engaged in for profit. Id.

Taxpayer’s Financial Status

A taxpayer’s lack of “substantial income or capital from sources other than the activity at issue may indicate that the activity is engaged in for profit. See Treas. Reg. § 1.183-2(b)(8).

Elements of Personal Pleasure or Recreation

The presence of personal motives in carrying on of an activity may indicate that the activity is not engaged in for profit, especially where there are recreational or personal elements involved. See Treas. Reg. § 1.183-2(b)(9). The Tax Court observed that many hobbies can take a lot of time and energy while still being mostly a source of personal recreation. See Betts v. Commissioner, T.C. Memo. 2010-164, *9. Where the possibility for profit is small, and the possibility for gratification is substantial, the Tax Court has historically found that the latter possibility (gratification) constitutes the primary motivation for the activity. See Burger, T.C. Memo. 1985-523.

Unfortunately for the petitioner, he was about as successful in lassoing a positive opinion from Judge Holmes as he was in his competitive steer competitions, which is to say, not at all.

(T.C. Memo. 2021-25) Gallegos v. Commissioner

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