Miles And Jack Vineyards Inc. V. Petitioneers Case Summary
United States Tax Court
Miles and Jack Vineyards, Inc.
Petitioner
V.
Commissioner of Internal Revenue,
Respondent
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Docket No.
Petition
Miles Raymond (“Miles”) the Petitioner, by his attorney, David Nguyen, hereby petitions for a redetermination of the deficiencies the Commissioner of Internal Revenue (the
“Commissioner”) has set forth in the notice of deficiency dated January 25, 2013. The notice was sent via the IRS Los Angeles, California office. The Petitioner request that this case be conducted under regular tax case procedures and alleges the following:
1. The Petitioner holds a 50% interest in Miles and Jack Vineyards, Inc., an S corporation with winery operations in Buellton, California (Santa Ynez Valley). The …show more content…
Petitioner’s taxpayer identifying number is 00-00000.
2. A notice of deficiency dated January 25, 2013 was issued to Petitioner by the Internal
Revenue Service. The tax years in contention are 2006, 2007, 2008, and 2009. A copy of the notice of deficiency is included in this petition under Exhibit A.
1
Items and Amounts in Dispute
3. Ordinary Loss or Taxable Income. The Commissioner erred in determining adjustments to ordinary, distributable net, or taxable income of the Petitioner for taxable years ending December 31, 2006, 2007, 2008, and 2009. The amounts of the adjustments are as follows:
Table 1
12/31/2006
12/31/2007
12/31/2008
12/31/2009
Depreciation
$24,175.00
$25,228.00
$25,228.00
$25,228.00
Sec.183 Not for
Profit Activity
$125,952.00
$147,262.00
$181,158.00
$185,322.00
Total adjustment to ordinary, distributable net, or taxable income $150,127.00
$172,490.00
$206,386.00
$210,550.00
The total amount of adjustments to ordinary, distributable net, or taxable income the
Commissioner deemed “not for profit” pursuant to Section 162(a) and 183(a) of the
Internal Revenue Code for each of the years listed in Table 1 is in dispute (20062009).
2
4. Depreciation. The amount in dispute also includes the amount of depreciation of the building, improvements, and equipment that was used in the “trade or business” or
“production of income” pursuant to Section 167(a).
These amounts are listed under
“Depreciation” on Table 1.
The amount of depreciation takes into account all buildings, equipment, and improvements made to the property for the purpose of producing wine. The calculation takes into account the applicable depreciation method, applicable recovery period, and applicable convention pursuant to Section 167(a).
The appropriate portion of personal, living, and family expenses have been deducted from capital expenditures and depreciation. Miles and Maya are Texas residents and travel to California on a monthly basis to maintain the winery. When they are at the winery, they use the master bedroom and occasionally the living room area. The majority of the property is dedicated to business purposes: entertaining guests, clients, and future wine tours.
5. Accuracy-related Penalty. Because of the Commissioner’s error in determination of depreciation and ordinary loss, the penalty of 20 percent of the portion of underpayment of any tax due pursuant to Section 6662(a) of the Internal Revenue
Code is also in
dispute.
Moreover, even if Miles is found to have underpaid taxes for the given period,
Section 6662(a) requires negligence or disregard of rules or regulation. “Negligence” is defined under this section as any failure to make a reasonable attempt to comply with provisions of this title, and “disregard” includes any careless, reckless, or
3
intentional disregard. Given Miles’ reasonable and bona fide belief that Miles and
Jack Vineyard, Inc. is a for profit business, Miles does not meet the mens rea element of Section 6662(a). Throughout the periods in question, Miles has retained a CPA for accounting and tax preparation purposes and diligently provided his CPA with information regarding business expenditure. For these reasons, a penalty should not be accessed against Miles.
Background & Facts
Approximately eleven years ago, in the aftermath of the tech bubble burst, Miles was able to acquire 36 acres of heavily wooded vacant land on a hillside in California’s wine country at the fire sale price of 18 cents per sq. foot! Though he only wanted to purchase a portion of the 36 acres to start a small winery, the land owner would not partition the land nor were there any smaller pieces of property for sale in that vicinity. At 18 cents per sq. foot, the property was sold
“as is” in its entirety. Because the land was dirt cheap, Miles reasoned that he would be able to recuperate the cost of the land while generating a profit from a small winery. Moreover, the beautiful landscape would add to the aesthetics of the winery and value to wine tours. The
Petitioner planned on selling more than just bottles of wine, he wanted to attract clients by offering them the ultimate experience of an outing in wine county—the rolling hills, beautiful trees, and fresh air of the Saint Ynes Valley. Though only 2 of the 36 acres are used as a vineyard (the actual planting of grapes), the entire 36 acres is used to attract clients and add value to the product line.
4
Furthermore, the extra land offered the owners the ability to expand if business proved to be successful. With his experience in real estate, the Petitioner was confident that even if the winery failed, the appreciation in land value alone would be well worth the investment.
Internal Revenue Service’s Errors
Section 162(a) of the Internal Revenue Code allows for deduction of “all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”
Under Section 183(c), if an activity does not qualify for deduction under Section 162(a), it is considered “not for profit” and falls under the Hobby Loss Rule Section 183(a). The
Commissioner applied the nine factors of Section 183-2(b) in determining whether the
Petitioner’s activities were for profit and erred as follows:
1.
Manner in Which the Activity is Conducted.
The Commissioner reasons that because Petitioner did not have a written business plan, budget or break-even analyses, nor a separate banking account for the business,
Petitioner did not carry the activity in a businesslike manner. Contrary to the
Commissioner’s findings, the Petitioner did have a business plan and explained it, in the words of the tax examiner, Maxwell Smart, “in great detail.” The Petitioner planned to create three types of pinot noir and even had labels for each of them. He also had plans on marketing initiatives, throwing parties, wine tastings, and donating wine to charity auctions to strengthen the brand and create a market for the Miles and Jack Vineyard label once the wine was ready for market.
5
Small businesses such as convenience stores, deli shops, and many owner-managed operations rarely have written businesses plans unless one is required by financial institutions to provide capital funding. A likely reason is that though they may have a detailed business plan and understand their goals well, they do not regularly communicate it to anyone and therefore do not memorialize it. Much like Miles’ real estate business, his winery started off without a written business plan but this does not mean that he had no business plan. When asked, he is able to orally communicate his plan in detail.
Further, though the Petitioner is missing some business records, he was able to provide material records that reflect operating expenses to his CPA. Extensive records are not currently necessary because no revenue will be generated until 2016. Much like the treasure hunter in Harrison v. Commissioner who failed to maintain proper records but was able to prove a profit motive by other means, Miles is able to demonstrate a profit motive without extensive records because he consulted experts in the wine industry, joined the Wine Growers Association, kept costs down by shopping for cost-efficient equipment, retained a CPA for accounting purposes, and spent a substantial amount of time working at the winery and studying the industry. Harrison v. Comm’r, 72 T.C.M.
(CCH) 515 (1996).
2. Expertise of the Taxpayer or Advisors.
The Commissioner alleges that the Petitioner had no expertise in operating a vineyard or winery, and because of his lack of experience, made a poor business decision in planting
2,750 grape vines (the usual amount planted across one acre) over two acres.
The Commissioner is correct in his assessment of Miles’ knowledge of the wine industry
6
when Miles first started the winery. However, because he was so self-conscious in his lack of knowledge, he was driven to do what he could to improve his knowledge gap.
He hired an expert vineyard management company to manage the vineyard to ensure its success, attended winery related meetings, engaged winery experts, and joined the Santa
Ynez Valley Wine Growers Association. His decision in spreading 2,750 grape vines across two acres verses the industry standard of one was the result of consultation and research. Because of the poor condition of the soil, more space was required per vine for a more abundant harvest. Miles did everything a reasonable new entrant could do to make up for his lack of experience. If the law requires a history of experience in an industry for profit motive to be found, by definition no new entrant in any market would have a profit motive.
3. Time and Effort Spent Conducting the Activity.
The Commissioner implies that the Petitioner spends the majority of his effort and time mowing grass between the grape vines while his wife focuses on marketing. The
Commissioner also contends that the Petitioner did not provide documentation to substantiate his activities in the business.
Though documentation on how you spend your time on a farm is difficult to come by, we are confident that testimony from Miles, members of the Wine Growers Association, experts that Miles consults with, and Stephanie will prove that he spends a substantial amount of time tending the vineyard and making up for his lack of knowledge in the wine industry. He is a driven entrepreneur with a desire to succeed in the wine business.
7
4. Expectation that Assets Will Appreciate in Value.
The Commissioner alleges that the Petitioner has not made any statements about his expectations regarding the appreciation in value of land or business to create an overall profit. The Commissioner also believes that the remaining land on the 36 acres is not arable unless substantial expenditure is made to improve and cultivate the land.
Miles has in fact already profited from the appreciation in value of land since purchasing it for a little over 18 cents per sq. foot. No one has questioned him about what he expects in terms of appreciation, but as the economy improves, the demand for wine will only increase. In turn, this will drive the value of real property in wine country up. Though it will be expensive for him to expand the vineyard, profitability will depend on how much he is able to sell this wine. At this point, it is too early to determine how much Miles will be able to sell his pinot negro.
5. Taxpayer’s Success in Similar or Dissimilar Activities.
The Commissioner believes that the Petitioner has successfully run an apartment rental business in Texas, but the Petitioner has not run the winery business in a businesslike manner and will not likely succeed because the two industries are very different from one another. The fifth factor is similar to the second factor. Though Miles has never run a winery, he has hired and consulted experts in the industry. His experience in real property has given him an advantage in that he was able to quickly move on the property when it was sold for below market value.
8
6. Activity’s History of Income and/or Losses.
The Commissioner believes that the business has been incurring losses due to the start-up period. The nature of the wine business is similar to the equine business in that the start-up period is longer than the average business. It takes a considerable amount of time from the moment that grape vines are planted and then grafted till the grapes are harvested, crushed, fermented, aged, and then bottled. It is common in the wine industry to record ordinary losses for 7 or 8 years during the start-up period.
7. Amounts of Occasional Profits.
The Commissioner and Petitioner both agree that due to the nature of the nascent business, not enough time has elapsed for there to be a history of profits.
Miles estimates that each bottle will fetch between $65-$85 per bottle. This will generate revenue of between $120,000 to $225,000 annually. Looking at Operating Expenses under the Analysis of Costs and Expenditures for 2006 and 2007, Miles expects the business to generate between $20,000 to $125,000 profit when the wine is ready to be sold. 8. Taxpayer’s Financial Status.
The Commissioner believes that a substantial amount of money from the Petitioner’s apartment business is used to fund the winery.
Miles started Miles and Jack Vineyards, Inc. with his wife and Jack Lopate. Half the capital required to start the business came from Jack and the rest has come from Miles and Maya’s personal savings and loans. The personal usage portion of the property has
9
been property deducted from the business expense. Furthermore, if the winery is a mere hobby for Miles, it would not make any sense for Jack to invest hundreds of thousands of dollars into Miles’ hobby. Jack and Miles are looking for profit.
9. Elements of Personal Pleasure.
The Commissioner believes that though the Petitioner does not gain personal pleasure from the operation of the winery, he does gain pleasure in the use of the winery’s assets.
Though Miles has gained some pleasure through the winery’s assets, the small and large buildings’ purpose is to attract clients and create more value in each bottle of wine created by Miles and Jack Vineyards, Inc.
Respectfully Submitted,
_____________________________
Miles Raymond
Date
Miles Raymond
1234 Winemaker Road
Buellton, CA 00000
(832)-555-5555
10
January 25, 2013
Exhibit A
Notice of Deficiency
11
Miles and Jack Vineyards, Inc.
Petitioner
V.
Commissioner of Internal Revenue,
Respondent
§
§
§
§
§
§
§
§
§
§
§
Docket No.
Petition
Miles Raymond (“Miles”) the Petitioner, by his attorney, David Nguyen, hereby petitions for a redetermination of the deficiencies the Commissioner of Internal Revenue (the
“Commissioner”) has set forth in the notice of deficiency dated January 25, 2013. The notice was sent via the IRS Los Angeles, California office. The Petitioner request that this case be conducted under regular tax case procedures and alleges the following:
1. The Petitioner holds a 50% interest in Miles and Jack Vineyards, Inc., an S corporation with winery operations in Buellton, California (Santa Ynez Valley). The …show more content…
Petitioner’s taxpayer identifying number is 00-00000.
2. A notice of deficiency dated January 25, 2013 was issued to Petitioner by the Internal
Revenue Service. The tax years in contention are 2006, 2007, 2008, and 2009. A copy of the notice of deficiency is included in this petition under Exhibit A.
1
Items and Amounts in Dispute
3. Ordinary Loss or Taxable Income. The Commissioner erred in determining adjustments to ordinary, distributable net, or taxable income of the Petitioner for taxable years ending December 31, 2006, 2007, 2008, and 2009. The amounts of the adjustments are as follows:
Table 1
12/31/2006
12/31/2007
12/31/2008
12/31/2009
Depreciation
$24,175.00
$25,228.00
$25,228.00
$25,228.00
Sec.183 Not for
Profit Activity
$125,952.00
$147,262.00
$181,158.00
$185,322.00
Total adjustment to ordinary, distributable net, or taxable income $150,127.00
$172,490.00
$206,386.00
$210,550.00
The total amount of adjustments to ordinary, distributable net, or taxable income the
Commissioner deemed “not for profit” pursuant to Section 162(a) and 183(a) of the
Internal Revenue Code for each of the years listed in Table 1 is in dispute (20062009).
2
4. Depreciation. The amount in dispute also includes the amount of depreciation of the building, improvements, and equipment that was used in the “trade or business” or
“production of income” pursuant to Section 167(a).
These amounts are listed under
“Depreciation” on Table 1.
The amount of depreciation takes into account all buildings, equipment, and improvements made to the property for the purpose of producing wine. The calculation takes into account the applicable depreciation method, applicable recovery period, and applicable convention pursuant to Section 167(a).
The appropriate portion of personal, living, and family expenses have been deducted from capital expenditures and depreciation. Miles and Maya are Texas residents and travel to California on a monthly basis to maintain the winery. When they are at the winery, they use the master bedroom and occasionally the living room area. The majority of the property is dedicated to business purposes: entertaining guests, clients, and future wine tours.
5. Accuracy-related Penalty. Because of the Commissioner’s error in determination of depreciation and ordinary loss, the penalty of 20 percent of the portion of underpayment of any tax due pursuant to Section 6662(a) of the Internal Revenue
Code is also in
dispute.
Moreover, even if Miles is found to have underpaid taxes for the given period,
Section 6662(a) requires negligence or disregard of rules or regulation. “Negligence” is defined under this section as any failure to make a reasonable attempt to comply with provisions of this title, and “disregard” includes any careless, reckless, or
3
intentional disregard. Given Miles’ reasonable and bona fide belief that Miles and
Jack Vineyard, Inc. is a for profit business, Miles does not meet the mens rea element of Section 6662(a). Throughout the periods in question, Miles has retained a CPA for accounting and tax preparation purposes and diligently provided his CPA with information regarding business expenditure. For these reasons, a penalty should not be accessed against Miles.
Background & Facts
Approximately eleven years ago, in the aftermath of the tech bubble burst, Miles was able to acquire 36 acres of heavily wooded vacant land on a hillside in California’s wine country at the fire sale price of 18 cents per sq. foot! Though he only wanted to purchase a portion of the 36 acres to start a small winery, the land owner would not partition the land nor were there any smaller pieces of property for sale in that vicinity. At 18 cents per sq. foot, the property was sold
“as is” in its entirety. Because the land was dirt cheap, Miles reasoned that he would be able to recuperate the cost of the land while generating a profit from a small winery. Moreover, the beautiful landscape would add to the aesthetics of the winery and value to wine tours. The
Petitioner planned on selling more than just bottles of wine, he wanted to attract clients by offering them the ultimate experience of an outing in wine county—the rolling hills, beautiful trees, and fresh air of the Saint Ynes Valley. Though only 2 of the 36 acres are used as a vineyard (the actual planting of grapes), the entire 36 acres is used to attract clients and add value to the product line.
4
Furthermore, the extra land offered the owners the ability to expand if business proved to be successful. With his experience in real estate, the Petitioner was confident that even if the winery failed, the appreciation in land value alone would be well worth the investment.
Internal Revenue Service’s Errors
Section 162(a) of the Internal Revenue Code allows for deduction of “all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”
Under Section 183(c), if an activity does not qualify for deduction under Section 162(a), it is considered “not for profit” and falls under the Hobby Loss Rule Section 183(a). The
Commissioner applied the nine factors of Section 183-2(b) in determining whether the
Petitioner’s activities were for profit and erred as follows:
1.
Manner in Which the Activity is Conducted.
The Commissioner reasons that because Petitioner did not have a written business plan, budget or break-even analyses, nor a separate banking account for the business,
Petitioner did not carry the activity in a businesslike manner. Contrary to the
Commissioner’s findings, the Petitioner did have a business plan and explained it, in the words of the tax examiner, Maxwell Smart, “in great detail.” The Petitioner planned to create three types of pinot noir and even had labels for each of them. He also had plans on marketing initiatives, throwing parties, wine tastings, and donating wine to charity auctions to strengthen the brand and create a market for the Miles and Jack Vineyard label once the wine was ready for market.
5
Small businesses such as convenience stores, deli shops, and many owner-managed operations rarely have written businesses plans unless one is required by financial institutions to provide capital funding. A likely reason is that though they may have a detailed business plan and understand their goals well, they do not regularly communicate it to anyone and therefore do not memorialize it. Much like Miles’ real estate business, his winery started off without a written business plan but this does not mean that he had no business plan. When asked, he is able to orally communicate his plan in detail.
Further, though the Petitioner is missing some business records, he was able to provide material records that reflect operating expenses to his CPA. Extensive records are not currently necessary because no revenue will be generated until 2016. Much like the treasure hunter in Harrison v. Commissioner who failed to maintain proper records but was able to prove a profit motive by other means, Miles is able to demonstrate a profit motive without extensive records because he consulted experts in the wine industry, joined the Wine Growers Association, kept costs down by shopping for cost-efficient equipment, retained a CPA for accounting purposes, and spent a substantial amount of time working at the winery and studying the industry. Harrison v. Comm’r, 72 T.C.M.
(CCH) 515 (1996).
2. Expertise of the Taxpayer or Advisors.
The Commissioner alleges that the Petitioner had no expertise in operating a vineyard or winery, and because of his lack of experience, made a poor business decision in planting
2,750 grape vines (the usual amount planted across one acre) over two acres.
The Commissioner is correct in his assessment of Miles’ knowledge of the wine industry
6
when Miles first started the winery. However, because he was so self-conscious in his lack of knowledge, he was driven to do what he could to improve his knowledge gap.
He hired an expert vineyard management company to manage the vineyard to ensure its success, attended winery related meetings, engaged winery experts, and joined the Santa
Ynez Valley Wine Growers Association. His decision in spreading 2,750 grape vines across two acres verses the industry standard of one was the result of consultation and research. Because of the poor condition of the soil, more space was required per vine for a more abundant harvest. Miles did everything a reasonable new entrant could do to make up for his lack of experience. If the law requires a history of experience in an industry for profit motive to be found, by definition no new entrant in any market would have a profit motive.
3. Time and Effort Spent Conducting the Activity.
The Commissioner implies that the Petitioner spends the majority of his effort and time mowing grass between the grape vines while his wife focuses on marketing. The
Commissioner also contends that the Petitioner did not provide documentation to substantiate his activities in the business.
Though documentation on how you spend your time on a farm is difficult to come by, we are confident that testimony from Miles, members of the Wine Growers Association, experts that Miles consults with, and Stephanie will prove that he spends a substantial amount of time tending the vineyard and making up for his lack of knowledge in the wine industry. He is a driven entrepreneur with a desire to succeed in the wine business.
7
4. Expectation that Assets Will Appreciate in Value.
The Commissioner alleges that the Petitioner has not made any statements about his expectations regarding the appreciation in value of land or business to create an overall profit. The Commissioner also believes that the remaining land on the 36 acres is not arable unless substantial expenditure is made to improve and cultivate the land.
Miles has in fact already profited from the appreciation in value of land since purchasing it for a little over 18 cents per sq. foot. No one has questioned him about what he expects in terms of appreciation, but as the economy improves, the demand for wine will only increase. In turn, this will drive the value of real property in wine country up. Though it will be expensive for him to expand the vineyard, profitability will depend on how much he is able to sell this wine. At this point, it is too early to determine how much Miles will be able to sell his pinot negro.
5. Taxpayer’s Success in Similar or Dissimilar Activities.
The Commissioner believes that the Petitioner has successfully run an apartment rental business in Texas, but the Petitioner has not run the winery business in a businesslike manner and will not likely succeed because the two industries are very different from one another. The fifth factor is similar to the second factor. Though Miles has never run a winery, he has hired and consulted experts in the industry. His experience in real property has given him an advantage in that he was able to quickly move on the property when it was sold for below market value.
8
6. Activity’s History of Income and/or Losses.
The Commissioner believes that the business has been incurring losses due to the start-up period. The nature of the wine business is similar to the equine business in that the start-up period is longer than the average business. It takes a considerable amount of time from the moment that grape vines are planted and then grafted till the grapes are harvested, crushed, fermented, aged, and then bottled. It is common in the wine industry to record ordinary losses for 7 or 8 years during the start-up period.
7. Amounts of Occasional Profits.
The Commissioner and Petitioner both agree that due to the nature of the nascent business, not enough time has elapsed for there to be a history of profits.
Miles estimates that each bottle will fetch between $65-$85 per bottle. This will generate revenue of between $120,000 to $225,000 annually. Looking at Operating Expenses under the Analysis of Costs and Expenditures for 2006 and 2007, Miles expects the business to generate between $20,000 to $125,000 profit when the wine is ready to be sold. 8. Taxpayer’s Financial Status.
The Commissioner believes that a substantial amount of money from the Petitioner’s apartment business is used to fund the winery.
Miles started Miles and Jack Vineyards, Inc. with his wife and Jack Lopate. Half the capital required to start the business came from Jack and the rest has come from Miles and Maya’s personal savings and loans. The personal usage portion of the property has
9
been property deducted from the business expense. Furthermore, if the winery is a mere hobby for Miles, it would not make any sense for Jack to invest hundreds of thousands of dollars into Miles’ hobby. Jack and Miles are looking for profit.
9. Elements of Personal Pleasure.
The Commissioner believes that though the Petitioner does not gain personal pleasure from the operation of the winery, he does gain pleasure in the use of the winery’s assets.
Though Miles has gained some pleasure through the winery’s assets, the small and large buildings’ purpose is to attract clients and create more value in each bottle of wine created by Miles and Jack Vineyards, Inc.
Respectfully Submitted,
_____________________________
Miles Raymond
Date
Miles Raymond
1234 Winemaker Road
Buellton, CA 00000
(832)-555-5555
10
January 25, 2013
Exhibit A
Notice of Deficiency
11