Originally published on Passive Activities and Other Oxymorons on April 13th, 2011.
Shawn C. Blanchette, et vir. v. Commissioner, TC Summary Opinion 2011-15
Tax court decisions bring us into many dimensions of human experience - lactation, mercenaries, underwear and "gentlemen's clubs" to name but a few. I wouldn't have thought that I'd ever get to mention tessaracts, but there you have it. Ms. Blanchette called her science fiction memorabilia business A Wrinkle in Time, no doubt in honor of Madeleine L'Engle's novel in which the existence of extra spatial dimensions beyond the three we are familiar with plays an important role. Just as a cube is what you get when you expand the concept of a square into the third dimension, a tessaract is what you get when you expand a cube into the fourth dimension. You can probably get a better notion of this from reading Sphereland, the sequel to Flatland, which you should probably read first. They are both great. "A Wrinkle in Time" is pretty good too although it doesn't stack up to a truly great science fiction work like Acts of the Apostles by John Sundman. (You would cause a great deal of offense if you counted the better selling work with the same title science fiction).
Because of my professional bias I usually root for the taxpayer when I am reading the case unless they are being really lame. The clever title for her business made me really pull for Ms. Blanchette as I was reading along. I guess I didn't root hard enough to cause a reversal in the flow of time so even after I was done reading the case, she had still lost. It was a hobby loss case and I think it is a fairly instructive one. Here's the story:
In 1992 Ms. Blanchette formed and operated a proprietorship under the name A Wrinkle in Time (AWIT). From 1992 through 1995 Ms. Blanchette operated AWIT as a retail store in Santa Clara, California, leasing space and obtaining a business license to do so. Ms. Blanchette was the primary business owner and was intimately involved with all aspects of the business. On average, she worked at her store 14 hours per day, 7 days a week. Ms. Blanchette aggressively promoted AWIT locally with newspaper advertisements and regionally at science fiction conventions. Although Ms. Blanchette adopted a business plan in 1993 to transform AWIT into a partnership that could further penetrate the science fiction memorabilia market, she never executed that plan. Despite Ms. Blanchette's efforts, her collectibles activity generated losses from 1992 through 1995.
In 1996 Ms. Blanchette relocated to Sunnyvale, California, where she operated AWIT as a retail store in leased space until 2001. During that time, Ms. Blanchette developed a Web site to sell her collection to online customers. Although she adopted a second business plan in 2000 to rebrand AWIT's online image, Ms. Blanchette did not bring that plan to fruition. She continued to incur losses from 1996 through 2001.
In 2001 Ms. Blanchette relocated to Las Vegas, Nevada. From 2002 through 2005 Ms. Blanchette sold science fiction memorabilia mostly online and at conventions. During that time Ms. Blanchette rented warehouse space to store her collection; and although the warehouse was generally not open to the public, she would sometimes show that collection to potential customers. Ms. Blanchette incurred losses from 2002 through 2005.
Not surprisingly the business also had losses in 2006 and 2007. Enough being enough, the Service disallowed losses from 2005 to 2007 for a total deficiency of slightly less than 10 grand. The Court referred to the nine factors that should be considered in a hobby loss (Section 183) case:
(1) The manner in which the taxpayer carries on the activity;
(2) the expertise of the taxpayer in carrying on the activity;
(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, which are earned by the taxpayer;
(8) the financial status of the taxpayer;
(9) elements of personal pleasure or recreation.
1. Although Ms. Blanchette separated her personal finances from the business and kept thorough records the court noted that she did not use those records to generate business intelligence to move her toward profitability:
Petitioners contend that the online expansion of Ms. Blanchette's collectibles activity demonstrates that she sought to improve the profitability of her activity during the subject years. We disagree. The adaptation of Ms. Blanchette's collectibles activity online occurred some time between 1996 and 2000. Since she moved her collectibles activity online, we have found no significant undertakings on the part of Ms. Blanchette to improve her overall profitability. To the contrary, she continued to add to her inventory without due regard for the losses she repeatedly incurred.
Score one for the IRS.
2. The court called the "expertise" factor a push, unfairly I think:
Ms. Blanchette testified that she consulted with other science fiction memorabilia collectors about her activity. However, she never consulted with accountants, lawyers, or business advisers about her activity. The failure to procure objective business advice is a negative factor while her consultation with other collectors is a positive consideration. This factor is neutral.
I doubt that there are many accountants and lawyers who can tell you a lot about how to make money in the collectibles business.
3. They also called the time and effort factor a push, which I thought was very unfair.
4. The court did not give Ms. Blanchette the benefit of the doubt on the expectation that her collection would appreciate. Part of their analysis was way off:
..........even though a portion of Ms. Blanchette's collection was worthless, she did not liquidate those items and reinvest the proceeds in other collectibles with potential for real appreciation.
You do not get very much to reinvest from selling things that are worthless. Presumably you score big in collectibles from keeping things that are presently perceived as worthless that subsequently become valuable.
Their next point though is one in which Ms. Blanchette could have really helped herself if she had had a detailed list of every item with its cost and estimated fair market value.
Also the court held it against her that she did not insure her collection. Whether to insure or self insure is a business decision that might be reasonable either way, but it would not have been that difficult for her to get a quote on the cost of insuring her collection.
Factors 5 through 8 were not good either. Essentially the losses from the science fiction business have been funded by her husbands salary. It was the ninth factor that was particularly hurtful:
Ms. Blanchette is passionate about science fiction, and she derives great pleasure from her collectibles activity. This enjoyment, however, cannot overcome the complete disregard for profit objective with which she has conducted her activity. Given the small profit potential and significant satisfaction derived from the collectibles activity, we are confident that it is Ms. Blanchette's quest for personal gratification that keeps her going and not any bona fide profit objective.
The IRS really seems to hate horse breeding as a business. Taxpayers seem to be able to win horse cases in tax court though. Reading those cases, I always get the impression that the taxpayers somehow convince the judges that they don't particularly like horses. Consider this from Richard A. Frimml, et ux. v. Commissioner, TC Summary Opinion 2010-176:
This factor favors respondent. Petitioners made many business decisions regarding the purchase, care and sale of a number of Paint horses for their horse activity. Petitioners paid extensive amounts to care for Special when he was injured. On the other hand, petitioners decided to put down a 2-year-old foal that hurt her leg in a fence accident because the cost to heal her exceeded the projected price in selling her.
You can check out my post on it to find out what was so special about Special (has to do with fluids).
I do have to admit that I would have a lot more fun fooling around with light sabers and phasers and reading great works of science fiction like Cheap Complex Devices by John Sundman than trying to manage animals that are considerably larger than I am that seem to defecate a lot so maybe Ms. Blanchette deserved to lose. I don't care I was rooting for her anywhere.
Full disclosure and celebrity name dropping:
John Sundman and I were in the same high school graduating class. The Xavier High School class of 1970 also included noted science fiction author Bradley Ferguson author of Flag Full of Stars.