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William G. Holsinger v. Commissioner

T.C. Memo 2008-191

MEMORANDUM FINDINGS OF FACT AND OPINION

Respondent determined deficiencies of $54,462 and $43,423 in petitioners' 2001 and 2002
Federal income taxes, respectively. Respondent amended his answer and increased petitioners'
2001 deficiency by $20,278, for a total 2001 deficiency of $74,740. After concessions by both
parties, the issues for decision are: (1) Whether losses from purchases and sales of securities are
deductible by petitioners as ordinary losses or are instead subject to the limitations applicable to
capital losses; and (2) whether expenses attributable to those purchases and sales are deductible
by petitioners as business expenses or are instead subject to the limitations applicable to itemized
deductions.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulation of facts and the attached
exhibits are incorporated herein by this reference. At the time they filed the petition, petitioners
resided in Florida.
William Holsinger (petitioner) retired in 1992, having worked approximately 30 years for Eli
Lilly & Co. In 1999 petitioners married. In 2000 petitioners began buying and selling stocks,
earning approximately $280,000 from that source during 2000. Petitioner opened brokerage
accounts in his name, using his Social Security number. Petitioners reported their trading 1
income as capital gains in 2000.
On April 19, 2001, petitioners incorporated Alpha Trading Co. of Sarasota, L.L.C. (Alpha) under
the laws of Florida. Petitioner owns 67 percent of Alpha, and petitioner Mickler owns the
remaining 33 percent. On or about May 17, 2001, Alpha made a timely election pursuant to
section 475(f) to use the mark-to-market method of accounting. 2
Petitioners maintained two trading accounts with E-Trade, two with Options Xpress, and one
with Ameritrade-Comdisco. From April 19 until December 31, 2001, petitioners executed
approximately 289 trades on their various trading accounts. In 2002 petitioners executed
approximately 372 trades.
In 2001 petitioners claimed an ordinary loss of $180,174 3 from Alpha on their 2001 Schedule E,
Supplemental Income and Loss. The loss consists of trading losses of $178,870, depreciation of
$1,284, and interest of $40. The aggregate cost or other basis of the securities sold in 2001 was
$933,147. The sale prices in 2001 collectively were $754,277. Also in 2001 petitioners claimed a
net loss of $80,100 on their Schedule C, Profit or Loss From Business. Respondent disallowed
the $80,100 as business expenses but allowed itemized deductions for investment interest of
$7,620 and miscellaneous deductions of $72,480. After adjustments for gross income limitations,
respondent allowed net itemized deductions of $69,153.
In 2002 petitioners claimed an ordinary loss of $45,521. This loss comprises $11,227 in trading
losses related to Alpha and $34,294 in claimed business expenses [pg. 1017] related to Alpha.
Respondent disallowed the $34,294 as business expenses but allowed a net itemized deduction of
$26,181.
After petitioner incorporated Alpha, he did not switch the name on his trading accounts.
Petitioner's Social Security number also remained on the trading accounts. Petitioners continued
to trade stocks and options during 2001 and 2002 with the accounts they had used before the
incorporation of Alpha. In December 2002 petitioners had one trading account in Alpha's name.
During the years in issue petitioners used five accounts to conduct trades.
Petitioners traded from a room in their house. The room contained computers with Internet
access in order for petitioners to trade and do research. Additionally, petitioner had four monitors
connected to his computer because he wanted to be able to trade and track different investments
and potential investments simultaneously. Petitioner purchased the computer equipment around
July 1, 2000, before incorporating Alpha. None of the computer equipment was transferred to
Alpha.
OPINION
I. Mark-to-Market Election
Respondent concedes that Alpha made a timely mark-to-market election pursuant to section
475(f). Section 475(f) applies only to those engaged in a trade or business as traders in
securities. Having made a timely election, if Alpha were a trader in securities, it would be
eligible to recognize gain or loss on any security held in connection with such a trade or business
at the close of any taxable year as if the security were sold at its fair market value on the last
business day of the taxable year. See sec. 475(f)(1)(A)(I). In general any gains or losses with
respect to the securities, whether deemed sold at yearend under the mark-to-market method of
accounting or actually sold during the taxable year, shall be treated as ordinary income or loss.
Sec. 475(d)(3)(A)(I). If Alpha is considered an investor in securities, the 2001 and 2002 net
losses from the purchases and sales of securities would be capital losses and only partially
deductible to petitioners.
II. Trade or Business
The Internal Revenue Code does not define the term "trade or business" for purposes of section
162. Commissioner v. Groetzinger, 480 U.S. 23, 27 [59 AFTR 2d 87-532] (1987); Estate of
Yaeger v. Commissioner, 889 F.2d 29, 33 [64 AFTR 2d 89-5801] (2d Cir. 1989), affg. T.C.
Memo. 1988-264 [¶88,264 PH Memo TC]. Whether activities constitute a trade or business is a
question of fact. See Higgins v. Commissioner, 312 U.S. 212, 217 [25 AFTR 1160] (1941);
Estate of Yaeger v. Commissioner, supra at 33; Mayer v. Commissioner, T.C. Memo. 1994-209
[1994 RIA TC Memo ¶94,209]; Paoli v. Commissioner, T.C. Memo. 1991-351 [1991 TC Memo
¶91,351]. Petitioners have neither claimed nor shown that they satisfied the requirements of
section 7491(a) to shift the burden of proof to respondent with regard to any factual issue.
Accordingly, petitioners bear the burden of proof. See Rule 142(a).
Petitioners argue that they were traders, trading as agents of Alpha. With the incorporation of
Alpha, petitioners argue they became traders. In determining whether a taxpayer's trading
activity constituted a trade or business, courts have distinguished between "traders" and
"investors". Moller v. United States, 721 F.2d 810, 813 [52 AFTR 2d 83-6333] (Fed. Cir. 1983);
see also Levin v. United States, 220 Ct. Cl. 197, 597 [43 AFTR 2d 79-1057] F.2d 760, 765
(1979).
In determining whether a taxpayer is a trader, nonexclusive factors to consider are: (1) The
taxpayer's intent, (2) the nature of the income to be derived from the activity, and (3) the
frequency, extent, and regularity of the taxpayer's securities transactions. Moller v. United States,
supra at 813. For a taxpayer to be a trader the trading activity must be substantial, which means
"frequent, regular, and continuous enough to constitute a trade or business" as opposed to
sporadic trading. Ball v. Commissioner, T.C. Memo. 2000-245 [TC Memo 2000-245] (quoting
Hart v. Commissioner, T.C. Memo. 1997-11 [1997 RIA TC Memo ¶97,011]). A taxpayer's
activities constitute a trade or business where [pg. 1018] both of the following requirements are
met: (1) The taxpayer's trading is substantial, and (2) the taxpayer seeks to catch the swings in
the daily market movements and to profit from these short-term changes rather than to profit
from the long-term holding of investments. Mayer v. Commissioner, supra.
As to the first requirement, we find petitioners' trading was not substantial. Courts consider the
number of executed trades in a year and the amount of money involved in those trades when
evaluating whether a taxpayer's trading activities were substantial. See, e.g., Mayer v.
Commissioner, supra; Paoli v. Commissioner, supra. In Paoli, the Court held trading activities
were substantial when the taxpayers traded stocks or options worth approximately $9 million. In
Mayer, the Court considered over 1,100 executed sales and purchases in each of the years at
issue therein to be substantial trading activity. Trading activity was found to be insubstantial
when a taxpayer executed at most 83 purchases and 41 sales in one year and 76 purchases and 30
sales in the second year. Moller v. United States, supra at 813. In 2001 petitioners executed
approximately 289 trades. An analysis of petitioners' trading activity reveals that in 2001 they
traded on 63 days. This total represents less than 40 percent of the trading days from April 19,
2001, the day petitioners incorporated Alpha, until December 31, 2001. In 2002 petitioners
traded on 110 days and executed approximately 372 trades. This total represents less than 45
percent of the trading days in 2002. We find it doubtful whether the trades were conducted with
the frequency, continuity, and regularity indicative of a business.
As to the second requirement, petitioners have failed to prove that they sought to catch the
swings in the daily market movements and to profit from these short-term changes rather than to
profit from the long-term holding of investments. Petitioner testified that his goal in forming
Alpha was to profit from short-term swings in the market. Additionally, petitioner testified that
he usually closed his account at the end of the day and tried to avoid holding stocks and options
overnight. The documentary evidence, however, paints a different picture. A list of petitioners'
trades shows they rarely bought and sold on the same day. Furthermore, a significant amount of
petitioners' holdings was held for more than 31 days. As a result, we find that petitioners have
not demonstrated that they sought to capture the daily swings in the market. We find that they
were not traders, but investors. Petitioners' trading pattern is consistent with that of an investor,
not of a trader.
III. Business Expenses
Deductions are a matter of legislative grace, and the taxpayer has the burden of showing
entitlement to any deduction claimed. See Rule 142(a); INDOPCO, Inc. v. Commissioner, 503
U.S. 79, 84 (1992). [69 AFTR 2d 92-694] Taxpayers must substantiate amounts claimed as
deductions by maintaining the records necessary to establish such entitlement. Sec. 6001; sec.
1.6001-1(a), Income Tax Regs.; see Hradesky v. Commissioner, 65 T.C. 87 (1975), affd. per
curiam 540 F.2d 821 [38 AFTR 2d 76-5935] (5th Cir. 1976).
Petitioners claimed business deductions for 2001 and 2002. Petitioners argue that their trading
activity was on behalf of Alpha, not for themselves as individuals. Petitioners claim they were
Alpha's agents and therefore had the authority to conduct trades on its behalf. Even if petitioners
acted on Alpha's behalf, because their activity, as we have already found, did not rise to the level
of a business (the business of trading securities), the expenses petitioners attributed to that
activity, even if incurred on Alpha's behalf, are not deductible as business expenses.
In reaching all of our holdings herein, we have considered all arguments made by the parties, and
to the extent not mentioned above, we find them to be irrelevant or without merit.
To reflect the foregoing,
Decision will be entered under Rule 155.
1 The use of the term "trading income" is not a conclusion that petitioners or Alpha were
engaged in a business of trading in securities.

2 Unless otherwise indicated, all section references are to the Internal Revenue Code, and all
Rule references are to the Tax Court Rules of Practice and Procedure.

3 The 2001 ordinary loss petitioners claimed on Schedule E is $20 less than the total claimed of
the trading losses, depreciation, and interest. Both parties have stipulated the amounts, and there
appears to be no explanation for the $20 discrepancy. The $20 discrepancy has no effect as to the
outcome of the case.