On appeal from the United States Tax Court, Tax Court Docket Nos. 15627-80, 15423-80, 10911-77 and 1485-81.
Gibbons, Chief Judge, Weis, Circuit Judge, Kelly, District Judge.*fn*
These four consolidated appeals are from a final order of the United State Tax Court determining that there was a deficiency in the taxpayers' federal income tax for the taxable year 1976.*fn1 At issue are claimed deductions for expenses paid or incurred in that year in carrying out a trade or business, or for the production or collection of income. 26 U.S.C. §§ 162(a)(3), 212a (1954). The expenses sought to be deducted are $6,000,000 in advance royalties, and $75,000 in management and legal fees, accrued by a limited partnership, Tennessee Coal Associates (TCA), in a coal mining venture. The Commissioner determined that the limited partnership did not enter into the coal mining venture for the predominant purpose of making a profit. The Tax Court made the same determination, and disallowed the deductions. We will affirm.
It is well established that in order to take a deduction for expenses incurred in carrying out a trade or business the taxpayer must have entered into the venture with the primary and predominant purpose and objective of making a profit. See Thomas v. Commissioner, 792 F.2d 1256, 1259 (4th Cir. 1986); Tallal v. Commissioner, 778 F.2d 275, 276 (5th Cir. 1985). "Primary" in this context means "of first importance" or "principally", while "profit" means economic profit independent of tax savings. Malat v. Riddell, 383 U.S. 569, 572, 16 L. Ed. 2d 102, 86 S. Ct. 1030 (1966); accord, Surloff v. Commissioner, 81 T.C. 210, 233 (1983); Seaman v. Commissioner, 84 T.C. 564, 588 (1985). "While a reasonable expectation of profit is not essential, the profit motive must be bona fide." Fox v. Commissioner, 80 T.C. 972, 1006 (1983), aff'd mem. sub nom. Kratsa v. Commissioner, 734 F.2d 6 (3d Cir. 1984), aff. mem. sub nom., Hook v. Commissioner, 734 F.2d 5 (3d Cir. 1984), aff'd sub nom., Barnard v. Commissioner, 731 F.2d 230 (4th Cir. 1984), aff'd mem. 742 F.2d 1441 (2d Cir. 1984). See also Hirsch v. Commissioner, 315 F.2d 731, 736 (9th Cir. 1963); Flowers v. Commissioner, 80 T.C. 914, 931 (1983). A deduction claimed under 28 U.S.C. § 212(1) must meet the same requirements applicable to trade or business expenses under section 162, except that the person claiming the deduction need not be in the trade or business. Fischer v. United States, 490 F.2d 218, 222 (7th Cir. 1973).
The taxpayers do not dispute the profit objective test as a general principle. They contend, however, that in applying that test the Tax Court erred in two respects. First, they contend that the Tax Court's finding that the limited partnership lacked a primary profit objective is clearly erroneous. Second, they contend that the court erred in applying the test at the limited partnership level rather than focusing on the objectives of the individual taxpayers. Our review with respect to the first issue is limited to determining whether the Tax Court's findings of fact, including inferences drawn from the facts, are clearly erroneous. Commissioner v. Duberstein, 363 U.S. 278, 291, 4 L. Ed. 2d 1218, 80 S. Ct. 1190 (1960); Imbesi v. Commissioner, 361 F.2d 640, 643 (3d Cir. 1966). The second issue is one of law, as to which our review is plenary.
Whether the partnership has the requisite profit objective is an issue of fact which must be resolved by examining the surrounding facts and circumstances. Capek v. Commissioner, 86 T.C. 14, 36 (1986). In making this determination, greater weight should be given to objective facts than to a mere declaration of the taxpayer's intent. Flowers v. Commissioner, 80 T.C. 914, 982 (1983). The burden of proving the requisite profit objective rests with the taxpayer. See Nickerson v. Commissioner, 700 F.2d 402, 404 (7th Cir. 1982); Golanty v. Commissioner, 72 T.C. 411, 437 (1979), aff'd mem., 647 F.2d 170 (9th Cir. 1981). The Tax Court determined that the taxpayers did not meet this burden, and that TCA did not engage in mining activities for profit. (App. at 71). In so finding, the Tax Court relied on the following factors:
(1) the individuals who organized and conducted TCA's activities failed to testify;
(2) the venture was marketed on the basis of expected tax benefits;
(3) the advance royalty payment in the coal lease was grossly disproportionate to any royalties previously paid for the property;
(4) the TCA partnership made an inadequate evaluation of area 5's mining potential; and
(5) the activities of the TCA partnership were conducted in a manner that assured failure.
The evidence of record supporting the Court's findings discloses that the TCA limited partnership was formed by Fannie Jacobs as general partner and her son Robert Jacobs as the limited partner to deal in and own interests in coal producing properties and leases. In the spring of 1976, Robert began efforts to recruit new investors into the partnership by discussion the possibility of investing in a coal mining venture with Peter Feldman, a partner in the accounting firm of Isidore Feldman and Company. According to Robert, coal was increasingly attractive as an investment due to the 1973 oil embargo and the upward trend in coal prices in 1976. Peter then spoke about the investment to his partners in the accounting firm, Herman Simon and his father Isidore Feldman. The investment discussions did not proceed any further at this time.
In June of 1976, Robert again approached Peter about investing in a coal venture. Numerous discussions followed between Robert and Peter, and between Peter, Isidore and Herman Simon. In the summer of 1976, Peter agreed to join TCA. Isidore then began soliciting investments from potential investors, some of whom were his clients for whom he did tax work.
Isidore succeeded in attracting seven investors, four individuals and three corporations. By letters dated September 23, 1976 and October 7, 1976, the four individuals -- Nathan Henin, Leonard Harris, Jerome Harris, and Jack Perlstein -- each agreed to contribute $150,000 for an interest in TCA. The three corporations -- Marilyn Togs, Inc., Consolidated Lumber Corp., and National Industries of Lexington, Inc. -- adopted resolutions dated September 7, 1976, September 9, 1976, and September 28, 1976, respectively, authorizing an investment of $250,000 in TCA or in a coal partnership in which Peter was a general partner. Three of these seven investors testified at trial that they agreed to invest in TCA, without conducting any independent investigation of the venture, because of Isidore's representations that the profit potential of the investment would be "two-fold." First, Isidore advised them that the coal itself would be profitable. Second, Isidore informed them that the investment would be a "tax shelter." Even if "worse came to the worse and they [the investors] wasn't [sic] able to make any money mining the coal . . . [Isidore] said there was some tax advantages in making an investment . . . " The seven investors did not make any cash outlays, however, until December of 1976. On December 31, 1976, TCA paid Isidore Feldman and Company $300,000 for finding these seven investors.
In the fall of 1976, Robert Jacobs advised Peter Feldman that he could arrange a coal sublease for TCA. While seeking coal properties in Kentucky, Robert Jacobs' partner in an accounting practice, Irving Kanarek, had met John Wolcott, the president of Southeast Coal, Oil & Gas Co., Inc. (Southeast), which held a mineral lease on a parcel of approximately 6,000 acres called the Lacy Tract. Robert Jacobs advised Peter Feldman that K & J, a partnership formed by Irving Kanarek and Robert's brother Alan Jacobs, proposed to sublease the Lacy Tract coal rights. Robert offered Peter (i.e., TCA) a sublease to a 900 acre portion of the Lacy Tract known as area 5. Initially, Robert told Peter that TCA would have to pay $7,000,000 to $7,500,000 in advance royalties for this property. After negotiation, Peter managed to talk him down to $6,000,000. In negotiating this price on behalf of TCA, Peter relied exclusively on Robert's representations ...