In Matter of Anthony and Renata Conte, DTA No. 825454 (N.Y.S. Div. of Tax App., Mar. 12, 2015), a New York State Administrative Law Judge concluded that personal income taxpayers validly claimed losses on their New York State and City return because the claimed losses were related to a business carried on for a profit and not related to a hobby.

Background. In 1999, Mr. Conte formed I Media Corporation (the “Corporation”) for the purpose of publishing a television listings guide and shopping periodical, TV Time Magazine. Separately, in 2003, Mr. Conte also formed I Media Company (the “Company”), a sole proprietorship, to develop, print, distribute, and market TV Time Magazine. It is unclear from the decision how the Corporation and the Company interacted with one another.

In November 2004, the Corporation began printing and distributing TV Time Magazine on a weekly basis on Long Island. TV Time Magazine was provided at no charge, as the Corporation intended to make money by selling advertising space and receiving payments from distributors for address lists and carrier route maps. In 2005, Mr. Conte hired a full-time advertising sales director who was delegated most of the advertising sales and marketing functions. In 2004 to 2005, the Corporation entered into contracts with 60 different distributors, and by 2005, TV Time Magazine reached a weekly distribution of 200,000 copies. However, after what Mr. Conte claimed was the interference of employees of Nassau County, the Nassau County District Attorney’s Office (the “DA’s Office”) and Newsday, Inc. (the publisher of a Long Island newspaper), route distributors refused to distribute TV Time Magazine, and the Corporation was unable to continue in business.

Mr. Conte received a letter from the Department in December 2005, informing him that the Corporation was administratively dissolved, and Mr. Conte then began to wind up the affairs of the Corporation. In 2006, the Corporation assigned all of its claims, rights, property interests, goodwill, and legal causes of action to Mr. Conte, and Mr. Conte subsequently sued the parties he believed had wrongfully interfered with his business. He was awarded approximately $1.4 million in compensatory and punitive damages against three individuals who performed services for the DA’s Office based on a tortious interference with contracts claim; that award was on appeal at the time of the hearing.

Mr. Conte and his wife filed a joint New York State personal income tax return. The Contes included a Schedule C “Profit or Loss From Business (Sole Proprietorship)” for the Company with their 2010 return, which reported that the Company did not receive any revenue and incurred a net loss of $47,923.00. After auditing the Contes on a number of issues related to their 2010 return, the Department, among other things, disallowed the Company’s losses because it did not consider the business of the Company to be carried on for profit. The Department reached its conclusion on the basis that the Company did not have any income in three of the previous five years. The Department never asked the Contes to provide substantiation for the amount of the claimed losses.

The law. For New York State personal income tax purposes, the calculation of taxable income starts with a taxpayer’s federal adjusted gross income. Under Internal Revenue Code (“IRC”) § 162(a), a taxpayer may deduct “all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” However, if an activity is “not engaged in for profit,” deductions may be taken only to the extent of income from such activity. IRC § 183(b)(2). Treasury Regulation § 1.183-2(b) provides nine factors to be considered in determining whether activities are engaged in for a profit: (1) the manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or his advisors; (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 (i.e., in turning a business from unprofitable to profitable); (6) the taxpayer’s history of income or losses with respect to the activity; (7) the amount of occasional profits, if any, that are earned; (8) the financial status of the taxpayer (i.e., whether the taxpayer has substantial income from other activities); and (9) the elements of personal pleasure or recreation involved in the activity.

The decision. After swiftly dismissing the Contes’ other challenges to the Department’s audit, the ALJ agreed that the Contes were entitled to the losses claimed on Schedule C because they were related to Mr. Conte’s business of publishing and circulating TV Time Magazine, and such business “was engaged in for profit and not as a hobby.”

In reaching his decision, the ALJ first rejected the Department’s argument that the Contes failed to provide evidence substantiating the amount of the losses claimed on Schedule C. The ALJ explained that the Department only raised the issue of substantiation after the ALJ hearing and concluded that such a factual issue may not be raised for the first time in the Department’s brief because doing so would deprive the Contes of the opportunity to offer evidence on the issue. Second, while recognizing the confusion created by the separate existence of the Corporation and the Company, the ALJ nonetheless accepted that, if the Corporation could be characterized as having been carried out for profit, such losses were properly claimed on the Contes’ tax return.

Finally, the ALJ applied the factors of Treasury Regulation § 1.183-2(b) to conclude that the business of the Corporation was carried out for profit. Among other things, the ALJ identified Mr. Conte’s prior experience in the distribution of periodicals for a supermarket chain, the time and effort required for TV Time Magazine to reach its weekly distribution at its height, the “inappropriate interference” with the business that caused its demise, and the lack of any recreational or diversionary purpose for having carried out the business of the Corporation. Further, the ALJ rejected the Department’s claim that there was no business engaged in for profit because the business was inactive in 2010. Instead, the ALJ said that to determine whether a business’s activities are carried on for profit, one must “focus upon the entire history of the enterprise and not just the year in issue.”

Additional Insights

The Tax Appeals Tribunal has consistently relied upon the factors listed in Treasury Regulation § 1.183-2(b) for determining whether a business is engaged in with the objective of making a profit. These determinations are necessarily highly fact-specific. This case reaffirms that an unsuccessful business venture may have been engaged in for purposes of making a profit, and that losses of inactive businesses may still be deductible as business losses.

Separately, this case highlights the Division of Tax Appeals rules that require all factual issues to be raised by both parties at or before the hearing. This rule is often invoked against a petitioner that belatedly tries to add new facts to the record. Here, because the Department did not raise the issue of substantiation until it filed its post-hearing brief, after the record had closed, it was foreclosed from challenging the evidence supporting the losses.