Deductions Not allowed for Fishing Boat and Fuel Boat ventures.

Paul Matthews, an attorney, purchased a commerical fishing boat at auction for $100,000; one of Matthews's clients had a judgment against the boat's former owner and owed legal fees to Matthews. Matthews hired an experienced commercial fisherman to operate a fishing venture using the boat in 1984. Matthews wrote a series of checks, totaling at least $80,000, apparently to overhaul the vessel. The fishing venture earned $25,000 in 1985, but did not earn a profit from 1985 through 1993. Matthews also purchased two fuel barges in 1984 and 1987. He leased both boats to a marine fuel company, but the lease payments were to be paid only out of profits. The fuel barge venture never earned a profit, and Matthews never received any rental income.

 On a joint 1985 tax return, Matthews and his wife reported income from his law practice, along with the $25,000 in gross income from the fishing venture, and claimed deductions totaling nearly $19,000 for depreciation of the fishing boat. In addition, they claimed deductions for an investment tax credit for the purchase of electronic equipment, and for expenses. In 1986 and 1987, the Matthewses reported income from the law practice and claimed depreciation deductions for the fishing boat. The IRS determined a deficiency, disallowing the investment credit claimed for 1985, denying certain deductions for the three years, and asserting penalties for negligence and substantial understatement. 

 The Tax Court held that the Matthewses did not enter into the two boating ventures with the intent to make a profit. The court allowed the couple's depreciation deduction for the fishing boat in 1985, but disallowed any deductions in 1986 and 1987 for either activity, and disallowed, for the lack of substantiation, the claimed investment credit or depreciation deduction in 1985 for the electronic equipment. The court imposed additions to tax under sections 6653(a) and 6661(a). The Matthews appealed. 

 The Second Circuit considered nine factors determining the Matthewses' profit motive, and agreed with the Tax Court that "these factors point to the conclusion that the Matthewses engaged in neither venture for profit." The appeals court pointed out that the Matthewses "did not keep complete or accurate books and records for either venture," wrote checks from various bank accounts to cover expenses, had no prior commercial boating experience, and did not consult with experts before entering the ventures, either to appraise the boats or to assess the fishing and fuel boat business. 

 Further, the court noted that neither venture ever made a profit; the "Matthewses did not offer any evidence indicating their losses were attributable to down business cycles, supply problems. etc."; and "Matthews stated that he purchased the fishing vessel to assist a client and secure his attorney's fees, and purchased the fuel boat business to provide a livelihood for his son." Finally, the court refused to disturb the Tax Court's finding that the Matthewses had failed to substantiate their claimed deductions, and affirmed the imposition of additions to tax.