However, PSINet continued to founder, and by the end of November 2000, PSINet traded at $1.13 per share. In April 2001 PSINet fired Mr. Schrader, and on April 27, 2001, NASDAQ delisted PSINet. In 2002 Mr. Schrader repaid $800,000 to Mr. Dagres. Mr. Schrader's financial situation worsened, and to avoid Mr. Schrader's filing for bankruptcy protection, on December 31, 2002, Mr. Dagres forgave the original loan in exchange for a new non-demand promissory note for $4 million, with 1.84-percent interest (when the short-term 2011 U.S. Tax Ct. LEXIS 12">*34 applicable Federal rate was 1.84 percent), maturing December 31, 2005, and with required monthly payments of $5,000.

Mr. Schrader made six payments of $5,000 in 2003; but on May 31, 2003, he notified Mr. Dagres that he would not be able to make any further monthly payments on the note. At Mr. Dagres's request, Mr. Schrader negotiated with a certified public accountant who worked at Battery Ventures, John O'Connor, and during the negotiations Mr. Schrader stated:

[F]or the record I would like him [Mr. Dagres] to know that which he already knows. I will always give him first opportunity to invest in any and all businesses where there is even the slightest fit between Battery's focus and my future.

Mr. Dagres and Mr. Schrader executed a settlement agreement on December 31, 2003, pursuant to which Mr. Dagres accepted $364,782 in securities ¹⁴ from Mr. Schrader and forgave the balance of the $4 million loan as restructured on December 31, 2002.

Upon the advice of Mr. O'Connor, who worked for BMC (and who in turn consulted 2011 U.S. Tax Ct. LEXIS 12">*35 with tax counsel at the law firm of 136 T.C. 263">*275 Holland & Knight and with tax specialists at the accounting firm that handled Mr. Dagres's tax return preparation), ¹⁵ Mr. Dagres claimed business bad debt losses on his Forms 1040, U.S. Individual Income Tax Return, for 2002 and 2003. In the block next to his name on page 2 of those returns (as on prior returns), Mr. Dagres indicated his "occupation" as "VENTURE CAPITALIST". To the 2002 and 2003 returns Mr. Dagres attached a Schedule C, Profit or Loss From Business, that reported a sole proprietorship for which the principal business or profession in line A was "Loan and Business Promotions" and for which the code entered in line B was 523900, which stood for "Other financial investment activities (including investment advice)".

The IRS did not examine Mr. and Mrs. 2011 U.S. Tax Ct. LEXIS 12">*36 Dagres's 2002 return, and we therefore do not discuss it further.

Although he had received $30,000 in payments and $364,782 in securities from Mr. Schrader in 2003, Mr. Dagres reported no business income on his Schedule C for 2003. ¹⁶ He reported one expense, labeled "Bad Debt Loss", in the amount of $3,635,218— the difference between the $4 million principal amount of the loan as renegotiated in 2002 and the agreed value of the $364,782 in securities he received from Mr. Schrader in December 2003.

The IRS examined Mr. and Mrs. Dagres's 2003 return and issued a timely notice of deficiency on March 21, 2008. The notice of 2011 U.S. Tax Ct. LEXIS 12">*37 deficiency stated:

The deduction of $3,635,218 shown on your 2003 return as a business bad debt is disallowed. The debt was a non-business bad debt because it was a personal loan and not created in connection with your trade or business. In the latter event, the [loss on the] loan is subject to the limitations of136 T.C. 263">*276 Section 1211 of the Internal Revenue Code. Accordingly, taxable income is increased $3,635,218.00. [Emphasis added.]

Mr. Dagres timely petitioned for redetermination of the deficiency.

In an amended answer filed May 15, 2009, the IRS seeks an increased deficiency based on Mr. Dagres's failing to report the $30,000 received in 2003. In the amended answer, the IRS also asserts two alternative positions with respect to disallowance of the bad debt loss deduction determined in the notice of deficiency.

On June 18, 2009, Mr. Dagres filed a "Motion to Shift the Burden of Proof to Respondent 2011 U.S. Tax Ct. LEXIS 12">*38 Under Rule 142(a)", asserting that the IRS changed its theory of the case and should bear the burden of proving whether Mr. Dagres was engaged in a trade or business when working as a venture capitalist. At trial we took Mr. Dagres's motion under advisement; and as we explain below in part I of this Opinion, we will deny the motion as moot, since in this case the burden of proof does not affect the outcome.

Mr. Dagres was in the trade or business of working as an employee of BMC, to which trade or business his wage income relates. However, he was also a Member Manager of the General Partner L.L.C.s, each of which was in the trade or business of managing venture capital funds, not mere investment. That venture capital management business is attributable to Mr. Dagres. When he made the $5 million loan to Mr. Schrader in 2000, Mr. Dagres's dominant motivation for lending $5 million to Mr. Schrader was to gain preferential access to companies and deals to which Mr. Schrader might refer him, so that Mr. Dagres could use that information in the venture capital activities that he undertook as a Member Manager of the General Partner L.L.C.s. His loan to Mr. Schrader 2011 U.S. Tax Ct. LEXIS 12">*39 was proximately related to those venture capital 136 T.C. 263">*277 management activities and to his personal intention to obtain "carried interest" from the General Partner L.L.C.s; and thus he made the loan in connection with his trade or business. Therefore, we find that he suffered a business bad debt loss in 2003.

The IRS contends that Mr. Dagres's loan to Mr. Schrader was personal and that Mr. Dagres's 2003 loss is a nonbusiness bad debt, deductible only as a short-term capital loss under section 166(d)(1) and subject to the limitations imposed by section 1211(b). Mr. Dagres contends that he was in the trade or business of venture capital (either personally or by imputation from entities he participated in), that he properly claimed a business bad debt deduction, and that it is fully deductible under section 166(a)(1). The question whether the debt was business or nonbusiness is principally an issue of fact. See 26 C.F.R. sec. 1.166-5(b), Income Tax Regs.

As a general rule, the Commissioner's determinations are presumed correct, and the taxpayer has the burden of establishing that the determinations in the notice of deficiency 2011 U.S. Tax Ct. LEXIS 12">*40 are erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 290 U.S. 111">115, 54 S. Ct. 8">54 S. Ct. 8, 78 L. Ed. 212">78 L. Ed. 212, 1933-2 C.B. 112 (1933). Similarly, the taxpayer bears the burden of proving he is entitled to any disallowed deductions that would reduce his deficiency. INDOPCO, Inc. v. Commissioner, 503 U.S. 79">503 U.S. 79, 503 U.S. 79">84, 112 S. Ct. 1039">112 S. Ct. 1039, 117 L. Ed. 2d 226">117 L. Ed. 2d 226 (1992). ¹⁸ With respect to a taxpayer's liability for penalties, section 7491(c) places the burden of production on the Commissioner.

However, Rule 142(a) places the burden of proof on the Commissioner "in respect of any new matter"—i.e., "new" in the Commissioner's answer. Section 7522(a) requires the Commissioner to "describe the basis for" any increase in tax 136 T.C. 263">*278 due in the notice of deficiency. "A new theory that is presented to sustain a deficiency is treated as a new matter when it either alters the original deficiency or requires the presentation of different evidence." Wayne Bolt & Nut Co. v. Commissioner, 93 T.C. 500">93 T.C. 500, 93 T.C. 500">507 (1989). However, a "new theory which merely clarifies or develops the original 2011 U.S. Tax Ct. LEXIS 12">*41 determination is not a new matter in respect of which respondent bears the burden of proof." Id.

The notice of deficiency identified the loan deduction disallowance as "Schedule C - Bad Debts from Sales and Services", and explained that "The debt was a non-business bad debt because it was a personal loan and not created in connection with your trade or business." In its motion for leave to amend his answer, however, the IRS described the amended answer as asserting two theories that were alternatives to disallowing the bad debt deduction as a nonbusiness bad debt: (i) that the deduction should be allowed as an unreimbursed employee business expense, or (ii) that the loss should be allowed as an expense under section 212(1). ¹⁹

Mr. Dagres's 2011 U.S. Tax Ct. LEXIS 12">*42 motion to shift the burden of proof to respondent therefore focuses on the IRS's alternative arguments. He asserts that the IRS implicitly conceded that he was in a trade or business by denying the deduction because the loan "was not created in connection with your business", and he argues that respondent's counsel's asserting at trial that he was not in a trade or business is a new matter requiring him to adduce proof different from that required by the notice of deficiency.

The notice of deficiency did disallow the loss on the grounds that the loan was personal rather than business related, whereas we have found that the loan was not personally motivated. This brings into focus Mr. Dagres's contention that any other theory by which the IRS might justify disallowance must be "new". It is true, as Mr. Dagres points out, that the evidence that disproved any personal 136 T.C. 263">*279 motivation for the loan to Mr. Schrader is completely different from evidence that would prove that the loan was proximately related to venture capital activity. However, the IRS counters that, even to challenge the notice of deficiency, Mr. Dagres must show not only that the loan was not personal but also that it was proximately 2011 U.S. Tax Ct. LEXIS 12">*43 related to a trade or business. That is, the IRS contends, even to rebut the original notice of deficiency, Mr. Dagres must prove the existence of a trade or business to which the loan was related.

Resolving these competing contentions in order to assign the burden of proof on the various sub-issues might require Solomonic and subtle distinctions—but on this record we can avoid that difficulty, since the preponderance of the evidence resolves these issues no matter which party has the burden of proof. Plainly Mr. Dagres was in the trade or business of being an employee of BMC, and both parties effectively admit as much. The disputed issue is whether Mr. Dagres was also in the trade or business of managing venture capital funds (or whether such a business of a Battery Ventures entity could be imputed to him), but the evidence relevant to the various factual questions subsidiary to that issue is not in equipoise. Rather, those questions are answered by the evidence in the record, particularly the limited partnership agreements of the Venture Fund L.P.s and the limited liability company agreements of the General Partner L.L.C.s. ^{202011 U.S. Tax Ct. LEXIS 12">*44 2011 U.S. Tax Ct. LEXIS 12">*45}

Section 166(a)(1) provides the general rule permitting full deduction of worthless debts. Mr. Dagres invokes that provision. However, two circumstances may limit that deduction, and the IRS invokes those limits:

First, the IRS points to section 166(d)(1), which provides that "nonbusiness" debts are deductible only as short-term capital losses. Section 166(d)(2) defines a "nonbusiness debt" by exclusion; i.e., it is "a debt other than—(A) a debt created or acquired (as the case may be) in connection with a trade or business of the taxpayer, or (B) a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business." Classifying a taxpayer's debt as business or nonbusiness therefore requires a determination of whether he incurred the bad debt loss in a trade or business rather than in some other activity. Section 1211(b) provides that an individual taxpayer like Mr. Dagres may deduct capital losses only to offset capital gains (plus no more than $3,000 on a joint return). Thus, in 2011 U.S. Tax Ct. LEXIS 12">*46 general, the capital loss deduction for nonbusiness bad debts is much less advantageous than the ordinary deduction for business bad debts. The IRS's primary contention here is that Mr. Dagres's loan to Mr. Schrader was a personal loan that, when it became uncollectible, yielded a nonbusiness bad debt deduction.

Second, the IRS observes that if a debt is incurred in the trade or business of being an employee, then a loss arising from the worthlessness of that debt is deductible as an employee business expense—i.e., as a miscellaneous itemized deduction as defined in sections 63 and 67. As a miscellaneous itemized deduction, an employee business bad debt deduction is subject to the 2-percent floor imposed by section 67 and is not deductible in computing alternative minimum tax under section 56(b)(1). The IRS's alternative contention is that Mr. Dagres's loan to Mr. Schrader was proximately related to his status as an employee of BMC (rather than to a trade or business of managing venture capital funds), so that it yielded a business bad debt deduction that was subject to those strictures. ^{212011 U.S. Tax Ct. LEXIS 12">*47}

Investing one's money and managing one's investments do not amount to a trade or business. Whipple v. Commissioner, 373 U.S. 193">373 U.S. 193, 373 U.S. 193">200, 373 U.S. 193">202, 83 S. Ct. 1168">83 S. Ct. 1168, 10 L. Ed. 2d 288">10 L. Ed. 2d 288, 1963-2 C.B. 642 (1963). Investors who invest their own funds in public companies or in privately held companies earn investment returns; they are investing, not conducting a trade or business, even when they make their entire living by investing. "No matter how extensive his activities may be, an investor is never considered to be engaged in a trade or business with respect to his investment activities." King v. Commissioner, 89 T.C. 445">89 T.C. 445, 89 T.C. 445">459 (1987) (citing Higgins v. Commissioner, 312 U.S. 212">312 U.S. 212, 312 U.S. 212">216, 312 U.S. 212">218, 61 S. Ct. 475">61 S. Ct. 475, 85 L. Ed. 783">85 L. Ed. 783, 1941-1 C.B. 340 (1941)).

However, an activity that would otherwise be a business does not necessarily lose that status because it includes an investment function. Rather, the activity of "promoting, organizing, financing, and/or dealing in corporations * * * for a fee or commission or with the immediate purpose of selling the corporations at a profit in the ordinary 2011 U.S. Tax Ct. LEXIS 12">*48 course of that business" is a business, Deely v. Commissioner, 73 T.C. 1081">73 T.C. 1081, 73 T.C. 1081">1093 (1980) (citing Whipple v. Commissioner, 373 U.S. 193">373 U.S. at 202-203), supplemented by T.C. Memo. 1981-229, as is "developing * * * corporations as going businesses for sale to customers", Whipple v. Commissioner, 373 U.S. 193">373 U.S. at 203. Bankers, investment bankers, financial planners, and stockbrokers all earn fees and commissions for work that includes investing or facilitating the investing of their clients' funds. ²² Selling one's investment expertise to others is as much a business as selling one's legal expertise or medical expertise.

In cases where business promotion activities are found to rise to the level of a trade or business, a common factor for distinguishing mere investment from conduct of a trade or business has been compensation other than the normal investor's return: "income received directly for his own services rather than indirectly through the corporate enterprise". 2011 U.S. Tax Ct. LEXIS 12">*49 Id. That is, if the taxpayer receives not just a return on his own investment but compensation attributable to his services, 136 T.C. 263">*282 then that fact tends to show that he is in a trade or business. Although fee, commission, or other non-investor compensation is a common element, it is not a necessary element, provided the facts support the conclusion that the taxpayer is more than a passive investor. Farrar v. Commissioner, T.C. Memo. 1988-385; see also Deely v. Commissioner, 73 T.C. 1081">73 T.C. 1093. Notably, in such business promotion cases, the trade-or-business characterization applies even though the taxpayer invests his own funds in, lends funds to, or guarantees the debts of the businesses he promotes. See Farrar v. Commissioner, supra.

A taxpayer may pursue more than one trade or business during a taxable year, see Commissioner v. Groetzinger, 480 U.S. 23">480 U.S. 23, 480 U.S. 23">35, 107 S. Ct. 980">107 S. Ct. 980, 94 L. Ed. 2d 25">94 L. Ed. 2d 25 (1987); and where he does so, any bad debt loss that he suffers will be characterized according to the activity that gave rise to the debt. That is, a bad debt loss may be deductible if the taxpayer was in a trade or business and the bad debt loss was proximately related to such trade or business 2011 U.S. Tax Ct. LEXIS 12">*50 (rather than some other activity of the taxpayer). United States v. Generes, 405 U.S. 93">405 U.S. 93, 405 U.S. 93">96, 92 S. Ct. 827">92 S. Ct. 827, 31 L. Ed. 2d 62">31 L. Ed. 2d 62 (1972). To determine whether a particular bad debt loss is proximately related to the taxpayer's trade or business, we evaluate the taxpayer's dominant motive for making the loan. 405 U.S. 93">Id. at 104.

The business nexus required for deducting a bad debt under section 166(a) exists where the dominant motive in incurring the debt was protecting or enhancing the taxpayer's trade or business. In the case of an employee, where the dominant purpose of a loan was protecting or enhancing his employment, then the loan will be deductible as an employee business expense. Id. In contrast, if the taxpayer's dominant motive was to protect his investment in a corporation—even if it was a corporation by which he was also employed—then the loss is a nonbusiness bad debt. 405 U.S. 93">Id. at 100-101. How a taxpayer would have benefited from the loan if it had not gone bad can be instructive. Tenn. Sec., Inc. v. Commissioner, 674 F.2d 570">674 F.2d 570, 674 F.2d 570">575 (6th Cir. 1982), affg. T.C. Memo. 1978-434. If the goal of the loan was to increase the value of the taxpayer's stock in the company, then the loan is a nonbusiness investment; but if the taxpayer's 2011 U.S. Tax Ct. LEXIS 12">*51 dominant 136 T.C. 263">*283 motive was to increase his salary or compensation, then the debt is a business debt related to his employment. Where both motives are found, then we must consider all the relevant facts, emphasizing the objective factors and not giving disproportionate weight to any single factor. Smith v. Commissioner, T.C. Memo. 1994-640.

Mr. Dagres contends that, for purposes of section 166(d), the Battery Ventures activity of identifying, developing, and pursuing investment opportunities for other investors in return for compensation is a trade or business, an amalgam of investment banking, stock picking, management consulting, and other disciplines. As that activity is shown on the record, we agree with Mr. Dagres and hold that the General Partner L.L.C.s are in the trade or business of managing venture capital funds. The fact that the subject matter of the activity is (other persons') investments does not dictate that the activity is mere investment. Rather, similar to any bank or brokerage firm that invests other people's money, the manager of venture 2011 U.S. Tax Ct. LEXIS 12">*52 capital funds provides a service that is an investment mechanism for the customer but that is a trade or business of the manager. In exchange for this service, the fund manager receives both service fees and a profits interest, but neither the contingent nature of that profits interest nor its treatment as capital gain makes it any less compensation for services.

Neither the Code, the regulations, nor the caselaw has defined "trade or business" for all purposes, see Commissioner v. Groetzinger, 480 U.S. 23">480 U.S. at 27, but the Supreme Court gave instructive analysis when it considered whether a taxpayer's gambling activity constituted a "trade or business" for purposes of the alternative minimum tax. Id. "We accept the fact that to be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity and that the taxpayer's primary purpose for engaging in the activity must be for income or profit." 480 U.S. 23">Id. at 35. The Supreme Court underscored the distinction between trade or business on the one hand and profit-motivated 136 T.C. 263">*284 transactions that are disconnected from a trade or business on the other, reiterated that an examination of all the facts in each case is 2011 U.S. Tax Ct. LEXIS 12">*53 required, and held that because Mr. Groetzinger applied skill in a constant effort to earn a livelihood, his gambling activity was a trade or business, and his deduction of losses was not limited by the alternative minimum tax. 480 U.S. 23">Id. at 35-36.

There is no dispute that Battery Ventures personnel worked continuously and regularly in investing fund money and growing companies, nor is there doubt that their motivation was income and profit. Like stockbrokers, financial planners, investment bankers, business promoters, and dealers, Mr. Dagres and his colleagues undertook a business by which they made money from other persons' investments.

The General Partner L.L.C.s were thus different from an investor (whose nonbusiness activity involves buying and selling securities for his own account) and were more like a broker (whose business is to buy and sell securities as inventory for commissions), cf. King v. Commissioner, 89 T.C. 445">89 T.C. 457-459 (distinguishing investors and dealers), or more like one who "promot[es] corporations for a fee" or "develop[s] * * * corporations as going businesses for sale to customers", Whipple v. Commissioner, 373 U.S. 193">373 U.S. at 202-203. The General Partner L.L.C.s did not vend 2011 U.S. Tax Ct. LEXIS 12">*54 companies or corporate stock to customers as inventory but nevertheless, like dealers, did earn compensation (in their case, fees and a significant profits interest) for the services they provided in managing and directing the investment of the venture capital entrusted to the Venture Fund L.P.s. The General Partner L.L.C.s provided early-stage funding to companies, primarily with money belonging to others. They actively participated in the growth and development of the portfolio companies and designed and implemented exit strategies for the recovery of the private equity and any profit. Like a stockbroker or a financial planner, the General Partner L.L.C.s received compensation for services they rendered to clients. Accordingly, we are satisfied that the General Partner L.L.C.s' management of the Venture Fund L.P.s has the characteristics of a trade or business.

However, two features of Battery Ventures' arrangements prompt the IRS to dispute the business character of the activity—first, the fact that the General Partner L.L.C. is 136 T.C. 263">*285 itself a 1-percent investor in the investment vehicle (the Venture Fund L.P.); and second, the fact that part of (and if the fund performs well, most of) 2011 U.S. Tax Ct. LEXIS 12">*55 the General Partner L.L.C.'s return from the activity is capital gain rather than ordinary income. For the reasons we now explain, these facts do not change the business character of the venture capital management activity.

In the deals that Battery Ventures arranges, the General Partner L.L.C. is an investor in the Venture Fund L.P. That is, the General Partner L.L.C. contributes 1 percent of the total capital, and the other investors invest 99 percent. The IRS contends that the General Partner L.L.C.'s character in the activity is governed by this 1-percent investment. As a factual matter, however, this contention fails.

The General Partner L.L.C.'s incentive for its work was not the 1-percent return it would otherwise get for its 1-percent investment but rather the promised 20 percent of the Venture Fund L.P.'s profit. And the Venture Fund's motive for offering that 20-percent return was not the General Partner L.L.C.'s very modest investment but rather its undertaking to manage the venture capital fund. The extreme disproportion between the 1-percent investment and the 20-percent profit interest yields the conclusion that the overwhelmingly predominant 2011 U.S. Tax Ct. LEXIS 12">*56 activity of the General Partner L.L.C.—and the activity that characterized it—was its management of the fund.

It cannot be denied that the General Partner L.L.C. has an investment (a 1-percent investment) in the Venture Fund L.P. and is therefore a (1-percent) investor in the Venture Fund L.P. And we do not hold that the 1-percent investment was de minimis (since it amounted to the hardly negligible sums of as much as $2 million for Fund IV and as much as $4 million for Fund V), or that it was nonessential to the arrangement.

But the Venture Fund L.P.'s agreement to pay 20 percent of its profit to the General Partner L.L.C. is inexplicable—and would be absurd—apart from the General Partner L.L.C.'s serving as a venture capitalist. The 99-percent investors were not looking for a 1-percent co-investor; they were 136 T.C. 263">*286 looking for someone in the business of managing venture capital funds, who could locate attractive investment targets, investigate those companies, negotiate investment terms, help the companies to thrive, design exit strategies, liquidate the holdings, and achieve an attractive return for them; and the General Partner L.L.C. conducted that business.

The General Partner L.L.C.s' 2011 U.S. Tax Ct. LEXIS 12">*57 relatively small activity of investing had a nonbusiness character; but the General Partner L.L.C.'s compensation for its work—i.e., the 20-percent profits interest—dwarfed the General Partner L.L.C.'s expected and actual return on its 1-percent investment. The General Partner L.L.C.s were therefore in the trade or business of managing venture capital funds by virtue of their management activities.

The IRS contends that the nonbusiness character of the General Partner L.L.C.'s activity is evident from the fact that it received not ordinary income but capital gain—an investor's return. However, while investment often produces capital gain income, capital gain income is not necessarily indicative of investment activity rather than business activity. See King v. Commissioner, 89 T.C. 445">89 T.C. 460 ("we are faced with the unusual situation of a taxpayer engaged in a trade or business [trading commodity futures] which produces capital gains and losses"). It may be anomalous that, with the IRS's concurrence, a venture capitalist may treat its receipt of "carry" as a nontaxable event, see Rev. Proc. 93-27, sec. 4.01, 1993-2 C.B. 343, 344, and may then report 2011 U.S. Tax Ct. LEXIS 12">*58 its eventual income as capital gain, see Rev. Proc. 2001-43, sec. 4.01, 2001-2 C.B. 191, 192; ^{232011 U.S. Tax Ct. LEXIS 12">*59} but that treatment is not challenged here. Accordingly, even though this profit interest is compensation for personal services, it is deemed to remain passthrough income with the same character in the hands of the 136 T.C. 263">*287 recipient (the General Partner L.L.C.) as in the hands of the partnership (the Venture Fund L.P.)—i.e., primarily capital gains from investment. See secs. 701, 702; 26 C.F.R. secs. 1.701-1, 1.702-1, Income Tax Regs. We do not agree with the IRS that the character of this income proves that the General Partner L.L.C.s were investors and were not in a trade or business.

The IRS relies upon Syer v. United States, 380 F.2d 1009">380 F.2d 1009 (4th Cir. 1967), and similar cases, which involved taxpayers who claimed they incurred business bad debt losses in their business of organizing and promoting corporations. The Court of Appeals for the Fourth Circuit required the taxpayer to prove not only that his business was to develop corporations into going concerns for sale in the ordinary course but also that his participation in those companies exceeded that of an investor seeking profits from the operations of the businesses. 380 F.2d 1009">Id. at 1010. The Court of Appeals did not answer the question whether the taxpayer was in the business of promoting corporations, because it held that, whether he was or not, the bad debt at issue was sustained by the taxpayer in his capacity as an investor and not in connection with his alleged business. Id.

The Court of Appeals observed that its outcome—limiting the deduction to capital loss—was "not inequitable" 2011 U.S. Tax Ct. LEXIS 12">*60 because "[i]f the business had prospered and the taxpayer had sold his stock for a profit, he would have reported his profit as a capital gain. A loss should receive the same treatment." 380 F.2d 1009">Id. at 1012. However, while Syer may well be correct that such a disallowance is "not inequitable", since it would make the income and the loss symmetrical, Syer does not hold that the character of anticipated gain necessarily dictates the character of losses. The fact that the income and loss are not symmetrical in this case is the result of the anomalous capital treatment, explained above, that is allowed to the recipient of a carried interest. We cannot address this anomaly by giving ordinary business bad debt losses an otherwise unwarranted capital characterization.

This real issue in Syer—whether the taxpayer made a given loan as promoter or as investor—is very pointed where, as in Syer, the bad debt that the taxpayer would deduct arises from a loan that he made to the very business that he claims is not an investment but is only a promotion project. 136 T.C. 263">*288 The salient question is whether that given corporation is not only a promotion project but instead is also an investment; and the loan, made to that 2011 U.S. Tax Ct. LEXIS 12">*61 very corporation, is itself some evidence that the corporation is simply an investment. No analogous circumstance exists in this case, where Mr. Dagres's loan was to Mr. Schrader and not to the General Partner L.L.C.s or to the Venture Funds. That loan by Mr. Dagres to Mr. Schrader is itself no evidence that the Venture Fund L.P.s are simply investments of the General Partner L.L.C.s. Thus380 F.2d 1009">Syer says little that is pertinent to this case.

Likewise, in another case the IRS cites—Deely v. Commissioner, 73 T.C. 1081">73 T.C. 1081 (1980), modified T.C. Memo. 1981-229— the taxpayer lent money not to a third party but to a corporation that he claimed was a part of his business of promoting corporations. In Deely we reached the question not resolved by the Court of Appeals for the Fourth Circuit in Syer, and we held that the taxpayer was not in the business of promoting corporations. Among the principal reasons for this holding was that the taxpayer's alleged business promotion activity was (unlike the facts here) not "conducted for a fee or commission". 73 T.C. 1081">Id. at 1093. We did indeed note, as the IRS points out, that "he always reported the proceeds as long-term capital gain or loss", 73 T.C. 1081">id. at 1095; but in that 2011 U.S. Tax Ct. LEXIS 12">*62 case the long-term capital nature of his reported gains was evidence that, contrary to the taxpayer's contentions, he was not making rapid turnaround of his interests in the corporations but was instead holding onto them as long-term investments. Such evidence contradicts a claim that one is in the business of dealing in corporations (rather than holding interests in them for investment); it would not defeat a claim that one is in the business of investing other persons' money and taking as compensation a share of their profits (chiefly capital gains).

As we have pointed out, a General Partner L.L.C. was entitled to a 1-percent investor's return for its investment of 1 percent of the capital of the Venture Fund L.P. However, it was for its management of the venture capital activity (not for its investment) that the General Partner L.L.C. earned the 20-percent carry. The investors considered the efforts of the managers sufficiently valuable to compensate the General Partner L.L.C. with 20 percent of the profits from the venture, above and beyond its 1-percent investment returns. 136 T.C. 263">*289 The General Partner L.L.C.'s function in employing capital—99 percent of which belonged to other investors—was 2011 U.S. Tax Ct. LEXIS 12">*63 different in quantum and in kind from that of an investor; and the skills that the General Partner L.L.C.s employed in finding, vetting, funding, and helping to manage the target companies produced the returns that the Venture Fund L.P.s enjoyed and shared with the General Partner L.L.C.

Having concluded that the General Partner L.L.C.s' management of the Venture Fund L.P.s was a trade or business, we now turn to the question whether Mr. Dagres made his loan to Mr. Schrader in connection with that trade or business.

Mr. Dagres was a Member Manager of the General Partner L.L.C.s. The IRS does not dispute that it was as a result of that Member Manager status that Mr. Dagres received his share of the carried interests of those L.L.C.s, and does not dispute that a Member Manager is deemed to carry on the trade or business of his L.L.C. See Rev. Rul. 98-15, 1998-1 C.B. 718; cf. Hoffman v. Commissioner, 119 T.C. 140">119 T.C. 140, 119 T.C. 140">149 (2002) ("A general partner may be deemed to be conducting the trade or business activity of the partnership of which she is a member"). We have held that the General Partner 2011 U.S. Tax Ct. LEXIS 12">*64 L.L.C.s' activity was not mere investment but was the trade or business of managing venture capital funds. Consequently, it follows that Mr. Dagres was in that trade or business.

However, as we have noted, Mr. Dagres was also an investor (i.e., of his portion of 1 percent of the Venture Fund L.P.'s capital), and if his loan to Mr. Schrader was proximately related to his investment interest, then the resulting bad debt was not a business bad debt. Moreover, Mr. Dagres was also a salaried employee of BMC and was therefore in the trade or business of being an employee. If his loan to Mr. Schrader was proximately related to his employment, rather than to the venture capital business, then the deduction of the resulting bad debt loss is severely limited. See supra part II.A. We must therefore determine to which of these activities—his investment, his employment, or his venture capital management—the loan was proximately related.

136 T.C. 263">*290 In United States v. Generes, 405 U.S. 93">405 U.S. at 103, the Supreme Court indicated that when determining whether a bad debt has a proximate relation to a taxpayer's trade or business and therefore qualifies as a business bad debt, the question to ask is whether the "dominant 2011 U.S. Tax Ct. LEXIS 12">*65 motivation" for the loan was business; a merely "significant motivation" is insufficient to show a proximate relation. In Generes, the Supreme Court held that the dominant motivation for the taxpayer's lending money to his company was not the business motive of protecting his modest salary; rather, in addition to protecting his son-in-law's livelihood, he was motivated to protect his sizable investment in the company. 405 U.S. 93">Id. at 106. Accordingly, non-business motives prompted the loan, and therefore the loss was not a business bad debt.

In this case, however, Mr. Dagres's compensation for his work as a manager of the Venture Fund L.P.s—i.e., his share of the 20-percent profits interest and the 2-percent management fee—exceeded by twenty-fold his share of the return on the 1-percent investment. Moreover, although his salary from BMC (i.e., his share of the management fees) was significant in absolute terms (nearly $11 million in five years, of which he received almost $2.6 million in the year of the loan), his carry was clearly dominant ($43 million of capital gains in those same five years, of which $40 million was carry received in the year of the loan). He lent $5 million to Mr. Schrader 2011 U.S. Tax Ct. LEXIS 12">*66 to protect and enhance what he considered a valuable source of leads on promising companies in which, as Member Manager of General Partner L.L.C.s, he could invest the money of the Venture Fund L.P.s, help manage those companies, and earn substantial income in the form of carry. Mr. Dagres's carry significantly exceeded both his salary and his return on his own investment. We are satisfied that venture capital motives and not employment or investment motives were the primary motivation for his loan. It is that venture capital business motive that characterizes the subsequent bad debt loss.

It is true that Mr. Dagres's Schedule C did not identify his principal business or profession associated with the bad debt loss as anything explicitly related to "venture capital", but rather as "Loan and Business Promotions", along with a code entered of 523900, meaning "Other financial investment activities (including investment advice)". As we have pointed 136 T.C. 263">*291 out, however, the caselaw discusses business promotion as meaning "promoting, organizing, financing, and/or dealing in corporations * * * for a fee or commission or with the immediate purpose of selling the corporations at a profit in the ordinary 2011 U.S. Tax Ct. LEXIS 12">*67 course of that business", Deely v. Commissioner, 73 T.C. 1081">73 T.C. 1093, and that business overlaps substantially with the business of managing venture capital funds. Moreover, the naming of his business on his return is hardly dispositive of his actual trade or business. ^{242011 U.S. Tax Ct. LEXIS 12">*68} Next to his signature on page 2 of his return, he did identify his "occupation" as "VENTURE CAPITALIST"; and the IRS does not suggest any code other than 523900 that would be appropriate for a business of managing venture capital funds. Mr. Dagres's reporting on his return does not estop him from contending that he was engaged in that business.

Section 6662 imposes a 20-percent penalty on an "underpayment" of tax that results either from negligence or disregard of rules and regulations or from a "substantial understatement" of income tax. See sec. 6662(a) and (b)(1) and (2). Stated simply, an "underpayment" of tax is the amount by which the tax actually imposed by the Code exceeds the amount of tax that the taxpayer reported. Sec. 6664(a).

The IRS imposed an accuracy-related penalty in the notice of deficiency because it found an underpayment attributable to both the bad debt loss and the $30,000 of interest income that Mr. Dagres omitted from his return. Mr. Dagres reported zero taxable income, because the bad debt loss he claimed exceeded the amount of all the income he reported; but when the IRS disallowed the loss and included the income, it determined an underpayment that was attributable to a "substantial understatement".

However, we have held in Mr. Dagres's favor as to the business bad debt loss he claimed. Even though he concedes 136 T.C. 263">*292 that the $30,000 of interest income should be included in his income, 2011 U.S. Tax Ct. LEXIS 12">*69 the bad debt loss still offsets all his income, and for 2003 he has no taxable income and, consequently, income tax liability of zero—the same amount he reported on his return. There is therefore no understatement of income tax for purposes of section 6662(d), and no liability for the accuracy-related penalty.

To reflect the foregoing,

An appropriate order and decision will be entered.