Programming note: No Tax Roundup will appear tomorrow, August 22. I will be up in Ames helping teach the ISU Center for Agricultural Law and Taxation class “Affordable Care Act (ACA): What Practitioners Need to Know“ in the morning. Webinar registration is closed, but you can still attend as a walk-in.
You saved the company. Big deal. Apparently pulling the company you started from the brink of failure wasn’t enough to convince the IRS that a taxpayer “materially participated” and could deduct losses on his tax return.
Charles Wade was a founder of Thermoplastic Services, Inc. and Paragon Plastic Sheeting, both S corporations. After his son Ashley took over daily management of the business, he still owned a significant stake in the company. He never really retired, though. From the Tax Court (my emphasis, footnotes omitted in all Tax Court quotes):
With Ashley there to handle day-to-day management, Mr. Wade became more focused on product and customer development. He did not have to live near business operations to perform these duties, so petitioners moved to Navarre, Florida. After the move he continued to make periodic visits to the facilities in Louisiana and regularly spoke on the phone with plant personnel.
In 2008 TSI and Paragon began struggling financially as prices for their products plummeted and revenues declined significantly. Mr. Wade’s involvement in the businesses became crucial during this crisis. To boost employee morale, he made three trips to the companies’ industrial facility in DeQuincy, Louisiana, during which he assured the employees that operations would continue. He also redoubled his research and development efforts to help TSI and Paragon recover from the financial downturn. During this time Mr. Wade invented a new technique for fireproofing polyethylene partitions, and he developed a method for treating plastics that would allow them to destroy common viruses and bacteria on contact. In addition to his research efforts, Mr. Wade ensured the companies’ financial viability by securing a new line of credit. Without Mr. Wade’s involvement in the companies, TSI and Paragon likely would not have survived.
Slacker. At least according to the IRS, who said that this participation failed to rise to the level of “material participation” and disallowed over $3 million in pass-through losses on Mr. Wade’s return.
The Tax Court took a different view. Judge Goeke explains :
A taxpayer materially participates in an activity for a given year if, “[b]ased on all of the facts and circumstances * * * the individual participates in the activity on a regular, continuous, and substantial basis during such year.” A taxpayer who participates in the activity for 100 hours or less during the year cannot satisfy this test, and more stringent requirements apply to those who participate in a management or investment capacity. The record reflects that Mr. Wade spent over 100 hours participating in TSI and Paragon during 2008, and his participation consisted primarily of nonmanagement and noninvestment activities. Ashley managed the day-to-day operations of the companies; Mr. Wade focused more on product development and customer retention.
Although Mr. Wade took a step back when Ashley became involved in the companies’ management, he still played a major role in their 2008 activities. He researched and developed new technology that allowed TSI and Paragon to improve their products. He also secured financing for the companies that allowed them to continue operations, and he visited the industrial facilities throughout the year to meet with employees about their futures. These efforts were continuous, regular, and substantial during 2008, and we accordingly hold that Mr. Wade materially participated in TSI and Paragon.
The 100 hours might not have been considered enough under some circumstances. Usually the IRS holds taxpayers to the default 500-hour test for material participation. This case is unusual in its use of the fall-back 100-hour “facts and circumstances” test. It’s good to see the Tax Court use it, as the IRS seems to think this test never applies.
It’s also interesting that the efforts at “customer retention” were counted. This could be useful in planning for the 3.8% Obamacare Net Investment Income Tax. The NIIT taxes “passive” income, defined the same way as the passive loss rules. A semi-retired S corporation owner who still calls on some of old accounts after turning daily operations over to successors might be able to avoid the NIIT under the logic of this case. If so, though, it would be wise to keep a calendar to prove it.
Russ Fox, A Passive Activity Case Goes to the Taxpayers. “Hopefully the IRS can get more of these cases right at audit and appeals–they’ll be dealing with many more of these over the coming years.”
Paul Neiffer, More than 100 but Less than 500. “It is nice to see that a subjective test went in the taxpayer’s favor.”
How far does $100 go in your city? Last week the Tax Foundation issued a map showing how far $100 goes in different states. Now they have issued a new map in The Real Value of $100 in Metropolitan Areas (Tax Policy Bl0g). It is wonderful — just scroll your cursor over your town.
In Des Moines, $100 is good for $105.82. In New York, it gets you $81.83.
Tony Nitti, Could The IRS Disallow Ice Bucket Challenge Charitable Contributions? Go ahead, IRS, just try it. You’re just too popular.
William McBride, Earnings Stripping, Competitiveness, and the Drive to Further Complicate the Corporate Tax (Tax Policy Blog)
Roberton Williams, One Downside Of Inversions: Higher Tax Bills For Stockholders (TaxVox)
Kay Bell, How does the U.S. corporate tax rate compare to other countries? Poorly.
TaxProf, The IRS Scandal, Day 469
David Brunori, Using Local Cigarette Taxes for Schools Is Silly (Tax Analysts Blog). Smoke ’em if you got ’em. For the children!
Cara Griffith, Was Oregon’s Tax Incentive Deal With Intel Unnecessary? (Tax Analysts Blog). No, it was absolutely necessary to enable the Governor of Oregon to issue this press release and YouTube announcement. That’s the point, after all.
The United States gets little tax from Americans overseas today. Most of them live in high-tax countries and have no U.S. income tax in any event because of FTCs and the section 911 foreign earned income exclusion. But as we all know, Congress couldn’t care less about this subject, and this is all a non-starter. Better to place your money on a genetically modified flying pig.
Robert L. Williams in Tax Analysts ($link)
Tags: Anthony Nitti, Cara Griffith, David Brunori, Judge Goeke, Kay Bell, Net Investment Income Tax, passive losses, Paul Neiffer, Robert L. Williams, Roberton Williams, Russ Fox, tax court, TaxGrrrl, TaxProf, William McBride