What’s an activity? The tax law’s “passive loss” rules limit business losses when a taxpayer fails to “materially participate” in an “activity.” Whether an “activity” is “passive” is mostly based on the amount of time spent in the activity by the taxpayer. That can raise a tricky question: just what is an “activity?”
Many businesses do multiple things. Take a CPA firm that does tax and auditing. If those feckless auditors lose money, is that a separate “activity” from the hard-working tax side? Or consider a convenience store owner with two locations; is each a separate activity, or are they one big activity?
The Tax Court addressed this problem yesterday in a case involving a South Florida developer. Greatly simplifying a complex story of real estate backstabbing and inter-family rivalry, the problem was whether an S corporation was the same “activity” as a partnership with the same owners set up for s specific development project. If so, family patriarch Mr. Lamas could cross the basic 500-hour threshold for participation in the combined activity, making his losses deductible.
Judge Buch explains the IRS regulation (1.469-4(c)) governing this issue:
This regulation sets forth five factors that are “given the greatest weight in determining whether activities constitute an appropriate economic unit for the measurement of gain or loss for purposes of section 469″:
(i) Similarities and differences in types of trades or businesses;
(ii) The extent of common control;
(iii) The extent of common ownership;
(iv) Geographical location; and
(v) Interdependencies between or among the activities (for example, the extent to which the activities purchase or sell goods between or among themselves, involve products or services that are normally provided together, have the same customers, have the same employees, or are accounted for with a single set of books and records).
This regulation further instructs that taxpayers can “use any reasonable method of applying the relevant facts and circumstances” to group activities, and that not all of the five factors are “necessary for a taxpayer to treat more than more activity as a single activity”.
The judge said that Shoma (the S corporation) and Greens (the partnership) met these requirements, considering they had the same control and both were in the same general business. Also:
Finally, Shoma and Greens were interdependent. Greens operated out of Shoma offices, used Shoma employees, and consolidated its financial reporting with Shoma’s. Greens was formed by Shoma as a condominium conversion project. The shareholders intended that Greens be dissolved after the project was completed and the capital returned to its shareholders.
Because Shoma and Greens meet these five factors, we find that they are an appropriate economic unit and should be grouped as a single activity.
The taxpayer was able to satisfy the court through witness testimony and phone records that he met the 500-hour requirement.
This case is good news for developers, as this structure is common in that business: a permanent S corporation sets up new LLCs for each development project. This case correctly concludes that they are all part of the same development business.
Cite: Lamas, T.C. Memo 2015-59.
Me, What an Iowa income tax might look like with a fresh start. My new post at IowaBiz.com, the Des Moines Business Record Business Professionals’ Blog, on what Iowa’s tax system might look like if we could start over. A taste:
A system designed from scratch would apply the ultimate simplification to Iowa’s corporation income tax: it wouldn’t have one. Iowa’s corporation income tax is rated the very worst, with extreme complexity and the highest rate of any state.Eliminating the corporation income tax would eliminate the justification for almost all of the various state incentive tax credits, all of which violate the principles of neutrality and simplicity in the first place. For its astronomical rates and complexity, it generates a paltry portion of the state’s revenue, typically 4-7 percent of state receipts.For S corporations, a from-the-ground-up tax reform might tax Iowa resident shareholders only on the greater of distributions of S corporation income, or interest, dividends, and other investment income earned by the S corporations. The investment income provision would prevent the use of an S corporation as a tax-deferred investment. The effect would be to put S corporations on about the same footing as C corporations.
I have little hope in the legislature actually doing something sensible, but we have to start somewhere. I’d love to hear any thoughts readers may have.
Roger McEowen addresses the Tax Consequences When Debt is Discharged (ISU-CALT): “There are several relief provisions that a debtor may be able to use to avoid the general rule that discharge of indebtedness amounts are income, but a big one for farmers is the rule for ‘qualified farm indebtedness.'”
Russ Fox, A Break in my Hiatus: Poker Chips and Tax Evasion. Russ lifts his head from his tax returns to tell of the tax problems of a poker chip maker that he has personal experience with. “A helpful hint to anyone wanting to emulate Mr. Kendall: Just pay employees in the normal way, on the books, and send the withholding where it belongs.”
Robert Wood, Tax Fraud Draws 6 1/2 Year Prison Term Despite Alzheimer’s. Specifically, a dubious claim of Alzheimer’s.
Peter Reilly, Did Andie MacDowell’s Mountain Hideaway Require Tax Incentives? To listen to some people, you’d believe nothing good ever happened until tax credits were invented.
Jason Dinesen, Financing a Small Business, Part 5 of 5: Know When to Keep Quiet With the Banker. “Here are a couple of real-world examples I’ve seen where business owners got hung up with the bank because the owner wouldn’t stop talking.”
This also has lessons for IRS exams, too.
Annette Nellen, Another Affordable Care Act Oddity. “Perhaps the problem is more tied to the “cliff” in the PTC that causes someone to completely lose the subsidy once their income crosses the 400% of the FPL (more on that here).”
Alan Cole, Richard Borean, Tom VanAntwerp, Which Places Benefit Most from State and Local Tax Deductions? (Tax Policy Blog):
The short answer? Places with high state tax rates and high-income earners. Note the purple spot right in the middle of Iowa.
TaxProf, The IRS Scandal, Day 686
Renu Zaretsky, Sense and Sensibilities. Today’s TaxVox headline roundup covers the House GOP budget, a Texas tax cut, and tax-delinquent federal employees.
Richard Phillips, How Presidential Candidate Ted Cruz Would Radically Increase Taxes on Everyone But the Rich (Tax Justice Blog). A taste:
On the flat tax, Cruz has not yet spelled out a specific plan that he would like to see enacted, but it’s unlikely that any plan he proposed will be significantly better than the extremely regressive flat tax proposals that have been offered in the past.
Or, “we don’t know what he will do, but it will be terrible!”
Caleb Newquist, Big 4 Gunning for Big Law. To steal a cheap line: who wins if the Big 4 and Big Law fight to the death? Everybody!