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Tax Litigation: The Week of May ninth, 2022, by way of May thirteenth, 2022
Lewis v. Commissioner, TC Memo. 2022-47| May 9, 2022 | Greaves, J. | Dkt. No. 10007-20W
Jackson v. Comm’r, T.C. Memo. 2022-50 | May 12, 2022 | Vasquez, J. | Dkt. No. 19634-18L
Evert v. Comm’r, T.C. Memo. 2022-48| May 9, 2022 | Marshall, A | Dkt. No. 12901-19
Harrison v. Comm’r, T.C. Memo 2022-6 | May 12, 2022 | Panuthos, J | Dkt. No. 12170-19S
Rogerson v. Commissioner, TC Memo. 2022-49| May 12, 2022 | Toro, J. | Dkt. No. 5848-20
Opinion
Summary: This deficiency case regards an analysis of the passive exercise loss guidelines of 26 U.S.C. § 469. Section 469 limits a taxpayer’s use of losses generated by passive actions to offset unrelated revenue generated by nonpassive actions. Michael Rogerson, the taxpayer, owned patents, and he led, for over 40 years as CEO, a quantity of firms in the aerospace business. For the tax years in concern, he additionally owned two yachts that he supposed for chartering and that sustained substantial losses in the tax years in concern. The federal revenue tax points regarded part 469 and the results of Rogerson’s participation in these endeavors.
In 2014 and 2015, Rogerson reorganized the Rogerson firms into three firms, referred to right here as RAC, RAEG, and RC, every of which engaged in varied traces of interrelated enterprise and RC employed the manager workforce and supplied administrative assist to RAC and RAEG. Before and after the 2014 reorganization, the operations of RAEG’s enterprise items remained usually the identical. As he was earlier than the reorganization, Rogerson continued to supervise and was very energetic in all features of the operations of the enterprise as an entire, serving as CEO of RAC, RAEG, and RC from the time of their incorporation by way of the years at concern.
The yachts had been referred to as the TOTO and the Falcon Lair. In 2014, 2015, and 2016, Rogerson engaged a crew and contractors to handle, keep, and restore TOTO, however the yacht was not charted. The Falcon Lair was not commercially registered throughout 2014, 2015, and 2016, nor was it chartered. But, Rogerson engaged a crew and a administration firm to handle the Falcon Lair.
In his private revenue tax returns for 2014, 2015, and 2016, Rogerson reported his involvement in RAC and RC as nonpassive and his involvement in RAEG as passive. He reported revenue pursuant to Schedules Okay-1 issued to him by RAC, RAEG, and RC. Rogerson sought to use a passive loss carryforward associated to his pre-2014 TOTO exercise to offset the passive revenue that he reported from RAEG. For 2014, 2015, and 2016, Rogerson reported his involvement in each the TOTO and the Falcon Lair as nonpassive. With respect to the TOTO and the Falcon Lair, Rogerson substantial claimed losses in 2014, 2015, and 2016.
Rogerson’s returns had been examined, and the IRS concluded that Rogerson didn’t correctly characterised his aerospace and yacht actions as passive and nonpassive. The IRS issued to Rogerson a discover of deficiency that recharacterized his exercise with respect to RAEG as nonpassive and with respect to the yachts as passive. Regarding RAEG, the discover acknowledged, amongst different issues, that Rogerson “materially participated in RAEG” and subsequently that “the revenue needs to be handled as non-passive revenue.” The discover decided deficiencies in Rogerson’s federal revenue tax of almost $6,000,000, plus accuracy-related penalties of $1,115,934, for 2014, 2015, and 2016, mixed. Rogerson petitioned the Tax Court searching for a redetermination of the deficiencies and penalties.
Key Issue:
Whether, for the tax years 2014, 2015, and 2016, Rogerson materially participated in sure of his aerospace actions, with the end result that revenue from these actions have to be handled as nonpassive?
Whether Rogerson’s yacht actions throughout the identical years had been per se passive as rental actions?
Whether Rogerson is answerable for accuracy-related penalties on the underpayments of tax ensuing from our first two holdings?
Primary Holdings:
Yes. Rogerson materially participated in his aerospace enterprise as an entire from no less than 2005 to 2013, and that participation remained considerably the identical for the tax years following. A taxpayer is handled as materially taking part in an exercise throughout a previous yr if the exercise was included in an exercise, or considerably overlaps with an exercise, in which the taxpayer materially participated for the previous yr. Treas. Reg. § 1.469- 5(j)(1). Thus, revenue from that exercise have to be handled as nonpassive in every of these years.
Yes. The yacht actions had been rental actions, as outlined in the Treasury Regulations, and no exception utilized. As such, Rogerson was not allowed to make use of the losses related to the TOTO and the Falcon Lair endeavor to offset revenue from Rogerson’s nonpassive actions in RAEG.
No. Rogerson fairly and in good religion relied upon competent practitioner’s recommendation with respect to the passive versus nonpassive tax issues that resulted in the deficiency, and he supplied all related and correct info for the practitioner’s recommendation. Therefore, accuracy-related penalties weren’t warranted.
Key Points of Law:
Burdens of Proof. In basic, the IRS’s determinations set forth in a discover of deficiency are presumed to be appropriate, and the taxpayer bears the burden of exhibiting that these determinations are in error. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). But the IRS bears the burden of proof with respect to any “new matter” he raises. See Rule 142(a).
Section 469 and Passive Losses. Individual taxpayers might usually deduct, below sections 162 and 212 respectively, odd and crucial bills paid or incurred in carrying on a commerce or enterprise or for the manufacturing of revenue. However, the Code disallows any present deduction for a “passive exercise” loss. 26 U.S.C. § 469(a)(1), (b). A passive exercise loss is the quantity by which the mixture losses from the taxpayer’s passive actions for a taxable yr exceed the mixture revenue from passive actions for that yr. at § 469(d)(1).
Passive losses can’t be used to offset revenue from nonpassive actions. See Beecher v. Commissioner, 481 F.3d 717, 721 (ninth Cir. 2007), aff’g Cal Interiors Inc. v. Commissioner, T.C. Memo. 2004-99. A disallowed passive exercise loss shouldn’t be misplaced; quite, it’s deferred or suspended and stays out there as a deduction in opposition to future passive revenue. 26 U.S.C.S. § 469(b).
Passive Activities. A passive exercise usually is an exercise involving the conduct of a commerce or enterprise in which the taxpayer doesn’t materially take part. at § 469(c)(1). Subject to sure exceptions, rental actions are passive regardless of whether or not the taxpayer materially participates. Id. at § 469(c)(2), (4), (7).
Material Participation. A taxpayer’s participation in an exercise is “materials” provided that his or her involvement in the operations of the exercise is common, steady, and substantial. at§ 469(h)(1). Temporary laws first issued in 1988 present seven checks for figuring out when this commonplace is happy. See Temp. Treas. Reg. § 1.469-5T(a) (stating that a person shall be handled as materially taking part in an exercise “if and provided that” one of the seven checks is happy).
Five of Ten Test. For functions of part 469(h)(1), a taxpayer is handled as materially taking part in an exercise if she or he materially participated in the exercise for any 5 out of the ten years instantly previous the taxable yr. Temp. Treas. Reg. § 1.469-5T(a)(5). The 5 of ten take a look at applies to an exercise that’s the similar over time, however the laws additionally clarify tips on how to apply the take a look at when a taxpayer’s actions change over time. In these circumstances, last laws name for a comparability of the taxpayer’s current-year actions with the taxpayer’s preceding-year actions. See Reg. § 1.469-5(j)(1).
Thus, if there may be substantial similarity between the current-year exercise and actions that the taxpayer materially participated in throughout a previous yr, then that previous yr counts as one yr in making use of the 5 of ten take a look at to the current-year exercise. If there may be substantial similarity between the current-year exercise and actions that the taxpayer materially participated in for 5 of the final ten years, then the 5 of ten take a look at is happy and the taxpayer is handled as materially taking part in the current-year exercise for the present yr. See id.; Temp. Treas. Reg. § 1.469-5T(a)(5), (j)(1).
Rental Activities. Rental actions are passive regardless of a taxpayer’s participation, topic to sure exceptions. See 26 U.S.C. § 469(c)(2), (4), (7). A rental exercise is “any exercise the place funds are principally for the use of tangible property.” at § 469(j)(8); see additionally Temp. Treas. Reg. § 1.469-1T(e)(3)(i) (stating that an exercise is a rental exercise if through the taxable yr tangible property held in reference to the exercise is utilized by prospects or held to be used by prospects and gross revenue attributable to the exercise represents quantities paid or to be paid principally for the use of the tangible property).
Exceptions to Rental Activity. Six exceptions exist to the definition of “rental exercise.” See Reg. § 1.469-1T(e)(3)(ii)(A)-(F). For one, an exercise involving the use of tangible property shouldn’t be a rental exercise if for the taxable yr—(1) the typical interval of buyer use for the property is seven days or much less; or (2) the typical interval of buyer use for such property is 30 days or much less, and important private providers are supplied by or on behalf of the proprietor of the property in reference to making the property out there to be used by prospects. See id. at § 1.469-1T(e)(3)(ii)(A) and (B). A interval of buyer use is the interval “throughout which a buyer has a steady or recurring proper to make use of” the property. Id. at § 1.469-1(e)(3)(iii)(D). The common interval of buyer use is calculated by dividing the mixture quantity of days in all durations of buyer use of the property by the quantity of durations of buyer use. Id. at § 1.469-1(e)(3)(iii)(C). To decide whether or not providers are important private providers, all of the related info and circumstances are thought-about. See Temp. Treas. Reg. § 1.469-1T(e)(3)(iv)(A).
Section 6662(a) Penalty. Section 6662(a) and (b)(1) and (2) imposes a penalty equal to twenty% of the portion of an underpayment of tax required to be proven on a taxpayer’s return that’s attributable to “[n]egligence or disregard of guidelines or laws” and/or a “substantial understatement of revenue tax.” Negligence contains “any failure to make an affordable try to adjust to the provisions of this title.” 26 U.S.C. § 6662(c). An understatement of revenue tax is a “substantial understatement” if it exceeds the higher of 10% of the tax required to be proven on the return or $5,000. at § 6662(d)(1)(A). The Commissioner right here has asserted part 6662(a) penalties on the idea of each negligence and substantial understatement.
Reasonable Cause and Good Faith. A taxpayer might keep away from a piece 6662(a) penalty by exhibiting that there was cheap trigger for the underpayment and that the taxpayer acted in good religion. 26 U.S.C. § 6664(c)(1). The willpower of whether or not a taxpayer acted with cheap trigger and in good religion is made on a case-by-case foundation, bearing in mind all of the pertinent info and circumstances, together with the taxpayer’s efforts to evaluate the correct tax legal responsibility and the taxpayer’s data, expertise, and schooling. Reg. § 1.6664-4(b)(1).
Reasonable reliance on skilled recommendation might represent cheap trigger and good religion if the taxpayer proves, by a preponderance of the proof, that (1) the adviser was a reliable skilled with adequate experience to justify reliance, (2) the taxpayer supplied crucial and correct info to the adviser, and (3) the taxpayer really relied in good religion on the adviser’s judgment. See Alt. Health Care Advocates v. Commissioner, 151 T.C. 225, 246 (2018); Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002).
“Most taxpayers are usually not competent to discern error in the substantive recommendation of an accountant or lawyer. To require the taxpayer to problem the lawyer, to hunt a ‘second opinion,’ or to attempt to monitor counsel on the provisions of the Code himself would nullify the very function of searching for the recommendation of a presumed professional in the primary place.’ ‘Ordinary enterprise care and prudence’ don’t demand such actions.” United States v. Boyle, 469 U.S. 241, 251 (1985).
Insights: Michael Rogerson seems to be a unprecedented particular person and entrepreneur in the aerospace business. But, his substantial losses related to the supposed passive exercise of renting out his tangible property—the yachts, TOTO and the Falcon Lair—couldn’t be used to offset revenue from Rogerson’s nonpassive actions in his enterprise endeavor. From a penalty-assessment perspective, Roberson was capable of stave off $1,115,934 in accuracy-related penalties by exhibiting the Tax Court that he engaged competent tax counsel, supplied that tax counsel with all crucial and correct info related to Roberson’s enterprise and yachting endeavors, and relied, in good religion, on that tax counsel’s recommendation.
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