Tax Court in Brief | Walters v. Comm’r | Deductibility of “for-profit” business expenses – Taxation

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United States: Tax Court in Brief | Walters v. Comm’r | Deductibility of “for-profit” business expenses

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The Tax Court in Brief – March 7 – March 11, 2022

Freeman Law’s “Tax Court Brief” covers all of the Tax Court’s substantive opinions, providing a weekly summary of its decisions in clear, concise prose.

For a link to our Tax Court in Brief podcast, download here or watch other episodes of The Freeman Bill.

Tax litigation: The week of March 7, 2022 to March 11, 2022

  • Hacker c. Comm’r, memo from TC. 2022-16 | March 8, 2022 | Paris, J | Dekt. No. 3870-12

  • Cosio c. Comm’r, TC Memo. 2022-18 | March 9, 2022 | Weiler, J. | Dekt. No. 23623-17L

  • Sherwin Community Painters Inc. v. Comm’r, memo from TC. 2022-19 | March 9, 2022 | Goeke, J. | Dekt. Nos. 4113-19, 4647-19 (consolidated with Ward v. Com’r)

  • Bunton c. Comm’r, TC Memo. 2022-20| March 10, 2022 | Morrison, E. | Dekt. No. 5770-19L

Walters v. Com’r. | TC Note 2022-17 | March 7, 2022 | J Wells | Dekt. No. 13060-15, 13097-15.

Opinion

Short summary: This notice resolves two separate cases involving the same issues and the same facts. The IRS denied expenses reported by a partnership in connection with an alleged business activity, which involved residential property. One case involved a husband and wife and another their daughter. She held an approximate 5% interest in the partnership. The IRS argued that the taxpayers’ conduct demonstrated personal use of the home, as opposed to “for-profit” activity. The taxpayers argued that the partnership built and maintained the residence to promote the “green” real estate consulting business that the partnership was working to develop. The parties instructed the court to determine whether the activity was “for profit” within the meaning of IRC § 183 and, second, whether the taxpayers were subject to penalties imposed in addition to the deficiencies.

Main holdings: The Court concluded that, although not perfectly carried out, the activities of the taxpayers – when considered as a whole – in connection with the house were “for profit” as defined by section 183 of the Code and related Treasury regulations. Since the irregularities were erroneously issued on the grounds that the activity was not “for profit”, the taxpayers were not liable for the penalties.

Main points of law:

  • Section 162 allows the deduction of business expenses and capital expenditures. However, under section 183(a), taxpayers cannot deduct expenses for an activity “if that activity is not carried on for profit”. Where a partnership is involved in a Section 183 analysis, the existence of the required profit objective is determined at the partnership level.

  • Treasures. Reg. Article 1.183-2(b) provides a non-exhaustive list of objective factors to be considered in deciding whether an activity is carried on for profit. These factors include: (1) the manner in which the taxpayer carries on the business; (2) the expertise of the taxpayer or the taxpayer’s advisers; (3) the time and effort expended by the taxpayer in carrying on the business; (4) the expectation that assets used in the business may appreciate in value; (5) the success of the taxpayer in carrying on other similar activities; (6) the taxpayer’s income or loss history with respect to the activity; (7) the amount of occasional profits, if any, that are made; (8) the financial situation of the taxpayer; and (9) whether elements of personal pleasure or recreation are involved.

  • When weighing factor tests such as the one at issue, the court does not reach conclusions based on a count of factors for or against a conclusion, because the relative importance of each factor can alter the overall analysis depending on the facts of the case.

  • When a partnership is involved in a 183 analysis, the existence of the required profit target is determined at the level of the partnership, which depends on the activities of the managing partners.

Knowledge: This case identifies the factors involved in determining whether an activity is “for profit” under section 183 so that expenses incurred in the “trade or business” of that activity can be deducted under section 162. Decisions on this will be made on a case-by-case basis. The manner in which a “business” activity or transaction is carried out, as well as the manner in which these transactions are documented, planned, planned and, if necessary, presented to the IRS or the Tax Court, are of critically important to ensure that “for-profit” factors, when placed on the scales of justice, favor the taxpayer for applicable tax benefits. If a taxpayer suspects that the IRS may challenge a deficiency in a closed case, before deciding on the most aggressive stance, consider: (1) whether the deductions are large enough to warrant funding a tax appeal and (2) establish a reserve to fund any future litigation while paying any dues.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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