Attorney-at-Law

PASSIVE AGGRESSIVE

In Uncategorized on 08/08/2012 at 17:01

Joe Veriha claimed his truck leasing operation was passive, but the IRS said his position was too aggressive, so Joe’s operation gets recharacterized as active, in Joseph Veriha and Christina F. Veriha, 139 T.C. 3, filed 8/8/12, with Judge Wells at the wheel.

Joe ran a trucking business C Corp, but leased his trucks and trailers from a Sub S he owned 99% of, or else from an LLC he owned 100% of. Joe also ran the C Corp, which employed both him and Chris; he materially participated in the C Corp.

Among the other little quips and jingles introduced by the celebrated Internal Revenue Code of 1986, as elaborated by Treasury, is Reg. 1.469-2(f)(6), Income Tax Regs. (sometimes referred to as the “self-rental rule or the recharacterization rule”).

This goodie says that, while all rental activity is generally (don’t you just love the word “generally”?) passive, rental of equipment from an entity controlled by taxpayer, which equipment is used in a trade or business in which taxpayer materially participates, is active, not passive. Thus passive losses cannot be used to offset income generated by such rental activity.

Now Joe’s Sub S rentals made money, but Joe’s LLC rentals lost, so Joe of course wanted to net the two and pay tax only on the overall net. IRS said Joe could net within the Sub S, and net within the LLC, but could not net the LLC’s losses against the Sub S’s gains. See my blogpost “Winning the Paper Chase”, 6/6/12.

Joe had separate leases for each truck and each trailer, either from his Sub S or his LLC.

Judge Wells: “Each tractor was leased (to Joe’s C Corp) as one unit, and each trailer was leased (to Joe’s C Corp) as one unit. The monthly rate for leasing each tractor was determined by the tractor’s age, and the monthly rate for leasing each trailer was determined by the type of trailer. During 2005, the tractors and trailers owned by (Joe’s Sub S) and (Joe’s LLC) were all parked in the same lot and were intermingled. All the tractors were painted the same yellow color, and all received the same scheduled maintenance. (Joe’s C Corp) paid the expenses for all of the tractors and trailers and insured all the tractors and trailers under the same blanket insurance policy. In determining which tractor or trailer to use on a route, (Joe’s C Corp) made no distinction between those (Joe’s Sub S) owned and those (Joe’s LLC) owned. Similarly, when it assigned drivers, (Joe’s C Corp) did not make any distinction on the basis of the ownership of the tractor or trailer.” 139 T. C. 3, at p. 4.

“Section 1.469-2(f)(6), Income Tax Regs., explicitly recharacterizes as nonpassive net rental activity income from an ‘item of property’ rather than net income from the entire rental ‘activity’. Section 469 and the regulations thereunder distinguish between net income from an ‘item of property’ and net income from the entire ‘activity’, which might include rental income from multiple items of property. Even when items of property are grouped together in one activity, section 1.469-2(f)(6), Income Tax Regs., still applies to recharacterize rental income from an item of property as nonpassive income.” 139 T. C. 3, at pp. 7-8 (Citation omitted.)

Now here’s where the trail becomes tangled. “The parties disagree about the definition of the phrase ‘item of property’. In the notice of deficiency, respondent (IRS) determined that the income from (Joe’s Sub S) should be recharacterized as nonpassive income. The notice of deficiency does not explain the rationale for that recharacterization, and petitioners contend that the notice of deficiency determined that each fleet of tractors and trailers (Joe’s Sub S) and (Joe’s LLC) owned was a separate ‘item of property’ and that the income from (Joe’s Sub S) should be recharacterized pursuant to section 1.469-2(f)(6), Income Tax Regs. However, on brief respondent contends that the notice of deficiency determined that each individual tractor or trailer is an ‘item of property’ but that respondent elected not to challenge the offsetting of income and losses with respect to each tractor or trailer within (Joe’s Sub S) or (Joe’s LLC). In contrast, petitioners contend that the entire collection of tractors and trailers, i.e., all the tractors and trailers whether owned by (Joe’s Sub S) or (Joe’s LLC), constitutes a single ‘item of property’.” 139 T.C. 3, at p.8.

Of course, neither the Code nor the Regs define the term “item of property”, so Judge Wells hits the books and finds: “…‘item’ is defined as a separate thing that is part of a larger collection. Those definitions support respondent’s contention that each separate tractor or trailer is an ‘item of property’. Indeed, the articulation of petitioners’ argument requires the use of a term such as ‘collection’, ‘group’, or ‘whole’, all of which serve to distinguish the collection of tractors and trailers from any single tractor or trailer, i.e., any single ‘item of property’. Accordingly, we conclude that each individual tractor or trailer is an ‘item of property’ within the meaning of section 1.469-2(f)(6), Income Tax Regs.” 139 T. C. 3, at pp. 9-10.

Joe argues that IRS did, at least in one reported case, treat bunch of over-the-road trailers as a single item of property, but Judge Wells won’t drive that road. “We are not persuaded by petitioners’ contention. We have repeatedly held that, even with respect to the same taxpayer, the Commissioner is not bound in any given year to allow the same treatment as in prior years.” 139 T. C. 3, at p. 11.

“Accordingly, we conclude that respondent is not bound to treat petitioners’ tractors and trailers as one item of property even though the Commissioner may have treated the over the road trailers … as one item of property. Moreover, it is not even clear that… the  Commissioner actually treated all of the over the road trailers as one item of property. Indeed, the Commissioner’s treatment of the trailers … is consistent with respondent’s position in his brief that, although respondent considers each individual tractor or trailer a separate item of property, respondent is electing not to challenge petitioners’ offset of the income and losses from each item of property within (Joe’s Sub S) and (Joe’s LLC).” 139 T. C. 3, at p. 12. (Citation omitted)

And if Joe claims that the entire fleet of tractors and trailers were all one “item of property”, why did he have two entities to run the rentals? Joe could have put them all under one entity, but under good old Commissioner v. Nat’l Alfalfa Dehydrating & Milling Co., 417 U.S. 134 (1974), you can pick the business form, but once you do, you’re stuck with it.

So no go, Joe. But your winning Sub S can net its aggregate losses against its aggregate winnings to get the amount of active income on which you must pay tax.

Leave a Reply

Please log in using one of these methods to post your comment:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.

%d bloggers like this: