Cantor v. IRS, T.C. Summary Opinion 2014-103 (Nov. 6, 2014).
The Tax Court put out a couple cases last Thursday (11/6), none friday. Cantor v. IRS, TC Summary Op 2014-103 does a bit of an injustice to blue collar businessmen. There, taxpayer was in the business of automotive, residential, and commercial glass install/repair. He also owned some rental property connected with his business. Taxpayer attempted to deduct his losses from his realty activities, but the IRS and TC allowed the Sec. 469 passive investment loss limitations to stop him. The injustice was that the Court focused on a narrow distinction of Taxpayer's activities--separating installation activities from what it construed to be actual construction. He, like other tradesmen making ends meet don't track their time between activities like lawyers (and former lawyers--TC judges). See pp. 10-11. So Taxpayer's attempt to deduct losses for his realty (which were really just costs of doing business) was disallowed basically because he doesn't keep 6-minute records of his activities. Pretty harsh record-keeping requirement if you ask me.
Burrell v. IRS, T.C. Memo 2014-217 (October 14, 2014).
Believe it or not, losses incurred while gambling are deductible for those who are engaged in the “trade or business” of gambling and to the extent the taxpayer has gains attributable to “wagering.” IRC Sec. 165(d). However, the IRS and Tax Court are suspicious of such deductions. A taxpayer who hopes to successfully claim this deduction by means of contemporaneous records (i.e. accurate self-kept records made at or near the time of the transactions they evidence) needs to do more than just record the amount of money with which he or she enters the casino. In yesterday’s** Burrell v. IRS, the taxpayer failed to also record the amount of money with which she left the casino each day. T.C. Memo 2014-217, 7 (October 14, 2014). The IRS and Tax Court affirmed the deficiency against her and the accuracy-related penalties for underreporting based on the taxpayer’s failure of proof.
** At least one Tax Court clerk appears to have celebrated Columbus Day right!
Langert v. IRS, T.C. Memo 2014-210 (Oct. 8, 2014).
In general, the American income tax system taxes net income (only "new money") rather than gross income. Section 166 of the Internal Revenue Code helps further this objective by allowing a taxpayer to deduct a loss of money from his income if that loss occurs in connection with his "trade or business." IRC §§ 166(a) and (b)(2). Non-business bad debt losses are still deductible, but only as short term capital losses. § 166(d)(1). So legally, there is an important business boundary that must be established by the taxpayer to take full advantage of so called "bad debt" deductions.
Wednesday's Tax Court case of Langert v. IRS, T.C. Memo 2014-210 (Oct. 8, 2014) demonstrates the IRS's and the Tax Court's interpretation of this law. That is, a taxpayer seeking to deduct "bad debt" must prove that he makes enough loans on a sufficiently regular basis to elevate that activity to the status of a separate business. Id. at p. 10. In Langert, the taxpayer was a real estate investor who had also made money by lending and re-lending money over his 30 year career. Id. at p. 2. One such loan was not repaid in 2006, and the debtor filed for bankruptcy. Mr. Langert did not exercise any of his rights under the loan document, as a bankruptcy creditor, or in connection with the debtor's property. He then attempted to write off the loan as a complete loss under Section 166. His justification for doing so was that the loan was made "for the sole purpose of obtaining interest income." The IRS and Tax Court disallowed the deduction based on the taxpayer's failure to carry his burden and prove he met the "trade or business" requirements of this law.
So while many small business people may see their various and diverse business activities as related or as part of a continuum (buy low, sell high—any kind of widget), the IRS and Tax Court require more definite boundaries when it comes to deductions for bad debt. This may actually be a good case to appeal based on the language of the statute, but a prudent attorney or accountant would further research along the lines of Bell v. Commissioner, 200 F.3d 545 (8th Cir. 2000).
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