Victory Over the IRS in Material Participation Challenge
In U.S. Tax Court, Frazer Ryan attorneys affirm
that a couple materially participated in the operation of a yacht chartering business.
On August 5, 2015, Derek
Kaczmarek and David Jojola won a
significant victory for their clients in U.S. Tax Court, reducing to less than $4,000 an IRS
claim of over $100,000.
In Kline v.
Commissioner (T.C. Memo. 2015-144), the IRS argued that the taxpayers did
not materially participate in their yacht chartering business, failed to
properly substantiate their claimed expenses, and owed a negligence penalty of
20%, resulting in a determination of tax, penalties and interest of over
The Tax Court found that the IRS determination was in error
and that the taxpayers owed less than $4,000 in taxes, with no penalties.
Material participation in a business allows a taxpayer to
offset any losses incurred in the business against their ordinary income. A lack
of material participation limits the available loss to offset only passive
income. (Internal Revenue Code § 469) Any rental activity is generally passive,
unless an exception applies. (I.R.C. § 469(c)(1), (3))
There are several ways to prove material participation. In
this case, the court ruled that the taxpayers met the 100 hour test found in
Treasury Regulation 1.469-5T(a)(3). The U.S. Tax Court accepted the taxpayers
reconstruction of the hours they spent working in the business and further
recognized that the business use of the rentals fit within the seven-day
exception of Treasury Regulation 1.469-1T(e)(3)(ii).
In disallowing the IRSs claim of a negligence penalty
against the taxpayers (I.R.C. § 6662), the Tax Court found that the taxpayers
reasonably relied on a tax professional to prepare their tax returns.
The taxpayers demonstrated that (a) the advisor was a
competent tax professional, (b) the taxpayers provided necessary and accurate
information to the advisor, and (c) the taxpayers relied in good faith on the
advisors judgment. (I.R.C. § 6664)
The IRS is becoming increasingly aggressive in disallowing
business losses when the losses have the effect of reducing ordinary income. In tax disputes with the IRS,
Derek Kaczmarek and
David Jojola can evaluate a taxpayers options for responding to an examination and
ultimately developing a strategy for resolution.
About the Authors
A Certified Specialist in Tax Law,
Derek W. Kaczmarek represents
taxpayers and employers in federal and state income, gift, estate, excise and
employment tax controversies. For seven years, he was a trial attorney with the
IRS. Derek earned his law degree at Indiana University School of Law and an
LL.M. in Taxation from New York University School of Law.
David R. Jojola is a Certified
Tax Law Specialist who, for 11 years before entering private practice, was a
senior trial attorney with the IRS. David represents clients in tax
controversies involving income, gift, estate, excise and employment tax matters.
He also has extensive experience in successfully representing individual
taxpayers seeking innocent spouse relief.
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