Llc Passive IncomeLiabilities Income
Percentage of LLC income accounted for as a liability.
The Fiscal Court ruled that a physician's distributing portion of the income from his interest in a private equity firm with restricted liabilities for surgery handled as a private corporation for income taxation purpose is passive and a distinct business from his doctor's office.
Also, the Finance Court came to the conclusion that the doctor was a Kommanditist within the sense of 1402 a)(13) and was therefore not liable to the self-employed person taxation on his distributing portion from the Partnership. This case concerned Dr. Hardy, who was a Plastic surgeon, who had his doctor's office through Northwest Plastics Surgery, his single-headed PLC and his Mrs. Hardy, who was the chief operational Officer.
Dr. Hardy has conducted operations at various surgery centres, such as Northwest Plastic Surgery, MBJ, in which he held a non-controlling interest, and clinics for more complicated operations. Dr. Hardy's patient payed him directly for his surgery fee and would separate the operating center for the use of the facilities.
The MBJ was an LLC that was considered a private company for income taxation reasons and was established in 2004 by a group of practising doctors to operate a surgical centre. Dr. Hardy acquired a 12.5% stake in MBJ in 2006. Dr. Hardy had no day-to-day managerial duties and had no influence on MBJ's managerial decision-making.
The MBJ was run in a professional manner, employed its own staff and did not assign staff to Northwest Plastic Surgery. However, the MBJ was not run by a professional. Though Dr. Hardy sometimes did operations at MBJ, he obtained MBJ allocations regardless of whether he did any operations at the operations centre, and his allocations were not dependant on the number of operations he undertook there.
In 2006 and 2007, the Hardys did not report their income from MBJ as passive as their preparation was based on Table K-1 obtained from MBJ. Annex K-1 shows that the income comes from a trades and includes the self-employment income taxes. Hardys also disclosed passive restrictions on losses from an independent 8582 asset of USD 58,786 for 2006 and USD 119,615 for 2007, which contained the 2006 transfer losses.
During 2008, after finding out that Dr. Hardy was not a member of MBJ's senior executive team and was not responsible for MBJ's debt, Hardys' Prep found that MBJ's income was passive by going through a check list of passive asset values and receiving confirmed information from the Hardys.
Hardys have not changed their yields for 2006 or 2007 because their preparers considered the changes insignificant. Rather, from 2008, the Hardys did not report income from MBJ as passive. During 2008 and 2009, Hardys offset its passive income against its passive asset loss, which included transfer loss of $119,615 from prior years.
In addition, they provided information on the income taxes on self-employment that Dr. Hardy of Northwest Plastic Surgery and MBJ earned. For the years 2008 to 2010, the IRS published a defect report prohibiting the passive withdrawal of Hardys' losses of activities. Financial court reviewed whether Hardys Dr. Hardy's income from MBJ was duly declared as passive by Hardys.
MBJ's income was not passive and could not make a reduction for their passive loss of income because they did not have a passive income against which they could make a reduction. IRS also claimed that the Hardys had grouped their MBJ operations with Dr Hardy's doctor's office in previous years and could not re-group these operations in later years.
According to the Finance Court, the Hardys did not pass the substantive test of holding under Section 469 and the income from MBJ was therefore passive. However, the Finance Court rejected the IRS's claim that the Hardys had tried to reclassify their operations under Section 469. The Finance Court relied on the Hardys producer's witness statements and found that the activity had not previously been consolidated.
Returnee stated that he had not grouped the activity and had initially found that MBJ's income was not passive by "applying his expertise and experience" and reliant on Annex K-1 coverage. Moreover, the Hardys did not specifically group their operations and were not obliged to do so in those years.
Thus, the Fiscal Court found that there was no proof that the Hardys had previously combined MBJ and Northwest Plastic Surgery and consequently handled them as independent commercial entities. In addition, the Finance Court found that the IRS could not reclassify the Hardys' operations under Treas. 469-4 (f) because the initial Hardys grouping was appropriate and had no primary objective of bypassing Section 469.
Although the Finance Court found that MBJ's income was passive, it finally came to the conclusion that the Hardys were not eligible for the full passive deduction of losses on activities made in 2008 and 2009. The tax court reviewed the passive losses carried forward from previous years. As the Finance Court had already established that MBJ's income was passive, it found that the Hardys had wrongly considered MBJ's income as non-passive in 2006 and 2007.
Had the Hardys duly recorded the MBJ income for 2006 and 2007 as passive, their passive asset losses in those years would have been fully compensated by their passive income so that no passive asset impairment could be carried forward to 2008. A further question examined by the Finance Court was whether the Hardys paid their self-employed overtax.
1402 (a)(13), which exempts the distributing part of the income or the losses of a Kommanditisten from the net income from self-employment in order to establish whether Dr. Hardys income from MBJ is liable to self-employment taxation. Citing Renkemeyer, Campbell, Weaver, LLP v. Commissioner, 136 T.C. 137 (2011), in which the Finance Court investigated the law's legal histories in order to construe the significance of limit partners within the sense of 1402(a)(13), the Finance Court found that the intention was to make sure that persons who only invest in a private company and were not active in the company's activities would not obtain loans to cover social security.
When differentiating Hardy from Renkemeyer, the Fiscal Court found that while Dr Hardy carried out surgery on MBJ, the distributing portion of the revenue and dividends he obtained from MBJ was not for MBJ service but for charges incurred by the patient for using the facilities. In addition, the Finance Court has stressed that Dr Hardy was not engaged in the activities of MBJ as a company.
For example, the Finance Court found that the distributing income portion of Dr Hardy of MBJ is not taxed independently because he obtained his income portion from MBJ in his role as an individual shareholder. Hardy's case shows that a tax payer may group activity in any appropriate way for the purposes of Section 469 as long as his primary object for grouping is not to prevent the basic aims of Section 469.
Moreover, it appears that the taxpayer is not tied to decisions taken in previous fiscal years as to whether the income is passive or not. Information herein is of a general character and is provided on an "as is" basis.