TAX COURT OPINION

Case: Stella Agu
Docket Number: 18492-12S
Judge: Carluzzo
Opinion Type: bench
Filed: 05/29/2014
Pages: 11

UNITED STATES TAX COURT WASHINGTON, D.C. 20217 STELLA AGU, Petitioner, v. ) ) ) ) ) Docket No. 18492-12S COMMISSIONER OF INTERNAL REVENUE, Respondent. ) ) ) ORDER Pursuant to the determination of the Court as set forth in its bench opinion rendered on May 1, 2014, it is ORDERED that the Clerk of the Court shall transmit herewith to petitioner and to respondent a copy of the pages of the transcript of the trial in the above case before Special Trial Judge Lewis R. Carluzzo at Los Angeles, California, containing his oral findings of fact and opinion rendered at the trial session at which the case was heard. In accordance with the oral findings of fact and opinion, decision will be entered under Rule 155. (Signed) Lewis R. Carluzzo Special Trial Judge Dated: Washington, D.C. May 29, 2014 SERVED MAY 29 2014 Capital Reporting Company 3 1 2 Bench Opinion by Special Trial Judge Lewis R. Carluzzo May 1, 2014 3 Stella Agu v. Commissioner 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 Docket No. 18492-12S THE COURT: The Court has decided to render oral findings of fact and opinion in this case and the following represents the Court's oral findings of fact and opinion (bench opinion). Unless otherwise noted, section references made in this bench opinion are to the Internal Revenue Code of 1986, as amended, in effect for the 2009, and Rule references are to the Tax Court Rules of Practice and Procedure. This bench opinion is made pursuant to the authority granted by section 7459(b) and Rule 152. This proceeding for the redetermination of a deficiency is a small tax case subject to the provisions of section 7463 and Rules 170 through 175. Pursuant to section 7463(b) the decision entered in this case shall not be treated as precedent for any other case. Except as provided in Rule 152(c), this bench opinion shall not be cited as authority. Stella Agu appeared on her own behalf. Vanessa M. Hoppe appeared on behalf of respondent. In a notice of deficiency dated May 10, 2012 25 (notice), respondent determined a $7,263 deficiency 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 4 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 in petitioner's 2009 Federal income tax and imposed a $1,452.60 section 6662(a) penalty. The issues for decision are: (1) whether petitioner is entitled to a deduction for a loss incurred in connection with her rental real estate activity (rental activity); (2) whether petitioner's adjusted gross income should take into account trade or business expenses not claimed on her original 2009 Federal income tax return (original return); and (3) whether petitioner is liable for a section 6662(a) penalty. Some of the facts have been stipulated and are so found. Petitioner resided in California at the time the petition was filed. Petitioner is a registered nurse. During 2009 she was employed as such by three employers. Each of her employers treated her as an employee and reported the compensation paid to her as wage income on a Form 18 W-2, Wage and Tax Statement. The total of the 19 20 21 22 23 24 25 amounts reported on the Forms W-2 is show on line 7 of the original return, which return also includes a Schedule E, Supplemental Income and Loss. The amounts of the items reported on the Schedule E are not in dispute and show that petitioner incurred a loss from the rental activity (rental activity loss). A deduction for the rental activity loss is taken 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 5 1 2 into account in the adjusted gross income, taxable income and income tax liability reported on 3 petitioner's original return. There is no Schedule 4 5 6 7 8 9 10 11 12 13 14 15 C, Profit or Loss From Business, included with the original return, and on income or loss attributable to a Schedule C business is show on that return. Petitioner estimates that she spent 8 hours per week, approximately 520 hours per year, performing services in connection with the rental activity during 2009; she acknowledges that she spent far more time that yea-r providing services as a registered nurse. According to the notice, petitioner is not entitled to a deduction for the rental activity loss because "rental activities of any kind, regardless of 16 material participation, are considered passive 17 activities unless the requirements of section 18 469(c)(7) of the Internal Revenue Code are met". 19 According to respondent, petitioner did not meet 20 21 22 23 24 25 those requirements during 2009. Because it appears that petitioner now agrees with respondent on that point, we need only include a brief discussion of those requirements in the following portions of this bench opinion. In general and as relevant here, an individual 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 6 1 2 3 4 is not entitled to a deduction for a passive activity loss incurred during the taxable year. See sec. 469(a). A passive activity is any activity which involves the conduct of any trade or business and in 5 which the taxpayer does not materially participate. 6 7 8 9 10 11 12 See sec. 469(c)(1). In general, a rental activity is treated as a passive activity regardless of whether the taxpayer materially participates. See sec. 469(c)(2), (4). There are two exceptions to these general rules, each subject to a variety of limitations and conditions, however, if the taxpayer's rental activity is a real estate rental 13 activity, as was pe.titioner's during the year in 14 15 issue. One exception is found in section 469(c)(7), 16 which is referenced in the notice. If a taxpayer is 17 18 19 20 21 22 described in that section (sometimes that taxpayer is referred to as a "real estate professional") then section 469(c)(2) does not apply, and the taxpayer's rental real estate activity, if conducted as a trade or business or for the production of income, is not treated as a passive activity if the taxpayer 23 materially participates in the activity. See sec. 24 25 469(c)(1); Fowler v. Commissioner, T.C. Memo. 2002- 223; sec. 1.469-9(e), Income Tax Regs. 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 7 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Section 469(c)(7) contains two tests that a taxpayer must satisfy to be described in that section. One requires that the taxpayer spend more than 750 hours of services during the taxable year in real property trades or businesses. See sec. 469(c)(7)(B)(ii). The other requires that "more than one-half of the personal services performed in trades or businesses by the taxpayer during such taxable year are performed in real property trades or businesses in which the taxpayer materially participates". See 469(c)(7) (B)(i). Petitioner does not claim that she has satisfied either of these tests and the evidence shows that she did not. It follows that she is not a taxpayer described in section 469(c)(7) and that exception does not apply. Another exception allows a limited deduction up to $25,000 for losses incurred in a rental real estate activity. The limited deduction depends upon 19 whether the taxpayer "actively" participated in the 20 21 22 23 24 25 rental real estate activity, and respondent concedes that petitioner met that test during 2009. The amount of the limited deduction, however, also depends upon the taxpayer's "adjusted gross income" as that term is defined in section 469(i)(3)(F) (modified adjusted gross income). If the taxpayer's 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 8 1 modified adjusted gross income exceeds a certain 2 3 4 5 6 7 8 amount, then the amount of the limited deduction is reduced to zero. See sec. 469(i)(2) and (3) (A). Because of the amount of the adjusted gross income reported on the original return, it would appear that no part of the rental activity loss deduction claimed on the original return is allowable under section 469(i) even though respondent concedes that 9 petitioner actively participated in that activity. 10 11 12 13 14 15 16 At some point during the examination of the original return petitioner apparently became aware of the section 469 limitations on passive activity loss deductions. She submitted two amended Federal income tax returns, neither processed by respondent and each showing a reduction in her adjusted gross income so as to allow at least a section 469(i) limited rental 17 activity loss deduction. The amended returns suggest 18 19 20 21 22 23 24 25 that some of the wage income reported on the original return should have been reported on a Schedule C, and deductions not claimed on the original return should be taken into account. This of course, would reduce the amount of her adjusted gross income, see sec. 62, and correspondïngly reduce her "modified adjusted gross income" so as to allow for a limited section 469(i) deduction. 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 9 According to petitioner the items shown on the Schedules C included with the amended returns relate to her a trade or business other than as an employee for the employers who issued the Forms W-2. She referred to that business as her consulting business, and for convenience we'll do the same. Even if we were to find that petitioner was engaged in the consulting business as she claims, we would not allow her to recharacterize wage income from her employers to Schedule C income attributable to her consulting business. Furthermore, even if we were to find that she incurred and paid some deductible expenses in carrying on her consulting business, see sec. 162(a); Cohan v. Commissioner, 59 F.2d 540 (2nd Cir. 1930), as the amended returns suggest, we would not allow those expenses to be taken into account in the computation of her adjusted gross income. This is because she admitted to an undisclosed amount of income earned, but not reported, from her consulting business. Consequently we could not determine what the correct amount of her net profit or net loss from that her consulting business might have been. All things considered, our view of the matter-is consistent with respondent's. That is, petitioner's 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 entitlement to a limited rental activity loss 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 10 deduction under section 469(i) must be computed with reference to the items of income reported on her original return. Lastly, we consider whether petitioner is liable for a section.6662(a) penalty. According to respondent she is, if only because the underpayment of tax required to be shown on her return, which in this case is computed in the same manner as and is equal to the deficiency, see secs. 6211, 6664(a), is a substantial understatement of income tax, see sec. 6662(b)(2), (d). We agree that respondent has met his burden of production with respect to the imposition of the penalty, see sec. 7491(c), because of the amount of the underpayment, but that does not end our consideration of the matter. The penalty is not applicable to.any portion of the underpayment if it is shown that there was reasonable cause for such portion and the taxpayer acted in good faith with respect to such portion. See sec. 6664(c). Petitioner has no training or experlence in accounting or Federal income taxation. Her original return and the amended returns were prepared by paid income tax return preparers, and the underpayment of tax required to be shown on that return relates entirely to a deduction disallowed only by virtue of 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 11 1 2 3 4 5 6 7 8 the operation of section 469 (as opposed to lack of substantiation). That being so, we are reluctant to impose an accuracy-related penalty. As noted in an article published in the October 24, 2011, edition of Tax Notes, Professor George S. Jackson section 469 contains "almost 4,500 words" (I didn't count) and "exemplifies why federal tax law is incomprehensible for most citizens". Passive 9 Activity Limitations: Time for a New Paradigm?, 133 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Tax Notes 447 (Oct. 24 2011). Petitioner's reaction to some of the Court's questions to her and to respondent's counsel during the trial shows that the operation of section 469 is, and was "incomprehensible" to her, and that she relied upon her return prepare to accurately reflect the Federal income tax treatment of her rental activity loss. We are confident that she had a sense of economic, if not financial loss from the rental activity and it would not be unreasonable for her to expect to be allowed a deduction for that loss, especially when the return preparer included the deduction on her original return. Furthermore, we find that she acted in good faith with respect to the underpayment, and we measure her good faith, or intent, at the time her original return was filed, and not at the time- of her 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 1 misguided and ill-fated attempts to salvage at least 12 a portion of the rental activity loss through the submission of amended returns. Cf. Gleis v. Commissioner, 24 T.C. 941, 952 (1995), aff'd, 245 F.2d 237 (6th Cir. 1957); Holmes v. Commissioner, T.C. Memo. 2012-251, at *37. It follows that petitioner is not liable for a section 6662(a) penalty. To reflect the foregoing, decision will be entered under 155. This concludes the bench opinion. (Whereupon, at 10:00 a.m., the above- entitled matter was concluded.) . 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 2 4 25 866.488.DEPO www.Capita1ReportingCompany.com