TAX COURT OPINION

Case: Timothy & Linda Klein
Docket Number: 4686-08S
Judge: Colvin
Opinion Type: bench
Filed: 03/27/2009
Pages: 12

UNITED STATES TAX COURT WASHINGTON, D .C . 202.1 7 TIMOTHY AND LINDA KLEIN, Petitioners , v . ) Docket No . 4686-08S COMMISSIONER OF INTERNAL REVENUE, Respondent . O R D E R Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it i s ORDERED that the Clerk of the Court shall transmit herewith'to petitioners and to respondent a copy of the pages of the transcript of the trial of the above case befor e Special Trial Judge'Lewis R . Carluzzo at Fresno, California, on March 10, 2009, containing his oral findings of fact and opinion rendered at the conclusion of trial . In accordance with the oral findings of fact and opinion, appropriate orders will be issued withdrawing Doyle E . Anderson, Sr ., as petitioners' counsel and dismissing this case as to Linda Klein, and decision will be entered under Rule 155 . (Signed ) Lewis R. Carluzzo Special Trial Judge Dated : Washington, D .C . March 27, 2009 SERVED Mar 31 2009 1 Bench Opinion by Special Trial Judge Lewis R . Carluzz o 2 Timothy & Linda Klein v . Commissioner Docket No . 4686-08S 3 March 10, 200 9 4 THE COURT : The Court has decided to render ora l 5 findings of fact and opinion in this case, and the following 6 represents the Court's oral findings of fact and opinion . 7 The oral findings of fact and opinion shall not be relied 8 upon as precedent in any other case . 9 This proceeding for the redeterminations o f 10 deficiencies is a Small-Tax Case conducted pursuant to the 11 provisions of Section 7463 of the Internal Revenue Code of 12 1986, as amended, and Rules 170 through 175 of the Tax Court 13 Rules of Practice and Procedure . 14 This bench opinion is made pursuant to th e 15 authority granted by Section 7459(b) of the Internal Revenue 16 Code of 1986, as amended, and Rule 152 of the Tax Cour t 17 Rules of Practice and Procedure . 18 Hereinafter in this bench opinion, unless otherwise 19 specified, section references are to the Internal Revenu e 20 Code of 1986, as amended, in effect for the years in issue . 21 Rule references are to the Tax Court Rules of Practice and 22 Procedure . 23 Timothy Klein (Petitioner) appeared pro se . Farhad 24 Asghar appeared on behalf of Respondent . (Upon oral motion 25 made by Petitioner, Doyle E . Anderson was withdrawn a s Heritage Reporting Corporation (202) 628-4888 4 1 counsel for Petitioners in this case .) There was no 2 appearance made by or on behalf of Linda Klein when thi s 3 case was tried in Fresno, California, on March 9, 2009, and 4 she did not sign the stipulation of facts admitted int o 5 evidence . The case will be dismissed for lack o f 6 prosecution as to her . Nevertheless, the decision entered 7 as to her will reflect the resolution of the issue s 8 presented for trial . 9 In a notice of deficiency dated November 23, 2007, 10 Respondent determined deficiencies in Petitioners' 2003 , 11 2004 and 2005 federal income taxes . For 2003, Respondent 12 also imposed a Section 6651(a)(1) addition to tax (the late . 13 filing penalty) . 14 The issues for decision are : (1) for each year in 15 issue, whether Petitioners are entitled to a deduction for a 16 passive activity loss ; (2) for 2003, whether Petitioners are 17 entitled to a deduction for other expenses claimed on a 18 Schedule E ; (3) for 2004, whether Petitioners are entitled 19 to a deduction for certain expenses claimed on a Schedule C ; 20 and (4) whether Petitioners had reasonable cause for their 21 failure to file timely a 2003 federal income tax return . 22 Some of the facts have been stipulated and are so 23 found . At all times relevant, Petitioners were married to 24 each other . They filed a joint federal income tax return 25 for each year in issue . At the time the petition was filed , Heritage Reporting Corporation (202) 628-4888 5 1 they resided in California . 2 Petitioner was employed as a mortgage broker during 3 the years in issue . In a year or years prior to the year s 4 in issue, Petitioner and two of his brothers formed tw o 5 limited liability companies pursuant to the Kansas Revised 6 Limited Liability Company Act (the LLCs), each owning a 7 one-third interest in the LLC . During each year in issue, 8 each of the LLCs elected to be treated as a partnership for 9 federal income tax purposes . 10 Over the years, the LLCs acquired rental real 11 estate properties, some in California, and some in Texas . 12 The properties were managed by a property managemen t 13 company, but from time to time, Petitioner provided some of 14 what might be considered managerial services in connection 15 with the various rental properties . He also traveled from 16 his residence in California to inspect the rental properties 17 in Texas, although the record does not contain any specific 18 information regarding any particular trip . Although there 19 was a management company involved in the rental of th e 20 properties owned by the LLCs, it was not unusual for a 21 tenant of one of the properties to make direct contact with 22 Petitioner on a matter relating to the rental property . 23 The amount of time that Petitioner spent in 24 connection with his interest in the LLCs or the renta l 25 properties held by the LLCs cannot be determined with any Heritage Reporting Corporatio n (202) 628-4888 6 1 degree or precision . Petitioner testified in general terms 2 as to what he was doing, but he readily admits, as he did 3 repeatedly during trial, that he kept no contemporaneou s 4 records that would show such information . 5 For each year in issue, Petitioners claimed a 6 deduction for a passive activity loss . Each loss relates to 7 the activities of the LLCs . For 2003, Petitioners als o 8 claimed a deduction for expenditures made by Petitioner on 9 behalf of one or both of the LLCs on a Schedule E . Fo r 10 2004, a similar deduction was claimed, this time on a 11 Schedule C, for a business identified on that schedule as 12 "Offset Ki" . For each of those years, some of th e 13 expenditures included in the deductions might have related 14 to trips that Petitioner took from his residence i n 15 California to inspect the rental properties in Texas owned 16 by one of the LLCs . 17 Except for irrelevant details, the operating 18 agreements for the LLCs, one of which is included in the 19 record, are identical . Section 5 .4 of the agreement s 20 provide, in part, as follows : 21 "Powers of Members . No member shall have 22 the right or authority to enter int o 23 agreements, execute contracts or other 24 instruments, incur obligations, o r 25 otherwise bind or act for, in the name or Heritage Reporting Corporation (202) 628-4888 7 1 on behalf of [the LLCI in any manner , 2 unless authorized in writing to do so by a 3 majority interest . " 4 Nothing in the record suggests that any written authorit y 5 supports any of the deductions for other expenses claimed on 6 the Schedule E included with Petitioners' 2003 return, o r 7 the Schedule C included with Petitioners' 2004 return . 8 Taking into account an extension, Petitioners' 2003 9 return was due to be filed on or before October 15, 2004 , 10 but it was not filed until February 16, 2005 . 11 In the notice of deficiency that forms the basis 12 for this case, Respondent : (1) disallowed the passiv e 13 activity loss claimed for each year in issue ; (2) disallowed 14 the deduction for other expenses claimed on the Schedule E 15 for 2003 ; (3) disallowed the deductions for expenses shown 16 on a "Offset Kl" Schedule C included with Petitioners' 2004 17 return ; and (4) imposed the late filing penalty for 2003 . 18 Other adjustments made in the notice of deficiency have been 19 agreed to or are computational, and need not be addressed in 20 this bench opinion . 21 The petition in this case is less than informative . 22 According to the petition, for each year in issue , 23 Respondent "wrongfully disallowed the taxpayer's Schedule E 24 losses," but not the slightest hint why is included in the 25 petition . In fact, no further allegations are made, and Heritage Reporting Corporation (202) 628-4888 8 1 although represented by counsel at the time, no pretria l 2 memorandum was submitted on behalf of Petitioners . Never- 3 theless, we make what sense can be made from what has bee n 4 presented, and turn our attention first to the deduction for 5 the passive activity loss claimed by Petitioners an d 6 disallowed by Respondent for each year in issue . 7 1 . The Passive activity loss deductions . 8 At trial, Petitioner took the position that, 9 coupled with his profession as a mortgage broker, his 10 interests and activities in connection with the LLC s 11 qualifies him as a taxpayer in a real property busines s 12 within the meaning of Section 469(c)(7) . The record in this 13 case, however, is wholly inconsistent with such treatment . 14 Petitioner's generalized testimony regarding the amount of 15 time he spent providing "personal services performed i n 16 trades or businesses" during each year "in real propert y 17 trades or businesses" hardly satisfies the time requirements 18 of Section 469(c)(7)(B) . Furthermore, Petitioner's claim to 19 Section 469(c)(7) status is inconsistent with the manner in 20 which the passive losses were claimed on each .return . I f 21 Section 469(c)(7) applied to Petitioner, then the losses 22 would not be treated as passive losses in the first place . 23 See Section 469(c)(2) . 24 The manner in which the losses attributable to the 25 LLC were treated on Petitioners' return for each year in Heritage Reporting Corporation (202) 628-4888 9 1 issue makes it clear that the deductions for such losses 2 were taken pursuant to Section 469(i), which allows a 3 natural person to deduct a passive activity loss, subject to 4 various conditions and limitations set forth in tha t 5 section . One of those conditions requires the taxpayer to 6 have "activity participated" in the activity during th e 7 taxable year . 8 The manner in which a taxpayer can "participate" in 9 an activity is shown, to some extent, in Sectio n 10 1 .469-5T(f), Temporary Income Tax Regs . Such participation 11 excludes "participation as an investor," which participation 12 is further described in Section 1 .469-5T(2)(ii), and 13 contemplates some of the types of the very activitie s 14 Petitioner described during his testimony . Focusing on the 15 details, or lack thereof, of Petitioner's participation in 16 the activities of the LLCs during the years in issue , 17 however, is not necessary . Although the legislative history 18 suggests that, for purposes of Section 469, activ e 19 participation is something less than material participation 20 (as defined in Section 1 .469-5T, Temporary Income Ta x 21 Regs .), Section 469(i)(6) provides that, "Except as provided 22 in the regulations, no interest in a limited partnershi p 23 shall be treated as an interest with respect to which the 24 taxpayer actively participates ." It appears that n o 25 regulations have been promulgated on the point . See, e .g ., Heritage Reporting Corporatio n (202) 628-4888 1 0 1 Estate of Quick v . Commissioner , 110 T .C . 172 (1998) . 2 Because the LLCs elected to be treated a s 3 partnerships, and because Petitioner's liability as a member 4 of each LLC under Kansas law is limited, his interest i n 5 each LLC is treated as a limited partner of a limite d 6 partnership . See Section 17-7688, Kansas Revised Limited 7 Liability Company Act ; see also Section 1 .469-5T(e)(3) , 8 Temporary Income Tax Regs . 9 It follows that Petitioner cannot be considered to 10 have actively participated in the LLCs within the meaning of 11 Section 469(i) . Respondent's disallowance of the passiv e 12 activity loss deduction claimed for each year is sustained .. 13 2 . Other deductions attributable to the LLCs . 14 Although treated differently on Petitioners' return 15 for each year, for 2003 and 2004, Petitioners claime d 16 deductions for other expenses attributable to the LLCs . 17 With the exception of trips that Petitioner might have taken 18 from his residence in California to inspect the properties 19 in Texas, the parties proceeded as though the expenses t o 20 which the deductions relate are properly considered th e 21 expenses of one or the other of the LLCs, more likely than 22 not deductible by one or the other of the LLCs pursuant to 23 Section 162 . Absent some agreement between the LLCs an d 24 Petitioner regarding reimbursement, however, and considering 25 the above-quoted language of the Operating Agreements, Heritage Reporting Corporation (202) 628-4888 1 1 1 Petitioners are not entitled to those deductions . See 2 Moline Properties, Inc . v . Commissioner , 319 U .S . 436 3 (1943) ; Deputy v . du Pont , 308 U .S . 488 (1940) ; Rink v . 4 Commissioner , 51 T .C . 746 (1969), with the possibl e 5 exception that expenses incurred by Petitioner to travel to 6 Texas from California might be deductible under Section 212 . 7 Respondent points out that no such claim has been 8 made by Petitioners in the petition or otherwise, an d 9 Respondent's point is well made . Nevertheless, i f 10 Petitioners are entitled to deductions for such expenses, 11 those deductions should now be allowed . Respondent also 12 notes that the record is insufficient to determine th e 13 amount of such expenses, and, again, Respondent's point is 14 well made . Be that as it may, to the extent tha t 15 Petitioners can establish to Respondent's satisfaction the 16 details and dates of such trips (we except Petitioner' s 17 credible testimony, if less than specific, that he took such 18 trips), and the expenses for such trips are adequatel y 19 substantiated in accordance with Section 274 and the 20 corresponding regulation, we expect that .any agreemen t 21 between the parties on any such allowances can be reflected 22 in the Rule 155 computations . 23 3 . Are Petitioners liable for the late filing penalty 24 for 2003 ? 25 Respondent imposed a late filing penalty for 2003 . Heritage Reporting Corporation (202) 628-4888 1 2 1 Respondent's Section 7491(c) burden with respect to the 2 imposition of the late filing penalty has been met . 3 Petitioners have the burden to establish reasonable cause 4 for their failure to file a timely 2003 return . Higbee v . 5 Commissioner , 116 T .C . 438 (2001) . Reasonable cause i s 6 shown if "the taxpayer exercised ordinary business care and 7 prudence and was nevertheless unable to file the retur n 8 within the prescribed time ." Section 301 .6651-1(c)(1), 9 Procedural & Administrative Regs . 10 Petitioners' 2003 return was filed several months 11 late . According to Petitioner, the return could not be 12 timely filed because information from one or both of th e 13 LLCs was not forthcoming . Waiting for information, however, 14 does not insulate them from the imposition of the lat e 15 filing penalty . As we noted in Graves v . Commissioner , T .C . 16 Memo 2004-140, Petitioners "could have filed a timely return 17 and later amended it" if necessary . See also Eddy v . 18 Commissioner , 115 T .C . 135 (2000) (late filing penalty 19 imposed even though taxpayer had not yet receive d 20 information from third parties necessary for the completion 21 of a timely return) . Petitioners are-liable for the late 22 filing penalty for 2003 . 23 To reflect the foregoing, appropriate orders will 24 be issued withdrawing Doyle E . Anderson as Petitioners ' 25 counsel and dismissing the case as to Linda Klein, and Heritage Reporting Corporation (202) 628-4888 1 decision will be entered under Rule 155 . 2 This concludes the Court's oral findings of fact 3 and opinion in this case . 4 (Whereupon , at 11 :48 a .m ., the bench opinion in the 5 above-entitled matter was concluded . ) 1 3 6 7 8 9 10 11 12 1 3 14 15 16 17 18 19 20 21 22 23 24 25 Heritage Reporting Corporation (202) 628-4888