Court Opinion

ID: 3047912
Source: CourtListenerOpinion
Date Created: 2015-10-13 23:22:38.189203+00
Date Added: 2024-06-11T07:51:44.326503
License: Public Domain

FOR PUBLICATION
  UNITED STATES COURT OF APPEALS
       FOR THE NINTH CIRCUIT

GARY BEECHER; DELORES BEECHER,            
           Petitioners-Appellants,                No. 05-71894
               v.
                                                  Tax Ct. No.
                                                    10870-01
COMMISSIONER OF INTERNAL
REVENUE,                                            OPINION
             Respondent-Appellee.
                                          
                Appeal from a Decision of the
                   United States Tax Court
            David Laro, Tax Court Judge, Presiding

                 Submitted February 15, 2007*
                   San Francisco, California

                      Filed March 23, 2007

      Before: Ronald M. Gould and Milan D. Smith, Jr.,
   Circuit Judges, and Alfred V. Covello,** District Judge.

                    Opinion by Judge Covello

  *This panel unanimously finds this case suitable for decision without
oral argument. See Fed. R. App. P. 34(a)(2).
  **The Honorable Alfred V. Covello, Senior United States District
Judge for the District of Connecticut, sitting by designation.

                                3463
3466                BEECHER v. COMMISSIONER OF IR

                                COUNSEL

Edward B. Simpson, San Francisco, California; John
Gigounas, San Francisco, California, for the petitioners-
appellants.

Eileen J. O’Connor, Assistant Attorney General, Washington,
D.C.; Kenneth L. Greene, Tax Division, Department of Jus-
tice, Washington, D.C.; Deborah K. Snyder, Tax Division,
Department of Justice, Washington, D.C., for the respondent-
appellee.

                                OPINION

COVELLO, District Judge:

  This is an appeal from a decision of the United States Tax
Court upholding a tax deficiency determination of the Com-
missioner of Internal Revenue (“Commissioner”).1 It is

  1
    “Within 90 days . . . after the notice of deficiency . . . is mailed . . . ,
the taxpayer may file a petition with the Tax Court for a redetermination
of the deficiency.” I.R.C. § 6213(a). “[T]he Tax Court shall have jurisdic-
tion to redetermine the correct amount of the deficiency. . . .” I.R.C.
§ 6214(a).
                    BEECHER v. COMMISSIONER OF IR                       3467
brought pursuant to Internal Revenue Code § 7482.2 The
appellants, Gary Beecher and Dolores Beecher (“Beechers”)
challenge the tax court’s ruling that the Beechers cannot apply
losses from their various rental properties to offset rental
income derived from leases of office space in their home to
lessee corporations which they happen to own.

   The issues presented are: 1) whether Treasury Regulation
§ 1.469-2(f)(6), as applied to “C” corporations,3 is arbitrary,
capricious, or contrary to Internal Revenue Code § 469
(“Section 469”); 2) whether Congress’s delegation of author-
ity to the Secretary of the Treasury to promulgate regulations
pursuant to Section 469 is unconstitutional; and 3) whether
the Commissioner must show that a taxpayer was motivated
to shelter income as a prerequisite to applying Treasury Regu-
lation § 1.469-2(f)(6).

   For the reasons set forth hereinafter, we AFFIRM the deci-
sion of the tax court.

                               I.   FACTS

  A review of the record reveals the following undisputed
material facts.

   Gary Beecher and Dolores Beecher are husband and wife.
Gary Beecher wholly owns Cal Interiors, Inc., a “C” corpora-
tion, that engages in the business of repairing automobile inte-
riors. Dolores Beecher wholly owns S&C Dent Corp., also a
“C” corporation, that engages in the business of removing
dents from automobiles.
  2
     “The United States Courts of Appeals . . . shall have exclusive jurisdic-
tion to review the decisions of the Tax Court. . . .” I.R.C. § 7482(a)(1).
   3
     Under Chapter 1, Subchapter C of the Internal Revenue Code, the
income of a “C” corporation is subject to corporate tax, and any distribu-
tions that the corporation makes to its shareholders is subject to a second,
individual tax. See I.R.C. § 301 et seq.
3468                 BEECHER v. COMMISSIONER OF IR
   Both Beechers work full time for these corporations, and
both corporations’ offices are located in the Beechers’ home.
The corporations pay the Beechers rent for the use of this
office space. In addition to renting this portion of their home,
the Beechers also own five rental properties.

   On their 1997, 1998, and 1999 federal income tax returns,
the Beechers reported net income from the leases of the office
of $39,307, $23,387, and $22,160, respectively. During these
same years, the five other rental properties yielded net losses,
such that the combined losses of the five properties exceeded
the income derived from the leases of the office. As a result
of this combination of income and losses, the Beechers paid
no tax on the rental income paid to them by their corporations.

   Although rental income is generally characterized as “pas-
sive,”4 the Commissioner determined that the income from the
leases of the office was non-passive income, pursuant to the
“self-rental” rule of Treasury Regulation § 1.469-2(f)(6).5 The
Commissioner reached this conclusion because the Beechers
materially participated in the business activities of the lessee
corporations, a fact which the Beechers do not contest. As
such, the Commissioner determined that the net income from
the leases of the office in their home could not be offset by
the losses from the five other rental properties. Because the
income from the office leases could not be offset, it was sub-
ject to taxation. Therefore, having concluded that the Bee-
chers had incurred a tax liability, the Commissioner issued a
notice of deficiency.
    4
      “The term ‘passive activity’ means any activity—(A) which involves
the conduct of any trade or business, and (B) in which the taxpayer does
not materially participate.” I.R.C. § 469(c)(1).
    5
      “An amount of the taxpayer’s gross rental activity income for the tax-
able year from an item of property equal to the net rental activity income
for the year from that item of property is treated as not from a passive
activity if the property . . . [i]s rented for use in a trade or business activity
. . . in which the taxpayer materially participates . . . for the taxable year.
. . .” Treas. Reg. § 1.469-2(f)(6).
                BEECHER v. COMMISSIONER OF IR              3469
   The Beechers thereafter filed a petition in the United States
Tax Court challenging this determination. The court rendered
judgment for the Commissioner, basing its decision on its
own precedent, as well as that of the Seventh, First, and Fifth
Circuits, citing Krukowski v. Commissioner, 279 F.3d 547
(7th Cir. 2002), Sidell v. Commissioner, 225 F.3d 103 (1st
Cir. 2000), and Fransen v. United States, 191 F.3d 599 (5th
Cir. 1999).

              II.   STANDARD OF REVIEW

   The Court of Appeals reviews de novo the Tax Court’s
conclusions of law, including its construction of the tax code.
Biehl v. Comm’r, 351 F.3d 982, 985 (9th Cir. 2003). As a gen-
eral rule, “the tax decisions of other circuits should be fol-
lowed unless they are demonstrably erroneous or there appear
cogent reasons for rejecting them.” Popov v. Comm’r, 246
F.3d 1190, 1195 (9th Cir. 2001) (internal quotation omitted).

   When reviewing regulations, where “there is an express
delegation of authority to the agency to elucidate a specific
provision of the statute by regulation . . . [s]uch legislative
regulations are given controlling weight unless they are arbi-
trary, capricious, or manifestly contrary to the statute.” Chev-
ron U.S.A. Inc. v. Natural Res. Def. Council, Inc., 467 U.S.
837, 843-44 (1984); see Dykstra v. Comm’r, 260 F.3d 1181,
1182 (9th Cir. 2001) (per curiam) (applying the Chevron stan-
dard in the context of tax regulations).

                     III.   DISCUSSION

  [1] Congress enacted Section 469 of the Internal Revenue
Code to prevent taxpayers from applying losses from rental
properties and other passive business activities to offset and
shelter non-passive income, such as wages. See S. Rep. No.
99-313, at 716-18 (1986), reprinted in 1986 U.S.C.C.A.N.
4075, 4235. Section 469 provides in part: “[F]or any taxable
year . . . , neither—(A) the passive activity loss, nor (B) the
3470            BEECHER v. COMMISSIONER OF IR
passive activity credit, for the taxable year shall be allowed.”
I.R.C. § 469(a)(1). As such, taxpayers are not permitted to
take advantage of a net loss from passive activity in a given
tax year, but rather must treat such losses as a deduction allo-
cable to passive activity in the next taxable year. I.R.C.
§§ 469(a)-(b).

   [2] Generally, “[t]he term ‘passive activity’ means any
activity — (A) which involves the conduct of any trade or
business, and (B) in which the taxpayer does not materially
participate.” I.R.C. § 469(c)(1). Moreover, the term “passive
activity” also “includes any rental activity . . . .” I.R.C.
§ 469(c)(2).

   When Congress enacted Section 469, it also authorized the
Secretary of the Treasury to promulgate regulations concern-
ing passive activity tax shelters, including regulations that
recharacterize otherwise passive activities as non-passive. See
I.R.C. § 469(l). Specifically, Section 469 provides that: “The
Secretary shall prescribe such regulations as may be necessary
or appropriate to carry out provisions of this section, includ-
ing regulations . . . (3) requiring net income or gain from a
limited partnership or other passive activity to be treated as
not from a passive activity . . . .” I.R.C. § 469(l).

  [3] Pursuant to this authority, the Secretary issued Treasury
Regulation § 1.469-2(f)(6). This regulation provides in rele-
vant part that:

    An amount of the taxpayer’s gross rental activity
    income for the taxable year from an item of property
    equal to the net rental activity income for the year
    from that item of property is treated as not from a
    passive activity if the property . . . [i]s rented for use
    in a trade or business activity . . . in which the tax-
    payer materially participates . . . for the taxable year
    ....
                BEECHER v. COMMISSIONER OF IR               3471
Treas. Reg. § 1.469-2(f)(6). This regulation is known as the
“self-rental” rule. Krukowski v. Comm’r, 279 F.3d 547, 551
(7th Cir. 2002). “In essence, the regulation provides that when
a taxpayer rents property to his own business, the income is
not passive activity income.” Fransen v. United States, 191
F.3d 599, 600 (5th Cir. 1999).

A.   Validity of the Self-Rental Rule

   The Beechers contend that the IRS exceeded its rule mak-
ing authority by issuing the self-rental rule. They argue that
the rule, “as applied to ‘C’ corporations [is] arbitrary, capri-
cious and contrary to statute and . . . thus invalid.” Without
specifically explaining why this is the case, the Beechers sim-
ply incorporate by reference the arguments asserted by tax-
payers in the decisions of those courts that previously have
addressed this issue. Specifically, they cite Krukowski v.
Commissioner, 279 F.3d 547 (7th Cir. 2002), Sidell v. Com-
missioner, 225 F.3d 103 (1st Cir. 2000), and Fransen v.
United States, 191 F.3d 599 (5th Cir. 1999), as well as the
lower court decisions in these cases. Notably, the Beechers
concede that in each of the cited cases, the Seventh, First, and
Fifth Circuits rejected the arguments of the petitioning tax-
payers.

   The taxpayers in those cases argued, as presumably do the
Beechers, that the self-rental rule’s recharacterization of cer-
tain rental income as non-passive is contrary to the tax code’s
general classification of rental activity as passive. While the
Beechers acknowledge that Section 469 empowers the Secre-
tary to promulgate regulations that recharacterize passive
activities as non-passive, they would have this court construe
this authority as being very limited. Specifically, they appear
to read Section 469 as authorizing the Secretary to recharac-
terize only two types of activities: 1) limited partnerships; and
2) activities not otherwise classified in Section 469.

   Their interpretation, however, has little support in the text
of the code. Section 469 directs the Secretary to issue regula-
3472                BEECHER v. COMMISSIONER OF IR
tions “necessary or appropriate to carry out provisions of this
section, including regulations . . . requiring net income or gain
from a limited partnership or other passive activity to be
treated as not from a passive activity . . . .” I.R.C. § 469(l)
(emphasis added). The plain text of Section 469 simply does
not bear out the taxpayers’ strained interpretation that “other
passive activity” refers to passive activity that, unlike rental
activity, is not otherwise classified in the code.

   [4] To the contrary, the Commissioner asks that we adopt
an interpretation that is consistent with the text of the code.
Namely, that the provision that provides for “regulations . . .
requiring net income or gain from a limited partnership or
other passive activity to be treated as not from a passive activ-
ity,” I.R.C. § 469(l), refers to regulations that treat income
from any passive activity, including a limited partnership, as
income from a non-passive activity. Because this case con-
cerns a statute in which “there is an express delegation of
authority to the agency to elucidate a specific provision of the
statute by regulation,” we must afford the Commissioner’s
interpretation “controlling weight unless . . . [it is] arbitrary,
capricious, or manifestly contrary to the statute.” Chevron
U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467
U.S. 837, 843-44 (1984). Applying this standard, we conclude
that the Commissioner’s construction of Section 469 is valid.
As such, the Secretary did not exceed his authority by pro-
mulgating the self-rental rule.

   Notably, this conclusion is supported by the legislative his-
tory of Section 469.6 The House of Representatives Confer-
ence Report reviewing the Secretary’s prospective authority
under Section 469 states:
  6
    As the Beechers’ interpretation of Section 469 is without support in the
text of the code, arguably there is no need to look further to the legislative
history. See United States v. Daas, 198 F.3d 1167, 1174 (9th Cir. 1999)
(“If the statute is ambiguous — and only then — courts may look to its
legislative history for evidence of congressional intent.”)
                    BEECHER v. COMMISSIONER OF IR                      3473
      The conferees intend that this authority be exercised
      to protect the underlying purpose of the passive loss
      provision, i.e., preventing the sheltering of positive
      income sources through the use of tax losses derived
      from passive business activities . . . . Examples of
      where the exercise of such authority may . . . be
      appropriate include the following . . . (2) related
      property leases or sub-leases, with respect to prop-
      erty used in a business activity, that have the effect
      of reducing active business income and creating pas-
      sive income . . . .

H.R. Rep. No. 99-841, at 147 (1986), reprinted in 1986
U.S.C.C.A.N. 4075, 4235. The example in the report appears
to squarely address the present case, and strongly suggests
that Congress intended the Secretary to issue regulations like
the one that the Beechers now contend is contrary to the tax
code.

   [5] By rejecting the Beechers’ argument that the self-rental
rule is contrary to Section 469, we join those circuits that
already have addressed this question, and uniformly upheld
the regulation. See Krukowski v. Comm’r, 279 F.3d 547, 552
(7th Cir. 2002); Sidell v. Comm’r, 225 F.3d 103, 107 (1st Cir.
2000); Fransen v. United States, 191 F.3d 599, 600-01 (5th
Cir. 1999). These courts have all held the self-rental rule is a
valid regulation in light of the plain text of Section 469, as
well as its legislative history. Krukowski, 279 F.3d at 552;
Sidell, 225 F.3d at 107-08; Fransen, 191 F.3d at 600-01.
Likewise, the First and Fifth Circuits have discounted the
notion that the self-rental rule is somehow inapplicable specif-
ically to “C” corporations. Sidell, 225 F.3d at 108; Fransen,
191 F.3d at 601.7
  7
    The Beechers repeatedly note that they were leasing their home office
space specifically to “C” corporations. There is no provision in Section
469 or the self-rental rule that would provide for distinct tax treatment for
“C” corporations in this context. Why the court should create such a dis-
tinction is not self-evident, and the Beechers, for their part, do nothing to
explain why such a distinction is warranted here.
3474             BEECHER v. COMMISSIONER OF IR
B.     Validity of Congress’s Grant of Authority to the
       Secretary

   The Beechers next argue that the provisions under which
the Secretary promulgated the self-rental rule are unconstitu-
tional. Specifically, they contend that Congress’s grant of reg-
ulatory authority to the I.R.S. is so “vague” and “uncertain”
as to be invalid. We disagree.

   [6] Although the Constitution vests exclusively with Con-
gress legislative or decisionmaking authority, Congress may
nevertheless confer “decisionmaking authority upon agen-
cies” so long as it establishes “by legislative [act] an intelligi-
ble principle to which the person or body authorized to act is
directed to conform.” Whitman v. Am. Trucking Ass’ns, 531
U.S. 457, 472 (2001) (internal quotation omitted, alteration in
the original). Here, in Section 469, Congress has directed the
Secretary to “prescribe such regulations as may be necessary
or appropriate to carry out [the] provisions” of Section 469,
including regulations that “specify what constitutes an activ-
ity, material participation, or active participation” and regula-
tions “requiring net income or gain from . . . other passive
activity to be treated as not from a passive activity . . . .”
I.R.C. § 469(l). Such direction is sufficient to avoid offending
the Constitution, and ample when compared to other statutory
schemes that courts have held to be lawful. See, e.g., Am.
Power & Light Co. v. SEC, 329 U.S. 90, 104 (1946) (uphold-
ing the statutory delegation of authority to the SEC to modify
the structure of holding company systems to ensure that they
are not “unduly or unnecessarily complicate[d]” and do not
“unfairly or inequitably distribute voting power among secur-
ity holders”); New York Cent. Sec. Corp. v. United States, 287
U.S. 12, 24-25 (1932) (upholding the statutory delegation of
authority to the ICC to approve railroad consolidations so
long as the mergers are in the “public interest”); United States
v. Dahl, 314 F.3d 976, 978 (9th Cir. 2002) (citing Whitman
v. Am. Trucking Ass’ns, 531 U.S. 457, 472-76 (2001), and
upholding the statutory delegation of authority to the U.S.
                BEECHER v. COMMISSIONER OF IR               3475
Forest Service to “charge and collect fees for . . . use of out-
door recreation sites”). As such, we reject the Beechers’ argu-
ment that Congress’s delegation of authority to issue the self-
rental rule under Section 469(l) is unconstitutional. In so hold-
ing, we join the Seventh Circuit, which has reached a similar
conclusion. See Krukowski v. Comm’r, 279 F.3d 547, 552 (7th
Cir. 2002).

C.   Validity of the Application of the Self-Rental Rule

   Finally, the Beechers contend that even if the self-rental
rule is valid, it should not apply to them. Specifically, they
argue that the rule is inapplicable because Section 469(l) “was
enacted specifically to combat ‘abusive’ tax shelters and does
not apply where motivation is for a bona fide business pur-
pose.”

   [7] The Commissioner concedes that Section 469 was
enacted to combat tax shelter abuse, but notes that Congress
did not expressly limit its scope “to transactions where a spe-
cific tax-avoidance motive was alleged and proved.” Further,
“[i]t simply would not be feasible for the Commissioner to
examine each taxpayer’s motive in entering into a related
party lease with an active business he controls.”

   [8] As the Tax Court noted below, there is “nothing in the
statute or the legislative history” that suggests that the tax-
payer must lack a bona fide business purpose in order to fall
within the scope of Section 469. The relevant statutory dis-
tinction under Section 469 is not between taxpayers who con-
trive to limit their tax liability and those who do not. See
I.R.C. § 469(c)(1). Rather, the distinction between passive
and non-passive activities is that in the case of passive activi-
ties, the “taxpayer does not materially participate” in the busi-
ness. Id. This question hinges on the extent to which the
taxpayer is involved in the affairs of both sides of a given
transaction, not the taxpayer’s motivation for structuring the
transaction in a particular manner. See id.
3476           BEECHER v. COMMISSIONER OF IR
   [9] Accordingly, the applicability of Treasury Regulation
§ 1.469-2(f)(6) is not limited to those instances in which a
specific tax-avoidance motive is alleged and proved by the
Commissioner.

  AFFIRMED.