THE GOOD. Minority interest in surgery center: The court allowed the taxpayer to report income earned through his minority interest in a surgery center as passive income not subject to the self-employment tax.
Acting on his CPA‘s advice, the surgeon reported his income from the surgery center as passive income. This allowed the doctor to offset his surgery center income with unrelated passive losses he had from prior years. The IRS disagreed with this treatment.
The court ruled that the surgeon was an investor in the surgery center since he took no part in the surgery center’s business operations. Because the distributions he received were based on his ownership percentage, the court found that he was not subject to self-employment tax on his income from surgery center and that it could be offset by his unrelated passive losses.
THE BAD. Member compensation All three attorneys in a Mississippi law firm were member-managers of a professional LLC through which they practiced law. The compensation agreement required that each attorney receive guaranteed payments based on legal salaries in the area. Any payouts that exceeded these amounts were treated as a return on capital. The attorneys reported their guaranteed payments as self-employment income however, they did not include the excess payments as self-employment income. The IRS disagreed.
The attorneys argued that the return of capital payments was excluded from self-employment taxes. The court’s decision focused on whether the attorneys were the equivalent to a limited partner.
The entity was member-managed. All three members testified that there was no general partner and that management participation was split equally among the members. As a result, the court sided with the IRS in determining that the members were not limited partners and disallowed any exclusion from self-employment tax.
THE UGLY. Rental property: The Tax Court denied an individual taxpayer numerous unsubstantiated business deductions on her individual income tax return. In this case, the taxpayer, who had a tax preparation business, was denied expenses for property that she rented to her cousin at less than FMV. Although she claimed that she reduced the rent because the property had been damaged, she provided no evidence of this and did not prove that she did not live there. The only expense the court permitted for the house was the property taxes that the taxpayer supported with documentation.