T.C. Summary Opinion 2009-153
UNITED STATES TAX COURT
SEAN KIERAN HEGARTY AND KERRY ANN HEGARTY, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3730-07S. Filed October 6, 2009.
Sean Kieran Hegarty and Kerry Ann Hegarty, pro sese.
James L. May, Jr., for respondent.
CARLUZZO, Special Trial Judge: This case was heard pursuant
to the provisions of section 7463 of the Internal Revenue Code in
effect when the petition was filed.1 Pursuant to section
7463(b), the decision to be entered is not reviewable by any
1
Unless otherwise indicated, section references are to the
Internal Revenue Code of 1986, as amended, in effect for the year
in issue. Rule references are to the Tax Court Rules of Practice
and Procedure.
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other court, and this opinion shall not be treated as precedent
for any other case.
In a notice of deficiency dated November 21, 2006,
respondent determined a $23,366 deficiency in petitioners’ 2003
Federal income tax. The issue for decision is whether a trade or
business conducted through a limited liability company owned by
petitioners constituted a passive activity under section 469(c).
The resolution of the issue depends upon whether petitioners
“materially participated” in that trade or business during 2003.
Background
Some of the facts have been stipulated and are so found.
At the time the petition was filed, petitioners resided in
Florida. (References to petitioner are to Sean Kieran Hegarty).
During the year in issue, petitioner was employed full time
by Carteret Mortgage Corp. Kerry Ann Hegarty was employed as a
real estate salesperson.
On August 1, 2003, petitioners formed Blue Marlin, L.L.C.
(Blue Marlin), a Maryland limited liability company, each owning
a 50-percent interest. Blue Marlin was organized to conduct a
charter fishing activity (the business)2 using what petitioner
described as a “46-foot Post luxury cruiser” that petitioners
2
Respondent agrees that the charter fishing activity
constituted a trade or business within the meaning of sec. 162(a)
during the year in issue.
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purchased earlier that year.3 The amount of time petitioners
participated in the business was recorded in a written log
petitioner maintained, but that log was lost during petitioners’
move from the Washington, D.C. area to Florida. Using numerous
receipts for expenditures made in connection with the business,
petitioner reconstructed the amount of time petitioners
participated in the business during 2003. The evidence presented
demonstrates that petitioners’ participation in the business
exceeded 100 hours during 2003. Furthermore, we are satisfied
that with minor exceptions during that year petitioners were the
only individuals who participated in the business.
For Federal tax purposes Blue Marlin did not elect to be
treated as an entity separate from petitioners. See sec. 7701;
sec. 301.7701-3(b), Proced. & Admin. Regs. (commonly referred to
as the “check-the-box” regulations). The income and expenses
attributable to the business are reported on a Form 1065, U.S.
Return of Partnership Income. That return, which was not
examined by respondent, shows income of $9,583, expenses totaling
$74,161 (which includes depreciation of $26,173), and a net loss
of $64,578. The net loss from Blue Marlin is deducted on a
Schedule E, Supplemental Income and Loss, included with
petitioners’ timely filed joint 2003 Federal income tax return
3
Petitioners retrofitted the vessel with the necessary
equipment to convert it into a fishing boat fit for charter.
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and is taken into account in the $267,187 adjusted gross income
reported on that return.
In the notice of deficiency respondent disallowed the
deduction attributable to the loss from Blue Marlin. According
to respondent, as far as petitioners are concerned, during 2003
the business was a passive activity because they did not
materially participate in that business. Other adjustments made
in the notice of deficiency are computational and need not be
addressed.
Discussion
Respondent relies upon section 469 to support the
disallowance of the loss from Blue Marlin. That section
generally disallows for the taxable year any passive activity
loss. Sec. 469(a)(1). The term “passive activity loss” is
defined as the excess of the aggregate losses from all passive
activities for the taxable year over the aggregate income from
all passive activities for that year. Sec. 469(d)(1). A passive
activity is any activity which involves the conduct of any trade
or business and in which the taxpayer does not materially
participate. Sec. 469(c)(1). For this purpose, a “trade or
business” is generally defined as any activity in connection with
a trade or business or any activity for the production of income
under section 212. Sec. 469(c)(6).
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A taxpayer is treated as materially participating in an
activity only if the taxpayer is involved in the operations of
the activity on a basis which is regular, continuous, and
substantial. Sec. 469(h)(1). The participation of the
taxpayer’s spouse is taken into account in the determination of
the extent to which a taxpayer materially participates in an
activity. Sec. 469(h)(5).
The applicable regulations provide that if: (1) The
individual participates in the activity for more than 500 hours
during such year; or (2) the individual’s participation in the
activity for the taxable year constitutes substantially all of
the participation in such activity of all individuals (including
individuals who are not owners of interests in the activity) for
such year; or (3) the individual participates in the activity for
more than 100 hours during the taxable year, and such
individual’s participation in the activity for the taxable year
is not less than the participation in the activity of any other
individual (including individuals who are not owners of interests
in the activity) for such year; or (4) the activity is a
significant participation activity for the taxable year, and the
individual’s aggregate participation in all significant
participation activities during such year exceeds 500 hours; or
(5) the individual materially participated in the activity for
any 5 taxable years (whether or not consecutive) during the 10
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taxable years that immediately precede the taxable year; or (6)
the activity is a personal service activity, and the individual
materially participated in the activity for any 3 taxable years
(whether or not consecutive) preceding the taxable year; or (7)
based on all of the facts and circumstances, the individual
participates in the activity on a regular, continuous, and
substantial basis during such year, then the individual will be
treated as materially participating in an activity for purposes
of section 469. Sec. 1.469-5T(a)(1) through (7), Temporary
Income Tax Regs., 53 Fed. Reg. 5725 (Feb. 25, 1988).
According to respondent, because the business was conducted
through a limited liability company, petitioners are treated as
limited partners in considering whether they materially
participated in the business. That being so, and relying upon
section 469(h)(2) and section 1.469-5T(e)(1) and (2), Temporary
Income Tax Regs., 53 Fed. Reg. 5726 (Feb. 25, 1988),4 respondent
argues that they did not materially participate in the business
because they have not established that their participation in the
business during 2003 exceeded 500 hours.
4
Sec. 469(h)(2) states, “Except as provided in regulations,
no interest in a limited partnership as a limited partner shall
be treated as an interest with respect to which a taxpayer
materially participates.” As relevant here, sec. 1.469-5T(e)(1)
and (2), Temporary Income Tax Regs., 53 Fed. Reg. 5726 (Feb. 25,
1988), provides that as limited partner a taxpayer shall be
treated as having materially participated in an activity only if
the taxpayer participated in the activity for more than 500 hours
during the taxable year.
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We would be reluctant to find that they did, but for reasons
discussed in Garnett v. Commissioner, 132 T.C. __, __ (2009)
(slip op. at 22), such a finding is not necessary. In Garnett we
found the Commissioner’s reliance upon section 469(h)(2) to be
misplaced and held that the material participation of a taxpayer
who participated in a business conducted through a limited
liability company is determined with reference to any of the
seven tests listed in section 1.469-5T(a)(1) through (7),
Temporary Income Tax Regs., supra.
As noted, a taxpayer is treated as having materially
participated in the activity if the taxpayer participates in the
activity for more than 100 hours during the taxable year and the
taxpayer’s participation in the activity for the taxable year is
not less than the participation of any other individual. Sec.
1.469-5T(a)(3), Temporary Income Tax Regs., supra. We are
satisfied that petitioners participated in the business for more
than 100 hours during 2003. We are further satisfied that their
participation was not less than the participation of any other
individual during that year. See sec. 1.469-5T(a)(2), Temporary
Income Tax Regs., supra. It follows that petitioners materially
participated in the business during 2003, and the deduction
attributable to that business is not subject to limitation under
section 469.
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Respondent’s disallowance of the deduction of the loss
attributable to Blue Marlin is rejected.
To reflect the foregoing,
Decision will be entered
under Rule 155.