Chris Moss CPA Tax Attorney
Welcome to TaxView with Chris Moss CPA Tax Attorney
Have you thought about locking in your record high 2016 stock market capital gains and perhaps offsetting against other current or prior year business investment losses in 2016? Sounds like a good strategy but be careful. If you have investment gains offsetting business losses in 2016, as you may be in store for a direct head on collision with the IRS and the Tax Reform Act of 1986 during an IRS Passive Loss Audit commencing a few years after you file your 2016 tax returns. The journey to disaster starts off innocently enough. You sold some stocks in June 2016 to lock in gains for a $10M long term capital gain and use the proceeds to purchase a small retail shopping center for the same price in July of 2016. You think about structuring the deal so that the losses from the first year of operations in 2016 at the shopping center could offset your 2016 capital gains from the sale of stocks. You never bothered to retain a tax attorney to create a tax plan because as you see it you have a no brainer zero tax due. You believe that a buy and sell for $10 Million equals a full and complete offset come April 15 2017; but perhaps not so fast says TaxView, because the offset is in great danger. There are land mines ahead that seem to explode at the worse possible moment with an IRS Passive Loss Audit usually years later perhaps commencing in 2020.. So if you are interested in how the IRS could dramatically change even your best tax plan for offsetting gains and losses, stay with us on TaxView with Chris Moss CPA Tax Attorney to see how the Tax Reform Act of 1986 makes your no brainer into a brain strainer and a tax disaster for you the unfortunate taxpayer victim of the creation of Section 469 and the dreaded IRS Passive Loss Audit.
.
To get a better idea of the catastrophe ahead, first let’s all take a short trip back to the source of confusion to Washington DC. Fasten up your tax plan as we turn back the clock to 1984 landing us right in the middle of the center table at the DC downtown Palm over at 1225 19th Street. Dan Rostenkowski (House Ways Means) and Bob Packwood (Senate Finance) have gotten together to finalize some last minute provisions of the soon to be signed by President Ronald Reagan Tax Reform Act of 1986. Legendary DC Palm manager, who is still there today, Tommy Jacomo spots us immediately with a great table. We hear Rosti roar over the boisterous dinner crowd to Bob: You personally have quite a large portfolio in stocks and bonds. Would you really consider interest and dividends “positive” income? Rosti, says Packwood, you know I don’t like that word “positive” taken in this context. Besides, we can’t really tell the average American taxpayer that the wealthy making dividends and interest are working as hard as they are with “positive income”. Let’s just go with this term “Portfolio”. It bridges the gap between those darn “passive” tax shelters and the American W2 worker. I say we treat these items like positive income similar to a salary except it would not be subject to self-employment tax like salary, but call it “portfolio” not ordinary income. In other words we tell America that their stocks and bonds are…well like working 40 hours a week for them as their “portfolio” not subject to social security withholding. Bob, says in disbelief, Rosti, you have got to be kidding, that is really dumb, really stupid… but you know, comparing portfolio to W2 earnings except without social security withholding, is so ridiculously outrageous it might just work. See Joint Committee on Taxation, page 209-213 which eventually morphed into IRS Code Section 469 Passive Loss Rules.
Agree or disagree with how this imaginary conversation might have unfolded that night in 1984, the fact is that Section 469 prohibits the offset of “portfolio” gains or losses and regular W2 income against “passive” but not "active"gains all losses.. In order to see the bizarre consequences of how these two opposing types of gains and losses can interact, let’s head over to US Tax Court just a five minute cab ride from the Palm over to Capitol Hill to survey a 2000 case More v IRS 115 T.C. No 9 More was an independent managing underwriter as part of a syndicate for Lloyds of London. In order to be accepted by Lloyds More had to demonstrate his ability to cover potential losses of his syndicate usually by posted a letter of credit. In 1988, More transferred his personal stock portfolio to a brokerage account at Bank Julius Baer (BJB), a London-based bank. During 1992 and 1993, petitioner underwrote £500,000 of Lloyd’s premiums which were secured by a letter of credit from BJB in the amount of £150,000. The policies written by More did in fact incur losses and More cashed in his stocks at a large gain to cover those losses as required by his letter of credit. More reported his losses and gains on his tax returns so that each offset the other. The IRS audited Moore, and disallowed all the losses, arguing “portfolio” income could not be offset against “passive” income. Moore appealed to US Tax Court.
Judge Vasquez in More writes a very short 16 page jam-packed with Section 469 Opinion. The Court then confirmed that Congress enacted passive loss regulations “to curb expansion of tax sheltering”. Judge Vasquez further noted that IRS regulation 469-2T makes an exception to the general rules regarding disposition of More’s stocks at a gain. Specifically, gross income derived in the ordinary course of a trade or business includes “income from investments made in the ordinary course of a trade or business of furnishing insurance or annuity contracts or re-insuring risks underwritten by insurance companies” The Court notices that More’s attorney, Louis B. Jack, did not refute or address this at all and was silent on the reason why More acquired the stock. If More could have shown that he primarily created this portfolio as a way to get into the insurance business and not as an investment More wins IRS loses. Unfortunately for More, no evidence was presented to the Court on when his investments in stocks turned primarily to assist More in keeping his job at Lloyds. I don’t know about you all, but it seemed More’s transfer to a brokerage account back in 1988 was primarily to show sufficient assets so he could work at Lloyds. Nevertheless, since More did not refute the Government’s argument leaving the Court no choice but to hold that More’s stocks were primarily created for investment and not for the convenience of Lloyds. Government wins, More loses.
So to win with any of your offset losses in 2016 make those losses bullet proof from the IRS Passive Loss audit and go with a fact pattern to prove that your losses were active ordinary or portfolio, just like Jose and Maria Lamas did in US Tax Court Lamas vs IRS March 25, 2015. The facts are simple: Mr and Mrs Lamas incurred substantial losses from Shoma Development Corp and Greens at Doral LLC in 2008. Lamas carried back their losses to 2006 resulting in a refund to Lamas of over $5 Million. Unfortunately, years later IRS audited and disallowed the losses claiming the losses were passive and could not offset 2006 income. with the Government sending Lamas a $5 Million tax bill. Lamas fought back and filed a US Tax Court petition in US Tax Court Lamas vs IRS March 25, 2016 arguing that the losses were not passive and indeed could offset ordinary and portfolio income..
During the US Tax court trial, Lamas called 10 witnesses arguing credibly that Lamas was very much involved in Shoma and Greens.. Judge Buch in a well thought out opinion opines that to establish the hours spent on the business you don't necessarily have to have contemporaneously daily records, but you can use other reasonable means to establish the facts that support that you are actively involved in the business. The Court goes on to say that "reasonable means includes the identification of the services performed over a period of time and the approximate number of hours spent performing such services during the period based on books, calendars or narrative summaries." While Lamas had none of these records the Court goes on to show that witnesses presented credible testimony and phone records to show that Lamas worked the required hours on Shoma and Green to materially participate to make the activity active not passive.. Lamas wins IRS Loses.
So in conclusion anyone out there in 2016 who wants to offset losses from one activity against gains of another be warned, the IRS in 2016 is actively and aggressively auditing these kinds of offsets, particularly any losses that offset W2 income or Investment Portfolio Income, or any gains that offset passive losses. The fix is easy:. Prior to filing your tax return with any offsets from different sources of gains and losses, ask your tax attorney the ramifications of Section 469, with particularly emphasis on what kind of offsets you have. If you have “portfolio” and “passive” losses or gains pay particular attention to whether or not the Section 469 allows those offsets. Finally have your tax attorney insert into your tax return detailed preferably contemporaneously prepared evidence of your tax strategy in 2016, or perhaps notarized witness affidavits if you don't have the required records,. explaining how these offsets were created, what provision of Section 469 controls, and how your tax strategy is being implemented for 2016 and beyond. For example if your tax strategy involves long range estate planning, make sure you tax attorney discloses this in the tax return before she files on April 15, 2017. Better you should support and bullet proof your tax strategy now before you file the tax return than to have to wait four years for the Government to do it for you during a surprise IRS Passive Loss audit.
.
May your 2016 losses and gains offset wisely as 2016 comes to a close.. See you all next year on TaxView in 2017.
Thanks for joining Chris Moss CPA Tax Attorney on TaxView
Kindest regards,
Chris Moss CPA Tax Attorney
Have you thought about locking in your record high 2016 stock market capital gains and perhaps offsetting against other current or prior year business investment losses in 2016? Sounds like a good strategy but be careful. If you have investment gains offsetting business losses in 2016, as you may be in store for a direct head on collision with the IRS and the Tax Reform Act of 1986 during an IRS Passive Loss Audit commencing a few years after you file your 2016 tax returns. The journey to disaster starts off innocently enough. You sold some stocks in June 2016 to lock in gains for a $10M long term capital gain and use the proceeds to purchase a small retail shopping center for the same price in July of 2016. You think about structuring the deal so that the losses from the first year of operations in 2016 at the shopping center could offset your 2016 capital gains from the sale of stocks. You never bothered to retain a tax attorney to create a tax plan because as you see it you have a no brainer zero tax due. You believe that a buy and sell for $10 Million equals a full and complete offset come April 15 2017; but perhaps not so fast says TaxView, because the offset is in great danger. There are land mines ahead that seem to explode at the worse possible moment with an IRS Passive Loss Audit usually years later perhaps commencing in 2020.. So if you are interested in how the IRS could dramatically change even your best tax plan for offsetting gains and losses, stay with us on TaxView with Chris Moss CPA Tax Attorney to see how the Tax Reform Act of 1986 makes your no brainer into a brain strainer and a tax disaster for you the unfortunate taxpayer victim of the creation of Section 469 and the dreaded IRS Passive Loss Audit.
.
To get a better idea of the catastrophe ahead, first let’s all take a short trip back to the source of confusion to Washington DC. Fasten up your tax plan as we turn back the clock to 1984 landing us right in the middle of the center table at the DC downtown Palm over at 1225 19th Street. Dan Rostenkowski (House Ways Means) and Bob Packwood (Senate Finance) have gotten together to finalize some last minute provisions of the soon to be signed by President Ronald Reagan Tax Reform Act of 1986. Legendary DC Palm manager, who is still there today, Tommy Jacomo spots us immediately with a great table. We hear Rosti roar over the boisterous dinner crowd to Bob: You personally have quite a large portfolio in stocks and bonds. Would you really consider interest and dividends “positive” income? Rosti, says Packwood, you know I don’t like that word “positive” taken in this context. Besides, we can’t really tell the average American taxpayer that the wealthy making dividends and interest are working as hard as they are with “positive income”. Let’s just go with this term “Portfolio”. It bridges the gap between those darn “passive” tax shelters and the American W2 worker. I say we treat these items like positive income similar to a salary except it would not be subject to self-employment tax like salary, but call it “portfolio” not ordinary income. In other words we tell America that their stocks and bonds are…well like working 40 hours a week for them as their “portfolio” not subject to social security withholding. Bob, says in disbelief, Rosti, you have got to be kidding, that is really dumb, really stupid… but you know, comparing portfolio to W2 earnings except without social security withholding, is so ridiculously outrageous it might just work. See Joint Committee on Taxation, page 209-213 which eventually morphed into IRS Code Section 469 Passive Loss Rules.
Agree or disagree with how this imaginary conversation might have unfolded that night in 1984, the fact is that Section 469 prohibits the offset of “portfolio” gains or losses and regular W2 income against “passive” but not "active"gains all losses.. In order to see the bizarre consequences of how these two opposing types of gains and losses can interact, let’s head over to US Tax Court just a five minute cab ride from the Palm over to Capitol Hill to survey a 2000 case More v IRS 115 T.C. No 9 More was an independent managing underwriter as part of a syndicate for Lloyds of London. In order to be accepted by Lloyds More had to demonstrate his ability to cover potential losses of his syndicate usually by posted a letter of credit. In 1988, More transferred his personal stock portfolio to a brokerage account at Bank Julius Baer (BJB), a London-based bank. During 1992 and 1993, petitioner underwrote £500,000 of Lloyd’s premiums which were secured by a letter of credit from BJB in the amount of £150,000. The policies written by More did in fact incur losses and More cashed in his stocks at a large gain to cover those losses as required by his letter of credit. More reported his losses and gains on his tax returns so that each offset the other. The IRS audited Moore, and disallowed all the losses, arguing “portfolio” income could not be offset against “passive” income. Moore appealed to US Tax Court.
Judge Vasquez in More writes a very short 16 page jam-packed with Section 469 Opinion. The Court then confirmed that Congress enacted passive loss regulations “to curb expansion of tax sheltering”. Judge Vasquez further noted that IRS regulation 469-2T makes an exception to the general rules regarding disposition of More’s stocks at a gain. Specifically, gross income derived in the ordinary course of a trade or business includes “income from investments made in the ordinary course of a trade or business of furnishing insurance or annuity contracts or re-insuring risks underwritten by insurance companies” The Court notices that More’s attorney, Louis B. Jack, did not refute or address this at all and was silent on the reason why More acquired the stock. If More could have shown that he primarily created this portfolio as a way to get into the insurance business and not as an investment More wins IRS loses. Unfortunately for More, no evidence was presented to the Court on when his investments in stocks turned primarily to assist More in keeping his job at Lloyds. I don’t know about you all, but it seemed More’s transfer to a brokerage account back in 1988 was primarily to show sufficient assets so he could work at Lloyds. Nevertheless, since More did not refute the Government’s argument leaving the Court no choice but to hold that More’s stocks were primarily created for investment and not for the convenience of Lloyds. Government wins, More loses.
So to win with any of your offset losses in 2016 make those losses bullet proof from the IRS Passive Loss audit and go with a fact pattern to prove that your losses were active ordinary or portfolio, just like Jose and Maria Lamas did in US Tax Court Lamas vs IRS March 25, 2015. The facts are simple: Mr and Mrs Lamas incurred substantial losses from Shoma Development Corp and Greens at Doral LLC in 2008. Lamas carried back their losses to 2006 resulting in a refund to Lamas of over $5 Million. Unfortunately, years later IRS audited and disallowed the losses claiming the losses were passive and could not offset 2006 income. with the Government sending Lamas a $5 Million tax bill. Lamas fought back and filed a US Tax Court petition in US Tax Court Lamas vs IRS March 25, 2016 arguing that the losses were not passive and indeed could offset ordinary and portfolio income..
During the US Tax court trial, Lamas called 10 witnesses arguing credibly that Lamas was very much involved in Shoma and Greens.. Judge Buch in a well thought out opinion opines that to establish the hours spent on the business you don't necessarily have to have contemporaneously daily records, but you can use other reasonable means to establish the facts that support that you are actively involved in the business. The Court goes on to say that "reasonable means includes the identification of the services performed over a period of time and the approximate number of hours spent performing such services during the period based on books, calendars or narrative summaries." While Lamas had none of these records the Court goes on to show that witnesses presented credible testimony and phone records to show that Lamas worked the required hours on Shoma and Green to materially participate to make the activity active not passive.. Lamas wins IRS Loses.
So in conclusion anyone out there in 2016 who wants to offset losses from one activity against gains of another be warned, the IRS in 2016 is actively and aggressively auditing these kinds of offsets, particularly any losses that offset W2 income or Investment Portfolio Income, or any gains that offset passive losses. The fix is easy:. Prior to filing your tax return with any offsets from different sources of gains and losses, ask your tax attorney the ramifications of Section 469, with particularly emphasis on what kind of offsets you have. If you have “portfolio” and “passive” losses or gains pay particular attention to whether or not the Section 469 allows those offsets. Finally have your tax attorney insert into your tax return detailed preferably contemporaneously prepared evidence of your tax strategy in 2016, or perhaps notarized witness affidavits if you don't have the required records,. explaining how these offsets were created, what provision of Section 469 controls, and how your tax strategy is being implemented for 2016 and beyond. For example if your tax strategy involves long range estate planning, make sure you tax attorney discloses this in the tax return before she files on April 15, 2017. Better you should support and bullet proof your tax strategy now before you file the tax return than to have to wait four years for the Government to do it for you during a surprise IRS Passive Loss audit.
.
May your 2016 losses and gains offset wisely as 2016 comes to a close.. See you all next year on TaxView in 2017.
Thanks for joining Chris Moss CPA Tax Attorney on TaxView
Kindest regards,
Chris Moss CPA Tax Attorney
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