Income Tax Situation

Topics: Taxation in the United States, Income, Itemized deduction Pages: 12 (2297 words) Published: February 19, 2014

Memo to File

Date: February 09, 2012

Re: Reducing Dr. Kevorkian’s tax liability from passive investments before year’s end.

Facts:In 2010 Dr. Kevorkian had the following transactions: He has active income, from medical practice of $150,000 (active income). He expects to receive $10,000 in interest and dividends (portfolio income). He invests $100,000 in Limited, a limited partnership (passive income). Limited lost money and Dr. Kevorkian’s share of the loss is $15,000.

In 2011 Dr. Kevorkian has the following:
He has been informed that his share of Limited’s losses will be $10,000. In January of 2011 he opens his own laboratory which will generate $30,000 of income, and he spends 320 hours managing the lab.

Issues:

1. How to reduce Dr. Kevorkian’s tax liability?
2. Should Dr. Kevorkian invest more time in the laboratory, making that an active income activity?

Analysis:

§ 465 Deductions limited to amount at risk.
Dr. Kevorkian invested $100,000 in Limited, a passive activity; in 2010 but he is not a material participant; should he invest more time in the laboratory that he set up for himself it would change the definition from passive income to active income. Therefore, his at-risk amount of $100,000 invested in Limited could not be reduced if he chooses to invest more time in his laboratory. Based on the participation level now both activities are labeled to be passive if he should invest more time he could change that definition. The lab is generating income of $30,000, if he should invest more time in the laboratory, then he could not take advantage of his losses from Limited $15,000 in 2010 and $10,000 in 2011. His at-risk amount was $100,000, now it could be down to $100,000 - $15,000 (Limited’s loss in 2010) = $85,000; $85,000 - $10,000 (Limited’s loss in 2011) = $75,000. He should report a passive activity credit of $5,000 ($75,000 + $30,000 = $105,000 - $100,000 = $5,000) §469 Passive activity losses and credits limited.

Code section 469(c) Passive activity defined.
For purposes of this section — in general.
The term “passive activity” means any activity—which involves the conduct of any trade or business, and in which the taxpayer does not materially participate.
§469(d)(1)-(2)(B) Passive activity loss and credit defined. For purposes of this section — Passive activity loss.
The term “passive activity loss” means the amount (if any) by which— the aggregate losses from all passive activities for the taxable year, exceed the aggregate income from all passive activities for such year.— Passive activity credit. The term “passive activity credit” means the amount (if any) by which— the sum of the credits from all passive activities allowable for the taxable year; t he regular tax liability of the taxpayer for the taxable year allocable to all passive activities.

Problem 1

§469(h) Material participation defined.
For purposes of this section — In general.
A taxpayer shall be 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. §469(j)(9): Election to increase basis of property by amount of disallowed credit. Passive credits are not deductible on disposition.  An election may be made to increase the basis of the disposed property.

Reg §1.469-4(b)(1) Definition of activity. b) Definitions. The following definitions apply for purposes of this section— Trade or business activities. Trade or business activities are activities, other than rental activities or activities that are treated under §1.469-1T(e)(3)(vi)(B) as incidental to an activity of holding property for investment, that— Involve the conduct of a trade or business (within the meaning of section 162); Are conducted in anticipation of the commencement of a trade or business; or involve research or experimental expenditures that are deductible under section 174 (or would be...
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