Thursday, October 25, 2007


The November 2007 issue of TAX HOTLINE just arrived. It reports on two Tax Court cases of interest – one disturbing and one helpful.

* The disturbing one (William Edward Colombell et ux, TC Summary Opinion 2006-184) concerns the definition of an “active participant” in an employer pension plan. The deductibility of a contribution to a traditional IRA is phased-out based on AGI if you are an active participant in a qualified employer-sponsored retirement plan.

In this case the wife was a part-time ER nurse. Her employer had a plan that provided benefits to employees who worked more than 1000 hours per year. For the year in question, the wife worked only 511 hours, and was therefore ineligible for any benefits. She made and deducted a contribution to a traditional IRA. Her W-2 for the year included an “x” in the box that indicated active participation in an employer plan, and the IRS disallowed the IRA deduction based on the joint return AGI.

In her defense the taxpayer claimed that she was not a “participant”, let alone active, in the plan as the word was defined in the dictionary. She said she could not be an active participant in a plan in which she did not participate.

The court ruled for the IRS, stating that, “Even if she never met the dictionary’s definition of what it would mean to be an ‘active participant’, the regulations make it clear that she was an active participant.” The regulations to which the court referred state that a person is an “active participant” in an employer plan “simply by not being excluded from the plan.” It is implied that nothing excluded her from the plan, as she would have received benefits if she had worked more than 1000 hours.

If you ask me, the fact that she did not work more than 1000 hours specifically excluded her from the plan. For my money this ruling clearly does not reflect the intent of the law. I do believe that Congress intended to encourage taxpayers who could not receive pension coverage from an employer plan to save for retirement by allowing a tax deduction for the contribution.

Of course nothing prohibited Mrs. Colombell from contributing to an IRA. She was just not allowed a tax deduction.

* The second one (Michael J Rozzano Jr, TC Memo 2007-177) concerns the issue of business vs hobby.

The taxpayers, who loved horses, purchased a farm and used it to run a horse-boarding business. The business showed a loss, ranging from $36,000 to $94,000, for eight straight years. The IRS disallowed the losses claiming that there was no “profit motive”.

The court ruled for the taxpayers. It noted that they boarded horses at the going commercial rates, hired employees to take care of the horses, kept complete business records, and had a credible business plan, and the husband, who had a full-time W-2 job, worked on the farm himself on a regular basis (every week-end) – all indications of a profit motive. The business passed the “duck test” – if it quacks like a business and waddles like a business then it must be a business.

This decision upheld the fact that you can have consistent net losses and still be considered a legitimate business for tax purposes as long as you dot all the i’s and cross all the t’s.


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