United States: Tax Court Decision Offers Guidance On Investor Hours And Proving Participation

The Tax Court held that a taxpayer established material participation in his businesses in Lamas v. Commissioner,T.C. Memo 2015-59 (March 25, 2015), and the decision provides insight into how the court views substantiation of participation, the rule regarding investor hours and the validity of a grouping election. The case also serves as a cautionary tale regarding the tax exposure and costly litigation taxpayers can face when they don't document their participation in their business activities.

The taxpayer in Lamas sought to establish material participation to avoid passive characterization under Section 469. Generally, losses from passive activities can be deducted against income from passive activities, with the excess carried forward. The rules have become more important since Section 1411 was enacted. Section 1411 and the related regulations began imposing a 3.8% tax on net investment income (NII) in 2013, and NII generally includes any passive income under Section 469.

Under Section 469, a taxpayer must generally materially participate in an activity to avoid passive status. A taxpayer can use any of seven tests to establish material participation, and the IRS argued that Lamas did not meet any of them. The court ruled that Lamas met at least two, including the most common test: 500 hours of participation.

The court largely accepted phone records and witness testimony as substantiation for many of the hours Lamas claimed to have worked in the activity. The regulations provide that taxpayers can prove participation by "any reasonable means" and specifically state that contemporaneous logs aren't required. However, the Tax Court ruled in 1993 (Goshorn v. Commissioner, T.C. Memo. 1993-578) and many times since that a "ballpark guesstimate" made in hindsight is not acceptable documentation. These decisions created uncertainty over what kind of testimony and affidavits are sufficient documentation.

In Lamas, the court found the testimony of 10 witnesses backed by phone records to be credible enough to establish the taxpayer's participation. It also accepted the taxpayer's election to group his two activities together as one under Section 469, although there appeared to be little question they represented an appropriate economic unit.

The analysis of whether any of the hours of participation were disqualified as investor hours is more valuable. Treas. Reg. Sec. 1.469-5T(f)(2) excludes any work done in an "individual's capacity as an investor," and the IRS had argued that Lamas' hours didn't qualify under this rule. The Tax Court noted that under the regulation, investor hours can be counted toward material participation if the "individual is directly involved in the day-to-day management or operations of the activity." The court determined that Lamas' efforts to secure capital for development projects and promote the business were essential to the company and should be considered participation in the day-to-day management of the activity. Thus, all of his hours — even those that were arguably investor hours — counted toward the material participation threshold.

The Tax Court cited Tolin v. Commissioner (T.C. Memo 2014-65), in which the court ruled that promoting a stallion for stud by promoting the horse and soliciting interest in networking and industry events qualified as participation. The court said the IRS's characterization of the Tolin ruling was too narrow and that the case directly supports the idea that promotional activity can be considered part of day-to-day management and operation of a business.

Finally, it's important note why the IRS challenged the participation. While this was a clear and decisive victory for the taxpayer, the victory required litigation in the Tax Court. The IRS's decision to challenge appears to result from two factors. The taxpayer had kept no record of his efforts on behalf of the businesses. When Lamas couldn't produce appointment books, calendars or other documentation of his involvement with the entities, the IRS was likely skeptical. The second factor was the taxpayer's brother-in-law. A business dispute seems to have motivated the brother-in-law to write a letter to the IRS during audit that said that "Mr. Lamas had no direct or indirect involvement with" the entities. This letter appears to have caused the IRS to dismiss as self-serving the declarations from Mr. Lamas' business associates. If Lamas kept an electronic calendar of his business appointments (with notes regarding the purpose of the meetings) or similar records, the IRS might have been satisfied despite the declaration of a disgruntled business partner.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions