The Tax Court recently ruled that losses a husband and wife incurred from their interest in two Subchapter S corporations weren't suspended passive activity losses as defined under Section 469 because the husband materially participated in the business of the two S corporations.
In the facts of the case, Wade v. Commissioner, T.C. Memo 2014-169 (Aug. 20, 2014), a husband and wife each owned stock in two S corporations. During 2008, the two S corporations incurred losses. The husband and wife reported their share of the S corporations' losses as nonpassive deductions on their 2008 federal income tax return.
Under Section 469, certain taxpayers may not deduct passive activity losses. A passive activity involves the conduct of any trade or business in which the taxpayer doesn't materially participate. Treas. Reg. Sec. 1.469-5T provides seven tests a taxpayer may use to establish material participation.
Under one of the tests, a taxpayer materially participates in an activity if, based on all of the facts and circumstances, the taxpayer participates in the activity on a regular, continuous and substantial basis during the year (facts and circumstances test). In applying the limitation under Section 469, married taxpayers who file a joint federal income tax return are treated as a single taxpayer.
The Tax Court held that the husband materially participated in the two S corporations in 2008 under the facts and circumstances test. In assessing that test, the court noted that the husband spent more than 100 hours participating in certain activities of the S corporations, including researching and developing new technologies for use in the S corporations, making periodic visits and phone calls to facilities of the S corporations, securing financing for the S corporations, and meeting with employees of the S corporations.
Because the husband and wife filed a joint federal income tax return in 2008, the wife was deemed to materially participate in the two S corporations for purposes of Section 469. As such, the Tax Court determined that the losses the husband and wife incurred from their interest in the two S corporations were not passive activity losses as defined under Section 469.
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