Author: Leon Clinton

When you own more than one business, you need to consider the grouping rules that apply for passive-loss purposes.

Should one of your businesses lose money, you may not deduct the losses from that business during the current tax year unless you

1. materially participate in the business or, if grouped, materially participate in the group; or
2. do not materially participate but have passive income from other sources against which to deduct your passive business losses.

Example. Sam Warren, MD, operates a medical practice and starts a new physical therapy business (his second business) in which he will not materially participate. The physical therapy business is going to lose money during its first years of operation. If Dr. Warren wants to deduct the losses from his physical therapy business, he has one choice: group that business with his medical practice.

Dr. Warren knows that he will have tax losses in his physical therapy business during its start-up years. Because he will not materially participate in the physical therapy business, the tax code deems his losses passive. He may deduct his passive losses

• against his passive income from other sources (excess passive losses are carried forward); and
• in total, when he sells or otherwise disposes of his entire interest in the passive activity.

This is ugly.

First, Dr. Warren has no other passive income. The medical practice, his only other business or activity, is an active business that produces active income.

Second, he does not plan on selling the physical therapy business anytime soon, so he would not realize any benefit from the accumulation of his carried-forward passive losses.

His solution: the group.

If Dr. Warren’s physical therapy business loses $175,000 as he projects, he can write off that $175,000 because the grouping makes him a material participant.

Without the grouping, he does not materially participate in the physical therapy business. Without material participation, his $175,000 loss is a passive-loss deductible against only passive income, of which he has none.

The medical practice income is active income, not passive income.

When he makes the grouping election, the law combines the two businesses for material participation purposes. Let’s say he works 2,000 hours a year in his medical practice. With grouping, he now works 2,000 hours a year in the combined activity, and that makes the loss from the physical therapy business deductible.

If you have multiple activities and want to discuss grouping, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• April 21, 2022

• By Leon Clinton
• April 16, 2022

Don’t let this happen to you.

Here’s what happened to Mr. Kazmi. First, a little background.

Urgent Care Center Inc., an Illinois corporation, employed Mr. Kazmi as a part-time hourly bookkeeper.

He had no ownership interest in Urgent Care.
He was not an officer of Urgent Care.
His name was not on any of Urgent Care’s bank accounts.
He did not have check-signing authority for Urgent Care or any power to make payments on behalf of Urgent Care.

At all times, Mr. Kazmi worked under the authority and direction of Dr. Senno, the sole owner of Urgent Care, an S corporation.

Problem

Urgent Care did not pay its payroll taxes. The IRS claimed that Mr. Kazmi was a responsible person—meaning that he was now on the hook for the unpaid taxes and the 100 percent trust fund penalty. Mr. Kazmi’s amount at risk: $10,375.

He took his case to court, where we pick up his story.

IRS Interview

In this case, the record before the court included IRS Form 4180, “Report of Interview with Individual Relative to Trust Fund Recovery Penalty or Personal Liability for Excise Taxes.”

During that interview with the IRS revenue officer, Mr. Kazmi described his job title as “bookkeeper” and his duties as “to take care of payroll.” On the form, he indicated the following:

He did not determine financial policy for Urgent Care.
He did not authorize payments of bills or to creditors.
He did not authorize payroll.

During the interview, he indicated that he was authorized to transmit payroll tax returns and make federal tax deposits. He was also aware that Urgent Care did not remit the employees’ withheld taxes.

So here we have the part-time, hourly paid bookkeeper who could not sign a check or authorize payments with $10,375 of payroll tax trouble—attributable entirely to Dr. Senno.

Missed Opportunity

The IRS sent by certified mail IRS Letter 1153 to Mr. Kazmi. He signed the postal service form signifying he had received the letter.

Letter 1153 set forth that the IRS considered Mr. Kazmi a person responsible for the unpaid payroll tax and subject to the 100 percent trust fund penalty—the $10,375. Mr. Kazmi had 60 days to challenge by submitting a written appeal. He did not.

Result

The court ruled that Mr. Kazmi had to pay $10,375 (Mohammad A. Kazmi v Commr., T.C. Memo. 2022-13).

But you can see in this opinion that the court does not rule that Mr. Kazmi was a responsible person. Instead, the court ruled that the IRS did its job correctly and that Mr. Kazmi owes the money because he failed to respond to Letter 1153.

Key point. Had Mr. Kazmi responded to Letter 1153, the IRS likely would not have considered him a responsible person based on his facts and circumstances.

Takeaways

Do not work for or deal with taxpayers who do not remit the payroll taxes to the government. What happened to Mr. Kazmi could happen to you.

By all accounts, you know that Mr. Kazmi is a victim of Dr. Senno’s failure to pay the payroll taxes. He’s pretty much an innocent bystander—but despite his innocence, he is now out of pocket $10,375.

Think about this: How many part-time bookkeeping hours will it take for Mr. Kazmi to pay $10,375 to the IRS? And keep in mind that the $10,375 is not tax-deductible.

One final thought: Don’t ignore IRS notices.

If you have a payroll tax issue and would like to discuss it, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• April 12, 2022