NOL Deductions Denied; Addition to Tax Imposed (Barker, TCM)

A music producer could not take a net operating loss deduction that flowed through to him from an LLC. He could not substantiate the LLC’s losses. The taxpayer did not produce tax returns for some of the tax years at issue. Moreover, those  he did produce did not contain the information needed to determine an NOL deduction.

The IRS argued that the LLC was not a trade or business because the taxpayer treated it as a hobby. And, that his primary purpose was not to make a profit. Therefore, the NOL was not deductible.

Denied net operating loss deductions

However, the taxpayer operated the LLC to make a profit. He had prior success in the music business. Also, he ran a successful defense contractor. Thus, he had significant business expertise.

Futher, the taxpayer ran the LLC in a businesslike manner. He worked there full time and invested significant capital to make it profitable. All this weighed in favor of a profit motive.

Moreover, the facts weighing in favor of a hobby:

  • the taxpayer enjoyed the creative aspects of the music industry,
  • had income from other sources, and
  • the LLC had yet to make a profit

were outweighed by the facts indicating a profit motive.

But, the taxpayer failed to show the LLC’s income and business expenses for all the years of its existence. Thus, he could not substantiate the LLC’s losses or, in turn, his claimed passthrough loss deduction.

Further, the taxpayer had access to more documentation, such as the LLC’s general ledger, but he failed to produce it. Thus, the court presumed the information would have been unfavorable to the taxpayer.

Late-filing penalty imposed

The taxpayer was liable for a late filing penalty because he filed his tax return almost two years late. His argument that he did not timely file his return because he was an identity theft victim was not a valid excuse. He had a personal nondelegable duty to file his return on time. Further, he was a sophisticated businessman and knew that he had to file his return on time. Moreover, he failed to ask his accountant or return preparer about the issue.

C. Barker, TC Memo. 2018-67, Dec. 61,177(M)

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All stories by: CCHTaxGroup