Passive Invest / Proving Material Participation ??

[bbrownatl]

I’m in the process of preparing the back tax returns for a client – Yrs. 04, 05, 06, and 07. The client is also a partner in an LLC (Note: Non real estate, rather a security company). Assuming passive status, the taxpayer is in a refund position of 04 & 05 and owes significantly for 06 & 07. The LLC has thrown off significant losses from 03 onward. Client contends that he had material participation in the LLC, worked more than 500 hours yearly, and thus contends as having non passive status. Now, I have some doubt as to this contention given that he has a regular 8-5 job. Furthermore, I’ve reviewed (IRC section 469(h) and Treas. Reg. section 1.469-5T(a)) and really question the ability to support his material participation claim. By the way, he did NOT receive any compensation for the services to the LLC nor was he part of the day-to-day management. Seems like his involvement was more along the lines of being an investor (i.e. reviewing financials, providing some network contacts, etc.). I surely don’t characterize it as being “regular, continuous, and substantial”.

My question is this - When do you draw the line and say NO, your claim in not supportable? I don’t feel comfortable signing a return while have substantial doubt (yet no proof) as to this claim. I sure would not want to be in front of an auditor trying to support this claim. Yes, it is his tax return and his burden of proof. Yet, I have professional responsibility as well to submit an accurate tax return.

By the way, seems that he is out of luck on 04 & 05 with regard to his refunds due to three year statue expiration. Basically, just gave $13K to Uncle Sam!

Again any insight appreciated.

Thanks,
Brian

[solomon]

Give him a copy of Exhibit 4.4 Activity Log for material participation in the ATG for PAL to complete - his countenance and confidence might change.

[bbrownatl]

Good point! Just sent to taxpayer with a note.

Much thanks,
Brian

[AuditorTurnedGood]

From the perspective of a tax professional, I always end up back in Circular 230 looking for guidance on my responsibilies in these situations. Unless your position is based on substantial authority (which, granted, is about the worst defined level of confidence ever devised) you could be in hot water for taking the position he is a material participant and not disclosing on the return.

In my experience, you're right. If the taxpayer has an 40-45 hour a week job, it's going to be pretty tough to justify that he is spending another 10 hours a week, 52 weeks a year, on an entity in which he has no management responsibilites and recieves no compensation.

[luke]

solomon

what is ATG? ("something Tax Guide"?)

[bbrownatl]

See the link below for the Passive Activity Loss Audit Technique Guide (ATG)

http://www.irs.gov/businesses/small/article/0,,id=146318,00.html

Was new to me as well.

[solomon]

what is ATG? ("something Tax Guide"?)

Sorry for too many abbreviations.