On September 29, 2021, the Tax Court issued a Memorandum Opinion in the case of Gregory v. Commissioner (T.C. Memo. 2021-115). The primary issue presented in Gregory v. Commissioner was whether the claimed deductions permitted under IRC § 183(b) for activities not engaged in for profit are not subject to the 2% floor on miscellaneous itemized deductions set forth in IRC § 67(a).
Background to Gregory v. Comissioner
During the years at issue, 2014 and 2015, the petitioners operated CLC Ventures, Ltd. (CLC), which generated income and incurred expenses from boat chartering activities. CLC was incorporated in the Cayman Islands and elected to be treated as a disregarded entity in 2012. The petitioners jointly filed tax returns for the years at issue and reported the income and expenses from their CLC activity on Schedules C (Profit or Loss From Business).
The IRS audited the petitioners’ 2014 and 2015 returns and issued a notice of deficiency dated. Among other things, the IRS recharacterized the gross receipts and “other income” (totaling $342,173 and $313,825, for 2014 and 2015, respectively), which income the petitioners had reported on their Schedules C as non-Schedule C “other income,” after concluding they lacked a profit motive with respect to their CLC activity. (We discuss the test for profit motive under IRC § 183 in this article.) The IRS also recharacterized the reported Schedule C expenses as miscellaneous itemized deductions to the extent allowable under IRC § 183.
The petitioners’ total miscellaneous itemized deductions for the respective years at issue were adjusted upwards by $341,423 and $313,699 pursuant to IRC § 183(b)(2), which provides that total deductions attributable to an activity not engaged in for profit are generally capped to gross income from that activity. See Zenzen v. Commissioner, T.C. Memo. 2011-167. However, because the petitioners’ total miscellaneous itemized deductions for both years at issue were less than 2% of their adjusted gross income (AGI), no deductions for the CLC expenses were ultimately permitted pursuant to IRC § 67(a), which provides that an individual taxpayer may deduct miscellaneous itemized deductions only to the extent the aggregate of such deductions exceeds 2% of the taxpayer’s AGI (the so-called “2% floor”).
The petitioners filed a motion for summary judgment, in which they requested that the Tax Court hold, as a matter of law, that deductions provided under IRC § 183(b) for activities not engaged in for profit are not subject to the 2% floor of IRC § 67(a). In support thereof, the petitioners made the following (unpersuasive) arguments
- The plain language of IRC § 183 provides that it is an above-the-line deduction;
- Under the rules of statutory construction, a general statute such as IRC § 67 cannot supersede a previously enacted specific statute such as IRC § 183(b); and
- Reg. § 1.67-1T, which provides that IRC § 183(b) deductions are, in fact, subject to the 2% floor on miscellaneous itemized deductions, is invalid.
Activities Not Engaged in for Profit and IRC § 183
IRC § 183(a) generally provides that an individual taxpayer may not claim deductions attributable to an activity not engaged in for profit except as provided in that section. IRC § 183(b) then provides that “there shall be allowed” (1) deductions which would be allowable for the taxable year without regard to whether or not such activity is engaged in for profit; and (2) a deduction equal to the amount of the deductions which would be allowable for the taxable year only if such activity were engaged in for profit (but only to the extent that the gross income derived from such activity for the taxable year exceeds the deductions allowable by reason IRC § 183(b)(1).
In other words, IRC § 183(b)(1) permits the petitioners to claim deductions, with respect to expenses attributable to their CLC activity, that are not predicated on the existence of a profit motive. See Powell v. Commissioner, T.C. Memo. 1986-369. Indeed, IRC § 183(b)(2) allows the balance of such deduction(s) otherwise permitted had the CLC activity been engaged in for profit, but only to the extent gross income from CLC activity exceeds the deductions allowed under IRC § 183(b)(1).
IRC § 183(b)(2) Constitutes a Miscellaneous Itemized Deduction Subject to IRC § 67(a).
IRC § 63(d) defines itemized deductions as deductions other than (i) those allowable in computing AGI and (ii) the deduction for personal exemptions allowed under IRC § 151. However, IRC § 183(b)(2) is not identified as a deduction allowable in computing AGI. See IRC § 62(a). Consequently, the Tax Court found that IRC § 183(b)(2) is properly viewed as an itemized deduction. The Tax Court further found that “[t]he broader statutory scheme confirms as much.”
IRC § 183(b)(2) is enumerated under Part VI, Itemized Deductions for Individuals and Corporations, of subchapter B of the Code (Computation of Taxable Income). As the title of Part VI suggests, IRC § 183(b)(2) is, by default, an itemized deduction, and nothing in the text of IRC § 183 or another provision of the Code suggests otherwise.
In turn, IRC § 67(a) provides that in the case of an individual, the miscellaneous itemized deductions for any taxable year shall be allowed only to the extent that the aggregate of such deductions exceeds 2% of adjusted gross income. Miscellaneous itemized deductions are defined as itemized deductions other than those described in IRC § 67(b). See IRC § 67(b). Thus, if an itemized deduction, such as IRC § 183(b)(2), is not identified on the list provided under IRC § 67(b), it is, ipso facto, a miscellaneous itemized deduction and therefore subject to the restriction provided under IRC § 67(a).
The Tax Court further notes that IRC § 183(b)(2) is not one of the recognized deductions listed or otherwise described under IRC § 67(b). See IRC § 67(b). Consequently, IRC § 183(b)(2) constitutes a miscellaneous itemized deduction, and the 2% floor of IRC § 67(a) applies to deductions claimed thereunder.
This holding is consistent with earlier statements made by the Tax Court. See, e.g., Strode v. Commissioner, T.C. Memo. 2015-117, at *32 n.12 (deductions claimed under IRC § 183(b)(2) are subject to 2% floor under IRC § 67(a) for miscellaneous itemized deduction); see also Bailey v. Commissioner, T.C. Memo. 2012-96; Baldwin v. Commissioner, T.C. Memo. 2002-162, n.24. Further, this holding is also consistent with the view of at least one other Federal court. See Purdey v. United States, 39 Fed. Cl. 413, 417 (1997) (holding that “deductions solely permitted pursuant to IRC § 183(b)(2) are miscellaneous itemized deductions”).
IRC § 183(b)(2) Is Not an Above-the-Line Deduction
The term “above-the-line” deduction is not defined by the Code; however, the term is understood to mean a deduction applied against gross income in calculating AGI. See Knight v. Commissioner, 552 U.S. 181, 184 (2008). Above-the-line deductions are identified in IRC § 62(a) and are not subject to the 2% floor applicable to miscellaneous itemized deductions because they are not itemized deductions. See IRC § 63(d) (providing that itemized deductions are deductions other than those allowable in arriving at AGI and the deduction for personal exemptions allowed under IRC § 151).
No Conflict Exists Between IRC § 67 and IRC § 183(b)
The petitioners argue that under the rules of statutory construction, a general statute such as IRC § 67 may not supersede a previously enacted specific statute such as IRC § 183(b), citing United States v. Jim, 891 F.3d 1242, 1250-1251 (11th Cir. 2018). This argument, however, assumes there is conflict between these two provisions of the Code.
The Tax Court held, however, that “in fact each provision may be given effect without precluding or otherwise undermining application of the other.” Stated simply, where there is no conflict, there is no supersession. See Williams v. Commissioner, 151 T.C. 1, 8 (2018) (holding that if “two statutes can coexist, it is the duty of the courts to give effect to both”).
Validity of Treas. Reg. § 1.67T Not an Issue
As to the petitioners’ claim that Treas. Reg. § 1.67T is invalid, the Tax Court declined to address this line of argument, as its holding did not rely on the validity of the regulation. “The relevant statutory language alone” establishes that IRC § 183(b)(2) is a miscellaneous itemized deduction subject to the 2% floor of IRC § 67(a).
(T.C. Memo. 2021-115) Gregory v. Commissioner
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