The recent Tax Court case of Estate of Roger Strangeland v. Commissioner illustrates a problem faced by families that have interests in numerous businesses and investments. Before his death in 2004, Roger Strangeland and his wife had ownership interests in over 10 businesses. In most cases, they owned interests in the businesses with other third parties. Each of the businesses had its own management team in place. However, Mr. Strangeland spent considerable time working with the various businesses to enhance their profitability, and even hired someone, whom he paid personally, to assist him in that regard. Mr. Strangeland did not receive any fees or compensation from any of the businesses. He deducted the expenses he incurred in connection with these consulting activities on Schedule C of his income tax return.
The IRS denied the deduction because it said Mr. Strangeland’s consulting business was not entered into for profit, as evidenced by the fact that it generated no revenue. The taxpayer argued that the expenses were deductible because the expenses were incurred to enhance the value of Mr. Strangeland’s various business investments. The taxpayer also argued that the expenses Mr. Strangeland deducted on Schedule C should be considered part of an undertaking that encompassed all of the other businesses.
The Tax Court rejected both of these arguments. It said that the activity of trying to make an investment more valuable is not a trade or business, relying on a prior Supreme Court case Whipple v. Commissioner. The court also rejected the argument that Mr. Strangeland’s consulting activities should be considered a part of all of the other businesses because each business had its own managers.
While the expenses incurred by Mr. Strangeland were not permitted as business deductions under IRC Section 162, they almost certainly would have been permitted as deductions under Section 212, which permits deductions for expenses incurred in connection with the production of income or in the management of property that is held for the production of income. The problem is that Section 212 deductions are treated on the tax return as miscellaneous itemized deductions. Under IRC Section 67, miscellaneous itemized deductions can only be deducted to the extent they exceed 2% of the taxpayer’s adjusted gross income. The taxpayer here did not even argue that the expenses were deductible under Section 212. This is probably because under the Section 67 limitation, miscellaneous itemized deductions would have been disallowed.
The taxpayer would have achieved a much better result if he had charged consulting fees to each of the businesses. If he received income for his consulting services, then his reasonable expenses should have been deductible. Each business that paid him a fee should also have been permitted to claim a business deduction for the fee. The tax law is indeed a “strange land.”