S Corporation and C Corporation Cannot Aggregate Activities to Determine Profit Motive.

Individual X is sometimes required to travel away from home on business. For the first, second and third years, X claimed substantial losses on his individual Federal income tax return, attributable to S corporation A. A is identified as an "airplane charter" Until several years before the tax years at issue, X was the sole shareholder of A. Since that date, Trust C (X's grantor trust) has been the 100% owner of A. C also owns C corporation B, which is X's personal service corporation. A has never shown a profit and has instead sustained losses each year for at least d years.

A owns several airplanes. They are not available for lease to the general public. A does not have an FAA (Federal Aviation Agency) Part 135 license, which is apparently necessary to lease the airplanes to the general public. Instead, the planes are almost exclusively used by X and his family. The only income that A earns comes from B. B contracts with other entities for X's services, and X sometimes uses A's aircraft to fly to business locations. X is a pilot and also uses the airplanes for personal reasons. Some allocation has been made on A's books for X's personal use of the airplanes.

Analysis

Sec. 183(a) provides that, if an individual or an S corporation is not engaged in a for-profit activity, the IRS will not allow a deduction attributable to the activity, except as provided in that section. Sec. 183(c) defines an activity not for-profit as any activity other than one for which deductions are allowed for the tax year under Sec. 162 or 212(1) or (2). Deductions are allowable under Sec 162 or 212(1) or (2) only when a taxpayer engages in an activity with an actual and honest objective of making a profit. Sec. 183(d) (as it applies to the present case) provides that an activity will be presumed to be for-profit if income exceeds deductions in three out of five consecutive tax years.

Regs. Sec. 1.183-2(b) lists some of the factors to Consider in determining whether an activity is for-profit. The factors listed include:

1. Manner in which a taxpayer carries on an activity;

2. Expertise of a taxpayer or his advisers;

3. Time and effort expended by a taxpayer in carrying on an activity;

4. Expectation that assets used in an activity may appreciate in value;

5. Success of a taxpayer in carrying on other similar or dissimilar activities;

6. Taxpayer's history of income or losses for an activity;

7. Amount of occasional profits, if any, that a taxpayer earns;

8. Financial status of a taxpayer; and

9. Involvement of elements of personal pleasure or recreation.

Regs. Sec. 1. 183-1(d)(1) states that, to determine whether (and to what extent) Sec. 183 applies, a taxpayer's activity (or activities) must be ascertained (i.e., if a taxpayer engages in several undertakings, each of these may be a separate activity, or several undertakings may constitute an activity). In ascertaining a taxpayer's activity, all the facts and circumstances must be taken into account. Generally, the most significant facts and circumstances in making this determination are the degree of organizational and economic interrelationship of various undertakings, the business purpose which is (or might be) served by carrying on the various undertakings separately or together in a trade or business or in an investment setting, and the similarity of various undertakings. Generally, the Service will accept a taxpayer's characterization of several undertakings either as a single activity or as separate activities. A taxpayer's characterization will not be accepted, however, when it appears artificial and not reasonably supported under the facts and circumstances.

Regs. Sec. 1.183-1(a) states that no inference is to be drawn from Sec. 183 that any activity of a corporation (other than an electing small business corporation) is or is not a business or engaged in for profit. A's losses should be analyzed under Regs. Sec. 1.183-2(b). X wishes to aggregate the activity of an S corporation with the activity of a C corporation, arguing that the two are under common ownership and management. If the two entities could be aggregated under Sec. 183, A's yearly losses would be combined with B's profits. As a result, A would apparently not have a history of yearly losses under Regs. Sec. 1.183-2(b)(6), and would instead meet Sec. 183(d)'s presumptions.

Sec. 183(a) only applies to individuals and S corporations. Regs. Sec. 1.183-1(a) extends the application of Sec. 183 to trusts and estates, because they are taxed as individuals. Similarly, Rev. Rul. 77-320 held that partnerships are subject to Sec. 183 because, under Sec. 703(a), the taxable income of a partner is computed in the same manner as an individual. In contrast, Regs. Sec. 1.183-1 (a) explicitly excludes C corporations from analysis under Sec. 183. By attempting to aggregate a C corporation with an S corporation, X is attempting to pull a C corporation into the purview of Sec. 183, in violation of the regulations.

We do not believe that undertakings conducted separately by two different taxpayers can be combined as a single activity under the regulations. Because Sec. 183 must be applied at one level for activities in which a C corporation engages and at the individual level for activities in which an S corporation engages, the taxpayer's activities are two separate activities. As a result, they cannot be combined; see Rev. Rul. 78-22.

Further, while arguing that the independent taxable entities should be ignored for purposes of the Sec. 183 aggregation rules, X is attempting to retain the benefits of the two different entities. The losses from A are flowing through to X's individual return, while, if they were in fact combined with the undertaking of B and became part of its business, they could not flow through to him.

For these reasons, the activities of A and B cannot be combined as one activity under Regs. Sec. 1.183-1(d)(1). IRS LETTER RULING (FSA) 200042001 (3/1/00)