Some tax
cases are just fun to read.
Our story
takes place in south Florida.
Dad started a
business many years ago. It did well, and Dad in turn started three businesses
for his children. He structured each business so that one sibling owned 60% and
the remaining two siblings owned the balance. He gave each child (two daughters
and a son) a controlling interest in their own business, with the remaining siblings owning a (non-controlling)
interest.
All
these businesses were somehow tied-in to real estate, whether by selling
lumber, providing mortgages, payroll services or other activities.
Our
protagonist (Jose Antonio Lamas) owned a company called Adrimar.
However the
company we are interested is called Shoma, and it is (majority) owned by Jose’s
sister and her husband (Masoud Shojaee).
Shoma formed an LLC (Greens at Doral) pursuant to a condominium development. The
two companies were closely intertwined. Greens had the same ownership as Shoma, operated
out of the same office, used the same employees and so on. Shoma intended to
liquidate Greens once the project was done, which is the standard structure for
these projects.
Shoma got
itself into financial straits. Jose was
called in to help turn Shoma around.
The soap
opera is in the details of how Shoma got itself into difficulties. Turns out
that Mr. Shojaee was using Shoma to guarantee loans for a non-family company he
owned. He made a pledge to the University of Miami for $1.5 million, in return
for which they were going to name a building after him. That is swell, except
that he had no intention of using his own money. Instead he used Shoma money to
fund the donation. He developed Shoma land – and we have a feel for his ethics
at this point – but decided to run the development (and profits) through his
own company.
Somewhere in
here Jose and his sister had enough and in 2008 sued Mr. Shojaee.
Knock me
over with a feather.
Shoma must
have been losing crazy-level money, as Jose filed for a tax refund of over $5
million.
Here is an
easy quiz: what happens when you file a tax refund of over $5 million with the
IRS?
The IRS
audits you, that’s what.
What is
there to audit, you ask? The “real” audit would be on the business books, not
Jose’s personal return, right?
Not so fast.
You see, if
Jose did not “materially participate” in the business, then the business would
be “passive” to him. He would not be able to offset his other income with that
big “passive” loss. The loss would have to wait for passive income to someday soak
it up.
Jose needed
to provide time records to show that he worked over 500 hours, which is the
gold-plated standard of showing “material participation” to the IRS.
Problem: he was
not accustomed to working someplace where he kept time records. He didn’t have
any. He had to go to plan B, which means evidencing his times through other
means, such as by showing regular appointments and obtaining the testimony of
other people.
He talked to
Tania Martin, who was CFO for Shoma. She testified that she did not see Jose at
the office, except maybe one time. There was a problem with her testimony,
though. You see she worked remotely from North Carolina.
Francisco
Silva was in-house counsel for Shoma. He testified that that Mr. Lamas would
walk past his office in the morning and say “hi.” Other than that, he didn’t
know “what, if anything, he was doing. I just don’t know.”
Then there
was a stream of other people who worked regularly and extensively with Jose,
including obtaining financing, soliciting investors, visiting jobsites and so
on.
Alex Penelas, for example, was a former Miami-Date County mayor who testified that it was “more effective”
to talk with Jose than Mr. Shojaee.
Jose had
provided a letter to the IRS from his employer – Shoma - and signed by Mr.
Shojaee, stating that he was a full-time employee. It appears that after
brother and sister decided to sue, Mr. Shojaee sent a corrected letter to the
IRS wherein he stated:
"Recently Shoma Development learned that the IRS requires
active participation and 500 hours of work to qualify” and that “Jose Antonio
Lamas had no direct nor indirect involvement with Shoma.”
Mr. Shojaee
did request the IRS to keep this letter quiet, of course, lest it cause him
family trouble. He is clearly all about the family.
The case
finally gets to Court, which decides that Jose did work over 500 hours and that
Mr. Shojaee was a creep.
But… there
is one more thing.
You see,
Jose worked for Shoma (an S corporation), not Greens (an LLC), and Greens was a
substantial part of the loss.
Which brings
us to the tax issue herein: can Shoma and Greens be combined, so that by
showing material participation in Shoma, Jose also showed material
participation in Greens?
The concept
at play is whether the activities comprise an “appropriate economic unit,” a
concept introduced to the tax Code as part of the passive loss rules in 1986.
An example would be four related companies, each of which owns theaters: one
east, one south, one north and one west. The common activity is owning
theaters, and if there are enough other similarities then one could determine
that the four companies comprise one economic activity. How is this important? If
one shows a big loss while the other three show profits, for example. If they
are one economic unit, the income and loss would automatically offset without
having to employ a lot of tax planning.
So the Tax Court
reviewed the rules in Regulation 1.469-4(c) for evaluating an appropriate
economic unit:
(1) similarities and differences in types
of business
(2) the extent of common control
(3) the extent of common ownership
(4) geographical location, and
(5) other interdependencies
It found
that there was sufficient overlap between Shoma and Greens that Jose was
materially participating in both, and that he was entitled to his tax refund.
And I
suspect that Mr. Shojaee is no longer invited to family functions.
