Charter Boat Business and Tax Issues

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We are still waiting to see how the Administration will treat the Section 179 for 2015 and hopefully 2016.

Meanwhile, here is an interesting excerpt about a case won by a taxpayer about active boat ownership. This is the prrof that those cases can be won.

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 Roundup, 8/6/15: Tax Court sinks IRS passive loss attack on boat charter business.

It can be difficult to win a “passive loss” examination. That’s why taxpayer victories are worth studying. A couple who chartered boats and who incurred losses overcame an IRS passive loss challenge yesterday in Tax Court. Can we learn anything from them?

The taxpayer husband, a Mr. K (name withheld), is an airline pilot who chartered boats and occasionally skippered charter excursions. They had a management agreement with a company called Horizon Charters, LTD. The Tax Court said “Pursuant to the terms of the management agreement Horizon was responsible for marketing the boats, setting charter prices, booking charters, keeping records of all charters, collecting money due from customers, and cleaning and maintaining the boats.”

The passive loss rules treat a loss as “passive” if the taxpayer fails to “materially participate” in the business generating the losses. Passive losses can only be deducted against passive income; net passive losses are deferred until either there is passive income or the business is sold.

The tax law determines losses are “passive” based on the amount of time spent on the activity by the taxpayers. For example, taxpayers who spend 500 hours on an activity are generally treated as non-passive. The taxpayers in the charter boat case argued that they met another test — (1) they spent at least 100 hours on the activity, and (2) they spent more time on the activity than anyone else.

While the taxpayers didn’t keep a daily time calendar or log, they were able to convince the court that they reached the 100-hour limit:

During the audit examination respondent’s agent asked petitioners to provide the number of hours they spent in connection with the charter activity. While they did not maintain a contemporaneous log of the time spent, Mr. K. did maintain copies of email communications with Horizon. Using this correspondence and records of the length and destination of the Kline charters, petitioners were able to develop a log of the time they spent… Though petitioners did not contemporaneously record their time, we find the time entries they provided to be reasonable reconstructions of the hours that they spent in the charter business and consistent with the requirements of section 1.469-5T(f)(4), Temporary Income Tax Regs.

So emails showing regular involvement help. So does having a credible story to explain how you spent your time. But the IRS still had another challenge — they said that Horizon employees spent more time on the activity than the taxpayers, defeating the requirement that the taxpayers spend more time than anyone else. The Tax Court sided with the taxpayer:

However, on the basis of the invoices Horizon sent to petitioners regarding work done on the boats and the testimony of Horizon’s operations manager during the years at issue, we conclude petitioners spent more time in connection with the boats than any individual employed by Horizon.  

The Moral? The taxpayers won without keeping a daily calendar because they were able to reconstruct their time based on other records, and because the Tax Court found them believable. While it would have been easier if they kept a log, failure to keep one isn’t fatal if you have other good ways to show the time you spent.

Cite: K, T.C. Memo 2015-144.

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Also read our article on Section 179 and how it can affect your Boat Business.

Contact Us for more detailed information.