Friday, November 2, 2018
Sixth Circuit Holds "Hobby Loss" Factors Can Help Determine if Money-Losing Nonmember Events are a Trade or Business
In Losantiville Country Club v. Commissioner, the U.S. Court of Appeals for the Sixth Circuit had to consider whether the U.S. Tax Court properly denied a section 501(c)(7) social club's attempt to apply losses from its nonmember events to offset its investment income and so avoid tax on that income. While the nonmember events had lost money during each of the 14 previous years (2002 to 2015), the Sixth Circuit held that the Tax Court had improperly treated that fact as conclusively establishing that those events did not constitute a trade or business. The Sixth Circuit instead held that the key issue is "intent to profit," for which profitability (or the lack thereof) is relevant but not determinative. Instead, the court looked to the factors listed in the "hobby loss" regulations under section 183 as providing relevant other considerations to the extent they applied to a tax-exempt nonprofit. Although normally this legal standard error would require remand, here the Sixth Circuit found that the factual record was complete and uncontested and so it could simply apply the correct legal standard to that record. When it did so, it found the lengthy history of losses combined with no evidence of attempts to stem those losses or of any other countervailing facts demonstrated a lack of the necessary profit motive. The Sixth Circuit also affirmed the imposition of the 20 percent accuracy-related penalty, finding no grounds for holding that the club relied on its accountants in a manner that was either objectively reasonable or in good faith.
The enactment of section 512(a)(6) (requiring siloing of unrelated trades or businesses in order to prevent use of losses from one such trade or business to offset income of another such trade or business) will make determination of whether a given, loss-generating activity is a trade or business less important in the future for tax-exempt organizations. Nevertheless, this decision may still be important to country clubs because Notice 2018-67 (see Section 7) asks for comments regarding how both nonmember activities and investment income for such clubs should be treated under that new section.