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IRS advice confirms taxpayers have broad discretion in grouping decisions

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Tax Hot Topics: Discretion in grouping decisionThe IRS ruled in a recent technical advice memorandum (TAM 201634022) that a doctor could treat his medical practice and ownership interest in an outpatient surgery center as separate activities for the passive activity rules under Section 469. The IRS analysis confirms that the grouping rules allow taxpayers significant flexibility in their decisions and that the IRS hurdle for reversing them is high.
 
Section 469 generally prevents taxpayers from deducting losses from passive activities against other kinds of income, and income from passive activities is generally subject to the net investment income tax under Section 1411. Taxpayers must generally fulfill participation requirements to avoid passive characterization. They can group activities for these tests if the activities represent an “appropriate economic unit,” but the taxpayer addressed by the TAM sought to keep his activities separate so that the passive income from one could offset the passive losses from an unrelated real estate investment.

The regulations provide five primary factors for determining whether activities can be grouped, and the TAM noted that the rules specifically state that there is often more than one reasonable method for grouping any set of activities. The regulations also allow the IRS to reverse a taxpayer’s grouping election only if the grouping does not represent an economic unit and a principal purpose of the grouping is to circumvent Section 469. This anti-abuse rules actually include an example involving a group of doctors who improperly create a separate entity to hold and lease their medical equipment.

The TAM differentiates the facts from this example because the doctor does not have control over the outpatient surgery center, and the outpatient surgery center has many other owners who do not practice with the taxpayer. The TAM notes the flexibility in the grouping rules to choose among several viable groupings and says there is not enough evidence to conclude that either of the grouping decisions is clearly inappropriate or that the doctor acquired his interest for the principal purpose of avoiding Section 469.

For more information, please contact Dustin Stamper, +1 202 861 4144.

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