Originally published on Forbes.com.
Although I think there may be comic possibilities in the notion of a flying urologist, the Tax Court ruled at least in the case of Dr. Richard Steinberger, that the undertakings of aviation and urology could not be considered one activity. Since the Court further ruled that the aviation activity was not entered into for profit, an IRS deficiency notice totaling over $130,000 for the years 2007. 2008 and 2009 was upheld. I think this case is particularly interesting because there are some hints as to what might have worked that may be useful in advising other professionals who want to live their dreams of piloting without giving up their day jobs.
Background
Dr. Steinberger was one of the seven principals in Wichita Urology. When he was interviewed by the Wichita Business Journal as part of its Best Doctors series he talked about his fascination with urology:
When l was a medical student I was fascinated by technology and urology is one of the specialities that has always been on the cutting edge. We were among the first to use laparoscopy and in particular the da Vinci Robot, which has almost eliminated the need for open surgery. For years we have also used various lasers and shockwave machines to treat our patients.
Frankly, I find the “cutting edge” term rather unsettling in that context, but maybe that is just me. Dr. Steinberger finds medicine very rewarding, but when asked what he might want to do instead, he had had an answer:
But if I had to choose I would consider something involving the outdoors and aviation. I have always thought that being an Alaskan bush pilot would be an interesting life.
For as long as Dr. Steinberger has been licensed as a physician, he has also held a pilot’s license. So in 2005, he decided it was time to explore owning his own plane. He contacted Advocate Aircraft Taxation Company (now known as Advocate Consulting Legal Group) and started down the path of aircraft ownership.
Aviation Not So Good As Medicine
Dr. Steinberger’s spouse, Maria Riva, is also a physician. Their combined income from the active practice of medicine averaged not quite $600,000 annually in the years in question. They also had passive income approaching $200,000 per year from something with the, to me scary, name of Cyberknife LLC. The two LLCs formed to own a Cirrus SR22 did not do so well. AU owned by AUI which was taxed as a partnership with Dr. Steinberger having a 75% interest and Dr. Riva having a 25% interest. Losses were $172,997, $132,212 and $26,759 in 2007, 2008 and 2009 respectively. Since there was plenty of passive income, the important question was whether there was a profit motive in the operation of AUI.
Combining Activities
When you are running an actual business, it is not unusual that you might be doing some things that are not very profitable or not profitable at all that somehow support the rest of the business. If the IRS were able to fragment your business it might be able to disallow a lot of legitimate deductions using Section 183 (the hobby loss rules). The regulations recognize this and provide for the combination of various “undertakings” into a single activity, but there are limits.
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 Commissioner will accept the characterization by the taxpayer of several undertakings either as a single activity or as separate activities. The taxpayer’s characterization will not be accepted, however, when it appears that his characterization is artificial and cannot be reasonably supported under the facts and circumstances of the case.
Some undertakings just don’t belong with others like in that Sesame Street song.
Doctor Steinberger’s argument was that he should be able to combine Wichita Urology with AUI.
Some Things Just Don’t Go Together
For 2007, the argument for combing the activities was hopeless.
On a statement attached to AUI’s 2007 Form 1065 petitioners elected to group AUI and AU for purposes of section 183 for 2007. The parties stipulated that AUI elected to combine its activities with WUG’s activities for the years in issue. That stipulation is contradicted by the election attached to AUI’s 2007 Form 1065 and signed by Dr. Steinberger, and the Court does not have to accept the parties’ stipulation.
Things looked a little better in 2008 and 2009 thanks to better return execution. The court got to run through the nine factors that determine whether activities can be grouped. (Coincidentally, whether an activity is for profit is also a nine-factor test) The activity grouping factors are:
(1) whether the activities are conducted at the same place; (2) whether the activities were part of the taxpayer’s efforts to find sources of revenue from his land; (3) whether the activities were formed separately; (4) whether one activity benefited from the other; (5) whether the taxpayer used one activity to advertise the other; (6) the degree to which the activities shared management; (7) the degree to which one caretaker oversaw the assets of both activities; (8) whether the taxpayer used the same accountant for the activities; and (9) the degree to which the activities shared books and records.
It did not go well.
WUG was formed in 2001 and had been in existence for five years before petitioners formed AUI in 2006. Petitioners did not consult with WUG or its president before forming AUI. The two entities do not share books and records and do not use the same accountant. While Dr. Steinberger is the caretaker of the airplane, he does not have the same role for WUG. He is one of seven shareholders and not its president. While both of the activities are based in Wichita, they are not conducted at the same place. WUG has it own office building, and the airplane is hangared at Benton Airpark, approximately 11 miles away.
They gave it a good try with one of the other shareholders testifying that Dr. Steinberger took the initiative in expanding the geographic reach of WUG’s practice. Unfortunately for that argument, the Tax Court after painful analysis concluded that he did not save any time by flying to places less than 100 miles away.
Dr. Steinberger did not advertise the use of the airplane for WUG business. Indeed, he was the only WUG doctor who used the airplane to travel to other communities to see patients, and the airplane was not leased to any other third parties. Additionally, Dr. Steinberger did not use the airplane to deliver medical supplies or equipment to rural clinics on behalf of WUG. WUG did not benefit from Dr. Steinberger’s use of the airplane because he could have just as easily driven to Wellington and Anthony.
It Is Not The Hard Rock Cafe
There was an attempt to compare Dr. Steinberger’s situation to that of Peter Morton, co-founder of Hard Rock Cafe, who was allowed to treat his jet owning S corporation as part of a unified business. I covered the Court of Claims decision on that shortly before moving over to forbes.com. The Court’s response to the comparison must have stung a little seeming to imply that Dr. Steinberger was just not as cool as Peter Morton.
Some Credit To Advocate Consulting
The IRS, as is routine, asserted the accuracy penalty. It was sustained for 2007, but the argument to group WUG with AUI was good enough to avoid the penalty
Advocate specializes in assisting taxpayers who wish to purchase and use an airplane for business purposes. It is made up of attorneys, CPAs, and tax advisers and has been in existence in some form or another since the late 1990s. Advocate was a competent professional with sufficient expertise to justify reliance upon its advice.
Petitioners provided Advocate with the airplane flight logs for each year in issue and other required documentation to prepare AUI’s returns. A partner at Advocate testified that AUI’s returns were driven by the airplane’s flight logs more than any other document. Advocate prepared AUI’s returns and advised grouping AUI and AU as a single activity for 2007 and AUI and WUG as a single activity for 2008 and 2009 for section 183 purposes.
Could This Have Flown?
If Dr. Steinberger had had a solo medical practice and the LLC that owned the plane had been owned by the S corporation that owned the practice, the grouping argument would have been much stronger. Probably more to the point, his audit profile would likely have been a lot lower, since the airplane deductions would have been offsetting his income rather than sticking out as a big ugly negative number on his return.
About Cyberknife
I thought something called Cyberknife belonged more in a horror novel than a Tax Court decision. So I consulted with F Paul Wilson who has written some great horror novels creating the memorable Repairman Jack in the process. Wilson is also a physician. He set me straight:
Cyberknife is an excellent cancer radiotherapy.