Campbell v. C.I.R.
| Decision Date | 24 August 1989 |
| Docket Number | No. 87-1892,87-1892 |
| Citation | 868 F.2d 833 |
| Parties | -728, 89-1 USTC P 9186 Donald R. CAMPBELL and Patricia A. Campbell, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. |
| Court | U.S. Court of Appeals — Sixth Circuit |
John P. Konvalinka (argued), Grant, Konvalinka & Grubbs, P.C., Mary Elizabeth McCroskey, Chattanooga, Tenn., for petitioners-appellants.
William F. Nelson, Chief Counsel, IRS, Gary R. Allen, Chief, Appellate Section, Acting Asst. Atty. Gen., Tax Div., Dept. of Justice, Jonathan S. Cohen, John J. Boyle (argued), Washington, D.C., for respondent-appellee.
Before MERRITT and RYAN, Circuit Judges; and POTTER, District Judge. *
The primary issue in this tax case is whether a partnership, which buys an airplane and leases it to a corporation controlled by the partners, for the purpose of generating a profit in the corporation, is engaged in an activity for profit under Sec. 183 of the Internal Revenue Code, 26 U.S.C. Sec. 183 (1988). 1 Here, the shareholders of the corporation were substantially the same as the partners, and the airplane was the partnership's only asset. The partners contributed little or no capital to the partnership venture, and the partnership generated significant tax losses. The Tax Court held that under such circumstances, the leasing activity was not engaged in for profit. Therefore, the Tax Court disallowed the taxpayer's deductions for ordinary business losses generated by the partnership and for the investment tax credit resulting from the purchase of the airplane by the partnership, and the Tax Court assessed a penalty against the taxpayers for nonpayment of taxes. We conclude that the relationship between the partnership and the corporation established the requisite profit motive, and we reverse. We would point out that no question of allocation of income, deductions or credits between the partnership and the corporation is raised by the parties in this appeal. See 26 U.S.C. Sec. 482 (1988) ().
Donald R. Campbell, the taxpayer, 2 was employed as a psychiatrist by the Area Psychological Clinic ("Clinic") in Chattanooga, Tennessee at all times relevant herein. In addition to his affiliation with the Clinic, Campbell was a shareholder in Health Care Corporation ("HCC") whose principal place of business was Chattanooga, Tennessee. HCC was formed to invest in and develop psychiatric health care facilities. It did so successfully and was later sold to Hospital Corporation of America at a substantial profit for its investors.
In furtherance of its business, HCC officers and employees engaged in extensive air travel. In 1978, following deregulation of the airline industry, air service to Chattanooga was substantially curtailed. Recognizing the need for air transportation of HCC officers and employees and the general public, the shareholders of HCC formed Health Air Partnership. Health Air purchased its only asset, a 1979 Beechcraft airplane from Hangar One, Inc. for $710,315.78. The partnership put $68,615.78 down and financed the balance. Each partner also executed full recourse promissory notes for the entire balance.
Health Air leased the airplane to HCC. Under the lease, HCC was obliged to pay Health Air rental, repairs, insurance, taxes and maintenance, and HCC had the right of first refusal on the day-to-day use of the plane. Health Air also leased the airplane to Hangar One, Inc., a "fixed base" operator for servicing and charter of general aviation aircraft. Hangar One was obliged to pay Health Air at a specified rate for a minimum of 240 hours per year of flight utilization reduced by the number of hours Hangar One could not use the plane due to Health Air's own use.
The partnership advertised the availability of the plane by word of mouth. Hangar One also attempted to market the plane. From July through December of 1979, the plane was utilized a total of 340.2 hours--approximately 8% by Hangar One, 77% by HCC, and 15% by nonrelated parties located directly through Health Air.
The accounting books and records of Health Air were maintained by HCC personnel and prepared from records of Hangar One. Accounts between HCC and Health Air were tracked by means of a credit/debit system.
For 1979, the partnership reported gross receipts of $95,325 and deductions totalling $173,056, claiming an ordinary business loss of $77,730. The basic numbers for the partnership for 1979-83 are:
1980 1981 1982
Gross Rec. 95,325.89 115,111.42 122,106.73 (20,965.37)
Deprecia'n (95,763.31) (164,165.67) (117,261.19) 0
Interest (18,509.71) ( 42,244.61) ( 39,338.59) (36,038.64)
Other Ded'n (58,783.64) (142,744.23) (193,088.02) (13,002.61)
Income/Loss (77,730.77) (234,043.09) (227,581.07) (70,006.62)
These losses were in part paper losses and in part due to the dramatic rise in the cost of fuel, inflation, and increased interest rates occurring during the late 1970's and early 1980's. Campbell claimed his distributive share of these losses and of the investment tax credit resulting from the purchase of the airplane on his 1979 calendar year tax return.
Section 183 provides that taxpayers may not fully deduct losses from an activity unless it is "engaged in for profit." 26 U.S.C. Sec. 183(a). An activity is engaged in for profit if the taxpayer entertained an actual and honest, even though unreasonable or unrealistic, profit objective in engaging in the activity. Treas.Regs. Sec. 1.183-2(a). In determining whether such a profit motive exists, a court must consider the objective facts and must also look to nine general factors set out in the Treasury Regulations. 3 For our purposes, the taxpayer is the partnership. It is the partnership motive that is relevant. See, e.g., Polakof v. Commissioner, 820 F.2d 321 (9th Cir.1987), cert. denied, --- U.S. ----, 108 S.Ct. 748, 98 L.Ed.2d 761 (1988); Rev.Rul. 79-300, 1979--2 C.B. 112; Rev.Rul. 77-320, 1977-2 C.B. 78. Additionally, "profit" means economic profit independent of tax consequences. See Ronnen v. Commissioner, 90 T.C. 74 (1988); Herrick v. Commissioner, 85 T.C. 237, 255 (1985).
Without any review of the prescribed factors, the Tax Court simply found that the sole motivation of the partnership for engaging in the airplane leasing activity was to provide HCC with air transportation while at the same time generating paper losses for the Health Air partners to offset their substantial incomes. The Tax Court based its conclusion concerning the lack of a profit motive on Health Air's history of losses and the close relationship between HCC and Health Air. The Tax Court's holding and reasoning are in error in several respects.
First, the Tax Court erred in its reliance on the close relationship between Health Air and HCC as determinative of the lack of profit motive. The Tax Court reasoned that the primary purpose of the operation of the plane by Health Air was to provide transportation to HCC employers and officers so that the corporation could profit and that this purpose was not a "business purpose" for Health Air. Campbell v. Commissioner, T.C. Memo 1986-569 at 28 (Nov. 26, 1986). To support its conclusion, the Tax Court noted that the Health Air partners were also HCC stockholders, that the plane was used predominantly by HCC, that funds from HCC paid the notes and operating expenses of the plane and that HCC employees maintained the "informal" accounting system used by Health Air. Id. at 26-27. The Tax Court overlooked the numerous authorities holding that an individual may arrange his affairs in order to use his assets to make a profit in a corporation and that such economic arrangements do not require an "either-one-or-the-other" profit motive. The profit motive in these cases need not be isolated and attributed to just the individual or to just the corporation. The entire economic relationship and its consequences are what determine profit motive.
In Horner v. Commissioner, 35 T.C. 231 (1960), for example, the taxpayer in his individual capacity, purchased merchandise and resold it through a corporation of which he was president, general manager and a major shareholder. When the corporation became insolvent and no longer able to repay him for the merchandise purchased, the taxpayer was held personally liable to the manufacturer therefor. The court allowed the taxpayer's loss deduction for its payment to the manufacturer reasoning:
If one enters into the activity of furnishing a corporation with goods to sell, upon his own credit, with the expectation of deriving gain when the goods are sold he certainly is engaging in a transaction entered into for profit. In this case, the expectation was that the profits would come to Horner either as salary as president and general manager, from dividends on his stock, or as an increase in the value of his stock.
Similarly, in Lee v. Commissioner, 51 T.C.M. 1438 (1986), a taxpayer who purchased a sea plane with personal funds with the intent of allowing a corporation he owned to use it and in anticipation that the corporation would realize a profit from its use was found by the court, relying on Horner, to have a bona fide profit motive in operating the seaplane. In Louismet v. Commissioner, 43 T.C.M. 1496 (1982), where the principal user of the taxpayer's charter aircraft service was a commodities business in which the taxpayer held a substantial ownership interest, the court found that the taxpayer's intention to profit from the commodities business established his profit motive in the air charter business. Finally, in Cornfeld v. Commissioner, 797 F.2d 1049 (D.C.Cir.1986), the court found that a taxpayer who leased his airplane to an aircraft charter...
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