Rogerson v. Comm'r of Internal Revenue

Decision Date12 May 2022
Docket Number5848-20
PartiesMICHAEL J. ROGERSON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
CourtU.S. Tax Court

Between 2005 and 2013, P was the president and 100% owner of S1, an S corporation engaged (directly or through wholly owned entities) in manufacturing aircraft parts and components (aerospace business). S1 and its wholly owned entities had multiple product lines, some of which involved digital products and some of which involved analog products.

In 2014, P began reorganizing the aerospace business to separate the digital products, analog products, and corporate functions. Following the reorganization, P owned the business directly through three S corporations: S1 (digital products) S2 (analog products), and S3 (corporate functions), each of which filed its own tax return.

In addition to the aerospace business, P owned two yachts that he intended to charter. However, P did not charter the yachts during the years at issue.

Each year, from at least 2005 to 2013, S1 filed Form 1120S, U.S. Income Tax Return for an S Corporation, reflecting all the results of the aerospace business that it and its wholly owned entities conducted. For these years, S1's returns did not separate out the various activities of the aerospace business for purposes of the rules under I.R.C § 469.

On his personal income tax returns for 2005 to 2013, P reported his involvement in S1's overall aerospace business as nonpassive for purposes of I.R.C. § 469. But on his 2014, 2015, and 2016 tax returns, P reported his involvement in S2 as passive and his involvement in the remaining portion of the aerospace business (in S1 for 2014 and in S1 and S3 for 2015 and 2016) as nonpassive. He also reported his involvement in his yacht activities as nonpassive for 2014 2015, and 2016.

R issued a notice of deficiency for tax years 2014, 2015, and 2016, determining among other things that P materially participated in S2 and therefore was required to treat income from S2 as nonpassive for the years at issue. The notice further determined that P's yacht activities were passive rental activities and that P was liable for accuracy-related penalties under I.R.C. § 6662(a).

P challenges R's notice, arguing among other things that (1) P did not materially participate in S2 during the years at issue, (2) R's reliance on the test for material participation set out in Temp. Treas. Reg. § 1.469-5T(a)(5) is a new matter not pleaded by R, (3) Temp. Treas. Reg. § 1.469-5T(a)(5) is procedurally and substantively invalid, (4) P's yacht activities qualify as nonpassive based on the rental exceptions of Temp. Treas. Reg. § 1.469-1T(e)(3)(ii), and (5) the accuracy-related penalties should not apply because P had reasonable cause and acted in good faith with respect to any underpayment.

Held: Under Temp. Treas. Reg. § 1.469-5T(a)(5) and Treas. Reg. § 1.469-5(j)(1), P materially participated in S2 during 2014, 2015, and 2016 because he materially participated in S1's overall business of manufacturing aircraft parts and components for at least five of the ten immediately preceding years.

Held, further, P's contention that R's reliance on Temp. Treas. Reg. § 1.469-5T(a)(5) is a new matter not pleaded by R is rejected.

Held, further, P's arguments regarding the substantive validity of Temp. Treas. Reg. § 1.469-5T(a)(5) fail because the regulation is not contrary to I.R.C. § 469.

Held, further, we need not address P's argument that Temp. Treas. Reg. § 1.469-5T(a)(5) is procedurally invalid because, even assuming for the sake of argument that P's argument is correct, P would not prevail under the text of I.R.C. § 469.

Held, further, P's yacht activities are rental activities that do not qualify for the exceptions described in Temp. Treas. Reg. § 1.469-1T(e)(3)(ii).

Held, further, the accuracy-related penalties under I.R.C. § 6662(a) do not apply because P had reasonable cause and acted in good faith with respect to his underpayments of tax.

Steven R. Mather, for petitioner.

Monica D. Polo and Samuel M. Warren, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

TORO Judge.

This deficiency case calls on us to apply the passive activity loss rules of section 469.[1] Enacted by Congress as part of the Tax Reform Act of 1986, Pub. L. No. 99-514, § 501(a), 100 Stat. 2085, 2233, the rules limit a taxpayer's use of losses generated by passive activities to offset unrelated income generated by nonpassive activities.

Petitioner Michael Rogerson is a successful entrepreneur. A patent holder and certified commercial pilot, Mr. Rogerson has owned and led an eponymous group of companies in the aerospace industry since the late 1970s. Also a sailing and boating enthusiast, during the tax years 2014, 2015, and 2016, Mr. Rogerson owned two yachts that he intended to charter.

The issues for our decision relate to the federal income tax consequences of Mr. Rogerson's participation in these two endeavors. Specifically, we must decide three questions: (1) whether, for the tax years 2014, 2015, and 2016, Mr. Rogerson materially participated in certain of his aerospace activities, with the result that income from those activities must be treated as nonpassive (we conclude he did); (2) whether Mr. Rogerson's yacht activities during the same years were per se passive as rental activities (we conclude they were); and (3) whether Mr. Rogerson is liable for accuracy-related penalties on the underpayments of tax resulting from our first two holdings (we conclude he is not).

As we explain in greater detail below, in light of the answers to the first two questions, Mr. Rogerson may not offset losses resulting from his passive yacht activities against income from his nonpassive aerospace activities. He is not liable for the accuracy-related penalties the Commissioner determined, however, because Mr. Rogerson had reasonable cause and relied in good faith on his certified public accountant in connection with the preparation of the returns at issue.

FINDINGS OF FACT

The parties have filed First and Second Stipulations of Fact both with attached exhibits, and a Stipulation of Settled Issues, all of which are incorporated by this reference. Trial of this case was held remotely on May 5 and 6, 2021. Mr. Rogerson resided in Nevada when he filed his petition.

I. Aerospace Activities
A. Establishment of the Rogerson Companies

In the late 1970s, Mr. Rogerson had a summer job in the aerospace industry. When an acquaintance called to ask for help finding a new part, Mr. Rogerson decided that he would build the part himself. He engaged an engineer to design the part and a manufacturer to build it, and soon established his first company: Rogerson Aircraft Controls, Inc. The company manufactured electromechanical products and eventually changed its name to Rogerson Aircraft Corporation (RAC), which still operates today.

Over the next 40 years, Mr. Rogerson grew his business by acquiring and developing new product lines, all of which were held directly or indirectly by RAC. Business operations were located in California, in Irvine and Pasadena. Mr. Rogerson served as the chief executive officer of RAC and its subsidiaries at all times, personally held patents used in certain product lines, and obtained his commercial pilot's license to better understand the industry. By the end of 2013, the Rogerson companies included the following units, which Mr. Rogerson referred to as "brands":

Name of Unit

Product Line

Location of Operations

Product Type

Owned Since at Least 2005?

Rogerson Aircraft Controls (Controls)

Controls systems

Irvine

Analog

Yes

Rogerson Aircraft Systems (Systems)

Lavatory systems

Irvine

Analog

Yes

Rogerson ATS

Auxiliary fuel systems

Irvine

Analog

Yes

Kratos Pressure Products (Pressure)

Pressure gauges

Irvine

Analog

Yes

Kratos Instruments

Analog instruments

Pasadena

Analog

Yes

Rogerson Kratos

Digital flat panel displays

Pasadena

Digital

Yes

InTheAirNet (ITAN)

Passenger entertainment systems

Irvine

Digital

Yes

B. 2014 Reorganization

By 2014, Mr. Rogerson was making an effort to separate the Rogerson companies' product lines based on whether they included legacy analog products or contemporary digital products. With the exception of analog instruments made by Kratos Instruments, the analog product lines were located together at RAC's facilities in Irvine.

During 2014, Mr. Rogerson gave further consideration to the organization of the Rogerson companies. In his view, the digital products of Rogerson Kratos were different from the analog products made by Kratos Instruments. Additionally, Mr. Rogerson had spoken with attorneys about estate planning and thought that "there was really no way the businesses would keep operating . . . after [his] demise." Accordingly, Mr. Rogerson wanted to reorganize the Rogerson companies.

In 2014, Mr. Rogerson decided that Kratos Instruments' operations should be moved from Pasadena to Irvine. He further decided to reorganize the Rogerson companies' legal structure: While all product lines had previously been owned directly or indirectly by RAC, Mr. Rogerson determined that the digital and the analog product lines would be divided and held (directly or indirectly) by two separate legal entities, each of which Mr. Rogerson would own directly.

Mr Rogerson's plans were implemented in 2014 and 2015. First, RAC transferred all its interests in the analog product lines (including interests in legal entities that manufactured analog products) to Rogerson ATS, a corporation wholly owned by RAC, effective January 1, 2014.[2] RAC then transferred 100% of the stock of Rogerson ATS to Mr. Rogerson, also effective January 1, 2014. Kratos Instruments' employees, inventory,...

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