Ryther v. Comm'r
| Decision Date | 28 March 2016 |
| Docket Number | T.C. Memo. 2016-56,Docket No. 17002-13. |
| Parties | THOMAS L. RYTHER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
Thomas L. Ryther, pro se.
Sandy Hwang, for respondent.
HOLMES, Judge: When his steel-fabrication business dissolved, Thomas Ryther found himself lacking income but in possession of a large quantity of scrap steel. To remedy the lack of income, Ryther sold the scrap whenever he needed to pay his bills. Ryther reported the sales as taxable income, but the question presented in this case is whether he had self-employment income subject to the Code's self-employment tax. And the answer to this question depends on whether these sales amounted to a trade or business.
Ryther incorporated Knight Steel in April 1997 and was its sole owner, officer, and board member. The firm fabricated steel frames, mostly for general contractors. Those contractors would bring large beams to Ryther which he would cut to size and in which he would drill bolt holes so that the contractors could easily assemble them into a frame at a construction site.
Knight Steel's fortunes sagged after the stock market collapsed in 2000. In 2001 it fell behind on paying employment taxes, and the IRS assessed trust-fund penalties against it.1 The troubles continued, and in 2004 a chapter 7 bankruptcy trustee took over the company to manage its liquidation. The trustee closed the business in April, and the bankruptcy court discharged the company's debts the following January. In winding up Knight Steel's operations, the trustee focused on the company's cash and accounts receivable and chose to abandon the company's few items of tangible property--a couple run-down trailers, some well-used fabrication equipment, and a large pile of scrap steel--because they appeared to be worthless.
Ryther didn't let the failure of Knight Steel sideline him. Even before that firm entered bankruptcy, Ryther had incorporated a second business, Mission Steel. When Knight Steel died, Mission Steel took control of its abandoned trailers and fabrication equipment and assumed its land leases. Ryther hoped to continue in the steel-fabrication business, but the new company never did much business. Ryther still had bills to pay, so he needed to find another source of income. He didn't have far to look: The scrap steel was about to come in handy.
Like all fabrication businesses, Knight Steel had generated scrap. The scrap that it generated was of substantial size: Some pieces were 40 feet long and weighed hundreds of pounds. Because he had no need for it when his business was active--except for needing it out of the way--Ryther would just leave the scrap in the empty lot next to his fabrication equipment. In a supersize version of the breeding colonies of paperclips many office workers keep in their desk drawers, Knight Steel's scrap pile grew continually from 1997 to 2004. During all this time Ryther was unaware the scrap had any value, and he never tried to sell it. But in 2004 he beheld the scrap pile and fabricated a new idea. After doing some research, he discovered that scrap had not only value but also an active market. He also learned that wholesalers were willing to come to his lot, fill their trucks with scrap steel, and pay him cash for what they took. Over the next seven years he sold scrap steel once or twice a month,2 to at least five different scrap wholesalers, in sales that totaled over $317,000:
Year
Receipts from scrap sales3
2004
$40,367 2005
26,046 2006
45,757 2007
60,584 2008
60,440 2009
55,740 2010
29,838
Ryther didn't file tax returns during these years. In February 2012 he untimely filed all seven missing returns, and reported his scrap sales as miscellaneous income. In April 2013 the Commissioner sent him a notice of deficiency and determined that Ryther's sales were a trade or business and his income from those sales was therefore subject to self-employment tax.
Ryther, a California resident, filed a timely petition. The only issue we have to decide is whether his income from the scrap-metal sales is subject to self-employment tax. The parties agreed that they needed no trial and submitted the case under Rule 122.4
We begin with the Code. Section 1401 imposes a tax on "self-employment income." Section 1402 defines self-employment income as "net earnings from self-employment" which it defines as "the gross income derived by an individual from any trade or business carried on by such individual." Sec. 1402(a) and (b). Section 1402(c) tells us that the phrase "trade or business" means the same in section 1402 as it does in section 162. Section 162, however, is a dead end. Nowhere in that section--or anywhere else--does the Code define "trade or business."5 The Supreme Court long ago forged a plug for this gap and defined a trade or business as an activity engaged in for income or profit and performed with continuity and regularity. Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987).Other cases tell us that whether an activity is a trade or business is a question of fact. Whitney v. Commissioner, T.C. Memo. 1990-163; see also Higgins v. Commissioner, 312 U.S. 212, 217 (1941).
Both parties thus correctly focus on the factual question of whether Ryther's activity was a trade or business. And we won't pretend the question is an easy one--cases can be found that support each of the parties.6 We think, however, that the solution is a bit clearer if we begin with the property that Ryther sold rather than how often he sold it. Section 1402(a)(3)(C) exempts the sale of a taxpayer's own property from the definition of "self employment income." But there are two big exceptions. The first is for the sale of property that is the "stock in trade or other property of a kind which would properly be includible in inventory if on hand at the close of the taxable year." Sec. 1402(a)(3)(C)(i). The second is for the sale of "property held primarily for sale to customers in the ordinary course of the trade or business." Id. cl. (ii). In other words, the Commissioner wins if Ryther's scrap sales fall within either exception; Ryther wins if they don't.
Property held as "inventory" and property "primarily held for sale in the ordinary course of a trade or business" overlap in many situations. A retailer, for example, might sell a number of different toys. These toys are both in his inventory and held primarily for sale to customers in the ordinary course of business. But inventory is a broader concept and includes many items not held for sale. A car manufacturer, for example, keeps many different auto parts on hand. These parts are also inventory, but are held for assembly into a car and not primarily for sale in the ordinary course of the company's business. We don't have to plumb the hidden depths of this distinction here, though, because the parties agree that Ryther was doing nothing to his scrap but selling it. For this reason, we need only decide if Ryther held the metal primarily for sale in the ordinary course of a trade or business.
Yet here again we seem to run into another statutory dead end. Section 1402 doesn't define the term "property held primarily for sale to customers in the ordinary course of the trade or business." The regulations under section 1402 are similarly silent. But the Code does have a whisper of a clue--both phrases also appear in section 1221(a)(1), which defines what property isn't considered a capital asset. Although section 1221 doesn't define these terms either, there's caselaw under that section and we can look to it to help us solve the mystery before us. See, e.g., Parkside, Inc. v. Commissioner, 571 F.2d 1092, 1094 (9th Cir. 1977) (), rev'g T.C. Memo. 1975-14; Si Boo, LLC v. Commissioner, T.C. Memo. 2015-19 (); Gardner v. Commissioner, T.C. Memo. 2011-137, slip op. at 6 ().
Distinguishing capital from noncapital assets can be tricky, and the question is important in most cases because the tax treatment of capital income can be so different from that of ordinary income. Not here: We aren't asked to consider whether Ryther's gain from the sale of scrap was capital or ordinary, but only whether its realization requires payment of self-employment tax.7 The language insection 1402 and section 1221(a)(1) is identical, and we think the cases explaining section 1221(a)(1) are exceptionally relevant.8
And this means we have to shift our focus to fine art. In Williford v. Commissioner, T.C. Memo. 1992-450, 1992 WL 188895, a taxpayer who sold pieces of art was a part-time art dealer but claimed that his income from the sale of particular pieces at issue in his case was capital gain because they were from his personal collection. We had to decide if these particular pieces were "held primarily for sale to customers in the ordinary course of a trade or business" or if they were property held as an investment. We used the following factors:
• frequency and regularity of sales;
• substantiality of sales;
• length of time the property was held;
• segregation of property from business property;
• purpose of acquisition;
• sales and advertising effort;
• time and effort spent on sales; and
• how the proceeds of the sales were used.
We do the same for Ryther's sale of scrap, and will look at each of these eight factors individually. We also understand that whenever a court uses a multi-factor test, it should be cautious in not...
To continue reading
Request your trial