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Tuesday, February 04, 2003


I once had a tax professor whose theory of taking tax positions was �Be a pig, not a hog.� The difference? Pigs get fatter. Hogs get slaughtered. I always thought this advice to be just a bit too imprecise to be of much practical use, but the summary opinion in the case of James J. Hogan illustrates this concept quite nicely. Tax Court was called to determine whether Mr. Hogan had engaged in the activity of running a bed and breakfast for profit, as well as whether he was entitled to head of household status. Mr. Hogan was a hog, and he got slaughtered.

On the surface this seems a bizarre decision by the Tax Court. If not a profit, what was his motive? Do people run hotels as a hobby? No, the theory was that he created a business shell only to create tax losses to shield W-2 income from taxation. Tax Court did a full section 1.183-2(b) nine-factor analysis, but they hint that what really swayed them was that Mr. Hogan claimed huge expenses unrelated to running the B&B. They discuss, for example, the claimed legal fees that were actually attributable to his divorce. The opinion also shows car and truck expenses that far exceeded his gross income for the years in question. Tax Court also refers several times to his claimed Schedule F losses for cattle ranching in years he owned no cattle, and some losses from a claimed woodworking activity. Tax Court had reasons for weighing all of the factors except pleasure against Mr. Hogan, but the one that really adheres to my thesis of its primary motivation was its analysis of the appreciation of assets. Mr. Hogan claimed losses that, on a yearly basis, exceeded the appreciation of the real estate, and Tax Court said that weighed against him.

Was this decision correct? I am not sure. Certainly many of the expenses claimed were ridiculous. But it is entirely possible that Mr. Hogan was running the B&B with the legitimate hope of covering the expenses of the building while its value appreciated, but when it came time file his taxes, he got greedy and went overboard on claiming expenses. If Tax Court had done the asset appreciation analysis by first subtracting out the absurd expenses and the substantial depreciation claimed (a legitimate tax expense without a real economic cost that was not acknowledged by Tax Court in this case), the balance sheet may have shown a profit. If so, the correct decision would have been to disallow the absurd expenses but allow a small overall loss. But then again, Mr. Hogan did not contest that he had the burden of proof, and I would not have wanted to be the attorney arguing that well, yes, my client lied about many of the larger trees, but he was telling the truth about the forest. Mr. Hogan should have simply been a pig from the beginning and claimed a small loss, which he could have then kept because the asset appreciation would be a legitimate economic motive. Instead, he was a hog, claimed absurd expenses, and he got slaughtered.

Tax Court also disallowed Head of Household status for the years that Mr. Hogan, and elementary school principal, was shacked up with the school psychologist in her house. To be a Head of Household, you have to live in a household you pay for.

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