The “Masters” Rule
In the case of Sinopoli v. Commissioner,[1] the taxpayers aimed to take advantage of IRC 280A(g), a clause that permits individuals to lease their personal homes for a maximum of 14 days each year without reporting the income. The taxpayer’s S corporation claimed rental expenses exceeding $290,000 across three years, alleging this was for renting the shareholders’ residences for monthly gatherings. Yet, the Tax Court notably reduced the permitted deduction.
IRC §280A(g) encompasses what’s often referred to as the “Master’s” provision. This allows taxpayers to exclude from their reported income any revenue earned from leasing their residence, as long as it’s rented out for 14 days or fewer annually. The name “Master’s” is a nod to the common use of this provision by inhabitants of Augusta, Georgia, during the yearly Master’s Golf Tournament. However, this rule is also invoked around other significant sporting occasions like the Super Bowl. States like Massachusetts have some modified stances on the Master’s Rule.
IRC §280A(g) states:
- Specific regulation for certain rental activities. Regardless of any other stipulations in this section or section 183, if a taxpayer uses a dwelling as a residence during the taxable year, and this unit is rented for less than 15 days during that year, then—
(1) any deductions related to the rental use of the dwelling, which would normally be allowed under this chapter, are disallowed, and
(2) the income generated from such use for that taxable year won’t be counted in the taxpayer’s gross income as per section 61.
Facts of this case
In this scenario, the taxpayers sought to merge the Master’s provision with the leasing of their residences to their S corporation. The plan was for the S corporation to write off the amounts given to the shareholders as rent. Consequently, these payments would be non-taxable on the shareholders’ personal tax returns. Such maneuvers are commonly propagated on social media, with many advocating for the claim of high rental figures. In this case, the shareholders wholeheartedly adopted this assertive strategy. The judgment outlines their setup as:
Before 2015, the petitioners occasionally convened either at the hospital where they were employed or at the Planet fitness center located in Gretna, Louisiana, to discuss matters related to Planet’s operations. Due to their work schedules and the considerable distance, coordinating meetings with all three petitioners was a challenge. More often than not, scheduling conflicts meant one of them was missing.
Starting in 2015, they devised a scheme where Planet would compensate them for using their personal residences as meeting venues. On the rare occasions, these meetings took place, they were typically the only participants, although sometimes a spouse might attend. Other family members were present in the home during some of these meetings. The petitioners couldn’t provide any persuasive evidence detailing the nature of business discussed during these meetings, and their testimonies were ambiguous and unconvincing regarding the gatherings’ specifics.
Planet compensated the petitioners for utilizing their homes. No formal appraisal was conducted to determine the homes’ rental value as potential meeting spaces. Dr. Sinopoli took it upon himself to investigate meeting space rental costs in their residential vicinity and found that they generally went for about $1.83 per square foot. This rate was then used by the petitioners to determine the rent for their residences’ shared spaces. Initially, based on these calculations, each petitioner received varying amounts in monthly rent. However, from some point in 2016 until September 2017, each petitioner began receiving a flat monthly rate of $3,000 from Planet…
For the years under consideration, both Dr. Sinopoli and Dr. Siragusa documented the rental income on Schedule E of their individual tax returns and omitted it from their gross income, referencing section 280A(g). This provision states that if a taxpayer’s residence is rented out for no more than 14 days in a taxable year, the income earned isn’t considered part of their gross income. Mr. Hurring followed a similar procedure for 2015 and 2017 but omitted to report the rent in 2016.
The sizable sum of over $290,000 paid by the S corporation for 36 monthly meetings, primarily with only a few attendees, struck the IRS agent as questionable. He chose to seek alternative benchmarks for comparable meeting room costs.
Assigned to review Planet’s S corporation filings and the petitioners’ individual returns for the relevant years, Revenue Agent (RA) Jacob Burgess delved into local meeting space rental rates. His findings showed that spaces fitting between 500 to 1,200 attendees typically went for roughly $500, either for a full or half-day rental. He approved a $500 rent expense for every meeting that was validated with actual meeting notes.
No meeting documentation was presented for 2015, but 12 meetings were confirmed at Dr. Sinopoli’s home in 2016 and 9 at Mr. Hurring’s in 2017. As a result, the rent deduction for 2015 was wholly rejected, while allowances of $6,000 and $4,500 were granted for the years 2016 and 2017 respectively.
What was the Tax Court’s Decision on the Master’s Rule?
The Court began by highlighting the necessity for deductions to adhere to the “ordinary and necessary” criteria for business expenses as specified in IRC §162(a).
Section 162(a) permits deductions for ordinary and necessary expenses that are incurred during the taxable year in the conduct of any trade or business. Determining whether an expense is ordinary and necessary is a factual matter. An expense is considered ordinary if it’s commonplace in the taxpayer’s field of business and necessary if it aids the operation of that trade or business. Regardless of an expense being ordinary and necessary, it’s only deductible if its amount is reasonable, especially in transactions between related parties.
The ruling emphasized the IRS’s skepticism concerning the deductions claimed across the three years.
The IRS argued that the petitioners only validated 12 and 9 meetings for 2016 and 2017, respectively, with none for 2015. Moreover, the IRS contested the reasonableness of the rent for each meeting, ranging between $3,000 and $4,000.
Upon evaluating the evidence, the Court determined that only a subset of these meetings was confirmed to have taken place. The petitioners failed to present written records such as meeting minutes or agendas that would verify all the declared meetings for the given years. Their inconsistent testimony further cast doubt on the true frequency of these meetings.
The Court’s assessment of the rent’s reasonableness was pivotal. As outlined in IRC §162(a), for an expense to be “ordinary and necessary,” it must be both prevalent in the taxpayer’s business field and beneficial for that business.
The proposed rent of over $290,000 for the shareholders’ homes over the course of these meetings seemed excessive, especially given that these meetings were relatively infrequent and involved a limited number of attendees. When comparing this figure with the average rental values for similar properties in the vicinity, the Court sided with the IRS’s estimate, deeming $500 per meeting as a more fitting rate for the homes’ business use.
The petitioners couldn’t validate the rent’s reasonableness either through documentation or trustworthy testimony. It seemed they designed a strategy to distribute earnings through supposed rent payments, claim these as deductions, and then exclude this rent from their gross income under section 280A(g). The Court, however, found the $500 monthly rent, as determined by the RA, to be more than fair, considering the limited space utilized during the meetings. Therefore, Planet was granted a deduction of $6,000 for 2015 and a previously allowed expense deduction for rent from January 2016 through September 2017.
Lesson Learned for the Master’s Rule
This case underscores an essential tenet: while the Internal Revenue Code (IRC) offers a range of provisions for tax deductions and exclusions, these provisions are not standalone. They often interconnect and adhere to the broader principles of taxation.
For instance, while IRC §280A(g) permits the exclusion of rental income under certain conditions, it doesn’t grant carte blanche for taxpayers to set any desired rental rate without considering its reasonableness. The stipulations of IRC §162 place their own criteria on business expenses, emphasizing the foundational tenets of being both “ordinary and necessary” as well as reasonable.
Complicating factors for the taxpayers in this scenario was the transaction’s related-party nature. When the same group has influence over both the entity disbursing the rent and the one receiving it, the potential for exploitation is inherent. Such dealings often attract scrutiny from both the IRS and the judiciary, as they present opportunities to divert corporate earnings or artificially construct deductions that wouldn’t ordinarily be valid.
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[1] Sinopoli v. Commissioner, TC Memo 2023-105, August 14, 2023, https://www.taxnotes.com/research/federal/court-documents/court-opinionsand-orders/most-of-s-corporation%27s-rent-and-advertising-expensesdisallowed/7h2tb (retrieved August 15, 2023) [2] Sinopoli v. Commissioner, TC Memo 2023-105, August 14, 2023 [3] Sinopoli v. Commissioner, TC Memo 2023-105, August 14, 2023 [4] Sinopoli v. Commissioner, TC Memo 2023-105, August 14, 2023 [5] Sinopoli v. Commissioner, TC Memo 2023-105, August 14, 2023 [6] Sinopoli v. Commissioner, TC Memo 2023-105, August 14, 2023 [7] Sinopoli v. Commissioner, TC Memo 2023-105, August 14, 2023