Three years ago, Paul Wilde exercised all his stock options in the start up company he helped establish and walked away with over $100 million. Since that time, he has spent all his energy, time, and effort in managing his portfolio. His investment philosophy is one of steady, careful investment in a well-balanced portfolio. Thus, although each year he engages in several sales and purchases, he generally buys and holds the securities for both the dividends and the growth potential. Consequently, most of the stock sales he makes are of securities he has held for over one year. Because his investment activities have grown so large, this year he rented a suite of offices and hired two investment advisors and five secretaries to help him. He also purchased several new computers and some new office furniture for the office.
Paul has now come to you for some tax help. Specifically, he would like to know if his activities are considered a business or an investment activity. In your explanation, please include whether the expenses incurred in the activity are deductions for or from AGI.
A partial list of research sources is as follows:
• Higgins v. CIR, 25 AFTR 1160, 41-1 USTC §9233 (USSC, 1941)
• Estate of Louis Yaeger, Deceased, Judith Winters, Ralph Meisels, Abraham J. Weber and the Bank of New York, 889 F2d 29, 89-2 USTC ¶9633 (CA-2)
• Frederick Mayer and Jan Perry Mayer, 67 TCM 2949 (1994)
• Rudolph W. and Abbie A. Steffler, 69 TCM 2940 (1995)
• Sec. 179
SOLUTION
FACTS:
Paul Wilde owns a large portfolio of stocks and securities which he manages himself.
His investing philosophy is to purchase and hold stocks for the dividends and long-term growth.
Although he buys and sells stock regularly during the year, most of the stocks he sells have been held over one year.
This year he has rented a suite of offices and has hired two investment assistants and four secretaries. He has also purchased some new computer equipment and office furniture for the offices.
ISSUES:
Do Paul’s activities constitute a trade or business, or are they an investment activity?
What is the tax treatment of his expenses? Specifically, are they deductions “for” or “from” AGI?
CONCLUSIONS:
Paul’s activities are not considered a business. Instead, Paul is involved in an investment activity.
The expenses are deductions “from” AGI. Additionally, they are deductible only to the extent they exceed two percent of Paul’s AGI.
Paul cannot deduct the purchase of the computers and office furniture under Sec. 179 because they are not used in a business. Instead, they must be capitalized and depreciated.
DISCUSSION:
In Higgins v. CIR, 25 AFTR 1160, 41-1 USTC §9233 (USSC, 1941), the Supreme Court held that a taxpayer who merely kept records and collected interest and dividends from his securities was not involved in a trade or business. This was the case, despite the size of the taxpayer’s holding. Subsequent cases also indicate that a taxpayer who buys and sells stocks and securities for the dividends and long-term growth and who is not involved in short-term trading is not engaged in a trade or business. See also Estate of Louis Yaeger, Deceased, Judith Winters, Ralph Meisels, Abraham J. Weber and the Bank of New York, 889 F2d 29, 89-2 USTC ¶9633 (CA-2), Frederick R. Mayer and Jan Perry Mayer, 67 TCM 2949 (1994), and Rudolph W. and Abbie A Steffler, 69 TCM 2940 (1995). In each of these cases, the taxpayer was more interested in the long-term investing potential rather than merely trading based upon short term market fluctuations. Furthermore, the taxpayers were not involved in selling stocks and securities to others in the capacity of a broker.
Since Paul is deemed to be engaged in an investment activity rather than in a business, the expenses are deductions “from” AGI. Furthermore, they are deductible only to the extent that they exceed 2% of Paul’s AGI.
Since Paul is not considered engaged in a trade or business, Paul must capitalize and depreciate the computers and office equipment and cannot take a current section 179 deduction.