United States Tax Court building in Washington DC
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Taking a recent Tax Court decision at face value Dr. Gurpreet Padda has found the secret of how to make a small fortune in the restaurant business. The key is to start with a moderate fortune from the practice of medicine. Lucien Gauthier of the Boston Tax Institute has nominated Gurpreet Padda TC Memo 2020-154 as the best Tax Court decision of 2020.
High Stakes And A Complicated Structure
The stakes in the decision were pretty high. Just over a million in tax and over three hundred thousand in late file and accuracy penalties for the years 2010, 2011 and 2012. The biggest issue concerned the passive activity loss rules of Code Section 469.
Dr. Padda is married to Dr. Pamela Kane and they filed a joint return. Dr. Kane works in a pediatric clinic. Dr. Padda practiced through Interventional Center, a pain management clinic. Interventional Center is a C corporation owned by Dr. Padda.
Then there was Masala, Inc an S corporation that did billing and collections for Interventional Center. Dr. Padda had another clinic- Padda Institute Center for Aesthetic and Laser Medicine.
And there were the restaurants. CA Group LLC operated Chuy Arzolas from 2009 through 2013. Cafe Ventana LLC operate a cafe serving food and beverages. Agave STL LLC opened Sanctuaria in 2009. Hendricks BBQ LLC opened in 2012. Finally Datina LLC opened Diablitos Cantina in 2011.
Serial Entrepreneurs
In all five entities Dr. Padda was a 50% owner with his CFO Ami Grimes. They are portrayed as serial entrepreneurs in this 2011 article in St.Louis. George Mahi interviewed them about the restaurants in the St.Louis piece in 2010. Here is some video on the barbecue place.
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Dr. Padda provided all the capital and was allocated 100% of the losses. The IRS did not challenge the allocation. For what it is worth that does seem to be the right answer from the viewpoint of substantial economic effect.
There was also a brewery owned 90% by Padda, 5% by Grimes and 5% by Padda’s attorney brother and Padda Equipment Co., an S corporation that purchased furniture, fixtures, decor, and machinery for the five restaurants and the brewery.
Dr. Padda and Dr. Kane reported losses on their 2010, 2011 and 2012 returns for the five restaurants and the brewery that totaled over $3.2 million. They reported the losses as nonpassive.
The Issues
There were three issues in the notice of deficiency. Whether the restaurant brewery losses needed to be suspended as passive, a constructive dividend from the medical C corporation and problems with late filing. The big money was in the passive loss question. Dr. Padda won that issue which is what makes the case so interesting to Lucien Gauthier. An activity is not passive if you materially participate in it.
The gold standard for material participation is 500 hours. Dr. Padda might have gotten there by electing to group the restaurants and the brewery, but IRS argued that that could not be done retrospectively.
That did not matter. Establishing that he had spent more than 100 hours in each of the activities made them “significant participation” activities. Time spent on significant participation activities can be put together to get to 500 hours.
Clearly this is a good path for a serial entrepreneur like Dr. Padda.
Getting The Court To Believe You
The reason that most people fail to establish material participation is that the Tax Court does not believe them. Their time records are dismissed as “ballpark estimates”. Doctor Padda overcame that.
Padda presented testimony to establish his hours spent on the restaurant and the brewery activities. He personally testified for an entire day of trial, explaining in detail his nontravel involvement in each restaurant and the brewery. Padda stated the nontravel hours he spent working on the restaurants and the brewery each year. Following Padda’s testimony, 12 individuals testified regarding Padda’s nontravel involvement in the restaurants and the brewery. They explained how Padda was involved in every aspect of the restaurants and the brewery. This included hands-on work and onsite instruction.
The time at the restaurants was supplemented by travel usually with Ms. Grimes devoted to research. You can see that discussed in the video.
And A Loss
For 2010 Dr. Padda was hit with a constructive dividend because of $81,828 in travel, dining and entertainment expenses that were charged to a credit card of the Interventional Center. Apparently IC was allowed deductions on those items in a settlement agreement, but Padda was not a party to that agreement.
Late File Penalty
I always thought that last minute was a kind of expression rather than something that happens literally. Here we have a literal last minute filing. The accounting software created a return for 2012 on October 15, 2013 at 11:59 PM. It was transmitted at 12:00 AM October 16, but mysteriously rejected as a duplicate filing. It was refiled and accepted on October 25.
Generally you can’t get out of late file by blaming your accountant. Timely filing is a duty that can’t be delegated. Dr. Padda seemed to have a pretty good argument though. The button was literally just pushed a few seconds late and it is not like he was able to push it himself.
Unfortunately for that argument, Dr. Padda and Dr. Kane have relied on the same accounting firm to file their return since at least 2006 and it was only filed on time once. That was the 2011 return.
Mostly A Win
According to the docket report computations on the outcome of the case will not be done until February, but it is clear that the bulk of the deficiency is wiped out.
Dr. Padda and Dr. Kane have had more than their share of time in Tax Court. Besides this case covering 2010, 2011 and 2012, there is a stipulated decision covering 2005, 2006 and 2007 with a total tab of around $100,000. There is another ongoing case, based on a petition filed in May 2019, but I have not dug into that. I noted some other litigation relative to Dr. Padda and his practice, but it is far from the tax reservation. I mention it only in the event that you think I am not paying attention.
The Big Vote
I was disappointed that I did not get more nominations for best Tax Court decision of 2020, but the three I received are pretty good. Besides this one, there is Oakbrook Land Holdings submitted by Lew Taishoff and Edward Duffy submitted by Title 26 US Code (that’s a twitter handle). To round it out I am going to nominate Chad Loube. The case is about deconstruction.
Don’t worry you don’t need to know about Jacques Derrida and the relationship between text and meaning. The case is about a charitable deduction for material salvaged from a home teardown. There is a bit of controversy about those sorts of deductions.
I looked into it a bit, but got distracted by the plague and like my brother and sister accountants who did not retire when I did, became obsessed with the Paycheck Protection Program.
Look for the poll on #taxtwitter and get your vote in.
Other Coverage
Ed Zollars has Taxpayer Hit With Late Filing Penalty When Accounting Firm Submits Return Seconds After the Filing Deadline.
The Tax Court rejected their defense, both because ultimately they were attempting to delegate timely filing to a third party, but also because even if that was allowed it would have been unreasonable to have relied on the firm to file timely in this case based on their previous experience with this accounting firm.
Ed Zollars also had something on the passive activity loss issue.
And it was via using the significant participation activity test, along with what turned out to better corroborated evidence than we tend to see in these passive activity cases to bolster Dr. Padda’s level of activity in these undertakings, that the Court found he did materially participate in each of the activities.
Lew Taishoff has Managing The Pain.
Gur’s practice involves Interventional Center for Pain Management, Inc., a C Corp., a pain-management practice. And he manages the pain of having his restaurant and brewery losses relegated to passive activity suspension by bringing before Judge Morrison such a great cloud of witnesses that paper, or even electrons, aren’t necessary.
Gur grouped some, but not all, so each stood on its own, so Gur roped in all the employees he could find to tell how he micromanaged them. IRS claimed Gur was too busy managing other peoples’ pain to do the chow-and-brew number.