Discussion:Partnership Rental Income & SE Tax
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Discussion Forum Index --> Advanced Tax Questions --> Partnership Rental Income & SE Tax
Discussion Forum Index --> Tax Questions --> Partnership Rental Income & SE Tax
| 13 March 2010 | |
| I represent a partnership that runs a salon. They rent a few salon chairs to other stylists who are neither employees nor Independent Contractors of the partnership. These stylists are paid by their own customers, not by the partnership. Should this rental income for the partnership be subject to self-employment tax? Lacerte is applying SE tax, and from what I've read, only rental income from real estate would be exempt from SE tax -- is that right? | |
| 13 March 2010 | |
| Oh, boy - are you in for a treat. Seriously, take a look at this discussion; there are lots of permutations and so you'll really benefit from seeing all of the various perspectives: Discussion:Booth rental in hair salons.
It's a long discussion, yes, but it's just not a simple answer, either. | |
| 13 March 2010 | |
| Wow. I never would have guessed I could be that specific with my search keywords. My first instinct was this should be passive income. The partnership in question has at least a half-dozen employees, so they're not trying to avoid employment taxes. As far as I know (though I will double-check this), they have one chair open so they rent it to outside stylists. They didn't get that extra chair for the specific purpose of renting it and bringing in more customers. I'm not sure how they handle supplies, phone service, etc. But I do know the rent is a fixed amount, not a percentage. Pro-rating expenses seems impossible. I have images of Nomar Garciaparra putting down red tape around his locker to define his personal space.
I'm wondering if a key component to this is, where do the customers come from? Do the outside stylists bring their old customers with them when they start renting the chair, and then take those customers with them when/if they leave to work somewhere else? That doesn't seem likely. In which case the salon is benefiting from renting those chairs. I guess another question is, if there are preparers out there who have treated this type of rental income as passive (and from that discussion, apparently there are), has the IRS ever questioned this? Has anyone ever had it disputed in an audit? The amount of rental income in my client's situation is only about $12,000 so it's not worth pushing the envelope if there is some precendent for the IRS disallowing this. But it would be good regardless to have some definitive answer on it. | |
| 14 March 2010 | |
| just because a tax preparer has done something on a return or on many returns and the IRS hasn't audited it doesn't mean the treatment is correct. Do the correct thing, not what you can get away with. | |
| 15 March 2010 | |
| I agree completely. But in this situation, what is "correct" seems to be in debate. So if the IRS has not disallowed this treatment, that could imply that it is an acceptable treatment. After reading the other discussion on this topic, most people seem to think that this type of rental income should be subject to SE tax. My question is, has anyone ever received some definitive answer on what the IRS position is? | |
| 15 March 2010 | |
| you might want to read the ATG for passive activities | |
| 15 March 2010 | |
| Thanks for the link to that doc. As I'm sure you can relate to, this time of year I can't really delve into a doc of that size, so I just jumped to the "equipment rental" section, which seemed to be the most relevant here. It read: "equipment lease of greater than seven days is generally passive". Also: "if the property is used only a few hours at a time, but the lessee has a recurring right to use the property all year, the period of customer use is a year." I'm guessing there's no formal lease in this situation -- does that matter?
Is there another section of the ATG that would qualify these statements and suggest that this particular type of rental income is non-passive? I don't expect others to do research for me, so if no one has the answer off the top of your head, I understand. I'll make this a summer project. | |
| 15 March 2010 | |
| you missed the part that said
non passive is any activity in which the sole proprietor materially participates or similar wording | |
| 15 March 2010 | |
| But are the salon owners materially participating in the rental of this salon chair? They obviously materially participate in the work of the salon. Is the rental of the salon chair considered separate from the salon's typical business activity (styling hair, giving manicures, etc.)? And if the two activities are grouped together, I'm just wondering what the basis is for combining these two activities or separating them.
For example, I'm aware of the "incidental" rules. But in this case, rental income would exceed 2% of the basis or FMV of the salon chair. And extraordinary personal services are not being provided to the outside stylists who rent these chairs (though even that is a pretty subjective concept). And the renter's use of the chairs is greater than 7 days/year. I think a legitimate argument could be made that this is passive income. But if there is some track record for the IRS disagreeing, in the particular situation I'm dealing with, it's not worth going to Tax Court. | |
| 15 March 2010 | |
| I dare say that the booth rental is connected to the operation of the salon. There certainly is no physical separation, no separate entrance. Perhaps they use a common receptionist or cashier. | |
| 15 March 2010 | |
| Well, this isn't the IRS disagreeing, but it's someone who worked at the IRS for 20 yrs saying it wouldn't fly, I guess - Discussion:Nail Technican received 1099-MISC as contract labor; jump down to the end where Deback asks User:Ex-IRS to read the discussion I'd originally linked to for you, and he takes a fairly firm stance on material participation... pretty much what Kevin just said above.
As discussed at length in that "booth rental" discussion, It's really going to come down to your client's specific facts and circumstances. In your second post, you describe facts and circumstances that are farther away from the "landlord" scenario and closer to the situations described by those who were inclined to net the booth/chair rental against the owner's rent expense or otherwise account for it on Sch C. But it probably comes down to your client's exact situation and their openness to going for it when you present the position (and its implications) to them. | |
| 16 March 2010 | |
| Thank you Trillium. That was another very useful discussion to read. I can see why the IRS would disagree with treating this income as passive. Even though this isn't what my client is doing, I think it would be easy for people to avoid both SE tax and payroll taxes by collecting "rent" from people who are really employees or at least IC's. These arrangements are so informal, there would be no paper trail to contradict the business owner's claims. I still say in the spirit of passive income, this particular case feels like passive income to me. But I have yet to use that defense in an audit and don't plan on starting now. | |
