Point 2 — The 1984 amendments did not cause section 212 activities to be included, nor were they intended toI have already shown that section 195 was originally inapplicable to section 212 activities, and that this was deliberately so. You will now see that the 1984 amendments did not extend the section to cover such activities, and moreover that they were not intended to.
As before, I'll start from the plain language of the statute. I've reproduced the 1984 version (available
here) with [[double brackets]] showing where substantive language was added, and XXdouble x'sXX showing where there was a substantive deletion of language:
- Code: Select all
SEC. 195. START-UP EXPENDITURES.
[[(a) CAPITALIZATION OF EXPENDITURES.—Except as otherwise pro-
vided in this section, no deduction shall be allowed for start-up
expenditures.]]
(b) ELECTION TO AMORTIZE.—
(1) GENERAL.— Start-up expenditures may, at the election
of the taxpayer, be treated as deferred expenses. Such
[[prorated equally]]
deferred expenses shall be allowed as a deduction XXratablyXX over
such period of not less than 60 months as may be selected by the
taxpayer (beginning with the month in which the [[active trade
or ]]business begins).
[[(2) DISPOSITIONS BEFORE CLOSE OF AMORTIZATION PERIOD.—In
any case in which a trade or business is completely disposed of
by the taxpayer before the end of the period to which paragraph
(1) applies, any deferred expenses attributable to such trade or
business which were not allowed as a deduction by reason of
this section may be deducted to the extent allowable under
section 165.]]
(c) DEFINITIONS.—For purposes of this section—
(1) START-UP EXPENDITURES.—The term 'start-up expenditure'
means any amount—
(A) paid or incurred in connection with—
(i) investigating the creation or acquisition of an active
trade or business, or
(ii) creating an active trade or business, [[or
(iii) any activity engaged in for profit and for the
production of income before the day on which the
active trade or business begins, in anticipation of such
activity becoming an active trade or business,]] and
[[operation]]
(2) which, if paid or incurred in connection with the XXexpansionXX
of an existing [[active]] trade or business (in the same field as the trade or
business referred to in subparagraph (A)), would be allowable as a
deduction for the taxable year in which paid or incurred.
[[The term 'start-up expenditure' does not include any amount
with respect to which a deduction is allowable under section
163(a), 164, or 174.]]
(2) BEGINNING OF TRADE OR BUSINESS.—
[[(A) IN GENERAL.—Except as provided in subparagraph
(B), the determination of when an active trade or business
begins shall be made in accordance with such regulations as
the Secretary may prescribe.]]
(B) ACQUIRED TRADE OR BUSINESS.—An acquired [[active ]]
trade or business shall be treated as beginning when the
taxpayer acquires it.
(d) ELECTION.—
(1) TIME FOR MAKING ELECTION.—An election under subsection
(b) shall be made not later than the time prescribed by law for
filing the return for the taxable year in which the [[trade or ]]business
begins (including extensions thereof).
(2) SCOPE OF ELECTION.—The period selected under subsection
(b) shall be adhered to in computing taxable income for the
taxable year for which the election is made and all subsequent
taxable years.
XX(3) MANNER OF MAKING ELECTION.—An election under subsec-
tion (a) shall be made in such manner as the Secretary shall by
regulations prescribe.XX
Most of the changes indicated are either extraneous to this discussion or depend on the definition of "trade or business" or "active trade or business". I therefore submit that only two changes could possibly be argued as broadening the scope of section 195: the insertion of the phrase "active trade or business" more frequently, and section 195(c)(1)(A)(iii) (hereinafter, "(1)(A)(iii)"), providing that certain expenses in connection with section 212 activities are considered start-up expenses.
The activities referred to in (1)(A)(iii) are clearly section 212 activities. However, the clause does not state that section 212 activities are to be included in the concept of an "active trade or business", nor does it offer the activities as an alternative to such concept (e.g., by introducing a term such as "active investment activity"). Rather, it provides for the inclusion of expenses related to a section 212 activity specifically in the case where the activity will later become an "active trade or business".
If "trade or business" or "active trade or business" indeed refers to section 162 activities as I have argued, then this clause merely asserts that the pre-opening phase to a section 162 activity can occur in the period before a section 212 activity transforms into such activity, and that expenses related to that transformation should be considered start-up expenditures. It makes no claim about the pre-opening phase of a section 212 activity unless we assert that "trade or business" in this context already refers to the section 212 activity, and that such activity must enter its active phase. Arguing for a new concept of an "active trade or business" is not sufficient; the term "trade or business" itself must include mere investment activities in order to proceed.
As I showed in point 1 above, this is an inherently unnatural proposition. Moreover, the proliferation of the phrase "active trade or business" in this section due to the amendments pushes us further toward an analysis of that phrase as a whole concept rather than an example of something being called "active" and happening to be referred to as a "trade or business" at the same time. More importantly, we haven't explained why Congress would choose such an inscrutable method to pull in section 212 activities when previously, the exclusion of those activities was so clearly the intent of this section. Why wouldn't they insert an explicit provision for 212 activities like they did with section 167(a)(2)?
The alternative argument, which is that "active trade or business" is a new concept in light of its more frequent appearance, and that such concept is broad enough to include section 212 activities, is actually defeated by (1)(A)(iii). If "active trade or business" as a whole term could already be used to refer to section 212 activities, then it would make no sense for (1)(A)(iii) to hinge on the transformation of a section 212 activity into an "active trade or business". Without opposition to the word "active" specifically, there is no reason to think the activity referred to in the first part of (1)(A)(iii) has not already begun, especially given the words "engaged in". If such activity is already included in the scope of an "active trade or business", then how can there be a transformation from the one to the other? We need to interpret "active trade or business" as exclusive of section 212 activities for this transformation to make sense.
For these reasons, section 195 as written continues to project the original intent of the Congress that drafted it, and the section simply cannot be read to incorporate section 212 activities. But did Congress intend for it to be read that way?
In the years following the original enactment of section 195, two things happened.
First, The Economic Recovery Tax Act of 1981 (ERTA) was passed into law. This act is still considered to be the greatest federal tax cut in U.S. history (see the OTA working paper on this
here with updated tables
here; the TCJA did not come close to topping the highest figures listed). The ERTA also inserted indexing for inflation, and so the era of constant bracket creep was over. Congress thus began looking for ways to raise revenue instead of lower it (the OTA working paper contains a good analysis of this on pages 4-5).
Second,
Hoopengarner v. Commissioner (80 T.C. 538) was decided. In this case, the Tax Court held that the pre-opening expense doctrine did not override section 212 (
supra, at 543) for two reasons: 1) that expenses necessary to the formation of a business venture were not capital for that reason alone, and 2) that the pre-opening doctrine was only useful as a criterion for evaluating deductions under section 162. Taxpayers now had support for the current deduction under section 212 of a wide variety of expenses that Congress, in its enactment of section 195, did not believe were deductible (see the 1980 Committee Report, first disclaiming that pre-opening expenses were incurred in an income producing activity, then framing start-up costs as incurred for the creation of a business).
Both of these events influenced the enactment of the section 195 amendments as can be seen in
Senate Report 96-1036. First and foremost, the Hoopengarner decision led to the transformation of this section into a capitalization provision (via section 195(a)) that specifically targeted Hoopengarner-like expenses (via (1)(A)(iii)). Any argument about the scope of capitalization or of the pre-opening expense doctrine was now moot due to specific statutory language. Second, the fact that section 195 could now serve to deny deductions gave the post-ERTA Congress, in search of revenue, a motive to broaden the range of activities to which it could apply—to a certain extent.
A "Hoopengarner-like expense" is one associated with investments that are held with the aim of establishing a business as a going concern - or in the words of section 195, an "active trade or business". Logically, in order to increase revenue, Congress would want to lower the threshold of what could be considered an "active trade or business" so that only the slightest input of effort on the part of the taxpayer would be enough to cross the threshold and subject the efforts of the taxpayer in developing his investments to capitalization and deferred deduction. They would want to stop short, however, of actually including those investments in the definition of "active trade or business". Not only would this render the "transformation from the one to the other" meaningless, as discussed above, it would allow more types of expenses to be deducted under the amortization provision, thus decreasing revenue. As we shall see, Congress behaved exactly as we would expect.
As we have seen, the phrase "active trade or business" was not actually defined in the original section 195. In keeping with the tradition of avoiding statutory definitions of a "trade or business", the 1980 Congress instead offered guidance via the Committee Reports. All it would take, then, to influence the definition of "active trade or business", would be more guidance from Committee Reports.
That guidance came at the very end of Senate Report 96-1036:
Active trade or business means that the taxpayer is actively conducting a trade or business. This definition of active trade or business may include a trade or business that is in many respects passive. For example, a business where property is regularly based on a net lease basis is an active trade or business for this purpose.
This guidance is in stark contrast to what was in
the 1980 Committee Report regarding rentals:
Further, in the case of rental activities, there must be significant furnishing of services incident to the rentals to constitute an active business (within the meaning of Code sec. 162) rather than an investment.
Interestingly, there is no mention of this contrast in the 1984 Committee Report—it's almost as though Congress is trying avoid calling attention to it. Undoubtedly, they were being mindful of the fact that their report could not become a part of the legislative history of the previous enactment, and could only be given "some consideration as a secondarily authoritative expression of expert opinion" (
Bobsee Corporation v. United States, 411 F.2d at 237). Their approach had to be one of examining the "trade or business" threshold from a different angle and hoping their emphasis would be given more weight.
The 1984 report's reference to a "business where property is regularly based on a net lease basis" is evocative of the petitioners' business in
King v. Commissioner (458 F.2d 245). In this case, the Sixth Circuit overturned the Tax Court's opinion that the petitioners were not engaged in the active conduct of a trade or business (within the meaning of section 355) based in part on the fact that they rented property on a net lease basis. Because there was a valid business reason for the net leases, and because they were accompanied by extensive acquisition, financing, and construction activities, it was held that although the net lease rentals were "pure passive income without concomitant expenditure of money or effort on the part of the lessor" (
supra, at 248), they nevertheless amounted to the active conduct of a trade or business.
By making section 195 applicable to situations such as that in
King, the 1984 Congress advanced an alternative theory of the trade or business threshold that diminished, but did not directly contradict, the words of the 1980 Committee Report. That report wanted significant services to be furnished, but it did not specify the exact nature or level of services, nor to whom they should be provided. Thus, the 1984 Congress was able to broaden the definition of "active trade or business" as much as it could without actual statutory intervention.
Point 2 in post #1 argues that the insertion of a "passive" net lease into the concept of "active trade or business" had the effect of stretching that term to cover all section 212 activities. This position discounts the presence of "passive" net leases in the active conduct of a trade or business such as in
King, and as we have seen, Congress did not have a motive to try to incorporate section 212 activities anyways. Moreover, even if they had wanted to, Congress could not have incorporated section 212 activities in a mere committee report. Not only would such an attempt fail to directly reverse the intent of the 1980 law and its statutory language, it would have, if successful, rendered the (1)(A)(iii) concept of transformation meaningless.
A more sensible position is that while the Committee Report's analysis did broaden the scope of the term "active trade or business", it only did so to the extent that the line separating it from section 212 activities was not crossed.