Tax Court takes a scalpel to surgeon's passive loss deductions.

• Author: Beavers, James A.
• Position: 2017 memorandum decision in Hardy v. Commissioner

The Tax Court determined a doctor's treatment of an interest in a surgery center as a separate passive activity from his medical practice, after he initially treated it as a nonpassive activity, was reasonable. However, it rejected his deduction of passive activity losses carried forward from the years when he treated the interest as a nonpassive activity, because the correct characterization of the income from the surgery center as passive income in those years would have resulted in the deduction of the passive losses in those years.

Background

Stephen Hardy is a pediatric plastic surgeon who runs his medical practice through a single-member professional limited liability corporation. He performs many surgeries--ones that require only local anesthesia at his office and ones that require general anesthesia or an overnight stay at a local hospital. Initially, Hardy performed surgeries at two local hospitals, allowing his patients to choose which hospital to use after his practice manager estimated how much surgery would cost at each hospital.

Hardy's surgical procedures generally have three fee components: (1) a fee for surgical services provided by the surgeon; (2) a fee for anesthesia services provided by the anesthesiologist; and (3) a fee for the use of a surgical facility and its accompanying services. Patients pay the facility fee separately from Hardy's fee as a surgeon. Facility fees typically include the use of medical equipment, supplies, and staff, who include the front office clerk and the nurses who provide pre- and post-operative care.

Because of the high costs to patients of having surgeries at the local hospitals and the difficulty in booking surgery rooms at them, Hardy considered opening his own surgery center where he could perform any surgeries that he was not required to perform at a hospital. After purchasing land and drawing up plans for a surgery center, he concluded that it would be better to join an already existing surgery center instead of constructing his own. In 2006, he bought an interest in Missoula Bone & Joint Surgery Center LLC (MBJ), at which he could perform his surgeries, except for certain complex procedures and those requiring an overnight stay. MBJ is treated as a partnership for federal tax purposes.

Hardy has never managed MBJ and has no day-to-day responsibilities there. Although he meets with the other members of MBJ quarterly, he does not have any input into management decisions. He generally is...