In 2020, Tom Taxpayer deducted losses he incurred from an Internet retail business operated by Tom and his sister.  Following a recent audit, the Internal Revenue Service determined that Tom’s losses were “passive” and were not deductible against non-passive activity income. The agent’s Revenue Agent Report (“RAR”) specifically noted that the membership interest fell under section 469(h)(2) of the Internal Revenue Code of 1986.

Tom’s business is organized as a limited liability company (“LLC”) in Michigan.  Tom and his sister are the only employees and each works about 20 hours a month managing the business operations.  The LLC has no other members and employees or members. 

What argument(s) and authorities would you raise in defense of Tom Taxpayer’s deduction of these losses?

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