In this second article of the series on grouping your business activities, we discuss the mechanics of making grouping elections. Check out the first article, which explains why grouping is an excellent tax strategy.
Revenue Procedure 2010-13 requires grouping disclosures in your tax returns for taxable years beginning on or after January 25, 2010.
The procedure requires a disclosure statement with your tax return in the taxable year you make a grouping, add an activity to an existing grouping, or regroup a clearly inappropriate grouping.
In addition, the revenue procedure sets forth special rules for disclosures of partnership and S corporation groupings. In general, should you fail to follow the requirements of Revenue Procedure 2010-13, your activities will be treated as separate activities for the passive-loss rules. In other words, the IRS will deny your grouping benefits when you fail to follow the procedure.
You are not required to file the grouping disclosure for your preexisting groupings (those groupings
that were in effect for taxable years beginning before January 25, 2010). Say you are on a calendar-year basis for your taxes, and you have a grouping already in place before 2011 that is
unchanged as of April 1, 2022; you didn’t need to make any disclosures on your prior-year returns, and you don’t
need to make a grouping disclosure in your 2021 tax return.
In part one of this series, we used the fictitious example of "Dr. Warren". Dr. Warrenoperates a medical practice and has started a new physical therapy business (her second business) in which she will not materially participate. In the previous blog post, we established that she qualifies for grouping.
Now in part two, we will use the example of Dr. Warren to show how an election is made to group:
Dr. Warren automatically qualifies for grouping under the common ownership rule because she owns both the medical practice and the physical therapy business, and the two businesses create an appropriate economic unit.
She attaches a written statement to her 2022 tax return that meets the requirements of Revenue Procedure 2010-13, declaring that the medical practice and physical therapy businesses are grouped as a single appropriate economic unit for measuring gain or loss under IRC Section 469.
Her statement identifies the names, addresses,
and employer identification numbers of the medical practice and the physical therapy business that she grouped into
this single activity.
Here’s a sample format for a statement attached to the Form 1040 creating a group:
[Taxpayer name and taxpayer ID number]
RE: The taxpayer hereby elects in accordance with Rev. Proc. 2010-13 to group the two activities below as a single appropriate economic unit pursuant to Reg. Section 1.469-4(c):
[Business 1, address, and taxpayer ID number]
[Business 2, address, and taxpayer ID number]
Reporting solidifies the claim of this single entity and does not require other corroborative evidence of intent to
group. This election in Dr. Warren’s tax return is audit-proof evidence of grouping. In fact, there is no easier way to
prove the grouping.
If Dr. Warren’s physical therapy business loses $175,000 as she projects, she can write off that $175,000 because the grouping makes her a material participant. Without the grouping, she does not materially participate in the physical therapy business. Without material participation, her $175,000 loss is a passive-loss deductible against only passive income, of which she has none.
The medical practice income is active income, not passive income. When she makes the grouping election, the law combines the two businesses for material participation purposes. Let’s say she works 2,000 hours a year in her medical practice. With grouping, she now works 2,000 hours a year in the combined activity, and that makes the loss from the physical therapy business deductible.
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