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The Ludlows’ Tax Reporting
For each of the years 1996, 1997, and 1998, Ludlow and his
spouse filed a joint Form 1040, U.S. Individual Income Tax
Return. On these returns, the Ludlows reported as ordinary
income from “Rental real estate, royalties, partnerships,
S corporations, trusts, etc.” $15,605.36, $27,362.14, and
$45,686.89 for 1996, 1997, and 1998, respectively. For 1996 and
1997, attached Schedules E, Supplemental Income and Loss,
characterize the foregoing amounts as nonpassive income from
Schedules K-1. For 1998, $38,486.89 is shown on Schedule E as
nonpassive income from Schedules K-1; $7,200 is shown on
Schedule E and on Form 4831, Rental Income, as rent; and $15,000
is shown on Schedule C, Profit or Loss From Business, as gross
receipts. (Although a deemed stipulation states that $45,686.89
was reported on the 1998 Schedule E as nonpassive income from
Schedules K-1, a subsequent stipulation and documentary evidence
reveal the allocation above.)
The Notice of Determination
Prior to the audit underlying the instant case covering
1996, 1997, and 1998, respondent neither audited petitioner for
employment tax purposes nor challenged petitioner’s treatment of
Ludlow as other than an employee. Thereafter, on June 8, 2001,
respondent sent to petitioner the notice of determination at
issue in this proceeding. The notice was based on a
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