The Seventh Circuit Court of Appeals had cause to cite the following from the case of Commissioner v. National Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 149 (1974):

"[W]hile a taxpayer is free to organize [her] affairs as [she] chooses, nevertheless, once having done so, [she] must accept the tax consequences of her choice, whether contemplated or not, and may not enjoy the benefit of some other route [she] might have chosen to follow but did not."

This was not good news for the taxpayer in the case of Estate of Stuller, et al, v. United States, 117 AFTR 2d ¶ 2016-379, CA7, Docket No. No. 15-1545.

The taxpayer was appealing an adverse decision from the United States District Court for the Central District of Illinois. 

The taxpayer was found to not have operated a horse-breeding operation with a profit motive.  The horse-breeding operation was conducted via an S corporation which paid rent to the taxpayers. 

The effect of the treatment of the transaction as subject to the “hobby loss” meant that the taxpayers did not receive any benefit from the rental expense paid by the corporation.  Based on that fact the taxpayers argued that they should not be required to recognize the rental income—after all, it seems unfair since the effect was to tax them even though they had incurred no net economic benefit.

Unfair or not, the problem was of their own making in the view of the court, leading to the quote cited above from a 1974 Supreme Court case.  They established an entity separate and apart from themselves and, having done so, had to live with the consequences of that structure.

As the Court noted:

Denial of the Stullers’ corporate-level deduction for LSA's losses did not change the fact that the Stullers annually received lease income from LSA, which was reported on their returns. Because denial of the corporate deduction does not change the "fundamental principle that an S corporation is a separate entity from its shareholders," the denial of a corporate-level deduction for an S corp’s shareholder does not entitle the taxpayer to remove rental income from an individual tax return. Catalano, 240 F.3d at 843-44. Similarly, the Stullers cannot now “look through the forms they chose themselves in order to improve their tax treatment with the benefit of hindsight.” United States v. Fletcher, 562 F.3d 839, 842 (7th Cir. 2009).