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December 14, 2010
A new Tax Court case ruled against a taxpayer with horses of impressive bloodlines, which she expected to sell for somewhere in the six figure amount. In the case, Betts v. Commissioner, T.C. Memo 2010-164, the judge made a number of points that I am outlining below. The taxpayer had been audited for earlier years with no changes, but did not have any luck in her second audit. The U.S. Tax Court is a Federal court for taxpayers to adjudicate the validity of IRS tax deficiencies. The judges are appointed for life by the President, and some of the judges are more (or less) sympathetic to the horse and livestock industries than others.
The court made the following points:
1. There was little evidence that the taxpayer’s books and records were kept for the purpose of cutting expenses, increasing profits, or evaluating the overall performance of her operation.
2. The taxpayer engaged in only minimal advertisement and promotion of the horse activities.
3. Given the taxpayer’s "circle of friends in the horse industry," her horse business activities served as a "social outlet.”
4. The taxpayer had a written business plan, but the court said that it was not prepared until her audit commenced, and in any event “consisted of little more than a summary of the horse industry; the plan did not determine, even at that late date, what should be done to make the business profitable... and was devoid of any meaningful financial analysis.”
5. Her trainer did not discuss the specifics of profitably running a horse activity with the taxpayer, did not advise her to do anything differently, and testified that the taxpayer “is doing a great job" and that most other owners do not pay attention to the industry at all.
6. The taxpayer studied educational materials, but the court said that none of this “relate to the economics or business aspects of profitably running a horse activity, and petitioner's background as a lifelong horsewoman is insufficient to indicate a profit objective.”
This case underscores the importance of having a realistic, meaningful business plan in writing. In commenting on this Tax Court case, Craig Koopman, a CPA in Arizona, has this to say: “My recommendation to clients is to prepare a business plan which includes income and cost. This aids the client in determining if there is a potential for profit and how long it will take to create a profit. The income and cost are based on assumptions, which are stated in the business plan. “Each year, I direct my clients to look at the prior year and determine if the plan was met, or what circumstances took place to cause the deviation. The business plan should be reviewed annually to determine if on track, or if an operational adjustment is needed.” In the above case the court seemed to be unimpressed with the taxpayer’s business plan, and was skeptical partly because she had prepared it after she got notice of an audit. I am encouraging my clients to implement a business plan before, not after, they get audited so that it can be used as evidence to show their businesslike approach.
John Alan Cohan is a lawyer who has served the horse, livestock and farming industries since l98l. He can be reached at (3l0) 278-0203, by e-mail at firstname.lastname@example.org, or you can see more at his website: www.johnalancohan.com