Sometimes the IRS goes after relatively small tax matters, for the sake of principle. For instance, take the Tax Court case of Richard Cramer of Las Vegas, Nevada, an entrepreneur who operated a local automobile dealer.
The taxpayer bred paint horses and he was a member of the American Paint Horse Association. He had no expertise in raising horses except that he grew up on a farm and had some experience in breaking horses. The IRS audited him for only one year, when he was in the early startup phase of the activity, at which time he had five horses kept at a boarding facility. As in all audits of this type, the IRS will examine the prior history of the activity even though only a later year or years are being audited.
According to the court’s decision, the taxpayer said that he expected to earn income from the breeding of these animals, but he had no monetary awards from participating in the horse shows. Unfortunately, the taxpayer represented himself in Tax Court without legal counsel, and he failed to show any evidence of what success he established or achievements he attained in the horse shows. This is one of the most important features of anyone’s case—-because the showing of horses is essential to establish a marketplace interest what you are selling.
I find this case peculiar because the petitioner actually made a profit in one year (a small one, of $829), and then terminated the activity because his creditors foreclosed on the horses. The taxpayer was truly unable to subsidize a losing venture because of downturns in his automotive business. He lost this case, apparently because he did not present adequate evidence on his behalf.
The Tax Court found that Mr. Cramer did not maintain books and records of his activity in a businesslike manner. He actually did not have any bank account, but dealt with all transactions in cash.
The court felt that his profit objective was not bona fide. The court said, “The activity was not conducted in a businesslike manner. The petitioner was deeply interested in the activity, and his motivation appears to have been primarily his love for horses. Petitioner had no formal or informal business plan and did not show that he sought the advice of experts on how to conduct the activity on a profitable basis.”
In addition, the court found that he failed to present any evidence that might show how much time he was engaged in the activity. He was a full time employee at a car dealership. The court said: “There is no indication in the record that petitioner undertook this activity for any purposes other than his love for horses. Petitioner has not satisfied the Court that he had a good faith primary objective of making a profit from his activity.”
On top of this, the court said that his expenses were not substantiated, which would automatically, in any case, present a very bad impression.
One of the elements in this case was that the taxpayer did not have a formal business plan. A business plan, in writing, is something that the IRS Audit Technique Guide--the Bible of revenue agents--says needs to be provided in order for the taxpayer to show a businesslike purpose in horse and livestock activities. Unfortunately, many people do not have a formal business plan. There is no “form” or template--each plan is an individual document that my clients often ask me to prepare. There are also books and other resources to assist taxpayers in formulating their own plans, but in any event this element has become increasingly important in recent years.
John Alan Cohan is a lawyer who has served the farming, livestock and horse industries since 1981. He serves clients in all 50 states, and can be reached by telephone at (310) 278-0203 or via e-mail at JohnAlanCohan@aol.com. His website is JohnAlanCohan.com.
