Taxes and the IRS Hobby Loss Rule
By Denise E. Farris, Esq.
With tax season around the corner, those of you running equine businesses are busily gathering your documents for that most favorite of tasks – TAX PREPARTION. If you’re new to equine business, you may not recognize that the IRS typically treats most horse businesses with a healthy dose of skepticism. This results from many years in which horse businesses abused existing tax laws by attempting to write-off business expenses of what was, essentially, a hobby for many owners. Thus the IRS applied the term “Hobby Loss” rule, which essentially disallows business expense deductions for any endeavor which when viewed as a whole essentially appears to be a hobby rather than a business.
An analysis of the Hobby Loss rule is a one day seminar in itself. However, in many instances whether your business qualifies as a legitimate business or a hobby depends on two factors: (1) is there an obvious intent to make a profit, and (2) how well did you keep your records evidencing that intent?
The following Hobby Loss Quiz was designed to enable you to quickly determine how you are keeping your equine business records. While it may be too late to make adjustments for the 2003 tax year, hopefully these questions, and your answers, will tell you how to modify your business record-keeping and practices for the most beneficial tax treatment in 2004!
Your goal, to support your claim of operating a legitimate equine business, is to answer “Yes” to each of the following questions. In that manner, you should be able to demonstrate evidence of a legitimate business purpose and profit expectation.
1.
Is your equine business established as a separate formal business entity?
Is your equine business established as a separate formal business entity?2.Did you secure legal assistance in forming the business?
Did you secure legal assistance in forming the business?3.Did you keep records of your payments for this service?
Did you keep records of your payments for this service?4.Did you start the business with a business plan identifying:
Did you start the business with a business plan identifying:a.Purpose of the business
Purpose of the businessb.Start-up steps
Start-up stepsc.Estimated expenses versus profit for first 5 years?
Estimated expenses versus profit for first 5 years?d.On a year by year basis?
On a year by year basis?5.Do you update it annually?
Do you update it annually?6.Did you identify the steps you would take to achieve a profit?
Did you identify the steps you would take to achieve a profit?7.Do you maintain a separate bank account for the business?
Do you maintain a separate bank account for the business?8.Do you use the services of a professional accountant to maintain the annual financial records of the business?
Do you use the services of a professional accountant to maintain the annual financial records of the business?9.Do you make it a policy to never write personal checks out of the equine business account?
Do you make it a policy to never write personal checks out of the equine business account?10.Do you make it a policy to never let the business use horses individually owned in your name?
Do you make it a policy to never let the business use horses individually owned in your name?11.I you use personally owned horses in your business, do you have a formal lease agreement between you and the equine business?
I you use personally owned horses in your business, do you have a formal lease agreement between you and the equine business?12.Do you pay the equine business anything for the use of the horses?
Do you pay the equine business anything for the use of the horses?13.Do you maintain detailed and separate business records on each horse owned by the business (i.e. purchase and sale documents, birth and registration documents, racing or competition records. Breeding records, insurance coverage, expenses and income, and veterinary information?)
Do you maintain detailed and separate business records on each horse owned by the business (i.e. purchase and sale documents, birth and registration documents, racing or competition records. Breeding records, insurance coverage, expenses and income, and veterinary information?)14.Do you use business forms in the regular course of your business (i.e. business stationary, business cards, standards written contracts, a business name, advertising, telephone listings and the like?).
Do you use business forms in the regular course of your business (i.e. business stationary, business cards, standards written contracts, a business name, advertising, telephone listings and the like?).15.Do you devote substantial time to the business?
Do you devote substantial time to the business?16.Do you keep detailed records identifying the date, time and work done for the business?
Do you keep detailed records identifying the date, time and work done for the business?17.Do you regularly consult, and keep records of your consultation, with professionals about your business (i.e. trainers, accountants, lawyers, trade journals, periodicals, seminars, etc.)
Do you regularly consult, and keep records of your consultation, with professionals about your business (i.e. trainers, accountants, lawyers, trade journals, periodicals, seminars, etc.)18.Do you keep a record of unexpected hardships, either by memo or in corporate minutes (unexpected deaths, illnesses, injuries, failures to conceive, abortions, productions of defective foals, etc?)
Do you keep a record of unexpected hardships, either by memo or in corporate minutes (unexpected deaths, illnesses, injuries, failures to conceive, abortions, productions of defective foals, etc?)19.Do you obtain periodic appraisals of your realty if it appreciates?
Do you obtain periodic appraisals of your realty if it appreciates?20.Do you obtain periodic appraisals of your horses if they appreciate?
Do you obtain periodic appraisals of your horses if they appreciate?21.Do you insure your horses and increase the coverage as they appreciate?
Do you insure your horses and increase the coverage as they appreciate?22.Do you devote over 30% of your annual adjusted gross income to the equine business?
Do you devote over 30% of your annual adjusted gross income to the equine business?23.Do you or other family members avoid competing or riding on horses owned by the business as “amateurs” of for pleasure?
Do you or other family members avoid competing or riding on horses owned by the business as “amateurs” of for pleasure?24.Do you limit the trips and business dinners charged to the business?
Do you limit the trips and business dinners charged to the business?25.Does your business show intermittent profit years in a ten year period?
Does your business show intermittent profit years in a ten year period?26.Do you engage in tax preplanning to achieve intermittent profit years in a ten year period?
Do you engage in tax preplanning to achieve intermittent profit years in a ten year period?Hopefully you can answer to most of these questions. If not, now is the time to keep this list and use it to modify your daily business practices and record-keeping for this year.
DISCLAIMER
This handout provides general coverage of its subject area. It is provided with the understanding that the author, publisher and/or publication do not intend this handout to be viewed as rendering legal advice or service. If legal advice is sought or required, the services of a competent professional licensed in your state should be sought. The author and the publisher shall not be responsible for any damages resulting from any error, inaccuracy or omission contained in the publication.
