In addition, the IRS will want to see evidence that the taxpayer sought or received financial advice from experts on the business end of the activity.
Cutting down on expenses is an important element. For example, in a recent case, Hylton v. Commissioner of Internal Revenue (T.C. Memo 2016-234), the Tax Court reviewed losses over a consecutive period of 16 years involving a quarter horse farm. (Not all of the years were at issue because of the statute of limitations, but the IRS and Tax Court can still look at the entire history of the operation.)
One aspect of the case was that the taxpayer purchased two motor coaches for use in to travel to and from horse shows and to say in while there. One cost $850,000 and the other was purchased for $950,000, and the taxpayer took depreciation on them. The court said that the taxpayer’s purchase of these two motor coaches was “not indicative of a businesslike manner,” and rejected the argument that the motor coaches were purchased to reduce travel costs.
In addition, the taxpayer did not issue either a Form 1099 or a Form W-2 reporting wages paid to hired farmhands for each of the years in issue.
But the biggest concern of the Tax Court was the large amount of losses over an extended number of years, which significantly reduced taxable income from family trusts.
The court said that “A record of large losses over many years and the unlikelihood of achieving profitability are persuasive evidence that a taxpayer did not have” the objective of operating a profit-making venture. “The amount of profits in relation to the amount of losses incurred may provide useful criteria in determining the taxpayer’s intent.”
[John Alan Cohan is an attorney representing people in federal and state tax disputes, IRS appeals, and Tax Court litigation, and is a long-standing author of a legal advice column published in numerous sporting magazines. In addition, he advises organizations on compliance with newly enacted laws and regulations. John is also author of the book, Turn Your Hobby Into A Business -- The Right Way. He can be reached at: (310) 278-0203, or email at [email protected]. His website is JohnAlanCohan.com.]