New Jersey Horse Council
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Phone: 856-231-0771
Fax: 856-234-1081
secretary@njhorsecouncil.com

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TAX NEWS

Tax Court Case Emphasizes Importance of Professional Advice
By John Alan Cohan, Attorney at Law

A recent case that seemed to rule correctly against a taxpayer was the Tax Court decision holding against Sandra J. Brannon of Southwest Texas with regards to her quarter horse breeding activity. [Brannon v. Commissioner IRS, TC Memo 2000-76.] The case also denied her depreciation deductions with respect to 4 emus because she was unable to prove she had purchased an interest in them, and so could not show that she had a tax basis in the animals.
Her activity involved six quarter horses with modest Schedule C losses ranging from about $l2,000 to $34,000 per year over an eight-year period. Ms. Brannon claimed that she was engaged in the activity for profit, but failed to keep accounting records to reflect expenses, profits or losses, although she maintained a "file folder" in which she "kept receipts." She calculated her expenses, income and net losses for income tax purposes only and appeared to engage in no strategic planning.
During the years in question she lived with her parents and engaged in horse breeding as a full time activity, holding no other jobs. She never paid rent or subsidized her parents for her living accommodations. She received some financial assistance from her parents as well, which was used to help defray the costs of her horse activity.
She and her father leased a farm located 25 miles from her parents' residence, and she kept her horses there. The property consisted of a pasture with some trees and a barn.
For the first few years Ms. Brannon focused on raising quarter horses for western, pleasure and halter, and then she decided that her chances for profit would be greater with cutting horses, so she changed her operation to that speciality.
She regularly attended horse shows, was a member of various associations, had business cards, and advertised in trade journals and newspapers. Her sales of horses, however, were minimal.
Petitioner believed that she could market her horses in Mexico but changed her mind when the Mexican peso declined in value. She attributed her overall losses to the fact that she did not have a sufficient number of broodmares, and that the bloodlines of her horses were not of the quality that were in demand. She thought that her chances of success could be better by switching to cutting horses, and said that she had the goal of producing a $l00,000 horse. However, to do that, she would have to pay breeding or stud fees of about $l0,000, and her finances did not allow her to do that. During the years at issue she paid only $750 for stud fees.
The court felt that Ms. Brannon's "sole motivation for engaging in her activity was her love for horses, dating back to her childhood." The court seemed influenced by the fact that she devoted full time to caring for six horses, that she did not have enough money to implement a plan to breed a potentially valuable cutting horse, and she had no educational training or experience in the business of breeding and training horses, nor did she consult any professionals. "She made no studies or consultations with professionals with respect to the business aspect of such an activity. She did not maintain a separate bank account for her activity, and she did not maintain formal books and records," nor did she make "any effort to change the direction of her operation, although she recognized her need to do so."
Section 183(a) of the Tax Code provides that if an activity is not engaged in for profit, no deductions attributable to that activity may be allowed. The court felt that Ms. Brannon did not engage in the activity with an "actual and honest objective of making a profit."
The court noted that the nine factors listed in the IRS Regulations, such as the manner in which the taxpayer carries on the activity, and the expertise of the taxpayer or the taxpayer's advisers--"are not merely a counting device, where the number of factors for or against the taxpayer is determinative, but rather all the facts and circumstances must be taken into account, and more weight may be given to some factors than to others."
The court felt that her activity was simply not conducted in a businesslike manner, although Ms. Brannon was "dedicated" to the activity. She had no formal or informal business plan, and never sought the advice of experts on how to conduct the activity on a profitable basis.
The court also considered a separate emu breeding business that Ms. Brannon engaged in with her father. She had claimed depreciation deductions on four of the birds, but that was disallowed because there was no evidence that she had purchaed any interest in the animals. There was no bill of sale or other evidence to reflect the purchase. Nor was she able to show that she had acquired the emus by gift.
The court also allowed a negligence penalty of 20% based on the finding that she "engaged in this activity with the knowledge that it was unrealistic to expect that any profit could be realized in the manner in which she conducted the activity." The court pointed out that she never sought the advice of professionals who could have advised her on what she should do to make the activity profitable.
Of course, with her limited budget, it is understandable that she could not obtain substantive legal advice on how to operate in accordance with IRS Regulations. My clients who engage me to prepare a tax opinion letter realize that they are investing in legal services that could help them withstand IRS scrutiny should they be audited.
The main lesson from the Brannon case is that if you have ongoing losses and are unable to pay for professional advice, you are likely to have your deductions denied if you are audited, plus be assessed a 20% negligence penalty, and that seems to be a fair outcome when compared to many other horse owners who conduct their activity in a more businesslike manner.

[John Alan Cohan is a lawyer who has served the horse, livestock and farming industries since l98l. He serves clients in all 50 states, and can be reached by telephone at (3l0) 278-0203 or via e-mail at johnalancohan@aol.com, or visit his web site at www.JohnAlanCohan.com.]

AHC WASHINGTON UPDATE: Two Tax Benefits Revert to Prior Levels

Despite the acrimony and brinksmanship, Congress eventually passed an extension of the payroll tax reductions in late December maintaining the 2% reduction in payroll taxes for workers and the self-employed. The relief is good for two months through February, 2012. Negotiations are already underway between the House and Senate to find a way to extend payroll tax relief through 2012.

But the bill ultimately passed by Congress did not extend the Section 179 expense deduction or 100% bonus depreciation at 2011 levels. Both provisions have returned to prior levels.

Section 179 Expense Deduction
The expense deduction has returned to $125,000 for 2012 and phases out dollar-for-dollar once purchases of depreciable property reach $500,000. The 179 expense deduction applies to horses, farm equipment and other depreciable property used in a business and permits a horse owner or breeder to write-off up to $125,000 in assets purchased and placed in service in one's horse business in 2012.

The expense allowance for 2010-2011 was $500,000 and phased out after purchases exceeded $2 million.

Bonus Depreciation
In addition, bonus depreciation has returned to 50% for 2012. Bonus depreciation allows horse owners and other horse businesses to write off 50% of the cost of "new" capital assets, including horses, when purchased and placed in service in 2012. To be eligible for bonus depreciation the original use of the property must commence with the taxpayer. Any prior use makes the property ineligible.

Bonus depreciation was 100% for eligible assets purchased and placed in service from September 8, 2010 through 2011.

Both provisions can be used together.

Retroactive Change is Possible
It is possible that the higher levels could be reinstated retroactively to January 1, 2012. In fact, the House-passed payroll-tax bill extended 100% bonus depreciation through 2012, but the Senate bill did not. The ongoing January-February negotiations on the one-year extension of the payroll tax reduction could include other changes to the tax code, such as the expense deduction or bonus depreciation. But this is speculation at this point.

The American Horse Council keeps its members up to date with electronic AHC Washington Updates that report on Congressional actions and other important federal issues affecting the horse industry. Permission to pass this Washington Update on to your members is granted on the condition that it is forwarded in its original form. Anyone interested in more information on federal legislation and regulatory issues affecting equine health, taxes, animal welfare, racing, recreation, and showing can visit the AHC website at www.horsecouncil.org

Informational Guide: Horse Keeping Businesses and New Jersey Sales Tax

Greetings Everyone,
Since this topic was mentioned at eth August EAB meeting, Lynn verified with Taxation about the 'Informational Guide Horse Keeping Businesses and New Jersey Sales Tax' publication.
Mr. Bob Bruch, before he retired, came to an EAB meeting to discuss this topic with everyone and the publication was handed out. Lynn asked that I once again send the guide to the EAB Delegates & Alternates. Please share this with your organization members. I am attaching a pdf version as well as the link to the NJDA website (which has many other useful agricultural publications.) http://www.nj.gov/agriculture/pub/farmer.html
As always, if you have any questions, please do not hesitate to contact me.
Regards,
Debra L. Moscatiello
Technical Assistant, Agriculture
(609) 984-4389 Fax (609) 984-8265