IRS Smackdown!

By February 1, 2011

In March of 2010 the IRS began a three-year process of random audits known as the IRS Employment Tax National Research Project (NRP), which has important implications for those working in the horse industry. These audits are not limited to any one industry or size of business and will be the most comprehensive of the past 20 years, as the federal government tries to distinguish between those who are running legitimate businesses and anyone for whom it might be an occasionally productive sideline.

As an attorney, I advise my clients to organize themselves ahead of time, because when you react after the fact it is typically more expensive to bring in a professional team (and in addition to legal counsel, a certified public accountant is usually required).

The Internal Revenue Service started the NRP campaign because of the belief that non-compliance in the employment tax area accounts for a $15 billion tax gap. The audits focus on four primary areas: worker classification; fringe benefits; reimbursed expenses; and compensation of officers and owner-employees. A significant issue is that unlike past audits, where revenue agents could ignore small dollar items, in these audits, agents will not have that discretion and no discrepancy will be ignored.

In examining how this new approach is likely to impact the equestrian community, it is safe to assume that the distinction between “business” and “hobby” will become more specifically delineated. Historically, the IRS determined whether equine activities were a trade or business by looking at whether the activity was operated with a clear and convincing profit motive. If one does not exist, the activity is considered a hobby.

This distinction is important and can have either positive or negative ramifications for the filer. If an activity is truly a trade or business, it qualifies for deductions under the tax code. However, if the activity is considered a hobby, the deductions are limited. There are nine “hobby loss” factors, which the IRS applies in determining if an activity is engaged for profit or is instead a hobby.

These include:

•The manner in which the taxpayer carries on the activity.
•The expertise of the taxpayer.
•The time and effort expended by the taxpayer in carrying on the activity.
•The expectation that assets used in the activity may appreciate in value.
•The success of the taxpayer in carrying on other similar or dissimilar activities.
•The taxpayer’s history of income or losses with respect to the activity.
•The amount of occasional profits earned, if any.
•The financial status of the taxpayer.
•The elements of personal recreation or pleasure in carrying on the activity.

While there is no exact equation of what will amount to a profit motive, some factors seem to be more thoroughly examined than others. For instance, auditors focus on the manner in which the taxpayer carries on the activity. Formal business plans, separate and distinct record keeping, maintenance of financial records and the abandoning of unprofitable methods can help demonstrate a profit motive. Other “hobby loss” factors often given more weight are the financial status of the taxpayer and whether the equine activity is engaged in for recreation and pleasure. The IRS is always in the process of adapting and refining its rules, so it is necessary to use a CPA and/or tax attorney who keeps up with these changes.

With the NRP campaign underway, it is critical that those involved in the horse industry be aware of the factors the IRS is focusing on and perform internal compliance reviews to assess potential areas of concern. Those in the equine business should get their financial house (or barn, as the case may be) in order and regularly confer with tax professionals. If you are not inclined to do this and/or cannot afford to do this, you should not be treating your equine activities as a business.

One additional word of caution, if you receive a request for information from the IRS, you must contact your CPA and/or tax attorney immediately. They will help you gather and prepare the information needed for the IRS. The IRS treats the information initially received from the taxpayer as an “admission” (i.e., documentation in building whatever case it goes on to make). Many times, cases are won or lost based on the information gathered by the auditor during the initial interview.

Author Polly Hey Panos is a horse owner and a partner in Hey & Hey Attorneys At Law, LLP, which focuses on equine issues. She welcomes questions and can be reached at 650-216-6012 or polly@blueribbonlaw.com. Or visit http:www.blueribbonlaw.com .

Short URL: https://theequestriannews.com/?p=2472