Horse Owners & IRS Taxes

An attorney gives the do's and don't's that horse owners should be aware of in complying with I.R.S. regulations.
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An attorney gives the do's and don't's that horse owners should be aware of in complying with I.R.S. regulations.

April 1, 2002 -- The I.R.S. recently announced that Americans in large numbers are evading taxes by secretly depositing money into tax havens like the Cayman Islands, and withdrawing the money by using American Express, Master-Card and Visa cards. Other Americans are using Bermuda as a mail drop to reduce their income taxes by millions of dollars. Senior senators from both parties are saying they will introduce legislation to close loopholes for individuals and companies that create nominal headquarter in Bermuda or the Cayman Islands, to evade U.S. taxes.

People in the livestock and horse industries are already hardpressed with I.R.S. audits and difficult rules requiring the showing of one profit year in a seven-year period. Charles O. Rossotti, the I.R.S. Commissioner, has already said the I.R.S. is determined to be more aggressive going after Americans who do not file tax returns, overstate their deductions, or who fail to report their offshore accounts, as well as farmers and ranchers who exaggerate depreciation and other deductions.

There are do's and don't's which farmers, ranchers and horse owners should be aware of in complying with I.R.S. Regulations. The IRS is not looking for any higher standard of recordkeeping than expected of ordinary small businesses. Even if you commingle funds, the main point is to have proper ledgers, separate records of each animal, cost projections, and some form of a business plan. Business plans often can change, and these changes should be documented in your files.

People who are starting up in the horse or livestock business have the opportunity to create a clean slate by consulting with an expert and laying out their plans with proper documentation. People who are in the formative years of an activity hopefully can, with proper planning, attain an early sign of profits. Others, who are encouraged but still fail to make a profit, need special expert guidance, documentation and opinions of counsel in order to withstand I.R.S. audits.

I.R.S. Regulations state that a farmer or rancher, or anyone who engages in breeding, selling or racing of horses or livestock--has the burden or proof if they fail to show two profit years in a seven-year period. However, some courts have held that the startup phase in a horse or livestock activity persists beyond seven-year period, even to ten and more years, provided the taxpayer has proper guidance and documentation to prove the intention to make a profit.

For people who are just starting, it's important to conduct extensive research of the horse or farming-livestock industry and particular breeds prior to engaging in the activity. This helps show how you established your intention to be engaged in an activity for profit.

Quite often I have clients who expect to make a profit through the eventual sale of a principal animal. This is a good point to document in your records. You should establish criteria to show how you expect to profit from an animal in the future, even though it is not presently profitable.

I am frequently asked whether it is advisable for an ongoing farm or ranch activity to be operated as a corporation or an L.L.C. (limited liability company) entity, and if so, to whether to incorporate in Nevada or some other state. The answer depends on the individual situation. Operating a business under a corporate entity is clearly more businesslike than a sole proprietorship, and can help show your overall business intentions. It is necessary to keep a Minute Book, pay a corporate filing fee, and incur other expenses when operating as a corporation or L.L.C. entity. A big advantage is that you are protected from liability in the event of a lawsuit, creditor claims, and the like.

In addition to looking more businesslike, transferring a family-held sole proprietorship into a corporation simply makes a stronger impression on the public at large. Corporate procedures are flexible, so a family or closely held company can allocate profits and losses to individual taxpayers. Also, a corporation can operate more than one type of activity. In other words, you can have one or more other businesses operating under the same corporate auspices. And if you ever decide to quit the horse or ranch activity, the same corporate vehicle can be retained for utilization in another venture without incurring costs of setting up a new corporation. Closely held corporations have great flexibility in the methodology of hiring personnel, making day-to-day decisions, and getting consensus from the shareholders on major issues.

John Alan Cohan is an attorney who has served the livestock and horse industries since 1981. For consultations, telephone at: (310) 557-9900 or e-mail at johnalancohan@aol.com.