Horse related businesses should be operated basically in the same way as other business, utilizing business principles and judgment in decision-making, and maintaining appropriate books and records. In fact, only a minimum level of recordkeeping or businesslike records is required by Tax Court cases, and the primary concern is the accuracy of the records kept–showing the number of horses owned at a given time, the date of purchase, sale prices, breeding data, horse show entry dates, racing results, and so on. On the other hand, in situations where taxpayers are hardpressed to show a profit within a given seven-year period, the Tax Court tends to view business records of such taxpayers with heightened scrutiny. In the past two or three years, in my opinion, the newer cases have seemed to impose a subtle but palpable skeptical attitude in cases involving taxpayers with successive years of losses.
What I do think is important is to keep “hard copies” of all potential evidence that shows your manner of recordkeeping and that might reflect your business motives. For example, keep originals of magazine advertisement (including the entire magazines in which they appear). I have found that in the actual arena of Tax Court some judges are extremely “picky” as to what evidence they will allow if the IRS objects. One standard objection of evidence is that a single page from a publication cannot be introduced because the entire publication needs to be available to see in order to substantiate the authenticity of the item. Similarly, if you update written business plans, it is important to retain the earlier versions (all of which should be dated) rather than superseding them in a computer generated update. With respect to payment to vendors and trainers, it is often the case in the horse industry that some vendors and trainers are not attentive to business practices such as issuing invoices. However, you should always insist on obtaining invoices from trainers and other personnel and vendors, and keep them as part of your permanent records.
You should maintain a “customer list” consisting of persons who have contacted you regarding horse sales, and keep them dated. When adding new people to the list you should generate a complete new list (dating it) and retain the older ones. It is helpful to also keep dated memoranda of telephone conversations to memorialize certain nontrivial phone conversations with potential customers. All sales of horses, leases, breeding agreements, and other contracts should always be in writing. All contracts should be completely filled out with the parties?’ names and the name of the horses, and the date of the contract. You should keep signed and dated copies of all such documents rather than keeping computer generated forms of them.
It is important to have a well-articulated business plan. Many Tax Court cases involving horses indicate that one must have “some type of plan”–referring to a business plan, preferably in writing. The plan should be reviewed, updated, and amended as needed to reflect your changing circumstances, goals realized, etc. In addition, particularly if there are no profit years, you should formulate budgets, income statements, balance sheets, income projections, or financial statements for the activity, other than those compiled annually by your accountant to prepare annual tax returns. In fact, this could be a problem for many horse owners whose overall business records often fall short of this standard. In light of this and other experience I have had, it would be prudent to seek out and obtain a tax opinion letter to insure that your activity and the manner in which it is conducted will be able to withstand IRS scrutiny if you are audited.
A willingnesss to allow for changes in your business plan suggests the activity is engaged in for profit. The willingness to continually keep on top of operations and make necessary changes implies that you are operating a business, not a hobby. This should be reflected in a business plan that takes into account future changes in circumstances.
John Cohan is a lawyer who has served the horse industry since 1981. He serves clients in all 50 states, and can be reached by telephone at (310) 278-0203 or via e-mail at johnalancohan@aol.com.
