Dr. Keith Schumacher and his wife Rhonda are a Nebraska couple engaged in breeding and training horses. They did what many taxpayers with costly hobbies do, or would like to.
They claimed their horse interest was a business, making the net losses from it deductible against their other income. In the Schumachers’ case, the horse-related losses were largely responsible for reducing their taxes by a total of nearly $200,000 between 2017 and 2019.
Their returns were audited, and the losses were deemed a hobby, making them non-deductible. This created additional tax, interest, and penalties for the Schumachers. The couple appealed, where they also lost.
The case was then presented in Tax Court where the Judge also rejected the couple’s horse-related deductions. One reason was that they didn’t show they intended to make a profit from their horse business during the years in question.
The Tax Court did not impose the maximum penalties, which saved them $34K, but it still left Mr. and Mrs. Schumacher with a monster tax bill.
Let me leave you with this…
Every year I have a customer or two come to me with a hobby that consistently loses money, and they want a tax deduction for it.
The lure of easy deductions can be strong. If you could get another $20,000 in deductions for your baseball trading addiction, then why not?
Proving that a hobby is a for-profit enterprise, which makes those losses deductible, is a slippery slope that everyone should understand. Some of the necessary questions when making this decision are…
1 – Do you carry out the activity in a businesslike manner such as maintaining separate financial records, bank accounts, and business plans?
2 – Do you have the necessary expertise or consult with advisors?
3 – Do you and your employees put in the requisite time and effort?
4 – Do you expect the assets to appreciate in value?
5 – Have you made a profit in similar activities in the past?
6 – What is the overall history of income and losses? Are losses due to startup phases, or
unforeseen disasters?
7 – Have there been occasional profits?
8 – Do you rely on the income for your livelihood or stable financial status?
9 – Is the activity undertaken purely for personal pleasure or recreation?
The IRS loves to audit these situations. If you throw large losses on a Schedule C for multiple years, the chance of an audit is high.
And the cards are going to be stacked against you. Walking into the examination, the auditors will already presume that you’re guilty.
Think about it. How many people make a reasonable living trading Major League Baseball Cards?
Probably a few, but not many.
I have two hobbies being sailing and wine making. In the 35 years that I’ve enjoyed these hobbies, I’ve never tried to deduct a penny from these activities. Why?
Because I could never correctly answer all nine questions that I just presented. Make no mistake about it.
This is not a majority rules type of thing. You must answer all nine correctly. Eight out of nine won’t pass muster.
And if they open up one year where you lose, they’ll certainly go back to the three year statute of limitations, open up two more years, and hit you with tax, interest, and penalties on all three.
Be smart. Don’t take the risk.
As always, if you’re having difficulties with your accounting and tax work, please contact us today.
We’re all going to get through this. Let’s get through it together…
Accounting Solutions Ltd. stands ready to complete our mission and purpose of protecting you, your family, and your business. Whether you need Payroll Services, Accounting and Tax Work, Tax Planning, or Tax Representation, you have but to ask. I’m here and I remain,
Sincerely yours,
Chris Amundson
President
Accounting Solutions Ltd.
773-267-7500
888-310-0300
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