People in the livestock and horse industries are already hard pressed with IRS audits and difficult rules requiring showing the intention to make a profit despite ongoing losses. In fact, the IRS Commissioner has said the agency is determined to be more aggressive going after Americans who don’t file tax returns, overstate their deductions, or 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 IRS regulations. The IRS isn’t 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 IRS audits.
IRS regulations state that anyone who engages in horse breeding, selling or racing, or livestock ranching – has the burden of proof if they fail to show two profit years in a seven-year period. (The standard is two in five for livestock.) However, some courts have held that the startup phase in a horse or livestock activity persists beyond seven-year period, even to 10 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 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 or group of animals. 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 isn’t currently profitable.
I’m frequently asked whether it’s advisable for an ongoing farm or ranch activity to be operated as a corporation or an LLC (limited-liability company) entity. 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’s necessary to keep a minute book, pay a corporate filing fee, and incur other expenses when operating as a corporation or LLC entity.
Perhaps the most critical event with any horse or livestock operation is an IRS audit. Keep in mind that the issue in an audit will be first to substantiate expenses, and second to prove the intention to be engaged in an activity for profit.
If you’re assessed a deficiency after an audit, the IRS will want you to sign a letter “agreeing” to the assessment. Or, you can request to have an appeal within the IRS bureaucracy or take the case to U.S. Tax Court. At that point, it’s helpful to have legal representation to ensure your case is presented in the best possible light. Most cases in IRS Appeals or U.S. Tax Court can be settled if the taxpayer has good evidence to support the argument that the activity is engaged in for profit despite a history of losses.
John Alan Cohan is an attorney specializing in the livestock and horse industries. Contact him at 310-278-0203, [email protected], or visit www.JohnAlanCohan.com.