ForLoveOrMoneyJan09.pdf

Defining your equine activity

By IRENE STAMATELAKYS

as a hobby or business is easy

when you ask the right questions.

e all dream of making money doing some-

thing we love. Imagine taking your horse

activity and developing it into a profitable

business venture. You’ve already got the

assets—the land, the buildings, the horses—and the

expenses—feed, farrier, vet—and maybe a little revenue

to boot. Wouldn’t it be nice to just declare this

a business, write off all those horse expenses

and reduce your tax bill?

Hold your horses. It’s not so simple. Are you

sure you’re running a business? Or is your

horse activity really just a hobby

you enjoy? If you’re not sure,

here are nine questions that will

help you decide if you’re doing it

for love or money. And if you are

already running an equine business,

like a large number of American

Paint Horse Association (APHA)

members, then the answers to these

same questions will help prove your

business is legitimate if the IRS ever

picks you for an audit.

Guiding us through this tax maze are

experts from inside and outside of the

equine industry, Lance Jacob and June

Walker. Jacob is a manager with Naden/Lean,

LLC, a firm of certified public accountants

and business consultants in Timonium, Mary-

land. Involved with horses nearly all his life and married to

Karen Jacob, a dressage trainer and competitor, Jacob’s

areas of expertise are the equine and health care industries.

Based in Santa Fe, New Mexico, Walker is the author of

Self-Employed Tax Solutions (Globe Pequot, $17.95), and

has been a tax and financial advisor to the self-employed

for nearly 30 years.

The IRS will look

at your profit/loss

history and

compare that to

what is expected

for your type of

business.

The moment

you say,

‘I’m in this

to make

money,’ you’re

in business.

But, if your activity was considered a business, that “left-

over” loss of $10,000 could be used to reduce other taxable

income, like your spouse’s salary. If you are in the top tax

bracket paying 35 percent in taxes, this could mean an

extra $3,500 in your pocket.

So how do you become a business, from the IRS’

point of view?

“The moment you say, ‘I’m doing this to make money,’

you’re in business,” said Walker. “That’s it. There is noth-

ing else required to form your business, as far as the IRS is

concerned, if you’re doing this so you can make a buck.”

In the tax world, that’s known as a profit motive.

Without it, the IRS considers what you do a hobby—

something you do for pleasure or entertainment and not

for profit.

The IRS says “an activity is usually considered a busi-

ness if it makes a profit during at least three of the last

five tax years, including the current year. An exception

The profit motive

Ultimately, knowing the difference between a hobby

and a business could have a significant impact on the

amount of taxes you pay.

“If the IRS deems an activity is a hobby,” said Jacob,

“they’ll only allow you to deduct expense to the extent

there is income. So if you have $10,000 in income but

$20,000 in expenses, you are allowed to deduct $10,000

of those expenses. You can’t generate a loss that you can

use to offset other income in your return.”

PAINT HORSE JOURNAL JANUARY 2009 95

Keep to the code

The Internal Revenue Code spells out nine

factors to look at when classifying an activity

as a hobby or a business. While these are more

like “guidelines” than actual rules, you should

try to meet as many as you can, advise both

Walker and Jacob.

1. Are you running your activity like a real

business?

Keeping records completely and accurately is

vital. It’s one thing, says Walker, when a business

making widgets has sloppy records.

“But if someone is raising horses and having

fun and they don’t have records, then it’s looked

at in a very different way,” she explained.

Walker stresses the importance of running

the activity in a business-like manner, just like

“the big guys.” When the business isn’t prof-

itable, research ways to reduce costs and

increase revenue.

A business plan, as well as a marketing and

advertising plan, are other elements that prove you

are actually running a business, emphasizes Jacob.

2. Do you have the know-how to run a suc-

cessful equine business?

“If you don’t, have you consulted or hired ex-

perts to help you run the business?” asked Jacob.

It’s not enough to hire an expert, he ex-

plains, if you ignore their advice. Changing

your practices based on their suggestions is

proof of your profit motivation. So is taking

continuing education courses.

The best insurance is running your operation

like a real business.

"An asset is

anything of

value that you

can hold on to

or sell."

3. Are you putting in enough

time and effort to make

a profit?

It’s important to show that you

are working on the business.

“They don’t want to see that

you are there just weekends clean-

ing stalls, feeding or turning out

horses,” said Jacob. “If you own

horses, you have to do that any-

way, whether they are for business

or pleasure.”

According to passive activity

rules, you have to show you are actively involved in the

business or you may not be able to use the losses to lower

your total income.

is breeding, showing, training or racing

horses. Such activity is presumed to be a

business if it makes a profit during at least

two of the last seven years.” This is the

hobby-loss rule.

“What happens when you say you’re in

this to make money, and then you don’t?”

asked Walker. “You have to be able to prove to the IRS

that you’re a business, doing it to make money and not

just to have fun. In fun kinds of businesses, like photog-

raphy or anything having to do with horses, often it is a

hobby and they try to write it off as a business because it’s

expensive.The IRS is going to look and say ‘wait a minute.

Someone is setting up their own homemade tax shelter.’ ”

If you need to prove your business is legitimate, or if

you’re not sure on which side of the fence your business or

hobby resides, read on.

—JuneWalker

4. Do you have assets that will appreciate in value?

“An asset is anything of value that you can hold on to or

sell,” explained Walker. “It could be your reputation, your

farm or your horses. If a horse proves itself in breeding or the

show ring, it’s [expected] to sell for a profit down the road.”

That, of course, could take time.

96 PAINT HORSE JOURNAL JANUARY 2009

5. Have you been successful in other businesses?

“Whether or not they are equine-related, it shows you

have the organizational skills to run a business and it’s not

a fly-by-night operation,” said Jacob.

“There’s a really big chance of making small profits every

year. Or there can be a small chance of making a huge

profit at some point.”

Are you in line with the kind of profit expected with

your business?

6. How do your profits compare to your losses?

The IRS will look at your profit/loss history and

compare that to what’s expected for your type of business.

Early losses due to start-up costs are common, but if they

continue beyond what’s typical, it could look like you are

not a serious or competent businessperson.

“If you’ve been going along for five or six years and

suddenly you have a profit, they’ll want to see what

you’ve done to make that profit and how significant that

profit is in relation to the expenditures made to gener-

ate it,” said Jacob.

“That being said, the IRS has realized that with an

equine operation it takes longer to make a profit. With

race or show horses, when you start with a foal, it may be

three years before they can perform. In that time, you’re

laying out a lot more cash than you are making.”

8. Do you rely on this income?

If this is your sole source of income, then your motiva-

tion to make a profit is pretty clear—you’re doing this to

feed your family. On the other hand, if you have another

source that’s substantial, like a spouse’s wages or invest-

ments, that might rouse the suspicion of the IRS.

“This is a common way they get many people,”

explained Jacob. “They get into the horse business because

they know in most cases, at least in the start-up period, it’s

going to throw off losses. They do that to shelter some of

their taxable income.”

9. Does your activity lend itself more to pleasure or

business?

“It’s not that you don’t want to have fun doing it,”

said Walker. “You

just have to make

sure that all the

other guidelines

are followed—the

7. How much “occasional” profits do you make?

Let’s say you only make profits occasionally. How big

are they? According to Walker, there are two typical profit

structures.

If you keep

good records,

you won’t have

to worry.

Even if your horse activity is just a hobby, if you are generating revenue, there

may be other required steps you’ll have to take.

PAINT HORSE JOURNAL JANUARY 2009 97

Your Paint is considered an asset

because if it proves itself in

breeding or the show ring, it’s

expected to sell in the future.

You have to be able to

prove to the IRS that

you're a business,

doing it to make

money and not just

to have fun.

“There’s no guarantee that it’s going to make you

bulletproof,” said Jacob. “But we always give these tests

as a guideline for our clients to meet because if they are

questioned we can say, ‘look, they met these tests.

Here’s how they are working towards a profit.’ ”

Both experts agree that the best insurance is running

your operation like a real business.

“For legitimate businesses, don’t worry about an

audit,” advised Walker. “It’s time-consuming to

worry. But if you keep good records, you won’t have

to worry. You prove what’s there. And if the records

are kept well in the first place, and you are audited,

it’s quick. Everything is in order.”

Walker recommends that her clients keep a file of

things that point out they are a business, like ads they

run, photos of them working, newspaper clips about

themselves and business cards of other professionals

they meet.

“You need to be creative in how you can prove you

are a business because you are not in a run-of-the-mill

business,” she explained.

Even if your horse activity is just a hobby, if you are

generating revenue there may be other required steps

you’ll have to take, which varies state by state.

“People think they are a

hobby, so they don’t have to

do anything that a normal

business would have to do,”

said Jacob. “You have to apply

for operating licenses and sales

tax numbers, even though you

may not be getting the benefit

of taking all those expenses as

deductions.”

And what if your horse activ-

ity is a mix of business and

pleasure? The IRS has an

answer for that too.

“Just because you receive

income, it doesn’t necessarily

mean that you are a business,” Jacob added. “On the other

hand, just because you used those horses for some pleasure,

it doesn’t mean you are necessarily a hobby.

“As accountants, when we prepare tax returns, there

are mixed-use assets that we report on the return all the

time. The best example is a car that somebody uses to

take care of their personal day-to-day activities, which

they may also use in the business maybe 20 percent of

time. In that case, we may allocate 20 percent to busi-

ness expenses and the other portion is not deductible. It

works the same way with a horse. If a horse is primarily

a breeding stallion that you use for trail rides 20 percent

of the time, we’ll allocate 80 percent to the business and

depreciate it. The rest is non-deductible. That’s done all

of the time, whether it’s a horse, a piece of machinery, an

auto or computer.”

For love or money? Sometimes the answer, when it

comes to your involvement in horses, can be both. p

business-like manner, the advi-

sors, the research, the time.”

How important is this factor to

the IRS? No more important than

the other eight, reports Jacob.

“Horse activities obviously give a lot of pleasure,” he

said. “Most people involved in equine activities love horses.

But they don’t hang a decision on one factor or another.

They take all nine into consideration.

“You could pass them all and they could come up with

other reasons why they would deem that you are not a

business. Or you could not meet all of them and still be

classified as a business as opposed to a hobby.”

The bottom line

The hobby-or-business question all boils down to this.

Do you have a profit motive or a tax-reduction motive?

The answer defines your horse operation in a nutshell,

helps you set a course to follow and ultimately has a

significant impact on your taxes.

Not only can these nine questions help you answer the

hobby or business question, but they can also help in case

of an audit.

98 PAINT HORSE JOURNAL JANUARY 2009

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