The IRS Manual has a section in the Audit Technique Guide entitled “IRC Section 183: Farm Hobby Losses With Cattle Operations and Horse Activities.” The guide is intended to alert IRS auditors to situations pertaining to the horse and cattle industries. The guide says that, “Current trends indicate that these two activities, due to their nature, contain certain opportunities for taxpayer abuse.” Auditors are advised: “Many of the taxpayers who potentially fall under the provisions of IRC section 183 with respect to horse and cattle activities have been involved in such activities during their youth. These taxpayers have grown up on farms or had close relatives who operated farms. Other taxpayers had unfulfilled childhood aspirations to be involved with such activities, but circumstances prevented participation. As adults, these taxpayers have achieved the financial wherewithal which permits participation.”
Other selected provisions in the guide are quoted below:
“The taxpayers who have had prior experience in these activities find peace and solace in returning to this lifestyle. These taxpayers have affection for the horses as well as the cattle. The taxpayers find pleasure and satisfaction from watching their herds and baby animals grazing in the pastures. Examiners will frequently find retirement homes nestled on the land set aside for the activity.”
“Some taxpayers have found that agricultural status will reduce the property taxes on their land. Small numbers of cattle have been maintained on large parcels of land in order to qualify for this agricultural status. In such situations, the cattle activity was not engaged in for profit, but rather for the purpose of reducing property taxes.”
“The examiner should be alert that some taxpayers may not maintain the contemporaneous records necessary to satisfy the requirements of the breed association. Some of the data may be “plugged.” Contemporaneous records would include some type of field book that is carried out to the pasture. The data would be transferred from the field book to a permanent record.”
“The taxpayer’s use of incomplete records could indicate a lack of profit motive.”
“The taxpayer should have a formal written plan. The plan should demonstrate the taxpayer’s financial and economic forecast for the activity. The plan should not be a “fantasy Schedule F or C.” In other words, some taxpayers may wish to submit a business plan that is nothing more than a Schedule F or C, which unrealistically overstates the expenses for the activity. This is not an acceptable business plan.”
“The examiner should not request the business plan in the first Information Document Request (IDR). Otherwise, the examiner will possibly receive a ‘canned’ document. The examiner should inquire as to the business plan during the initial interview and follow-up with a subsequent IDR.”
“Some taxpayers will attempt to downplay any pleasurable aspects of the activity. Some will attempt to portray the activity as laborious with emphasis placed on the drudgery. These taxpayers know where the examination is leading. They will emphasize the labor to clean or muck the stalls. The examiner needs to understand that if these taxpayers care about their animals that any such task is a labor of love or concern for the well being of the animal.”
“The examiner should establish if the taxpayer has used any advisors or experts in the operation of the activity. Obtain names, position titles and addresses of these advisors. Document how the advisors were chosen by the taxpayer. Establish the credentials of the advisors. Document if a personal relationship exists between the taxpayer and his advisors.”
“Many taxpayers will express a passion for their activity. A skilled examiner will be able to draw this passion from the taxpayer through conversation.”
“The tax return may have minimal or zero gross receipts. The activity’s history of gross receipts should be addressed. The examiner needs to determine why there have been minimal or no gross receipts. The examiner needs to determine specifically when the taxpayer expects for gross receipts to increase and specifically how the taxpayer expects to accomplish this.”
“Determine that the income source truly relates to the activity contained in the Schedule. Examiners should also determine that the income source truly exists as some taxpayers have manufactured income in order to make it appear as though the activity earned some income. Manufactured income raises a potential fraud issue.”
“Horse activities provide a competitive outlet for some taxpayers. For example, some taxpayers have been quoted as saying that cutting horse competitions provide stress relief from the chaos in the corporate world.”
“The thrill of competition draws participants into various shows and competitive events. A sense of accomplishment attracts participants to compete in events where there may not be any monetary compensation for their efforts. Great pride accompanies the receipt of large trophies and fancy rosette ribbons and award banners.”
“The taxpayer knows about the nine relevant factors. A taxpayer with a savvy representative has been advised to downplay the pleasurable aspects and emphasize the drudgery and dirty work of the activity.”
“A significant amount of showing and showing-related expenses could be indicative of an activity not engaged in for profit if the prizes are minimal in financial remuneration. The examiner needs to determine the specific purpose for which the taxpayer participates in show competitions. The examiner needs to determine if the show winnings justify the showing expenses.”
