Most of the problems with hobby loss audits involve people who have a history of losses with their ranch, farm or horse venture. The IRS tends to say that the activity is not conducted as a business, so the tax losses are disallowed. This can result in a substantial tax payment.
Most people who get an unfavorable result in an IRS audit often are so frustrated that they accept the IRS agent’s determination that their activity is not run “for profit,” and that their deductions are disallowed. They may not have adequately prepared for the audit, or failed to present favorable evidence (such as appreciation in assets, changes in methods of operation, explanation of setbacks, efforts to promote the venture, etc.). The problem, if you agree to the IRS determination, is that you may be denied tax deductions in the future, should you continue to treat your venture as a business on tax returns.
If you are assessed a deficiency after an audit, the IRS will want you to sign a letter “agreeing” to the assessment. However, there are remedies available to disgruntled taxpayers. For example, you can request to have an appeal within the IRS bureaucracy. This often can be a fruitful route to negotiate for a settlement or even to get the matter entirely dismissed, depending on the strength of your evidence. It is important to have a taxpayer representative or a tax attorney handle your case at this point so as to ensure you will be able to present favorable facts in the best possible light.
Alternatively, you can go directly to U.S. Tax Court once the IRS issues a 90-day letter, known as a Deficiency Notice. The U.S. Tax Court is a Federal court established by Congress to provide a forum in which taxpayers can dispute IRS tax deficiencies assessed against them. Most cases are settled, often with favorable terms.
Tax Court cases can be filed in most major cities in the U.S. Most cases are handled by tax attorneys experienced in Tax Court procedure. Federal rules of procedure apply to all proceedings.
Tax planning in advance is always the best approach in operating a ranch, farming or horse activity. Although these industries are crucial to the American economy, the IRS takes a skeptical view towards taxpayers who have a history of losses in these areas. But at the same time, taxpayers who go to the effort of pursuing their cases in Tax Court usually can get a better opportunity to have a satisfactory result. It will still be necessary to have evidence that your activity is conducted in a businesslike manner, and often this entails proving that you consulted an expert at an early stage – preferably at the time of starting the venture – in order to determine just how you could make a profit in this activity over time.
The main issue in an audit is the taxpayer’s honest intentions, even if there is a history of losses. An occasional profit year can be helpful in supporting your overall intentions. Evidence of significant sales of livestock is also helpful. Evidence of efforts to advertise and promote the activity can be very important as well. All of these point to the honest intention and expectations of the taxpayer. Still, in an audit, the revenue agent’s main goal is to raise revenue, and you will often be met with skepticism. But keep in mind that the end of an audit is not the end – for worthwhile remedies are available at that point in IRS Appeals in U.S. Tax Court.
John Alan Cohan is a lawyer who has served the horse, livestock and farming industries since 1981.
