Posts Tagged ‘section 183’

Tax Roundup, 8/28/2013: Saxes and day jobs edition.

Wednesday, August 28th, 2013 by Joe Kristan

20130828-1Keep a day job.  And good records.  A sax player recently had to justify his career choice in Tax Court.  Tom Carswell was working in Chicago for awhile, until he moved to Wisconsin, where he got a computer programming job while keeping a hand in the business: 

Since moving to Wisconsin petitioner has organized the Driftless Jazz Festival in Southwestern Wisconsin and has recorded four compact disks (CDs), including “Catharsis” in 2006 and “Carswell” in 2009. “Carswell” was advertized in the May 2010 edition of JAZZed Magazine.

The Wisconsin years weren’t lucrative:

The following table reflects his gross receipts and net losses from his musical activities:

      Year                Gross receipts                Net loss
 _____________________________________________________________________

      2004                     $1,483                    $12,163
      2005                        530                     11,842
      2006                        983                     17,872
      2007                      1,615                     20,315
      2008                      2,625                     32,541
      2009                      2,931                     26,003
      2010                      3,154                      9,467

      Total                    13,321                    130,203

As is their way, the IRS jumped to the conclusion that the sax playing was a hobby, not a for-profit activity.  Judge Kerrigan explains the law (citations omitted):

We are satisfied that petitioner’s musical activities were conducted with continuity and regularity during the years in issue. Nevertheless, a taxpayer must conduct the activity with the requisite profit motive or intent for the activity to be considered a trade or business. The taxpayer generally bears the burden of proving that the requisite profit objective existed.

Apparently our Sax Man has talents in addition to jazz.  He convinced the judge that he was, in fact, trying to make money:

Petitioner had a series of losses from 2004 to 2010 and a small profit in 2011. Respondent contends that petitioner’s small profit in 2011 could not offset years of sustained losses that total over $100,000; however, petitioner was able to explain these losses. The music industry changed, and petitioner’s focus moved from performance to original composition and other aspects of music. Petitioner contends that he made adjustments and retooled his career and that he was profitable in 2011…

After considering all the facts and circumstances, we hold that petitioner was engaged in the trade or business of music during the years in issue.

The Sax Man would never have won if he didn’t have the records to support his expenses in the first place.  If he didn’t have the mileage and other records, the IRS would have won on substantiation grounds.

As my oldest son is embarking on a career as a professional musician, I can only hope he doesn’t incur six figures in losses before he figures out a profitable business model.

Cite: Gullion, T.C. Summ. Op. 2013-65

 

TaxProf, Roe: Did Taxes Cause the Financial Crisis?   “And yet the argument that this tax preference for debt played a role in the financial crisis – and that it remains an ongoing risk to financial stability – was quickly rejected.” 

Jack Townsend, Sentencing, Redemption and Predicting the Future:

Paroles can permit someone to take a later look to see if there mitigating factors exist that could not be known to the judge in fashioning a sentence, even with Booker discretion.  Judges do not always predict the future well. 

 

All hail Skwire’s First Law.  The science is settled.  (Lynne Kiesling)

 

Joseph Thorndike, Can Debt Ceiling Debates Be Useful? History Says Maybe. (Tax Analysts Blog):

But the 1953 experience underscores the way in which debt limit debates have historically been used to focus the nation’s political attention on fiscal policy. That leverage has always entailed certain risks. But it’s also been successful – at least once.

Anything’s possible, but refer to Skwire’s First Law.

 

For those of you who have extended returns, 6 Weeks Is Not That Much Time.  (Trish McIntire).  Get your information together and to your preparer now.

 

TaxGrrrl, Ask The Taxgirl: Taxing Social Security Benefits   

Jason Dinesen, Glossary of Tax Terms: HSA   

Kay Bell, Rapper Fat Joe heads to jail for failing to pay federal taxes

Tax Trials, Elmore Leonard’s Tax Connection

 

TaxProf, The IRS Scandal, Day 111

Clint Stretch is Home From Vacation (Tax Analysts Blog):

Perhaps, with vacation fresh in their minds policymakers can think about tax reform and whether it’s fair to ask ordinary taxpayers to pay tax at higher rates so that wealthier taxpayers can get help from the treasury in buying second homes.

The obvious place to start is with the repeal of the mortgage interest deduction for second homes. 

You can’t deduct interest to go on a cruise, after all.

 

Russ Fox is interviewed.  “I needed to either add an employee or a partner, but the tax and regulatory climate in California made that unprofitable. So I moved—both myself and my business—to Nevada.”  He also posts on a three time Tax Court loser:  The Third Time Wasn’t the Charm

 

Robert D. Flach surprises with a special midweek Buzz!

 

Peter Reilly,  Louisiana Second Amendment Sales Tax Holiday – Why Stop There ?  

The Critical Question:  Why Are Cab Fares So Expensive? (Alan Cole, Tax Policy Blog)

 

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F. Lee Bailey, tax litigator

Tuesday, April 3rd, 2012 by Joe Kristan

F. Lee Bailey once had fame as an attorney like a rock star.  His name is no longer a popular synonym for “awesome lawyer,” so maybe that’s why he decided to see whether he should try his hand at tax litigation. 

He certainly chose a difficult case — his own.  The IRS was after him on several issues, the biggest of which was an attempt to tax him on client funds that he was holding (long story involving a foreign fugitive).  The IRS wanted to tax him on about $5.9 millions of funds on the grounds that it was available for his personal use.  The Tax Court assessed him on about $450,000 of the funds that he “wrongly appropriated” and later repaid.

Mr. Bailey did less well on the hobby loss portion of his case.  He failed to convince the judge that his custom-built yacht was a “for-profit” activity.  One of the elements of the “hobby loss” tests is whether the taxpayer derives personal pleasure from the activity.  Mr. Bailey said the yacht was just no fun.  From the Tax Court opinion:

The Commissioner contends that Mr. Bailey took a great deal of personal pleasure from sailing on the Spellbound with his family and friends, but Mr. Bailey claims that “[i]t’s no fun to drive a boat”. Mr. Bailey testified that the steering wheel and navigational instruments of the Spellbound are isolated from the rest of the deck, and the pilot is therefore isolated from the party-goers on the deck.

While it may be true that Mr. Bailey did not enjoy piloting the yacht, the record belies the claim that he derived no personal pleasure from it. First, the Spellbound was built to Mr. Bailey’s specifications, and he testified that it was beautiful. Second, the record does not show that Mr. Bailey always took on the job of piloting the Spellbound. PBR hired a captain and crew to sail and maintain the Spellbound, and Mr. Bailey could have used their services to pilot the yacht any number of times. Even assuming arguendo that Mr. Bailey piloted the Spellbound on every personal trip–and that he disliked the task–we find that he derived pleasure from sharing the yacht with his family and friends and that he anticipated doing so when he purchased the yacht in 1989.

This factor–elements of personal pleasure–is in the Commissioner’s favor.

The 143-page opinion covers over a dozen different tax disputes the famous litigator had with the IRS, with the IRS prevailing on most of them, to the point that the court upheld an accuracy-related penalty

Peter J. Reilly has much more

Update: The TaxProf also has more.

Cite: Bailey, T.C. Memo 2012-96

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Iowa Department of Revenue goes after law prof’s Schedule C losses

Wednesday, September 21st, 2011 by Joe Kristan

The Iowa Department of Revenue has historically stuck to state-only issues. They would do exams to see if non-residents were reporting all of their Iowa income, for example, or they would examine taxpayers claiming Iowa-only breaks, like the 10-year capital gain deduction. But for the most part Iowa tax law piggybacks federal law, and if the IRS missed an error, Iowa wouldn’t come looking for it.
No more. At least when it comes to hobby losses, Iowa has begun its own examination program. A Des Moines resident recently lost an argument before an administrative law judge over his Schedule C losses.
The taxpayer is a former Drake University law professor who took emeritus status in 2004 — meaning he retired. He continued to keep his hand in, though, working with the Drake Legal Clinic and developing a motivational program for law students, among other activities. Over a five year period he reported gross income from these activities of $12,670 and expenses of $84,669, for a net loss of $71,199. No single year of the five showed a profit. The hearing officer decided that the professor had not established a profit motive:

Rather, my assessment of the record leads me to conclude that as he approached retirement Professor Power continued to be involved in the same activities that he had throughout his career

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Losing the llama loss in Fairfield

Friday, May 6th, 2011 by Joe Kristan

Fairfield is an Iowa hotbed of Eastern thought, so you wouldn’t be too surprised to find a one-L Lama there. There are also quite a few two-L llamas.* The Iowa Department of Revenue thinks they’re there for fun, not profit.
The Department this week published an administrative ruling rejecting deductions for a Fairfield Llama farm as an activity not engaged in for profit — a “hobby loss.”
20110506-2.jpg
Flickr image courtesy Jonty Sewell under Creative Commons license.
The Llama farm is conected with the Overland Store in Fairfield, a seller of “Shearling Sheepskin Coats, Leather Jackets, Fur Coats, UGG Boots, Sheepskin Rugs and more.” The “more” apparently includes llamas. From the store’s web site:

Behind the Overland building, you can find one of the largest llama herds in the Midwest. There are some 240 registered llamas with blood lines from Peru, Bolivia, Chile, New Zealand, and several from some of the best North American ranches. Bring your kids and visit the farm!

The llama business had losses over the years as follows, according to the ruling:
1998: $83,089.00
1999: $77,072.00
2000: $75,826.00
2001: $65,587.00
2002: $60,197.00
2003: $89,533.00
2004: $115,681.00
2005: $63,411.00
2006: $39,481.00
2007: $45,141.00
The department appeals panel applied the factors in the Section 183 “hobby loss” rules:
1. Manner in which the taxpayer carries on the activity.
2. Expertise of the taxpayer or his advisors.
3. Time and effort expended by the taxpayer in carrying on the activity.
4. Expectation that assets used in activity may appreciate in value.
5. Success of the taxpayer in carrying on other similar or dissimilar activities.
6. Taxpayer

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Why you don’t want to bring cats to work

Wednesday, February 2nd, 2011 by Joe Kristan

There is surprisingly little tax law on IT-consulting C corporations combined with a cat-raising division. The Tax Court this week stepped into this void in a case right out of my hometown of West Des Moines.
A taxpayer performed IT services out of her C corporation, DKD, on contract. DKD was based in her home. It was a busy place, as the home also served as the “cattery” for DKD’s “cattery activity” of raising “Norwegian Forest cats.”
20110202-2
Flickr image of Norwegian Forest Cat courtesy don.banane under Creative Commons license.
The taxpayer had the bad fortune of being a client of a Clive, Iowa tax prep firm that the IRS is trying to shut down, ensuring that the IRS would take a close look at her tax filings. The IRS noted that the the corporation’s cattery revenues were from zero to under $3,000 over a period of several years, but the cattery expenses ranged from $55,000 to $75,000. As a result, the IRS jumped to the conclusion that the activity was not conducted with a profit motive. The Sec. 183 “hobby loss” rules disallow losses from activities not conducted for profit. UPDATE: A commenter correctly points out that the loss was disallowed not under Sec. 183, which applies only to individuals and S corporations, but under Sec. 162, which only allows “ordinary and necessary” expenses “in carrying on any trade or business.” If there is no profit motive, there is no “trade or business,” and therefore no deduction under Sec. 162.
The Tax Court sided with the IRS, saying that the only evidence of a profit motive was the testimony of the taxpayer and her domestic partner, “on which we are unwilling to rely.” They said the cat expenses were an expensive hobby of the taxpayer, DKD’s sole shareholder, and were therefore non-deductible. The court also treated some of the expenses paid by the corporation as disguised dividends to the shareholder.
This case points out that the courts may be unwilling to accept your word that you are really, truly in it for profit when the numbers seem to show that profit will never happen.
The case also should give pause to practitioners. The preparer here was under investigation by the IRS anyway, but preparing returns with these large “hobby” losses probably didn’t score the preparer any points with the preparer oversight folks. At some point, preparers may have to tell clients that they don’t believe the cat ranch (or multi-level marketing deal, or horse farm, etc.) will really turn a profit someday.
Cite: DKD Enterprises, T.C. Memo 2011-29

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Blogging deductions?

Friday, February 12th, 2010 by Joe Kristan

TaxGrrrl has a long and useful list of potentially deductions for bloggers.
A note of caution: If the deductions exceed your blogging income, or the income from the trade or business for which you blog, think twice. The tax law’s “hobby loss” rules only allow net losses from activities conducted with a profit-making objective. If your blogging is a hobby, and it only produces a few dollars annually from Google Ads, don’t expect your tax return to help pay for new computer equipment and a video-casting studio. But if your blogging makes you some real money, or if you blog as part of your business marketing, go for it.

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Ex-Iowan wins six-figure hobby-loss case

Friday, October 3rd, 2008 by Joe Kristan

Alan Miller became a successful entrepreneur while living in Van Meter, Iowa, about 20 miles west of Des Moines After making a success out of Electric Pump and Tool Services, he developed an interest in Paso Fino horses – an interest that led him to move to Florida and engage a prominent trainer to help him develop his herd.
Horses cost money, and Mr. Miller’s schedule C’s reflected that, according to a Tax Court opinion issued yesterday:

Beginning in 2002 and continuing in 2003, 2004, 2005, and 2006 Mr. Miller filed a Schedule C, Profit or Loss From Business, listing his principal business as “show horse breeding”. In 2002 Mr. Miller reported losses of $95,571 on his Schedule C. In 2003 Mr. Miller reported losses of $126,377 on his Schedule C and losses of $9,223 on Form 4797, Sales of Business Property. In 2003 Mr. Miller sold three horses at a loss. In 2004 Mr. Miller reported Schedule C losses of $139,098 and losses of $13,742 on Form 4797. In 2004 Mr. Miller sold one horse at a loss

The IRS invoked the Section 183 “hobby loss” rules, saying that Mr. Miller wasn’t really trying to make money. The court ruled for Mr. Miller and against the IRS. Mr. Miller had some important facts on his side:
– He kept good financial records
– He kept his business and personal horses separate, and did not deduct expenses for his personal mount.
– He kept logs of his business activity, recording 800-1000 hours per year on the horse breeding.
– He modified his business to fix bad results.
– He engaged experts to improve his busineses.
– He had a track record of success as an entrepreneur.
– He had a plausible plan to show a profit.
The more typical hobby loss facts feature a professional – a doctor, lawyer, dentist or accountant – who spends full time on his professional activity, keeps poor records, and has no hope of ever making money.
Congratulations to local attorney Ron Mountsier, who lawyered the winning case.
Cite: Miller, T.C. Memo 2008-224.
Related: Hobby losses dog IRS auditor

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YOU CAN LOSE MONEY, AS LONG AS YOU ARE TRYING TO MAKE SOME

Thursday, August 21st, 2008 by Joe Kristan

The IRS has issued a new “fact sheet” (FS-2008-23) on the so-called “hobby loss” rules of Code Section 183. The tax law itself doesn’t use the term “hobby loss”; it revers to “activities not engaged in for profit.” Even if you aren’t having any fun at all, the IRS will disallow loss deductions if they think you aren’t serious about trying to show a profit.
The fact sheet lists the following factors the tax law uses to determine whether there is a profit objective:

* Does the time and effort put into the activity indicate an intention to make a profit?
* Do you depend on income from the activity?
* If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
* Have you changed methods of operation to improve profitability?
* Do you have the knowledge needed to carry on the activity as a successful business?
* Have you made a profit in similar activities in the past?
* Does the activity make a profit in some years?
* Do you expect to make a profit in the future from the appreciation of assets used in the activity?

The classic “bad facts” under the hobby loss rule would be someone with a full-time job – say, a dentist – who offsets a high level of salary income with losses from a farm – maybe a horse farm – that never comes close to showing a profit. Multi-level marketers also frequently have trouble with the hobby loss rules.
If you are really trying to make a living from your business, Section 183 isn’t a problem. If you’re just playing at it because you like the tax deduction, you have a problem.

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HOW NOT TO FARM THE GOVERNMENT

Friday, November 16th, 2007 by Joe Kristan

20071116-3.JPGKansas is a prosperous agricultural state, but you can’t try to raise just anything. Just ask Dennis and Margaret Knudsen.
These Liberal residents (Liberals? Libertarians?) took a fling at raising exotic animals. It’s not for the faint of heart, as the Tax Court explains:

* Petitioners lost many bird eggs and chicks after an employee brought her young child into the bird breeding facility.
* Wind storms caused eye problems for the Rocky Mountain goats, which affected their breeding.
* A drought in Kansas negatively affected the breeding of many animals.
* A very expensive bird escaped after an employee left the bird cage open.
* A heater failed on a very cold night, resulting in the deaths of two bongos.
* Two Clydesdale horses died in a barn fire.
* Several gemsbok crashed into a fence during the barn fire, and one of them was killed.
* Several others lost market value after breaking their horns.
* A coyote killed a Black Buck antelope.
* A mountain lion killed an East African crowned crane and its chick.
* A male addax died during a windstorm.
* A giraffe died after slipping on wet ground.
* A giraffe calf died as a result of the cold weather on the night of its birth.

From 1995 through 2002, the Knudsens deducted over $2.9 million in taxable losses from the farm — not surpising, considering their Job-like litany of mishaps. Fortunately, Mr. Knudsen has a good day job as aon OB-Gyn physician. Unfortunately, the IRS came calling.
The tax law’s “hobby loss” rules (Section 183) disallow business losses from businesses “not engaged for profit.” Such losses carry forward against the day, if ever, that the business makes money. The Tax Court evaluated whether the Knudsen’s farming operation was a profit-seeking venture using nine tests in the section 183 regulations. The court decided that the farm passed one of the tests, failed six, and tied two. The Knudsens lost.
The Moral: If you want to farm the government, forget the giraffes and alpacas; best stick with the time-tested corn subsidy and CRP programs.
Taxable Talk has more.
Cite: Knudsen, T.C. Memo. 2007-340

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