Code §183(a) generally disallows any deduction attributable to an activity “not engaged in for profit.” The section prevents those indulging in a hobby from offsetting their hobby losses against taxable income from other sources. See a recent case, Henry J. Metz, et ux. v. Commissioner, TC Memo 2015-54, which applies §183. SPOILER ALERT: The Metzes won, showing that they intended to make a profit from the sale and breeding of Arabian horses. Metz is not particularly important because of its application of §183 nor its extended discussion of the breeding of Arabian horses. What makes the case memorable is how proactive the Metzes were in building their case. The Metzes had to have seen a §183 case in the making. Between 2004 and 2009, the years in issue, the Metzes lost millions of dollars in breeding Arabian horses. When the Commissioner came knocking, the Metzes were ready—really, really ready.
Henry J. Metz, et ux. v. Commissioner
The Facts: As said, the Metzes won, showing that they intended to make a profit despite the loss of millions of dollars. How did they do it? See The Law below.
The Law: Treas. Reg. §1.183-2(b) lists nine factors in determining whether taxpayers intend to make a profit. The list is not exclusive, and courts don’t just throw a factor on one scale or the other to see which way the scales tip. A court’s decision, based on all the relevant circumstances, pretty much comes from the general sense of the weight and interrelationship of all these factors. Some of the factors are set out below:
- Records: The taxpayers kept careful records, hiring a CPA firm to perform monthly bank reconciliations, monthly profit and loss statements, workers’ compensation payments, and quarterly payroll-tax returns. The taxpayers also hired a law firm, apparently noted for its expertise in horse breeding, to prepare sale contracts. The taxpayers also had a list of prospective customers.
- Business Plan: The taxpayers had a written business plan, including goals, job descriptions, and policies and procedures.
- Advertising and Promotion: The taxpayers advertised extensively and had a website. Their expert testified that their site was prepared by the industry’s best website builder. And, just as good, the taxpayers used Google analytics to track which pages were most often read and the location of the visitors.
- Horse-by-Horse Tracking: The taxpayers sold dozens of horses between 2004-2009, including some in the six-figure range (one for $250,000). They gave horses away to cut feed costs. As the Court noted, the taxpayers were not just keeping pets.
- Change in Operating Methods and Adoption of New Techniques: The taxpayers moved their operations from Florida to California because of increased foot traffic, an excellent vet clinic, and the lower costs of supporting their herd.
- Expertise of Taxpayers and Advisors: The taxpayers knew the horse business (they were not weekend riders) and hired professionals to handle aspects of horse breeding that were not part of their expertise.
- Time and Effort: The taxpayers worked full time at horse breeding during the years in question.
The Court listed other factors in the taxpayers’ favor, but you get the idea.
As said, Metz is not particularly significant because of §183 or Arabian horses. The case has a much broader reach. It tells us to profile a new client to determine when we can give proactive ideas, no matter the area of the law, and to tell clients, new and old, to call if they start new ventures. In Metz, the move from Florida to California is a stretch but see how easy it is to do the rest.
The Tax Court applied the Golsen rule, which is simple. Because Metz is appealable to the Ninth Circuit, the Tax Court followed the Ninth Circuit rule—which is the subjective intent of the taxpayers, a significantly lower bar than that of other Circuits. See Golsen v. Commissioner, 54 T.C. 742 (1970), aff’d 445 F. 2d 985 (10th Cir. 1971).