The IRS continues to give significant scrutiny to sole proprietorships filing as Schedule C businesses in the horse, livestock and farming industries where there is a history of losses. The concern of the IRS is that these taxpayers are engaged in a hobby, not a business, and that they should not be allowed to take tax deductions to offset their principal source of income. People who are being audited by the IRS in connection with these activities should have in mind certain strategies. The principal issue is whether losses in the venture are deductible or whether they are hobby losses which are not deductible. Some suggestions are as follows:
1. You or your representative should find out what the IRS agent is looking for prior to formally participating in the audit.
2. You should not personally attend the audit, but should delegate that duty to a representative (an attorney or qualified tax representative) because it is an adversarial proceeding and often the less you say, the better.
3. If the amount of money at stake is considerable, you should hire a tax attorney to represent you.
4. You should make sure your business records are in good order, with the arithmetic adding up, and that there is no commingling of personal funds with the expenditures of your horse, livestock or farming venture. Many people operate under the auspices of an LLC entity or a corporation, and in those cases one should be able to present the Corporate Minute Book in an updated state.
5. At the audit your representative should provide only those documents specifically requested. Your representative should ascertain beforehand the specific issues involved in the audit.
6. In tax planning for the future, particularly if your losses are large, you should obtain a tax opinion letter from a tax attorney to support that your operations are consistent with IRS Regulations. A tax opinion letter serves an important evidentiary function to show that you are in compliance with IRS Regulations, and that you have sought out the advice of an expert.
7. If the IRS agent asks you to waive the statute of limitations, this is not recommended because there is no benefit to you in doing so, and it only gives the IRS more time to conduct a fishing expedition.
8. If you are denied the deductions and issued a 30-day letter, this starts your appeals process. At this stage you should consult an attorney and decide whether to go to Tax Court, or to IRS Appeals. In order to proceed to Tax Court you have to await issuance of a deficiency notice, giving you 90 days in which to take action.
9. In Tax Court you have a better chance of prevailing, and there are opportunities to settle the matter for a fraction of what the original auditor claimed was due.
The taxpayers who succeed at the audit phase are those who have had the best tax planning. Taxpayers who go to the trouble and expense of obtaining a tax opinion letter from an attorney usually do well in audits because they are able to show more clearly that they are serious about their activity and that it is conducted in a businesslike manner.
One of the most important features of IRS Regulations pertaining to the horse, livestock and farming industries is your intention to make a profit, meaning your objective as well as subjective intention in engaging in the activity.
Nowadays the IRS will want to know if you have a formal business plan rather than a plan that is merely in your head, and most people do not. A business plan should cover a forecast of the activity for future years, and allow for contingencies for unforeseen circumstances. A business plan should show how you determine gross receipts for each year and what circumstances will cause the venture to become profitable.
[John Alan Cohan is a lawyer who has served the horse, livestock and farming industries since l98l. He serves clients in all 50 states, and can be reached at: (3l0) 278-0203 or via e-mail at JohnAlanCohan@aol.com.]