By: Diane Ring
In teaching Basic Income Tax, I have found that teaching students about the lines between engaging in a trade or business, profit seeking, and hobbies helps them become comfortable using facts in tax analysis and argument. It confirms for students that tax law is a type of law demanding factual and legal analysis – facts do matter and they are not self-evident. Thus, in anticipation of my next class, I have been collecting (thanks to Tax Notes and the BNA Daily Tax Report) new examples of taxpayer failures to convince a court that their activity was, in fact, for profit. It turns out the pool is quite large, but some personal favorites have risen to the top . . .
Flying: In May 2016 the U.S. Tax Court ruled the taxpayer’s acquisition of an airplane was not part of his urology practice and its status as a profit-seeking venture must be assessed on a stand-alone basis. Of course I was very curious about the grounds on which the taxpayer had claimed that the plane was part of his medical practice. I was in for a surprise; I had not anticipated the level of tax planning that the taxpayer had pursued to create an aura of profit seeking. Before acquiring the plane, the taxpayer consulted Advocate Aircraft Taxation Co. (later called Advocate Consulting Legal Group). Ultimately, the taxpayer created two new limited liability companies (one as owner of the plane, one as operator). The court, after examining the relevant leases and agreements between and among the various parties, concluded that the activity of the two new entities was not one engaged in for profit. Thus, taxpayer’s use (on a flow-through basis) of the entities’ losses on his personal tax return was denied. Additionally, the court concluded that the air travel activities of the two new entities could not be combined with the taxpayer’s existing urology business (so as to be treated as a single business, thereby securing deductions for the air travel activities). Flying to rural clinics took more time than driving. Moreover, the taxpayer purchased (through his entities) a plane “because he enjoyed flying and personally preferred to fly instead of to drive [to rural locations].”
Alpaca Farm: The classic case of an activity failing to be profit seeking and being relegated to hobby status is the horse farm. (Think the 1968 case of Margit Bessenyey and her beloved Hungarian horses). But what about an alpaca farm? That seems more likely to be a trade or business. I am not familiar with people riding alpacas for pleasure in the same way they do horses. Unfortunately for the taxpayers, in a May 2016 decision (White v. Department of Revenue, State of Oregon), the Oregon Tax Court was persuaded that in this case the taxpayer’s 15-year history of income and expenses did not reflect the expected pattern of “decreasing expenses and increasing income; instead the amounts appeared to be random. . . [and] very little income was derived from the sale of alpacas and the largest gains were from an insurance policy from the death of an animal and the sale of a trailer.” Taxpayers did not maintain financial records, did not change farming methods that had proven unprofitable, and “presented no evidence of the possibility of even an occasional substantial profit.” On the other hand, the taxpayers enjoyed “the social connection of joining associations dedicated to the animals” and “lived and worked on the farm which offered them a rural lifestyle that many in their area seek.” Ultimately, these alpaca farmers had a hobby, not a profit-seeking venture, much less a business. From a tax lawyer perspective, these alpaca farmers clearly did not read the earlier Bessenyey horse farming opinion, with its undercurrent that to prevail you should be awash in financial data and have only minimal affection for your animal charges.
Baseball Cards: The all-American hobby of many generations of youth, collecting baseball cards, could be a profit-seeking activity, but not for the taxpayer in the May 2016 Oregon Tax Court Decision (Alexander v. Department of Revenue). Although the taxpayer maintained a website inventorying his collection, and had hired an assistant to handle sales logistics and manage the website, the taxpayer also noted that he “felt contented with his retirement income and . . . decided that his goal was not to make current income . . . but create a legacy for his grandchildren.” Like the Alpaca farmers, this baseball card collector ran losses for years (in this case from 2001 through 2014), and testified that he considered “the loss was a gain, in the sense that it would reduce my tax burden.” His plan was to keep purchasing more cards than he sold with the expectation that he would continue to “‘lose’ money until he stopped accumulating cards when he died or became incapacitated.” At this point, the outcome of this case was not hard to foretell.
In the end, my own collection of business, profit seeking, and hobby cases reveals more than the importance of facts and storytelling in tax – it inevitably provides great examples of aggressive tax planning, “persistence” in the face of clear law to the contrary, and the sometimes confused understanding of “loss” in the tax system.