Exam
HOBBY VS. BUSINESS
words, you need to go through the process of looking at every horse in your barn and be able to say “this is how much I have into this horse and this is how much this horse is worth today.” If the purpose of owning the horse is to sell him, then doing this analysis lets you determine whether you stand to make money if you sell the horse soon or, if not, how much you are un- derwater on any specific horse. Know what sales price you hope to
achieve for each horse and when. Do you expect the horse’s value to appreciate or de- preciate over time? If so, based on your cost basis and an estimate of what it is costing you to maintain this horse per year, what is the minimum sales price that will allow you to break even on this horse? Will the expected sales price at date X allow you to realize a profit on this horse, or not? If you are not going to make money on this horse, the IRS is going to ask why you continue to own and maintain him: you’d better have a good answer or else that horse starts to look less like a business as- set and more like a pet. If you didn’t make money last year, un- derstand what you must do to make money this year. To do this, you really need to look at your past numbers (first guideline above), and come up with a plan to have a profitable year this year and document it well. It is not a good idea to say, “My plan is to sell more horses, earn more prize money and make a profit!” You have to do the math, on paper, and show your work (think back to middle-school math). If you have ever sustained a loss year,
have a plan for recouping past losses. In the past decade or so, the IRS has taken the posi- tion that proving you are a business requires being able to demonstrate how the business will make enough money in future years to recoup past losses. In other words, you have to analyze not only last year, but previous loss years, and formulate a plan for how the entire enterprise will operate profitably over the course of its lifetime. Again, it is crucial that you crunch the numbers and write them down, and address recoupment of past losses as a long-term business goal.
80 March/April 2016
A BONA FIDE PLAN Ideally, you will take all your math and hard
thinking about these issues and come up with a plan for next year. And you will write it all down. Remember, a proper business plan is not just what you hope to do in the future. Instead, it is a documented analysis (including the math) of what you have done in the past, what you hope to achieve in the future and what you intend to do now as a stepping stone to realizing your future goals. From the IRS’ point of view, you should have only one goal: making a profit, so you can pay more taxes. As painful as it may be to think about docu-
menting a business plan, you must understand and accept that a proper business plan is not a one or two page document. It is more like a term paper or end of year project—the kind of thing you had to do in high school or college. Ideally, I estimate it should be ten pages or more, with charts and numbers and calcula- tions, and long paragraphs explaining what you’ve been doing, what you plan to do this year, what the future will look like and any re- cent setbacks. At this point, you might be thinking that this is all crazy advice. How can one find time to write a ten-plus page report when there are horses to train and a barn to manage? Guess what? Getting audited will be much more painful and time consuming than writing a business plan. My advice to you is to create a business plan
now. Simply get it over with and file it away until next year, when you’ll need to update it. If you are unfortunate to receive a notice
from the IRS of an audit, you will thank me, because I can almost guarantee that the first thing the IRS examiner will ask to see is a copy of your business plan. When you have one ready, you demonstrate that you take your business seriously. It helps differentiate the business person from the hobbyist—and that can make all the difference.
Attorney Krysia Carmel Nelson, from Virginia, is a nationally-recognized expert in equine law. She represents owners, trainers, riders, breeders, facilities, farms, clubs and associations across all nationally and interna- tionally recognized disciplines.
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