Originally published on Forbes.com.
One of the joys of reading Tax Court decisions is the Monday morning quarterbacking aspect. I can’t fault the advice that Michael and Sally Judah followed that led them to a Tax Court battle with the IRS about losses from their horse activities, but with the benefit of hindsight, I can dream up other approaches, that might have worked – or not.
It’s Not Easy Raising Horses
As I have mentioned often, everything I know about the horse business, I have learned from reading tax decisions. Conservatives of the Tea Party ilk believe they were targetted by the IRS for persecution. All I can say is they should be thankful they are not money-losing equestrian types. Interestingly, horse people often win in Tax Court, unlike Amway Independent Business Owners, who pretty much always lose.
The Judahs were challenging assessments totaling just over $130,000. The approach they took to the business was to buy horses that for the most part would be ridden by their daughter Ali in competition. The thinking was that if she did well that would enhance the value of the horse. As of 2012, they had not yet turned the corner and had racked up losses totaling over $1.5 million since 1998. That would be enough for the skeptical bean counter in me to think they were being lame, but I did a bit more research, which made me rethink things a bit.
A World Class Rider
I found that Ali Judah had made the US Team in the 2012 Saddle Seat World Cup in Parys, South Africa (I’m going out on a limb here in assuming that it is the same Ali Judah as in the case, but since otherwise would mean two people with the same name who started in a pretty obscure sport at the same time and are both from Lexington, KY, I’m going to risk it) Here is the tryout video
The other limb I’m going out on is assuming that going to the World Cup means you are world class. Whenever I encounter a new sport in a tax decision, I have this great fear of making an error like the time I got the “sport” of dressage all wrong when Mitt Romney’s horse was in the Olympics.
One of the things that was held against the Judahs was that there were no financial projections. The Tax Court has been easing up on the whole “business plan” thing in recent cases. Most notable was that of Susan Crile
Like most artists, petitioner did not retain professional business consultants. Rather, her principal “advisors” were the galleries that represented her. Through-out her career, petitioner was represented by five New York art galleries. These galleries exhibited her work; arranged openings and customer receptions; and marketed her work to collectors. The expertise of petitioner’s advisors seems indisputable.
While conceding that petitioner and her advisors have the requisite artistic expertise, respondent contends that she lacks expertise in the economics of being an artist. But petitioner does not need an economics degree to know how to sell art.
I would have been inclined to use a similar argument here, since apparently Ali Judah has established herself as world class it is conceivable that a couple of lucky horse purchases of underappreciated potential champions could wipe out all those losses. The theory needs some work, particularly since there was a cutback in expenses when Ali started vet school. Regardless, the Judahs took another approach.
Another Approach
They claimed that the horse business was really integral to their real estate business and helped them attract clients. Unfortunately, they were not able to point to much in the way of real estate business that could be attributed to the horse activities. In earlier cases this year that strategy has both worked and not worked.
If that was going to be the strategy, though, it seems that the seemingly sensible accounting advice to have a separate entity and keep separate books and records might have backfired.
In addition, the formation documents of Judah Saddlebreds, JREG, and Judah Construction do not establish that petitioners intended for these activities to be operated as a single undertaking. Judah Saddlebreds’ operating agreement does not mention anything about real estate. Rather, its stated purpose is “to operate in the horse business industry by purchasing, breeding, training, showing and selling horses.” Likewise, Judah Saddlebreds’ mission statement does not refer to petitioners’ real estate activities. …..
Shared Books and Records Petitioners maintained separate books and records for each of their entities. Petitioners did not consolidate financials at yearend to present the financial statements of JREG, Judah Construction, and Judah Saddlebreds on a unitary basis. This factor favors respondent.
It really seems that there were two perhaps not contradictory but not entirely consistent arguments being made. One was that the horse activity had profit potential and the other that it had synergy with the real estate business. Some of the moves that supported the first argument detracted from the second argument.
All in, this might have been a hopeless case, but I think there would have been a better shot if the taxpayers had gone all in with one approach.
Good Advice But Not Expert
In discussing the whole business plan thing, the Court had a pretty amusing line. Discussing advice from their CPA, it noted
Petitioners argue that they sought business advice from their C.P.A. However, Mr. Malone simply advised petitioners to acquire horses and sell them for a profit. Petitioners also assert that Mr. Malone instructed them to form an LLC. These simple instructions form the basis of petitioners’ argument that Mr. Malone was an expert consultant. We disagree.
Mr. Malone’s advice to sell horses for more than petitioners paid for them is not expert advice by any means.
This makes me want to repeat the story about the two brothers who went out into the country and bought apples for a nickel which they brought to the city and sold for four cents, but I think I have overused it.
Other Coverage
The only other coverage was by L Carpenter on Taxing Lessons. It is presented in a kind of “You be the judge” format that goes through the various factors. This appears to be a relatively new blog and is worth a look.
Lew Taishoff, who covers the Tax Court very closely, passed on this case. I asked him why and he responded.
Mr. Reilly, I’ve blogged several hobby horse cases, and this one was much of a muchness: big losses, tiny income (if any), much fun for the taxpayer, much income from unrelated sources, the whole Section 183 rodeo, at the end of which IRS wins.
So, in Mark Twain’s immortal words “”I don’t see no p’ints about that frog that’s any better’n any other frog.”
On My Low Productivity
I attribute my low posting rate in the past week or two mainly to the holidays, but there was something else. I rate myself fairly literary for a CPA, which is not really that daunting a standard. I was rather ecstatic when my creative writing major son told me that one of his professors had seen my blog and referred to me as a writer. Anyway, I was tied up for a couple of days on a literary project which will either totally grab you or, much more likely, not register at all. I obtained James Gould Cozzens’s personal copy of Boswell’s Life of Johnson with marked passages. It was like looking over the shoulder of my favorite author as he read one of my favorite books. And thanks to my hours of tedious typing, you can have the same experience.