Non-Corporate Tax Information
Business vs Hobby
The IRS draws a strong line between what they consider to be a business and what they term a "hobby" operation. A "hobbyist" doesn't really intend to make a profit, and uses their supposed business deductions to get a significant tax refund from the funds that were withheld from wages reported on their W2. Most "hobbyists" hold down regular jobs and play with horses on the side. If the majority of your income comes
W2 wages, you will immediately be suspected of being a "hobbyist", so be prepared to support your "business" position.
How to Start
According to IRS guidelines, if you start a small business, your "intent" must be to make a profit. A small business must make a profit two out of every seven years. You can lose money for the first five years you're in operation. At that point in time, you can simply stop your business and take any "assets" you have been depreciating, out of service. You can also regroup, and change the type of operation you are running,
from breeding (Animal Production, Code 11210) to horse training and sales, (Other Businesses, Code 99999) on federal form Schedule C, for Small Businesses. Assets are items purchased to operate your business that cost over $400 to $500 and must be set up on a depreciation schedule. You deduct a portion of the purchase price each year for a specified number of years. It's the law.
Create and keep a
business plan on file that substantiates the plausibility of breeding or selling horses, in case your business proves to be unprofitable, and you get audited. A business plan is written proof that you researched your potential investment, and helps substantiate your "intent" to make a profit if the IRS tries to disallow your expenses. We set our business up as a "sole proprietorship"
on a federal form called a Schedule C. A "sole proprietor"
is one individual. I have a Schedule C in my name, for the breeding end of our business, and my husband has one for his training. I have several clients who raise cattle and horses. I have their farm, with the cattle, on a Schedule F, and the horses on a Schedule C. That is the proper way to do it. Generally, it might be more prudent for the individual who is not the main bread-winner in the family, to have their name and social security number associated with the business, especially
if they are really doing the work. This may avoid an audit, if the IRS doesn't think you're in this business to avoid taxation, or to recoup a portion of the federal taxes you've already paid in to the government. We'll discuss corporations and partnerships later on.
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Schedule F: Farm
When this federal form was created, it was intended to be used by legitimate farms that produced consumable agricultural plants and animals. Beef and dairy cattle, swine, chickens, goats, sheep and commercially run fisheries are normally expensed on a Schedule F. This form has all of the categories we use in our horse business, like feed, veterinary fees and farm fuel. It does not have categories for travel, motels, mileage, entertainment or
these expenditures were never associated with farming. I often wonder if auditors frown when they see these expenditures listed on a Schedule F, under "other" expenses. They must be wondering how pig "farmers" can justify taking a client out for a power lunch! I like to keep the IRS happy by complying with federal guidelines, so I use a Schedule C.
Schedule C: Horses, Small Business
All non-agriculturally consumable animals like horses, dogs, cats, snakes, birds, fur bearing ranch animals and exotics like ostrich, are all supposed to go on a Schedule C. The Schedule C has a section for business expenses, including mileage, motels, meals and entertainment. I break all other equine related expenses down into categories like feed, horse show entries, veterinary fees, breeding fees, bedding and blacksmith charges and enter
under "other" expenses. Buckets, brushes, muck forks, wheelbarrows and small tools, are deducted under "supplies".
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The IRS doesn't care whether you have a small business, or a multi-million dollar empire….they expect you to keep the same type of business records. You must prove the expenses were both
ordinary and necessary to run your business. You must show cancelled checks and receipts for each deductible purchase and your quarterly American Express statements are worthless as far as the IRS is concerned. Cancelled checks and receipts. A cash purchase must be documented with a receipt and journal entry for the amount and description, or it can be disallowed.
You must keep your
records in a safe place. You must keep your records forever, if you are
running a business. Records consist of cancelled checks and receipts. During an audit, you are guilty until you prove yourself innocent. If the IRS finds against you in an audit and you want to appeal, the shoe goes on the other foot, but you have to have records to prove your case. If you lose the records, or they are destroyed by flood, fire or theft, it is still your responsibility. If you cannot produce your records, the IRS can disallow your expenditures.
IRS suspects fraud of any kind, whether from stupidity or by design, they can audit your tax returns back to the first one you ever filed. I tell my clients to remember what happened to the country singer, Willy Nelson. They audited his returns back to his college days and he ended up owing them several million dollars in back taxes, penalties and interest. It didn't matter that Willy Nelson knew nothing about income taxes, or that his accountant hadn't taken care of him.
you sign your tax return, you take responsibility for what's in it. That's the law. The IRS has a lot of power. They have the power to take your home and all of your business assets. They have the power to put you out on the street and keep all of your clothes and personal belongings. Keep good records, and employ a top equine tax specialist to keep you on track, and you have nothing to fear. Check with your tax person BEFORE you buy or do something, not afterwards. It's
too late then!
Michelle A. Stallings
Equine Income Tax Specialist