Business Deductions Profit Motive
Required
We’re
all familiar with the rules that deny a tax
deduction for losses from activities engaged in
as hobbies. There have been many court
decisions on this issue, with the taxpayers
involved often being high-income professionals
seeking to write off their avocation to reduce
the taxable income from their vocation. Three
recent tax cases remind us of these rules and
point out that even a well-intentioned taxpayer
is vulnerable to the profit-motive requirement.
Giles.
The April 2005 issue of Tax Tips covered the case
of Elizabeth Giles, a California dentist whose
attempt to deduct losses from a horse breeding
operation was disallowed by the Tax Court under
the hobby loss rules. Despite the court’s
decision, Dr. Giles has tried again for three
later years. She has met with the same
result, for the reasons summarized as follows by
the Tax Court:
“Petitioner
repeatedly testified that she intended to derive
a profit from her horse activity and wished to
use the activity as her source for retirement
income. Petitioner’s assertions,
however, are not supported by the facts. In
16 years of operation, petitioner had 1
profitable year. Despite continual heavy
losses, petitioner did not seek out expert
advice, or attempt to educate herself, on the
economic aspects of running a profitable
horse-breeding business. Petitioner did not
operate the activity in a businesslike manner.
In addition, if not for her significant annual
wage and rental income, petitioner would have
been unable to continue the horse activity at a
loss year after year.”
Dr. Giles’ case is a
textbook example of trying to write off a hobby.
(Losses in 15 out of 16 years will not often
fly.)
Montagne.
In another recent case, Montagne, the Eight
Circuit upheld the Tax Court’s decision
against another hobbyist horse breeder. Here,
the taxpayers were a chiropractor and his wife
whose case was summarized as follows by the
court.
“The evidence in the
present case established, among other things,
that the Montagnes lacked a written business plan
or financial projections for their horse breeding
and training activities; that they maintained a
single bank account for both personal and farm
expenses; that they failed to generate separate
business records for their horse-related
activities; and that they failed to develop
economic expertise or to solicit such expertise
from others regarding their horse-related
activities.”
Once again, we have a
textbook case of how not to run a business, with
the Eight Circuit predictability disallowing the
Montagnes claimed deductions.
While
it may seem obvious that Drs. Giles and Montagne
deserved to lose, since they were just trying to
write off a hobby that they enjoyed, sometimes it’s
not so clear who the good guys are (as you’ll
see in the Lamb case below). Remember that
the essential question is not whether the
taxpayer enjoys the activity (after all, some of
us enjoy preparing tax returns), but whether the
activity is engaged in for a profit, as stated in
the latest Giles decision:
“For these and all
other reasons stated herein, we find that
petitioner’s horse activity was not engaged
in for profit within the meaning of section 183.
Therefore, respondent’s determination that
petitioner may not deduct losses from that
activity is sustained.”
Lamb.
So what’s the story with the Lamb case we
mentioned above, where an apparent good guy lost?
Here, the taxpayer was a doctor employed by a
V.A. hospital. He was also an attorney.
In
addition to his full-time employment with the
V.A., Dr. Lamb maintained what he considered to
be a private medical practice and a law practice.
All of his patients were elderly and indigent,
and he didn’t charge them for his services.
This unusual situation came about from his days
as a private practitioner, before he began
working at the V.A. hospital. When he
accepted his full-time job with the V.A., all of
his financially capable patients went to other
doctors, and his indigent patients had nowhere to
go. Dr. Lamb felt an obligation to continue
attending to their needs. However, he did
not see any patients at his home. He
attended to them at either public clinic or other
health/medical facilities. As to his law
practice, the clients were also nonpaying. Virtually
all o his work in that area involved incarcerated
clients. Dr. Lamb considered these two
activities a trade or business for tax purposes.
His claimed office was in his home.
Dr.
Lam claimed Schedule C losses of $50,312 and
$44,235 for two years. The IRS argued that,
since Dr. Lamb realized no income from these
activities, he wasn’t engaged in a trade or
business; therefore, none of the Schedule C
expenses were deductible as trade or business
expenses. The Tax Court agreed with the
IRS, stating that:
“The law is well
settled that a business is a course of activities
engaged in for profit. Activities that are
for a purpose other than profit do not evidence
business engagement.” The decision
further states that “The Court rejects
petitioner’s argument that his salary from
the V.A. should be aggregated or attributed to
his Schedule C activities as a counterargument to
respondent’s determination that, because
there was no trade or business income, the
expenses related thereto are not deductible.”
While there was another
issue in the Lamb case concerning the
deductibility of purported job search expenses
that perhaps slightly darkens the shade of Dr.
Lamb’s white hat, he’s still a good guy
in our book for providing free medical and legal
help to the needy. Unfortunately, the book
that counts here is the Internal Revenue Code,
Section 183 of which requires a profit motive,
not good intentions, to sustain deductions.
So whether a taxpayer is enjoying his horses or
providing essential care for the poor free of
charge, the result is the same: no profit motive,
no deduction.
Giles, TC Memo
2005-28 and 2006-15; Montagne, 97 AFTR 2d
2006-992 (8th Cir. 2006); Lamb,
TC Summary Opinion 2006-13
Information provided by Tax
Tips Quickfinder Newsletter, April 2006,
v.3.4 (Thompson PPC)
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