With April 15th just around the corner, horse owners nationwide are trying to find out if they can deduct the costs of owning their horses. For those involved in horse training, breeding or sales, knowing the IRS rules for horse business deductions is crucial to success.
Profits and Losses
At the end of the year, you will need to add up all of the money your business brought in (revenue) and all of the money you spent (expenses). When you subtract the expenses from the revenue, you'll find out your business' earnings for the year.
If you earned more than you spent, you made a profit -- congratulations! However, Uncle Sam wants to share in your good fortune (and hard work) by charging you a tax on your earnings.
If you did not earn more than your expenses, you have a loss. Luckily, in certain situations, the IRS will lighten your burden by allowing you to pay less tax on money you earned elsewhere for the year. This can be a boon for those of us who also work off of the farm. However, be advised that using horse-related losses to offset income from other sources may make the IRS curious about your equine business.
In order to deduct your horse expenses, your operation must be a business and not a hobby. In order to prove that you have a business, you must be running your operation with the purpose of making a profit. While you are not required to make a profit every year, you are expected to make an occasional profitat least two out of seven years. Otherwise your business will be reclassified as a hobby and your expenses will not be deductible. According to the IRS, most legitimate horse businesses fall into one of the following categories: breeding operations, equine camps and workshops, boarding, riding lessons (with a horse that is not your personal pleasure horse) and horse racing.
If the IRS begins to suspect that your equine activities are more hobby than business, it may attempt to have your business reclassified as a hobby. If the IRS is successful in its attempt (and it reportedly is successful about 80% of the time), you will probably owe back taxes and penalties.
Passive losses and material participation
Due to changes in the tax code brought about in the 1986 Tax Reform Act, your ability to deduct losses is dependent on your active participation in the business. This means that if you have a few brood mares that someone else is managing, your losses may not be deductible.
Active participation does not require that you physically perform work on the farm or with your horses. If you are actively making decisions about what stallion you will breed to, what training they will get, or other regular decisions about your horse's care, you may be able to deduct your losses to offset your regular income.
Keeping proper records
If you are trying to deduct your business expenses, it is essential that you maintain proper records of your income and expenses. Ideally, the records should be created on a regular basis, not created solely when needed for an audit. For example, weekly updates in an appointment book or daily updates to a mileage log are much better records, and much more convincing in tax court, than reconstructed records pieced together after the fact.
In the case of an audit by the IRS, you will need to produce receipts that validate the expenses that you are trying to deduct. Also, you should be able to show that all of your receipts (especially if you receive a lot of cash payments) are deposited and accounted for as income.
If you do not keep good records, the IRS can refuse to allow you to deduct some of all of your expenses -- adding an additional financial burden to you and your business.
How to find a Horse Income Tax Accountant
The greatest number of people in the tax field are accountants, followed by attorneys. In addition there are many seasonal tax preparers -- people that work only during the tax season and are able to help you fill out your tax returns.
Few of these seasonal tax preparers (i.e. folks who work seasonally at H & R Block or other big companies) are likely to be well-versed in the complexities of horse tax law, so you may be better off having looking for advice from a full-time accountant or lawyer. However, many full time accountants and lawyers may also lack familiarity with the nuances of farm and equine tax laws, so you may have to look around for an advisor who specializes in farm and equine tax laws and accounting.
Most people looking for a tax specialist find their tax advisors by referral. Thus you should start your search by asking friends or your equine attorney. Often your attorney will know a tax preparer that does work for many of her clients. You can also ask your local horse breed association for a referral. The internet is another way to find a specialist, but it is wise to get references if you are going to use a lawyer or accountant who operates outside of your community.
Whether or not your equine activities qualify you for a tax deduction, now is the time to think about it. And if you don't qualify this year, you may be able to make a few changes in the new year to comply with the tax regulations and save yourself on taxes next year!