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New state tax rulings place targets on ranchers

John Alan Cohan Published on 27 December 2010

Because state governments are hard-pressed for revenue, state tax authorities are getting more aggressive in audits, and this has an impact on the horse and ranching industries. In a new case, the Minnesota Tax Court ruled against the taxpayers who operated a horse and cattle ranch [Molnar v. Commissioner of Revenue, Docket No. 8039-R].

Ranchers who have a history of losses are the ones most likely to be audited by state or federal tax authorities. The state courts rely on federal regulations (the “hobby loss” rule) in deciding whether an activity may be considered “for profit.”

The taxpayers in this case consisted of a husband and wife who maintained Scottish Highlander cattle as well as horses, and operated Green Oaks Ranch and Stables, Inc., an S corporation.

I will summarize the main points of the decision below. The court made the following findings:

  1. The taxpayers began raising Scottish Highlander cattle, but had no formal education in cattle or the business of livestock breeding. The court said that the taxpayers “provided little evidence of businesslike operations at Green Oaks” and never developed or maintained a business plan for Green Oaks or any financial objectives in spite of huge expenses and minimal income. “Appellants made no investigation as to basic profitability and had no plan to pay back years of significant losses.”
  2. The court noted that the taxpayers engaged in limited advertising, and in fact spent no money on advertising in any industry magazines. “If the advertising undertaken is not sufficient to reach a large enough customer base, it is not consistent with a profit motive.”
  3. The court noted that Mr. Molnar attended the University of Minnesota during the tax years in issue, but “he did not pursue a degree or even take a course in business, accounting, management or marketing, which may have provided him with knowledge and expertise in the business operation of Green Oaks.”
  4. The court said that the taxpayers did not pay or receive any salary. “One may expect to work for nothing in a hobby or other form of recreation but one does not expect to work for nothing in a business, especially over a 20-year period.”
  5. The court said that Mr. Molnar “had little knowledge of when cattle were purchased or sold, or the prices paid for cattle.”
  6. Mr. Molnar claimed he worked 30 to 40 hours per week on the ranch, but the court said “there are no records to show how this time was spent,” and that he worked full-time at a bank, as well as attended the university to obtain a degree in computer science.
  7. The court noted that the taxpayers did not have insurance on their animals: “Thus, when a bull, Willie, slipped on some ice and eventually died, Green Oaks received nothing for its loss. Business assets, as opposed to recreational assets, are normally insured.”
  8. The court concluded that the taxpayers failed to show that their activity was operated in a businesslike manner, and denied their tax deductions. The court added that their activities were “more indicative of engaging in a recreation, rather than operating a business for profit.”

This is one of a series of adverse cases in state and federal tax courts that emphasize why a formal business plan, with substantive cost projections and other elements, is crucial in order to prove that the activity is operated in a businesslike manner. In this regard, the court said:

“If a taxpayer undertakes an activity in a businesslike manner, including the keeping of books and records or the development of a business plan, a profit motive may be implied.”  end_mark

John Alan Cohan has served the livestock, horse and farming industries since 1981. His website: www.johnalancohan.com

John Alan Cohan

John Alan Cohan
Attorney at Law

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