Tax court case involving cow activity and horse activity |

Tax court case involving cow activity and horse activity

The outcome of cases in Tax Court depend somewhat on the philosophical approach of the individual judge hearing the case. Some judges are more sympathetic than others to losses incurred by taxpayers in the horse and livestock industries.

Some cases involve a combination of activities, such as Smith v. Commissioner, T.C. Memo 2007-368. This involved a cow and dairy farm, a cutting horse operation, and dog breeding. The court held that the cow and dairy farm was engaged in for profit under the IRS hobby loss rules, but not the other activities.

The taxpayers had taken significant tax deductions against their income from the activities, thus prompting an IRS audit, which they lost and then appealed to the Tax Court.

As discussed in the decision, the taxpayers believed that their dairy farms were not doing well, so they sought a niche market in Normande cattle. They installed a milking parlor with automatic milking equipment and other improvements were made, pastureland reclaimed, and miles of fencing installed.

The taxpayers had a formal 7-year business plan written by a professional that focused on importing of bull semen from France. They obtained certification as an organic farm with a view towards selling milk at higher prices than conventional milk. They consulted with experts, maintained a separate checking account, and focused on ways to maximize revenue. Gross revenues exceeded $100,000 for some years, but there was still a net loss. The taxpayers said they expected to increase revenue due to the organic certification.

They took steps to maximize revenues that the court said demonstrated their intention to show a profit (despite ongoing losses). They hired a full-time farm manager who, the court noted “did approach the operation of the cow activity in a businesslike manner,” although he did not keep many formal records. The manager lived on a trailer on the property, and the taxpayers retained decision-making authority.

Through study, the taxpayers gained expertise in the breeding of cows and in the use of Normande cows for dairy purposes. They grazed the cattle rather than confining them because they believed that grazing positively affects the longevity of the cattle. They sought professional advice and successfully used their previous dog-breeding expertise in the farm venture. They spent an average of 20 to 30 hours per week on the cow and dairy farm activity, and the court said this was “significant.”

The court ruled in favor of the taxpayers on the cow operation. The court noted that the taxpayers reduced expenses, had a farm manager, spent a significant amount of time on the farm, had a separate checking account, and focused on a competitive breed. Their formal business plan helped them win the case.

The court, however, ruled against them regarding their horse activity. The taxpayers showed and bred cutting horses. There was no business plan and very little by way of books and records. Oral testimony about the horse activity was “lacking in specifics.” The taxpayer who testified “discussed horse bloodlines but failed to indicate much about his horses, such as the year and cost of purchase, the training regimen, the events entered, purses and competitions won, breeding efforts, profit analyses, business plans, necessity of expenses, sale price, and so forth.”

The bank account used for the horse activity was the taxpayer’s personal checking account. There was no evidence to show the horses purchased or their progress and profitability. There were no budgets, operating statements, or analysis to show the financial aspects of the activity.

The court said: “Someone with the intent to make a profit from cutting horses could be expected to have adequate information from which to analyze the expenses and to project the progress of the activity. The activity was for the most part undocumented and there was little or no interest shown in the financial aspect of the activity or its prospects.”

The court noted that the taxpayer consulted with numerous experts, but didn’t have details of the specific advice obtained. There was no explanation of “how the advice he obtained was used or how it assisted in the attempt to seek profits from the activity.” The court said that that this factor was in favor of the taxpayer, despite the limited nature of the evidence. Still, the court ruled against the taxpayers on the horse activity.

The court also ruled against the taxpayers on their dog breeding activity, for much of the same reasons as it denied the horse activity deductions. F

John Alan Cohan is a lawyer who has served the horse, livestock and farming industries since l98l. He can be reached at: (3l0) 278-0203, by e-mail at, or you can see more at his website:

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