Hobby or Business?

ANSC 236 Equine Business Mgt. Spring 2010

Elaine Long Bailey

Hobby vs. Business . . .

• Business: “intent to make a profit . . .”• Revenue from horse “interests. . .”– Declare as income, business or not– Hobby Loss Rule (IRS) limitations

IRS Business Factor Test

• 1: Activity carried out in a businesslike manner?

• Accurate records• Separate accounts• Time records (daily

business operations)• Business plan• Financial statements

2: Time & effort reflect efforts to generate profit?

• Material participation (>500 hours/yr.)• Partial withdrawal from other profession?• Employ competent, qualified persons to

conduct the business• “The fun” vs. “the chores”

3: Dependence on income?

• Supported from other sources?

• Taxpayer’s financial status

• Hobby Loss Rule*• IRS prevents large

businesses from reducing taxes on other income

4: Normal startup costs or catastrophic circumstances?• Lag time in breeding

operation• When do we sell our product

in the cycle of the business?• When is expected “pay

day?”• Disease problem: MRLS or

EHV-1, e.g.• IRS: profit 2 years out of 7

(horse businesses ONLY) [typical business profit required 2 years out of 5]

5: Changes to improve profitability?

• KEY FACTOR• Goes back to success

in previous businesses (mgt. skills)*

• Cut costs• Increase revenue• Business plan

review/update*

6: Knowledge to be successful

• Horse experience and skills• Learn from others in business• Financial, business and management skills• Classes or workshops (UME, e.g.)• Show records/training records/successes• Certifications (ARIA, CHA, e.g.)*• Engage professionals (financial, legal, etc.)

7: Past record of running profitable businesses

• Management professionals who change “products”

• How turn businesses around, financially?

• Previous business ventures

• Previous business track records

8: Does the business make a profit?

• Balance of profit vs. loss• WHY profits occur?• Small profits occasionally vs. large losses

commonly• Speculative ventures*

9: Future profit from appreciated assets?

• Real estate vs. horses• Imported foals sold as

“under saddle”• Purchase of

performance horses w/no show record (train and show)

• Breeding stock (progeny’s successes)

Business vs. Pleasure?

• Recreational activity*• Business• Income generators• Family “pets”• Use percentages: 3

days/wk. for lessons vs. 3 days/wk. for pleasure (50% of expenses deductible)

IRS Audits

• Beware “red flags” that trigger IRS attention/audits

• Large losses from “hobby” enterprises• Business: records, records, records!• Respond to the IRS audit letter!!!• Get appropriate professional assistance!!!

Tips to Avoid IRS Challenges

• Advance planning & written records• Separate bank accounts• Accurate, complete records• Business plan• Disprove recreational or pleasure motive• Adequate time & money spent on business• Expert consultation• Document excessive losses• Create profit when feasible*

IRS Form 5213

If no profit in 2 out of 7 years . . .

• http://www.irs.gov/pub/irs-pdf/f5213.pdf

• IRS postpones determination of profit intention

• KEEP records– Catastrophic circumstances– Natural disasters– Other unpredictable

occurrences

Forms of Doing Business

• Type of ownership• Sole proprietorship• Partnership (general

or limited)• Corporation (regular,

limited liability or subchapter S)

Sole Proprietorship

• Most popular & least complicated• Individual in business• “Tax shelter” farms*• Material participation**– >500 hours tax year, e.g.– See text for “tests”– Documentation of time use for business

Partnership

• Two or more individuals in business• In what way are individuals involved?– Money– Property– Business expertise/effort– Share profits/losses

• Agreement in WRITING!

Comparisons

• General partnership• Management “say” in

decisions• Unlimited liability*• Partnership must

complete separate tax return

• Profits/losses flow through to each partner

• Partnership not taxed; individuals taxed per profits/losses

• Limited partnership• Little or no management

responsibility• Reduced liability• Partnership must complete

separate tax return• Profits/losses flow through

to each partner• Partnership not taxed;

individuals taxed

Corporations

• Need legal assistance to form• Certificate of Disclosure• Incorporators: organize, promote, raise funds,

do paperwork• Statutory agent to represent entity• Transfer funds, issue stock

Comparisons

• Regular Corporation• Its own entity, from tax

stance• Files tax return, pays its

own taxes• Funding advantage• Limit to debts, losses,

negligence (individuals)• Protects personal assets

• Subchapter S Corporation

• Like partnership, from tax stance (individuals)

• Shareholders report income or loss

Limited Liability Corporation (LLC)

• Why LLC?• LIMITED liability• Protect personal

assets• Family farms or

businesses • More later

Syndicates

• Common interest: stallion shares, e.g.

• One-time breeding rights sold by shareholders or lifetime

• “Security” requires attorney services

• Within syndicates, various agreements (partnerships, e.g.)

A Few Resources . . .

• http://mredc.umd.edu/hotlistHorseBoarding.htm• http://mredc.umd.edu/rootbeginning.html• http://www.agnr.umd.edu/MCE/Publications/Publica

tion.cfm?ID=97&cat=C• http://www.agnr.umd.edu/MCE/Publications/Publica

tion.cfm?ID=102&cat=C• http://www.agnr.umd.edu/MCE/Publications/Publica

tion.cfm?ID=3&cat=C

My contact info:Elaine Long Baileyelbailey@umd.edu

Good luck!!