COVER 1 - NMHBA SUMMER 2017 low res

. . . taxpayers need
to somehow review
records so as to
reduce expenses
or enhance the
possibility of
generating income.
by John Alan Cohan
who is an attorney representing
people in federal and state
tax disputes, IRS appeals, and
Tax Court litigation, and is a
long-standing author of a legal
advice column published in
numerous sporting magazines.
In addition, he advises
organizations on compliance
with newly enacted laws and
regulations. John is also author
of the book, Turn Your Hobby
Into A Business -- The Right
Way.
He can be reached at:
(310) 278-0203, or email at
johnalancohan@aol.com. His
website is JohnAlanCohan.com
Is the Tax Court Biased
in Favor of the IRS?
The U.S. Tax Court is a critically important
institution. It is the the most common forum
in which taxpayers litigate federal tax disputes.
The court frequently decides IRS assertions that the
taxpayer understated the correct tax liability, resulting
in a tax “deficiency.”
Many commentators argue that Tax Court judges
are biased in favor of the IRS. Judges hear cases
alone, without a jury. Many Tax Court judges have
worked in the IRS Chief Counsel’s office or in the Tax
Division of the U.S. Department of Justice. The Tax
Court does not assign judges randomly to cases. The
procedures are extremely burdensome. The burden
of proof is “preponderance of the evidence,” which is
a loose standard of evidence, and highly subjective. It
means the the IRS could win if 51% of its evidence is
more convincing to the judge than the taxpayer’s.
The Tax Court makes budget requests to
Congress’s tax-writing committees. In justifying its
budget requests, the Tax Court invariably explains
to congressional committees how well it is enforcing
the tax laws.
A Tax Court judge, Diane L. Kroupa, was
indicted on tax evasion, conspiracy to defraud the
United States, and obstruction charges, raising
questions about whether any of her rulings could be
vulnerable to challenge as a result. (Judge Kroupa
abruptly resigned prior to the indictment without
explanation. Her husband, now divorced, was also
indicted.) As a Tax Court judge, Kroupa heard and
decided a wide range of cases, including some that
came down against taxpayers in the horse and cattle
industries. In October of 2016, she pleaded guilty
to conspiring to defraud the IRS and other crimes.
When sentenced at a later date, she is likely to serve a
significant prison term.
Another judge, L. Paige Marvel, has also been
harsh with respect to the horse industry. In a recent
case, Carmody v. Commissioner, T.C. Memo 2016-
225, Judge Marvel came down hard on a taxpayer’s
efforts to run his horse racing venture profitably.
The taxpayer, Jerald Carmody, has owned race
horses for more than 20 years, mainly as co-owner
with others, and worked full-time as a sales representative
for a helicopter company.
He owned lower priced horses, which were actively
raced in Washington State. Professional trainers were
employed. He spent time every day on his horse racing
activity, researched horses that would be in competition,
and searched for other horses to purchase.
He purchased and improved a five-acre property
with a 4,000 square-foot barn, horse stalls, a
5,000-square-foot arena, indoor horse shelters, and
nine pastures. He personally cleaned stalls and pastures.
Some of the horses won several races each, and
one was the all-time race winner at Emerald Downs
with 21 wins. Mr. Carmody was named owner of the
year at Emerald Downs. The races entered ranged in
purses from $8,000 to $50,000.
During a 10-year period, the taxpayer’s losses were
from $16,064 to $81,345, with no profit year. But
there was income in each year, ranging from $17,917
to $128,068.
When horses were retired from racing, they were
sold or given away. Of 36 horses sold, there was a net
gain on only eight of those sales.
Mr. Carmody had a horse racing bank account,
but paid for expenses out of his personal account as
well as the racing account.
Mr. Carmody kept a folder for each horse with
various receipts and documents related to that horse.
Judge Marvel said that Mr. Carmody did not
use any of his records to reduce losses or to achieve
profitability. The court noted that Mr. Carmody
had no written business plan, no budgets and no
economic forecasts. “In fact, the record is devoid of
any credible evidence that petitioner engaged in any
meaningful financial management with respect to his
horse racing activity.”
The court said, “While a taxpayer need not
maintain a sophisticated cost accounting system, the
taxpayer should keep records that enable the taxpayer
to cut expenses, generate or increase profits, or evaluate
the overall performance of the operation.”
The court also faulted Mr. Carmody for commingling
his personal and horse racing finances. “This
commingling of personal and horse racing activity
funds is not indicative of a businesslike practice.”
The court also noted that Mr. Carmody realized
no profits in a 20-year period, and that “he contends
that he suffered losses because he reinvested his gross
receipts back into the horse racing activity and that
he used his gross receipts to improve his barns, arena,
and other horse racing activity property. Petitioner’s
contentions are woefully insufficient to justify or
even explain an unbroken string of over 20 years of
substantial losses.”
The court concluded that the petitioner did not
engage in his horse racing activity with the predominant,
primary, or principal objective of making a profit.
The only silver lining in this case is that the judge
rejected the IRS’ accuracy-related penalties because
the taxpayer had reasonably relied on his accountant’s
advice in taking the deductions.
One of the important lessons in this case is
that taxpayers need to somehow review records
so as to reduce expenses or enhance the possibility
of generating income. It is important to keep
track of expenses on a per-animal basis. And it is
important to prepare financial statements, profit
and loss projections, budgets, breakeven analyses,
or marketing surveys, as the IRS considers these
to be significant financial tools to aid in evaluating
the overall performance of an operation.
54 New Mexico Horse Breeder