VAN VELDHUIZEN, GLENDA & JOHN (TRU) (2013)
Topic Code: H026 Hobby/Business Document Reference: 13201028
Linda Kennedy
R. E. Scott Co.
916 Grandview Blvd.
Sioux City, IA 51101-1028
RE: Glenda & John Van Veldhuizen
Docket No. 2012-200-2-0112
Individual Income Tax Protest
Dear Ms. Kennedy:
Thank you for your letter and the information provided with your response dated March 20, 2013. The Department has considered the above-referenced protest. After reviewing the facts and evidence presented and the laws that apply, some expenses that were originally denied have been allowed but other expenses have now been denied. This letter explains the Department’s positions.
The initial adjustments and assessment were based on the Department’s denial of expenses relating to Mrs. Van Veldhuizen’s business as a day care provider. However, the protest process has extended the review to include the alleged horse business. The taxpayers state their alleged business was to train and show quarter horses for reining competition with the idea of winning some shows and later raising breaking colts to sell for reigning competition. We have determined that the horse operation was an activity not engaged in for profit under IRS Reg. §1.183-2. As such, these losses (a/k/a hobby losses) have been denied in full. While these types of cases are dependent on each taxpayer’s facts and circumstances, there are many federal cases that offer guidance in addition to the regulations. Here are the reasons for denying these losses, following the factors described in the federal regulations:
1. Manner in which the taxpayer carries on the activity. The taxpayers did not have a business plan nor have they offered any specific explanation of how they expected to turn a profit. They used a business name some of the time but all horses were bought and sold under their individual names. They did not explain why they did not keep using the business name. They did not obtain a federal ID number. They did not maintain separate books and records for this business.
The horses were boarded and trained outside Iowa until near the end of the operation. Taxpayers have not offered any explanation as to how or why they arrived at the decision to start the activity, including the research and planning that took place, the purchase of equipment, the initial purchase of two horses, how they would monitor the activity from Iowa, decisions regarding further acquisitions of horses and their sales, etc.
Taxpayers state that in 2009 horses were boarded locally and they did their own training. Taxpayers have not explained how they did their own training, i.e., when and how they acquired the expertise to train horses, and how they trained them when they are both elderly and do not ride horses.
Another issue is that the taxpayers also stated this about their business, “Raised quality bred and trained quarter horses to sell to people interested in working ranch and farm related businesses.” Our review finds that raising horses for reigning competition appears to be quite different than raising them for working ranch and farm related businesses. The conflicting stories about their business do not help their position.
Taxpayers have provided no information regarding their research before starting the business, what made them decide to move forward and acquire horses, nor their expectations for size and operation of the business.
2. The expertise of the taxpayer or his advisors. Taxpayers provided a list of people they relied on for expertise. However, taxpayers admitted they had no background in raising horses. Taxpayers have provided no explanation of their own efforts to become experts or even learn about training horses as time went on.
3. The time and effort expended by the taxpayer in carrying on the activity. Taxpayers made a generic statement about devoting 75-100 hours per month to this business, but have not explained their direct involvement in detail. Was that only after they boarded the horses locally? We do not know which and how many hours he or they devoted to the horses and when. It appears that most years the horses were boarded and trained in Oklahoma; presumably the taxpayers’ time would be minimal. Taxpayers have not provided enough specific information about the time and effort expended when the horses were boarded in Iowa. He mentioned he did “90% of the work” including feeding, cleaning stalls and fixing fences but did not provide details about training.
4. Expectation that assets used in activity may appreciate in value. Taxpayer clearly states he intended to derive a profit from the operation, but that is to be expected. However, his expectations may not have been realistic. Many horse businesses are not profitable. Taxpayers have not provided detailed information about their purchases (how, why, quality, etc.), plans, and the basis for their expectations. Taxpayers did not explain how soon the horses would appreciate in value, what the odds were that they would appreciate, and why these horses or these trainers would generate success.
5. The success of the taxpayer in carrying on other similar or dissimilar activities. Taxpayer’s wife has operated a successful in-home day care business for many years. No information was provided about the taxpayer. We feel it is noteworthy that the taxpayers went through bankruptcy. Large losses from something other than the horse activity are shown on old tax returns but we do not know the source of those losses.
6. The taxpayer’s history of income or losses with respect to this activity. The venture began in 1998. As far as we can tell, they never had a profit in any one year and were not close to making a profit in any of the 13 years the activity existed.
7. The amount of occasional profits, if any, which were earned. Taxpayers never earned a profit. Taxpayers have not provided any information regarding purchase prices of horses acquired nor have they provided information regarding sales prices. They have not provided details of the horse market, breeding, and what it would take to earn a profit. The only thing they have said is that the shows and auctions appear to be “political.”
8. The financial status of the taxpayer. In 2002, the taxpayers filed bankruptcy. However, taxpayers both maintained steady sources of income throughout the period of the horse activity, including the addition of Social Security for both, along with some other annuity or retirement income. Taxpayers did not rely on the horse activity for income.
9. Elements of personal pleasure. Taxpayers’ only response remotely addressing this factor is that they do not ride horses so “they didn’t own them for personal pleasure.”
Overall, these factors clearly weigh against the taxpayers. Taxpayers have presented little evidence they acted in a business-like manner. Even though they changed trainers, they did not explain how or why those changes or any other actions might result in profitability.
In regards to the day care business, the Department explained in previous correspondence that the taxpayers cannot take a deduction for the business use of the home, except for real estate taxes and mortgage insurance which are allowable on Schedule A. The taxpayers have already filed amended returns reducing the meal expense claimed on the original returns. The Department accepts the amended meal expenses. The Department also denies several other items because they are not ordinary and necessary business expenses, such as landscaping, auto repair, and picture frames. All items denied are on the enclosed schedule.
The final adjustment is to charitable contributions on Schedule A. The Department denies the “Haiti” contributions for all three years because there is no evidence the contributions were made to a qualified charitable organization. See IRC Sec. 170(c). Contributions made directly to an individual or to groups of individuals are not deductible. Also, the Department denies the contributions to Covenant House on the 2009 return. There is not enough information to confirm that Covenant House is a qualified organization.
Enclosed are adjustment sheets showing the correct tax, penalty (if applicable), and interest, along with the payments applied. If you agree, or choose not to pursue the protest, then your letter and payment of $1,244.43 by May 31, 2013 will serve as authority for the Review Unit to request the Director to close the protest. Please note that interest accrues at the rate of $4.48 per month. Please respond in writing within 30 days of the date of this letter whether you agree with the Review Unit’s position.
If you disagree with the Department’s position in this matter, then you must identify those areas of disagreement and provide any additional documentation to support your position. Upon receipt of your letter, the Department will forward the file to the Attorney General’s staff for further review and filing of an Answer that will initiate the process for an administrative hearing on this protest. A departmental attorney will be assigned to the protest at that time.
If no response is received within 30 days of the date of this letter, then the Department will construe this inaction as failure to pursue the protest and will request dismissal of the protest pursuant to departmental rule 701 IAC 7.11(2).
If you have any questions regarding this matter, please do not hesitate to contact me at (515)281-6463 or jeff.aten@iowa.gov.
Sincerely,
Jeff Aten, Technical Tax Specialist
Audit Services Section
Policy and Communications Division
cc: Glenda & John Van Veldhuizen