Taxes – Hobby or Business

Under the Tax Code Taxpayer’s Ranching Operations Constituted a ‘Trade or Business’ and Not a Hobby.

Taxpayer was an economics professor for approximately 40 years. He also owned an economic consulting firm. In addition to his regular job as an economist, he also ran a ranch and cattle operation in Texas. Taxpayer’s ranching operation incurred large losses in 2007 to 2010 tax years. The IRS issued a notice of deficiency for tax years 2007, 2008 and 2009 because in the IRS’s view the livestock operation wasn’t engaged in for profit. According to the IRS, since the operation was a hobby, the deductions claimed by the taxpayer weren’t proper. The issue before the tax court was whether the taxpayer’s ranch and cattle operation was a ‘trade or business’ under the tax code. The court cited the tax code for the proposition that deductions for ordinary and necessary expenses paid or incurred in conducting a trade or business or for the production of income are deductible. The tax court referred to prior case law and IRS regulations and then listed the following as the most important factors in deciding whether a particular activity qualified for ‘trade or business’ under section 183 of the tax code:  (1) the manner in which the taxpayer carries on the activity, (2) the expertise of the taxpayer or his advisors, (3) the time and effort expended by the taxpayer in carrying on the activity, (4) the expectation that assets used in the activity may appreciate in value, (5) the success of the taxpayer in carrying on other similar or dissimilar activities, (6) the taxpayer’s history of income or losses with respect to the activity, (7) the amount of occasional profits, if any, which are earned, (8) the financial status of the taxpayer, and (9) whether elements of personal pleasure or recreation are involved. After a thorough review of the facts and circumstances, the tax court found that the taxpayer’s ranching operation was a for-profit activity because he acted in a businesslike manner. The ranching operation’s size and its vertical integration were among the factors mentioned by the tax court. Welch, TC Memo, 2017-229.