Horse Business Found Liable for Unpaid Employment Taxes

Do you withhold payroll taxes from your farm help’s wages? A recent tax case illustrates the bad things than can happen when a horse business incorrectly calls its farm workers “independent contractors”, and fails to withhold payroll taxes from their wages.

Are your farm workers really independent contractors?

Case Background:

Twin Rivers Farm, Inc., a Tennessee S Corporation, was engaged in the business of raising, training, and showing horses for anticipated sale or lease.

Twin Rivers hired Adam Lopez Morales and Nallhelyo Ruiz (workers) to work on the property where it ran its horse business. Morales and Ruiz lived in a trailer on the property and did not pay rent during the three years at issue in the case.

Morales and Ruiz’s primary job duties included: cleaning stalls, the barn area, the barn offices, the restroom, and the tack room; grooming horses; watering the horses; and moving the horses between pastures. The workers also occasionally fixed fence and mowed.  The equipment Morales and Ruiz used to perform their job duties was owned by Twin Rivers.

Twin Rivers paid both workers by check, with Morales receiving $300 per week, and Ruiz receiving $150 per week. With respect to the years at issue, Twin Rivers did not make deposits of employment tax, nor did it file Forms 1099 with respect to the workers.

Holding:

Over farm owner Diana Militana’s objections, the court found that Morales and Ruiz were employees of the farm and not independent contractors. As a result of the farm's misclassification of the employees, the court found Militana liable for approximately $30,000 in unpaid employment taxes and penalties for a three year period.

Case Info

Twin Rivers Farm, Inc. v. Commissioner; T.C. Memo 2012-184; Docket No. 14074-10 (July 2, 2012)

Related Posts:

Employee v. Independent Contractor: Pitfalls of Misclassification (Part 1)

Employee v. Independent Contractor: Pitfalls of Misclassification (Part 2)

Guest Post: I Got Dem Ol' Cathouse Blues Again Mama! (Part 3)

By B. Paul Husband

            One of the significant holdings in Van Dusen was that indirect supervision of the work by the 501(c)(3) charity can suffice to support deductibility of unreimbursed out of pocket expenses from volunteers. The Court stated:   “Nothing in Section 170 or [relevant] regulations suggests that, as a condition to the deductibility of unreimbursed service-related expenses, the services must be performed under the control or supervision of a charitable organization. . . .” 

            One of the keys to winning as much as she did was that some of the receipts were itemized. The itemized receipts were given substantial deference by the Court. 

Saved by The Yankee Doodle Dandy

            The Van Dusen Court utilized the Cohan Rule in a fair manner.   The Cohan Rule is named for the great American composer/lyricist, George M. Cohan, who wrote songs like “Give My Regards to Broadway,” “Over There,” “You’re a Grand Old Flag” and “The Yankee Doodle Boy.”   In addition to his contributions to American musical comedy and patriotism, he made his mark in American tax law in Cohan v. Commissioner, 39 F.2d 540 (2d. Cir. 1930). He challenged the stringent IRS substantiation requirements. Judge Learned Hand wrote the just and enduring opinion. The Cohan Rule provides that, even if the substantiation is incomplete, if some factual basis is provided for the Court to base a finding, a Court may make inferences to support granting of deductions. Ms. Van Dusen may not have kept the records exactly as she should have kept them, and she did not have everything she should have had, but she did prove what a bag of kitty litter cost, and she showed by receipts that she typically bought eight bags at a time. The Tax Court found that was enough to invoke the Cohan rule.

                Van Dusen successfully proved up the cost of kitty litter 

           The Court expressly found Van Dusen to be credible witness. The evidence reflected that Van Dusen had about seven pet cats and about 70 to 80 feral “foster” cats in 2004. She argued that the foster cats consumed a greater percentage of the veterinary care than her pet cats, on a pro rata basis. However, she did not have specific proof and therefore the Court only allowed a pro-rata portion of the veterinary expenses as deductions -- 90% with respect to the veterinary, pet food and pet supply expenses. Specific testimony would have helped.

            It is fair to infer that unreimbursed expenses incurred in volunteer work for qualified 501(c)(3) charities which benefit horses, dogs and other animals would be treated the same way by the Tax Court.

            The bottom line is: keep records, keep records, keep records, and for amounts in excess of $250 be sure you get a written acknowledgment from the charity before you file your tax return.

Related Posts:

Guest Post: I Got Dem Ol' Cathoues Blues Again Mama! (Part 1)

Guest Post: I Got Dem Ol' Cathouse Blues Again Mama! (Part 2)

©B. Paul Husband 2012

Guest Post: I Got Dem Ol' Cathouse Blues Again Mama! (Part 2)

By B. Paul Husband

            In June of 2011, the United States Tax Court decided Van Dusen v. Commissioner, which addresses the rules for deductions of unreimbursed out of pocket expenses incurred in charity work. 

            In Van Dusen, a cat-loving attorney worked on a volunteer basis in association with a Section 501(c)(3) charity called “Fix Our Ferals” with dozens of feral cats, for which Attorney Van Dusen provided food, shelter, veterinary care and pet supplies, including kitty litter.

            Ms. Van Dusen deducted a broad range of expenses which she associated with her volunteer work for Fix Our Ferals. The expenses deducted included cat food, kitty litter, veterinary care for cats, funeral expense for one cat, her bar association dues, Costco membership dues, Department of Motor Vehicle fees, electric bills, water bills, garbage collection charges, vacuum cleaner repair, and the costs of a custom air filtration system for her residence.

          Happy Mardi Gras:  Laissez les bons temps rouler!

  The significant holdings in Van Dusen are: 

            (1) Out of pocket expenses incurred in connection with providing services to a charity are considered under the set of rules applied to gifts of “money” (Tr. Reg. Section 1.170A-13(a)) rather than the rules applied to gifts of “property” (Tr. Reg. Section 1.170A-13(b). The “money” rules are simpler than the rules applied to gifts of property.

            (2) The Tax Court will allow some flexibility in accepting alternatives to “adequate records” as substitutes for the records required by the Treasury Regulations to substantiate expenses incurred in connection with gifts to charity, of less than $250. However, the flexibility only works for gifts which are less than $250; not the gifts greater than $250.

            (3) For amounts above $250, the Tax Court will enforce the technicalities of Treasury Regulations Section 1.170A-13.

            (4) The test of “relatedness” between the charitable purpose of the donee and the expenses which were sought to be deducted was applied in Van Dusen and as a result of the “relatedness rules” the bar association dues , the Costco membership dues, the Department of Motor Vehicles expenses, and the vacuum cleaner repair expenses were disallowed. Concerning the connection between the expenses deducted to the work done, the Van Dusen Court stated: “To be deductible, unreimbursed expenses must be directly connected with and solely attributable to the rendition of services to a charitable organization.”

            The Costco membership and vacuum cleaner repair deductions were rejected by the Court on the grounds that they were not exclusively for charitable purposes. 

            (5) Percentage deductions were allowed for the electric bill, the water bill, cat food, cat supplies and the air filtration system, based on the ratio of the taxpayers own pet cats (7) to the “foster” cats (70-80). Thus, deduction of 90% of the pet supplies and cat food were allowed, but only 50% of the cleaning supplies and utility expenses were allowed. 

            For the veterinary expenses, the pet supplies, the cleaning supplies, and the utilities, the Court showed some flexibility and allowed a percentage of the expenses, on the grounds that the taxpayer would have had fewer veterinary service expenses, purchased fewer pet supplies and fewer cleaning supplies if she had not been doing volunteer work for the charity. Similarly, her utility bills would have been significantly lower if she had not had to run a special ventilation system, due to the numbers of cats involved.

The Evidence

            At trial the donor, Ms. Van Dusen, introduced evidence:

            (1) Copies of checks;

            (2) Bank account statements;

            (3) Hospital account history;

            (4) Credit card statements;

            (5) Costco purchase history;

            (6) Gas and electric invoices;

            (7) Waste management payment list;

            (8) Water billing history;

            But all of the records were compiled for trial, well after the expenditures were made in 2004. No written statement from Fix Our Ferals, the donee charity, was obtained prior to the filing of Ms. Van Dusen’s tax return. She would have had better success if she had obtained the “contemporaneous” statement from Fix Our Ferals. For contributions of $250 or more, the Court held a taxpayer must satisfy not only the record keeping requirements, but also the requirements of Treasury Regulation § 1.170A-13(f)(1).

Related posts:

Guest Post:  I Got Dem Ol' Cathouse Blues Again Mama! (Part 1)

Guest Post:  I Got Dem Ol' Cathouse Blues Again Mama! (Part 3)

©B. Paul Husband 2012

Guest Post: I Got Dem Ol' Cathouse Blues Again Mama! (Part 1)

            Paul Husband, an equine tax attorney based in California, will be contributing a series of guest posts over the next few weeks on the 2011 tax opinion, Van Dusen v. Commissioner. There are many valuable lessons contained in this opinion from which equine charities might benefit. Enjoy!

            In the context of deductions claimed by a woman who kept 70 to 80 “foster” cats, in addition to her own seven pet cats, the U.S. Tax Court addressed the deductibility of out of pocket expenses incurred as a volunteer for a properly qualified IRC Section 501(c)(3) charity in Van Dusen v. Commissioner, (2011) 136 T.C. 515.

            There is no deduction whatsoever available for the value of labor or services provided when an individual volunteers to do work for a charity, even though a gift of money to the same organization would be deductible. Nonetheless, out of pocket expenses incurred during the course of performing services for a qualified charity may be deductible if the expenses are sufficiently related to the charitable purpose of the organization, and substantiation and record keeping requirements are met.

          Happy Valentine's Day!

            There are lengthy and complex Treasury Regulations concerning the deductibility of gifts to charity, with separate rules for gifts of property versus gifts of money. 

            Before getting deeper into Van Dusen, lets take a quick look at the requirements and limitations provided by the Treasury Regulations concerning the deductibility of out of pocket expenses incurred in the course of volunteer work for a § 501(c)(3) charity.

Less Than $250

            Generally, for expenses of less than $250, to justify a tax deduction for out of pocket expenses for a charitable work, the donor must maintain, as a record of the contribution, either:

            (a) a bank record; or

            (b) a written communication from the donee (the charity) showing:

                        (1) The name of the donee organization;

                        (2) The date of the contribution; and

                        (3) The amount of the contribution.

More Than $250

            For expenses which are incurred in the course of doing volunteer work for a charity which are more than $250, in addition to meeting the requirements for expenses less than $250, the donor must have a contemporaneous written acknowledgment from the donee, which must include:

            (a) The amount of cash and a description (but not the value) of any property other than cash which was contributed;

            (b) Whether the donee provided any goods or services in consideration for any part of the contribution; and

            (c) A description and a good faith estimate (by the donee) of the value of those goods or services.

Contemporaneous

            The term “contemporaneous” as used in the Treasury Regulations concerning a written acknowledgment of contributions of out of pocket expenses related to charitable work means a written acknowledgment prepared on or before the earlier of:

            (a) The due date of the donor’s tax return, including extensions; or

            (b) The date that the donor files his/her/its tax return.

Acknowledgment

            The acknowledgment requirement for unreimbursed out of pocket expenses can be met if:

            (a) The taxpayer has “adequate records” to substantiate the amount of the expenditures; and

            (b) The taxpayer obtains a statement prepared by the donee that, in addition to the required information listed above for contributions of less than $250, the statement must describe the services and expenses performed, incurred and/or received. See Treasury Regulation § 1.170A-13(f)(10). 

            The $250 level is an important line of demarcation. Above it, the contemporaneous written acknowledge from the donee must be obtained.

Multiple Gifts Under $250 Do Not Trigger Higher Standard

            On the bright side, if a particular donor makes several gifts of unreimbursed expenses incurred doing volunteer work for a charity in amounts less than $250 each, even if they add up to more than $250, they need not be aggregated for the purpose of triggering the contemporaneous written requirements set forth in Treasury Regulation 1.170A-13(f) for contributions of more than $250.

Related posts:  

Guest Post:  I Got Dem Ol' Cathouse Blues Again Mama! (Part 2)

Guest Post:  I Got Dem Ol' Cathouse Blues Again Mama! (Part 3)

©B. Paul Husband 2012

New Requirement for Texas Sales Tax Exemption Number May Affect Horse Businesses

Currently, anyone in Texas can say they are “ag exempt”, sign a form, and buy agricultural products tax free. But this is about to change. As of January 1, 2012, the Texas Comptroller will require all farmers and ranchers to obtain an Agricultural Sales Tax Exemption Registration Number in order to buy tax-free farm and ranch supplies. This new measure was signed into law during the 2011 Legislative Session via House Bill 268, and will be included in Chapter 151, Subchapter E of the Texas Tax Code.

When I was home in Ellis County last weekend, I heard several farmers grumbling about this new requirement and the added “red tape” being imposed on farmers. But is it such a bad thing? Texas Farm Bureau doesn’t think so.

Texas Farm Bureau discussed the new law and posted information for farmers on its blog, Texas Ag Talks. According to the Texas Farm Bureau blog post, the new “registration number” will be good for the overall agricultural industry, because abuses under the current system were so rampant that the agricultural sales tax exemption itself was at risk. 

I'm not sure what the State’s intent was in enacting this new law, but I don’t think its affects will be good for many horse businesses. I predict that many Texas horse business owners that have been buying ag supplies tax free in the past will not be able to successfully apply for a registration number in 2012 (at least if they are honest on the application). A link to the application for the new registration number can be found here

On the very first page of the application, the State boldly warns horse racing, boarding, and training businesses that they do NOT qualify for an ag exemption registration number. Under the list of “principal types of exempt activities” on page 2, the only activity on the list that involves horses states, “I raise and sell horses, mules, donkeys, burros and/or ponies.” The application and other applicable authority suggests that “raising and selling horses” must be your principal activity or your “normal course of business” in order to qualify for the sales tax exemption. The States’s intent with respect to mixed operations such as boarding operations who also breed and sell horses is not altogether clear.  The Comptroller has answered some FAQs about horse businesses that give a little insight on how various circumstances will be treated.  The Horses FAQ page published by the Texas Comptroller can be found here.

Boarding facilities and horse trainers who check the “raise and sell horses” box when they do not engage in said activities do so at their own risk. Page 3 of the application includes a signed statement by the applicant that acknowledges all of the penalties (criminal and otherwise) that may arise from the misuse of the tax exemption ID. I don’t have any data that suggests how strictly these forms are enforced.

But one thing is clear, the State of Texas will have the name, federal tax ID, Texas taxpayer ID, legal entity filing number (if any), mailing address, physical location, and Texas drivers license number for all horse businesses who buy tax exempt products from January 1, 2012 onward. I would think these things would make it much easier for the State to investigate and discipline someone if the State deemed purchases to be to frequent, too large in amount, or otherwise suspicious.  

As under prior law, the sale or lease of horses will still be exempt from sales tax in Texas and a registration number is not required for horse sales or lease transactions.  Further, the purchase of horse feed, grain and hay will remain tax free for everyone in Texas (with or without a registration number or exemption certificate). 

To access a quick reference chart published by the Texas Comptroller that outlines items that do and do not qualify for sales tax exemption for agricultural production, click here.

Follow me on Twitter @alisonmrowe

100% Bonus Depreciation for Horse Businesses through December 31, 2011

Forbes.com featured a story this week, entitled “Tax Deductions for Yearling Thoroughbreds”, that may be of interest to many horse businesses. To read the article, click here. Many Thoroughbred racing industry experts are quoted in the article, including Kentucky equine lawyer Joel B. Turner, whose guest post was featured on the Equine Law Blog this Tuesday.

The focus of the Forbes article is the applicability and effect of the 100% bonus depreciation feature of the Tax Relief Act of 2010, and its potential tax benefits to qualified horse businesses. As the Forbes article suggests, some race horse operations who buy yearlings in 2011 may be able to deduct 100% of the yearling’s purchase price in 2011. 

Before the bonus depreciation feature of the Act became effective on September 9, 2010, the percentage of depreciable basis allowed as bonus depreciation on qualified property was only 50%. This 50% depreciation percentage will apply again in 2012.

The potential tax savings offered by the Act for the 2011 tax year are significant for qualified horse businesses. Walt Robertson, Keeneland’s vice president of sales, indicated in the Forbes article that the Act may have positively affected sales activity at the Keeneland 2011 September Yearling Sale. 

It is important to note that the Act does not refer to specifically Thoroughbreds, yearlings, race horses, horses or livestock. The Act provides 100% bonus depreciation for all “qualified property”. In general, “qualified property” is tangible personal property and equipment purchased for use in a business operation, as long as certain conditions are met. For horse businesses, qualified property could arguably include horses, trailers, trucks, tractors, ATVs, and other horse/farm equipment.  Among the conditions that must be met are the following:

1) the horse / equipment’s original use must begin with the taxpayer (i.e. horses that have not begun training; new equipment); and

2) the horse / equipment must be placed in service after September 8, 2010 and before January 1, 2012.

As many of the experts quoted in the Forbes article indicate, the Act does not provide an “easy write-off”. For starters, taxpayers wishing to avail themselves of the 100% bonus depreciation must be able to prove that they are in the “horse business” and that the property was purchased for said business. This element may pose difficulties to taxpayers who have not shown a profit in their horse business for many years. Further, purchasers of fractional interests in racing syndicates are generally considered “passive investors”, and therefore may not see any tax savings through application of the Act.

There are other considerations that come into play to determine whether the 100% depreciation is available, such as whether the taxpayer borrowed money to purchase the horse/equipment through an LLC or other entity. 

Horse businesses who purchased or will purchase new horses or equipment in 2011 should consult a CPA or attorney who has expertise in the equine industry to determine the possible applicability of the Act to their newly-acquired property.

Follow me on Twitter @alisonmrowe

Guest Post: ClassicStar Meets the IRS in Tax Court

Happy Tuesday!  As of August 15, 2011, we now have a reported tax case arising from the infamous ClassicStar debacle.  Not surprisingly, the precedent involves "bad facts" and is not helpful for other taxpayers who took part in a ClassicStar deal or similar deal.  The following guest post on the opinion, entitled Van Wickler v. Commissioner, is by Paul Husband, a California equine lawyer whose practice emphasizes tax matters.  Enjoy!

"ClassicStar LLC was a company which offered highly leveraged mare leasing deals.  They offered top quality Thoroughbred mares and stallion breeding rights to leading sires like Elusive Quality and Mineshaft. The tax benefits of their programs, turbo-charged with leverage provided by loans which they helped arrange were prodigious. Leveraged mare leasing combined with the expensing of stud fees and the expensing of certain prepaid expenses can generate very significant tax savings. Unfortunately, the principals of this company ended up in prison for fraud.

But the fraud was not based on invalidity of the income tax law principles related to mare leasing and horse breeding which were involved. Rather, the fraud involved misrepresentations concerning  facts of various sorts, such as the “high quality Thoroughbred” mares, who sometimes turned out not to be Thoroughbreds at all, but Quarter Horses, or grade horses. The ClassicStar program also suffered problems in some cases with the reasonableness of charges, such as, a lease fee of over $200,000 which was charged for a mare which sold for $350. 

            There were hundreds of IRS audits of individuals who did business with ClassicStar. There were hundreds of assessments by the IRS based on these audits, and hundreds of Tax Court petitions were filed. Now we have a reported decision.

            The “ClassicStar” case decided August 15, 2011 was entitled Van Wickler v. Commissioner, T.C. Memo 2011-196; 2011.  It was tried before Tax Court Judge Maurice Foley, a fair-minded judge, who had previously recognized a horseman’s profit motivation in Routon v. Commissioner, T.C. Memo 2002-7 (2002).

            But, horse breeders lose Tax Court cases based on the “hobby loss” rules of Internal Revenue Code Section 183 all the time. Why should we care about this one? We should care because this precedent may be used as a bludgeon against others who did business with ClassicStar, even if the facts of the later cases were very different than the facts in Van Wickler. This reported opinion reflects a conscious policy by the Internal Revenue Service to “manage” case law. The IRS wants case law which is favorable for them. Favorable precedents give IRS Appeals Officers greater leverage in discussing settlements with horse business owning taxpayers and/or their representatives.

            The nature of the facts varies enormously in the hundreds of ClassicStar cases pending across the United States from cases in which the horse leasing taxpayers had very strong facts, and would likely win at trial, to cases such as Van Wickler. The facts in Van Wickler constituted a parade of horribles. In it, the taxpayer:

            1. Signed an agreement purporting to be the managing member of an LLC that had not yet been formed;

            2. Backdated a board agreement to November 1, 2002, when he did not enter into the transaction until December 30, 2002; and

            3. Signed a lease in which the schedule setting forth the names of mares to be leased and stallions whose breeding rights would be used was blank - the taxpayer did not know the identities, or even the breed of the mares which he had allegedly leased.

            The Tax Court in Van Wickler found:

            1. The accountings submitted to the court were contradictory and varied from version to version; and based on them, neither the taxpayer nor the Court could tell how much money was spent, or what it was spent on.

            2. The taxpayer not only did not negotiate the contract terms, he did not even know what the contract terms were.

            3. The taxpayer could not tell what horses had been leased.

            4. The mare named “Lita May” sold for $350, but one chart showed that the lease fee for her was $260,723, and on a different chart, the lease fee for that same mare was shown as $185,000.

            The Court held that there was no basis in the record to determine which expenses were allowable and which were not. Therefore Court concluded that there could not be any expenses allowed as deductions. 

            Yet there was some mercy shown. The Court found that Van Wickler had relied on an independent C.P.A., who had been deceived by the promoters, and who advised Van Wickler that the ClassicStar deal had a high degree of risk, but could have a high return. Based on what the court perceived as good faith efforts to get professional advice and his reliance upon a C.P.A., no penalties were assessed.

           The fact that Van Wickler is a reported case reflects that the IRS is judicious in managing their caseload. It was the Van Wickler case, with terrible facts for the taxpayer, that was tried and reported, rather than a case with good facts for the taxpayer.

            By contrast, in 2009, the IRS had another ClassicStar case in Tax Court which the mares leased were identified and were high quality Thoroughbreds; where the taxpayers were actively involved in managing their business, and had made visits to the farm where the mares were boarded, and to the auctions, had taken extensive horse business education, and had good books and records. The taxpayers had a highly qualified expert witness and your writer as an attorney. In that case, the IRS conceded shortly before trial. It was obvious that they did not wish that case to be the first judicial precedent for ClassicStar breeders.

            Make no mistake, I favor concessions by the IRS when it is obvious to them that the taxpayer is going to win the case. But my point is that as practitioners and horsemen and horsewomen, we should not be overwhelmed when case law like Van Wickler is brandished by an IRS Revenue Agent, Appeals Officer or District Counsel lawyer. They do pick and choose their cases, and therefore, often the judicial opinions come out of cases which are factually favorable for the IRS. These opinions do not mean that cases with facts favorable to the taxpayer/horseperson cannot be won. The individual facts of each case are paramount in determining the outcome of cases such as the ClassicStar cases. Representatives and horsemen should not be cowed into submission by an IRS reference to the Van Wickler decision." 

© B. Paul Husband 2011

Employee v. Independent Contractor: Pitfalls of Misclassification (Part 2)

Hello all!  I'm back stateside after a brief business trip to Germany.  Unfortunately, the Equine Law Blog went "postless" last week due to a bad internet connection in the Hotel Dorint in Ausgburg, Germany.  Hotel management reported to me that the bad connection was unavoidable and due to the fact that the walls of the hotel are about 2 feet thick and made of concrete!!

In any event, I am happy to see that I seem to have brought some cooler temeratures back with me from Germany!

Last week I was at the Americana Horse Show in Augsburg, Europe's biggest Western horse show.  Below is a photo I took of my friend Uwe Roeschmann, a German cutting horse trainer whose training facility is located in Gainesville, Texas.  The photo shows Uwe entering the arena on September 1, 2011 and preparing to work cattle in the European Cutting Championship Open Finals.  As you can see, he was showing in front of a packed house!

I hope you find the following guest post material helpful.  It is Part II of a series on employer vs. independent contractor status by  employment law specialist Russell Cawyer, publisher of Texas Employment Law Update.  Enjoy! 

In Texas, the test for determining independent contractor status is a multifactor analysis that centers on the economic realty of the relationship.  The focus is on whether the worker is, as a matter of economic reality, dependent on the alleged employer or in business for himself.   This inquiry includes whether the employer has the right to control the progress, details, and methods of operations of the work.  A nonexclusive list of factors that are usually considered in this analysis include: 

  • the degree of control exercised by the alleged employer;
  • the extent of the relative investments of the work and the alleged employer;
  • the degree to which the worker's opportunity for profit or loss is determined by the alleged employer;
  • the skill and initiative required in performing the job;
  • the permanency of the relationship.

No one factor is determinative. If a court or taxing authority determines that the independent contractor was misclassified, the employer may be responsible for failing to provide the benefits the employee would have otherwise enjoyed had he been properly classified as an employee (e.g., participation in certain employee benefit plans and unpaid overtime).  Depending on the size of the workforce and the work it engages in, these sums can be significant.  Consequently, operations making extensive use of independent contractors should review these relationships carefully to ensure that the workers are properly classified and incorporate changes in the relationships that enhance the ability to defend that classification."

Follow Russell Cawyer on Twitter @RussellCawyer

Follow Alison Rowe on Twitter @alisonmrowe

Employee v. Independent Contractor: Pitfalls of Misclassification (Part 1)

Hey everyone!  I hope you like this picture I took today at the "Reiterstadion" in Hannover, Germany. The yellow building (pictured) is a barn within the Hannover city limits that was built at the turn of the century for the Germany cavalry. Now it's a boarding and training stable surrounded by indoor and outdoor arenas plus a small cross-country course.

For today we have a guest post by employment law specialist Russell Cawyer, publisher of Texas Employment Law Update.  Enjoy! 

"Owning and operating a horse operation requires a lot labor. Owners use a variety of types of personal services. Improperly classifying these workers as independent contractors instead of employees can have a variety of adverse consequences. Potential liability that can result from misclassification include:

1)  Potential tax exposure from federal and state taxing authorities (i.e., unemployment tax, FICA, FUTA);

2)  Exclusion from certain insurance policies depending on the kind of coverage provided;

3)  Claims that misclassified contractors should be entitled to participate in employer benefit plans covering employees (e.g., stock option plans, health and benefit plans);

4)  Claims that misclassified contractors are entitled to overtime compensation.

Moreover, the likelihood of a misclassification mistake being discovered has increased as state workforce divisions, the U.S. Department of Labor and IRS are now coordinating their resources to catch employers that have misclassified workers. In Part 2 of this post I’ll outline the test that is used by Texas courts in determining whether a workers is an independent contractor or an employee."

Follow Russell Cawyer on Twitter @RussellCawyer

Follow Alison Rowe on Twitter @alisonmrowe

Performance Horse Breeders Win in Tax Court

Guten Tag aus Hannover, Germany, dear Equine Law Blog readers!

For the first time since the Equine Law Blog's inception in early 2008, we are broadcasting "live" from a location outside the United States!  Speaking of the United States, this update is to let you know about the good news found in the U.S. Tax Court decision Blackwell v. Commissioner, decided on August 8, 2011. 

Minnesota performance horse breeders Mark and Patti Blackwell of Fresh Horses Farm stood up to our dear Uncle Sam and they prevailed in a hobby loss case! 

See this related post for more details on why this win is significant.

Why the Blackwells won, in a nutshell [according to the opinion]:

--They developed a "rather comprehensive" written business plan;

 --They prepared to start up the breeding and training activity by taking educational courses and consulting experts;

 --They were not "absentee, aloof, or recreational" horse owners;

 --They made adjustments, as necessary, in their business plan and activities in an effort to make a profit;

--They maintained reasonably good books & records of income and expenses related to their horse activity.

My take aways:  Keep good business records and a written business plan; do as much as you can yourself so that you're not "absentee" or "aloof"; do research and consult experts as to how you might make a profit int he horse business and change things up if you find that the business plan is not working out.

About the picture Before I head to the great horse shows at Luhmühlen and Augsburg, I am staying a couple of days with my former host parents from my days as a Rotary Youth Exchange student (Eberhard and Renate Nickel).  Eberhard Nickel [pictured, on the way to the courthouse this morning] is a German attorney who specializes in construction law and public finance law.  The lawyers in Germany still wear robes to court [but I'm told they never wore wigs].

Follow me on Twitter @alisonmrowe

How Your Horse Business Can Survive an IRS Audit

There is a sense among equine tax professionals and tax lawyers that as of recently, IRS has begun to audit more horse businesses than ever before, and that the IRS is allowing fewer deductions and losses for taxpayers who run horse businesses.

If your horse business is audited, your first call should be to your accountant, who can advise you how you should handle yourself and your paperwork during the audit. However, once your audit begins, there is often little your accountant or lawyer can do to influence the auditor’s decision about what is contained in your business records. Thus, it is highly important that you take steps in advance (beginning with the first day you start running your horse business) to stave off an audit, or at least end up with a “no change” audit (i.e. a finding by the auditor that you reported everything correctly).

Jim Hodges is a certified public accountant (CPA) in Dallas, Texas who has over 30 years of experience preparing returns for horse businesses and horse owners, and has assisted many horse owners with audits. Here are Jim’s top 5 tax tips for horse businesses:

1)         Draft a business plan that describes how you plan on making a profit in your horse business. 

2)         Keep very good business records, including records of the time you spend on your horse activity. 

3)         Hire a good bookkeeper to keep your books and records for your horse business. 

4)         Do not commingle personal funds and funds used for the horse business. Use separate bank accounts and credit cards.

5)         If you have large losses from your horse business one year, it is tempting to deduct only part of the losses so it is not as much of a “red flag” to the IRS.  DO NOT DO THIS.  For all expenses or deductions for your horse business, you should take an “all or nothing” approach.

**I (Alison) put together a sample business plan for horse businesses (for a fictional business), and it can be downloaded here.  For more information on equine business plans, see this post.**

The sense I get from talking to many with their “ears to the tracks” on audits is that if you make a lot of money in your “day job”, you are likely to get audited, even if you are doing everything correctly. Similarly, if you write off large losses, you are likely to be audited, even if you did not do anything inappropriate. But as long as you are legitimately running your horse operation “like a business”, you are likely to survive an audit.

Follow me on Twitter @alisonmrowe

Does Your Property Qualify for Agricultural Appraisal?

If you are looking to buy a “horse property” in Texas, or if you are starting an equine operation on your land in Texas, the following information may be helpful for you to determine whether or not you may successfully apply for agricultural appraisal or maintain your current agricultural appraisal status. 

Agricultural appraisal values land based on its capacity to produce crops, livestock, qualified wildlife or timber, rather than its value on the real estate market. This method typically reduces your property tax bill.

Generally speaking, land will qualify for agricultural appraisal if the land is “currently devoted principally to agricultural use to the degree of intensity generally accepted in the area.” Texas Property Tax Code, Section 23.51.

Land used primarily to raise or keep horses qualifies for agricultural appraisal. Land used primarily to train, show, or race horses, to ride horses for recreation, or to keep or use horses in some other manner that is not strictly incidental to breeding or raising horses does not qualify. Similarly, land used as a stable, where horses are kept, fed and cared for, is not being used primarily for an agricultural purpose, unless the stable is incidental to breeding and raising horses."  Agricultural Appraisal Manual at 8. 

In essence, if your primary use is breeding horses, you should not have a problem qualifying your land for agricultural appraisal. If you run a stable or training facility, you might be able to qualify your land for agricultural appraisal based on another agricultural use, such as raising hay. 

Other items of interest found in the Agricultural Appraisal Manual:

  • If your land has qualified for agricultural appraisal and your county appraisal district finds that you changed its use to a non-agricultural purpose, you will owe a “rollback” tax for each of the previous five years in which your land received the lower appraisal.
  • Agricultural appraisal applies to the land and not to other property that may be connected with the land. Barns, sheds, and other farm out-buildings must be appraised separately at market value. However, fences are treated as appurtenances and are not appraised separately. Land beneath farm buildings and other agricultural improvements does qualify because it is used in connection with the agricultural operation. 
  • Land is ineligible for agricultural appraisal if it is owned by a nonresident alien or foreigner, or if it is located within the boundaries of a city or town, unless the town has used it for a similar purpose, or if it is underserved by utilities. 

Instructions for how to apply for agricultural appraisal in Texas can be found here.

More information about the Agricultural Appraisal Manual and other property tax publications can be found here

Highlights from 2010 National Conference on Equine Law

I just returned from the 2010 National Conference on Equine Law , held last week in Lexington, Kentucky. This was my fifth year in a row to attend the conference, and it was a great year.  The conference had a record number of attendees--180 practitioners from all over the United States. This year's lineup of speakers and topics was the best I've seen so far in five years.

I was lucky enough to be invited to speak this year.  My topic was "A Multi-Jurisdictional Comparison of Equine Liens".  With only 30 minutes to speak, I only had time to cover Texas, Kentucky, and Florida.  However, I hope the materials are helpful by reference to every practitioner or horseman regardless of state.  My handout can be accessed in two parts: Part 1 and Part 2.  Click here for a copy of my PowerPoint presentation.

Takeaways from my presentation:  1) no matter what state you're in, and regardless of whether your state requires it, always send written notice directly to the debtor (if you can find them) before foreclosing on an equine lien; 2) if you want to do a private lien sale under the UCC foreclosure provisions, make sure you can prove to a judge or jury that your debtor was engaged in a "farming operation" (i.e. they are in the horse business--not just a hobbyist); and 3) there may be multiple liens on the horse at issue.  Be aware of which lien has priority.  The person in possession of the horse almost always has the most bargaining power, regardless of priority.

Ned Bonnie, a long-time Kentucky horseman, equine lawyer, and graduate of Yale undergrad and law school, told me he also attaches (seizes via court order) the original registration papers to a horse when a lien dispute arises.  I like this idea, though it requires filing a lawsuit in Texas.

Other highlights from this year's conference:

1) Frank T. Becker's annual Equine Case Law Update--The "case of the year" (the year's most wacky or novel case) was State v. Coates, 2009 WL 2414334.  Frank calls it a "silly case of no legal significance", but interesting nonetheless!  It involved a case of "road rage" between a jogger and a horseman fighting over who should yield a pathway.  The jogger intentionally startled the horse and ended up getting arrested.  Horsemen 1, joggers 0.

2) Ted Martin and April Neihsl talked about the recoverability of damages in equine cases.  Ted stressed the importance of determining the fair market value of the horse at issue and said it is usually determined by 1) expert testimony; 2) previous sales prices and offers to buy; and 3) the owner's testimony (in some cases).

April addressed the recoverability of lost profits, sentimental, and punitive damages.  April stressed that when proving up lost profits, it is essential that the plaintiff had income in the past and that the focus is on net profits rather than gross profits.  Also, while sentimental damages are rarely awarded in equine cases, some states (Colorado, Illinois, Oregon, Tennessee, and Utah) allow them by statute.  

3) Bob Webb and Chris Coffman discussed the IRS's "National Research Program" that is targeting many horse businesses.  The key issue to survive these audits is to prove that the horse operation is a for-profit business, or a trade at the very least.

4) Doyice and Mary Cotten discussed changes in the law affecting the enforceability of liability waivers.  The most frequent causes of liability waiver failure are, according to the Cottens: 1) statutory prohibition of waivers in some states (such as Montana and Louisiana); 2) lack of clarity in the waiver (use of phrase "all liability"); 3) inclusion of waiver in entry form or membership contract; 4) waiver is overbroad or too narrow; and 5) surprisingly--the party to be released is not named in the waiver!

5) Paul Husband presented on the law determining whether someone is an independent contractor or an employee.  Paul stressed the importance of this issue as 6,000 employment tax audits are planned as part of the IRS National Research Program.  The Obama administration has budgeted $25 million to target misclassification of workers as independent contractors.  If an employer misclassifies an employee as an independent contractor, they can receive the "100% penalty" (the person with signature authority on checks for the employer personally pays the employee's tax and serves time in jail).

6) Jay Hickey of the American Horse Council addressed current federal legislation affecting the horse industry.  The Economic Stimulus Bill contains at least one thing that might benefit horse owners--$1.7 billion that can be used for the maintenance and construction of equine trials.  The AHC encourages local organizations to contact district offices to make sure funds are appropriated to horse-related projects.

7) Julie Fershtman discussed liability issues surrounding equine shows and events.  Because most shows or rodeos do not get each spectator to sign a liability waiver, it is important that event sponsors ask their insurance company about insuring against spectator liability.  Furthermore, it was noted that many accidents at equine activities do not involve horses at all, thus bringing them outside the Equine Activity Acts.  Sponsor insurance should, if possible, cover all premises liability issues...not just accidents involving horses.

8) Krysia Carmel Nelson and Tamara Tucker addressed liability issues in boarding and training arrangements.  They suggested including the following clauses in some boarding/training agreements: 1) "training disclaimer" to protect against claim that bad training diminished value of horse; 2) "risk of loss/indemnity" provision to curtail claims that the trainer or boarding facility injured the horse; 3) "veterinary power of attorney" to protect boarding facility from claim that veterinary services were not authorized and ruined horse; 4) "abandonment clause" holding that after a certain period of time, a horse becomes property of the boarding facility/trainer if the owner doesn't pay, make contact, or move the horse.

9) Bruce Smith and Mike Meuser covered fraud in horse sales transactions.  They addressed the crucial issue of a seller's duty to disclose a known defect in a horse.  A duty to disclose can arise when 1) a sales contract requires it; 2) a seller voluntarily makes a partial disclosure that is misleading; 3) the seller knows the buyer has the wrong impression about something related to the horse; 4) a confidential or fiduciary relationship exists; and 5) the seller knows the horse has dangerous propensities.

10) Gregory Dennis, a practitioner who specializes in veterinary malpractice and disciplinary proceedings, discussed various issues surrounding veterinary malpractice cases involving horses.  His presentation highlighted the difference between general negligence in veterinary actions versus veterinary malpractice.

If you would like further information about this year's conference, please click on the individual presenters' names discussed above to find their contact information, or contact me for details.

Equine Business Plans

Every horse business should have a written business plan.  There are a couple of reasons for this.  First, if your business is a start-up, the business plan will help you reduce financial risk by realistically assessing anticipated income and expenses before the business is launched.  Second, a written and regularly-updated business plan will help you in the case of an audit by the IRS, especially if the IRS suspects that your horse business may actually be a "hobby" or that you did not actively participate in the management of the business.  Finally, a written business plan, especially if attractively packaged, can help foster good business relationships with banks, creditors, and others in the horse industry who can either send you business or help you in some other way.

Since there is really no downside to have a written business plan, I suggest that every horse business (including businesses that have been operating for a while without a written business plan) keep an electronic and hard copy of a business plan that addresses the following items:

1)  A summary of the business goals and objectives of the business;

2)  An outline of how you will attain your business goals; 

3)  A list of the types of advisers you will consult (such as horse industry mentors, accountants, and attorneys);

4)  How the business will be owned (i.e. through and entity such as an LLC, who all owns an interest in the business, the percentage interest each owner holds, etc.);

5)  How the business will be financed (i.e. where you will obtain the initial capital needed to start up the business, and the amount needed);

6)  Projected income and expenses for the next 6 months and year (be conservative...most business plans underestimate expenses and necessary capital;  also, you should avoid projecting income and expenses further out than one year as these often become meaningless due to changing conditions and strategies);

7)  The method(s) you will use to find and secure good clients (advertising, networking, shows, etc.).

There really is no "magic formula" for a good business plan, nor should it be set in stone.  Your business is your dream, and your plan needs to set out your unique and individual vision and talents.  Your business plan will act as a "road map" for your business to help you stay on course with your goals and avoid foreseeable hazards.  It should be updated and revised at least once per year, if not more often.

To help you get started, see the attached Sample Equine Business Plan, to which you can add information to fit the needs of your particular horse business.  As you can see, my sample is fairly basic.  There are a lot of sample business plans you can pull up online, and most of those are pretty complex.  One site that provides sample business plans is BPlans.com.  Do not let the complexity of others' business plans intimidate you into not doing one at all.  While more detail is better in some instances, do not put off doing a business plan just because you don't know your exact numbers or you see others putting pie graphs in their business plans.  The key here is to have something in writing that you can add to and enhance as your business grows.

 

Bonus Depreciation in Economic Stimulus Act

Bonus Depreciation

The second incentive of the Economic Stimulus Act of 2008 brings back 50% first-year “bonus depreciation” for horses and most other depreciable property purchased and placed in service during 2008. “Bonus depreciation” was first passed in 2002 but had phased out at the end of 2004. Bonus depreciation helps horse businesses by allowing them to depreciate 50% of horses or property in the first year the horse or property is purchased or placed in service instead of depreciating smaller percentages of the property year after year.

Eligible property. Bonus depreciation applies to horses or any other property with a useful life of 20 years or less. Also, the property must be “new”, meaning the original use of the horse or other property must begin with the taxpayer to be eligible.

No limit. There is no limit on the amount of bonus depreciation that can be taken in any one year.

How Bonus Depreciation Works. Assume that in 2008, a horse business pays $500,000 for a colt to be used for racing and $50,000 for other depreciable property, bringing total purchases to $550,000. The young colt had never been raced or used for any other purpose before the purchase. The business would be able to expense $250,000 as a Section 179 deduction, deduct another $150,000 of bonus depreciation (50% of the remaining balance), and take regular depreciation on the $150,000 balance.

These tax incentives help horse businesses increase income by providing a tax relief for activities they are currently conducting. They should also provide an incentive for new or existing businesses to buy more horses and other related property.

Economic Stimulus Act Increases Section 179 Expense

On February 13, 2008, President Bush signed into law the Economic Stimulus Act of 2008. “The new law includes two tax incentives that would allow a much bigger write-off for horses and other depreciable property purchased and placed into service in 2008,” said Jay Hickey, President of the American Horse Council. The Act applies to taxable years beginning after December 31, 2007.

Increase of the Section 179 Expense

The first incentive for horse owners in the Act is an increase of the Internal Revenue Code Section 179 expensing allowance for horses purchased and placed into service in 2008 from $128,000 to $250,000.

How does Section 179 help horse owners? Typically, if horses or property for your horse business has a useful life of more than one year, the cost must be spread across several tax years as depreciation with a portion of the cost deducted each year.

But there is a way to immediately receive these income tax benefits in one year. The provisions of Section 179 allow horse businesses to fully expense tangible property in the year it is purchased.

The changes made in the Act mean that in 2008, a horse business can expense $250,000 in capital expenditures up to an overall investment limit of $800,000.

Eligible Property. The expensing allowance applies to horses, farm equipment and most other depreciable property such as trucks, trailers, and tractors purchased and placed into service in 2008 (but it would not include buildings such as barns or stables).

How it works. Assume a horse business purchases $750,000 of depreciable property (including horses, a pickup, and a new trailer) in 2008. That business can write off $250,000 on its 2008 tax return and depreciate the balance.

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