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The Farm CPA

RSS By: Paul Neiffer, Top Producer

Paul is now part of the fourth generation in America that is involved in farming and hopes the next generation will be involved also. Through his blog he provides analysis and insight to farmer tax questions.

Another Cattle Tax Shelter Bites the Dust

Jul 30, 2014

I have previously done some posts on certain cattle or horse hobby loss cases. The Tax Court released the Gardner case on Monday July 28, 2014. In this case, Mr. Gardner operated a very successful insurance business in North Carolina. In 2001, he met John and David Pearl, who operated several businesses related to cattle and seems to have talked Mr. Gardner into starting a cattle operation to raise genetically superior livestock.

Over the next few years, Mr. Gardner issues numerous promissory notes to Mr. Pearl and various entities. In the tax court memorandum, the listing the various promissory notes ran more than 20 pages (out of a total of 70 pages). Essentially, Mr. Gardner would issue a promissory note to these entities for the purchase of cattle and/or operating expenses and equipment. The promissory notes totaled more than a $1 million, however, it appears that Mr. Gardner effectively paid less than $100,000 on any of these promissory notes. Also, in almost all cases, Mr. Gardner defaulted on all notes and no collection efforts were made to collect.

Mr. Gardner took a net deduction of about $700,000 during 2002-2004. As you can expect, the IRS audited these returns and assessed taxes and penalties. The tax court summarized all of the facts of the cattle operation and then examined whether the cattle operation met the 9 steps normally required under Section 183 (dealing with hobby losses). In our previous posts, we reviewed some of the cases where taxpayers were allowed to deduct the losses since the tax court agreed they were a business and not a hobby.

In this case, I am not even going to list all of these reasons since the taxpayer was essentially found to not have any of the 9 steps be in his favor. For example, the primary goal of Mr. Gardner was to raise genetically superior livestock. This requires meticulous records to be maintained on the cattle being raised. In this case, no records were maintained at all, therefore only commercial cattle values could be used. This value was about $193,000.

The tax court did not view favorably that the cattle loss suddenly rose from about $30,000 or so in 2002 and 2003 to over $600,000 in 2004 when his insurance business netted more than $500,000.

All-in-all, this was not a good case for the taxpayer. In many cases, a taxpayer may owe the tax, but get relief from the penalties which can be at least 20% of the tax owed. In this case, the tax court found the taxpayer liable for the penalty. All-in-all, this was not a good case for the taxpayer.

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