Does your business accept checks or credit cards?
If your business accepts checks or credit cards from Massachusetts residents, this article is definitely for you. Even if you live in a state where there are currently no requirements for this type of security, something similar may be coming to your state soon. So see what plan Massachusetts is putting into place. No matter where your business is located, safeguarding your customers' personal information just makes good business sense.
Effective March 1, 2010, every organization who collects, owns or licenses personal information about a resident of Massachusetts should be in full compliance with 201 CMR 17. This new personal data protection law establishes a standard set of regulations for businesses to protect and store Massachusetts residents' personal information. Personal information is defined under the new regulation as a resident's first name and last name, or first initial and last name, and one or more of the following:
· Social Security number· Driver's license number or state-issued ID card number· Financial account number (bank account number) or credit or debit card number (with or without any type of security or access code or password).
So this law applies to ANY BUSINESS, regardless of size, who accepts checks or credit cards.
The law requires companies to develop and implement several security safeguards, including:
· A comprehensive written information security plan (WISP) creating effective administrative, technical and physical safeguards of personal information.· Protection against any anticipated threats or hazards to the security or integrity of personal information (such as restricted physical access, computer passwords).· Policies regulating employees' ability to access and transport records outside work.· Disciplinary measures for violations of these new safeguards. MGL Chapter 93A, section 4 specifically "authorizes the Attorney General to seek injunctive relief against the organization involved in the unauthorized act or practice and allows a court to impose a $5,000 civil penalty for each violation". If "violation "is interpreted to mean the unauthorized access to a single individual's personal information, potential damages could be enormous.
It's not as daunting a task as it sounds. Most of the procedures are fairly simple to implement. Here are links to the law and WISP guidelines.If you would like more information or assistance, you can contact a private company who specialize in helping you implement an acceptable plan.
Thank you to David Javaheri at http://r20.rs6.net/tn.jsp?t=zlc7kgdab.0.0.tnz777cab.0&ts=S0464&p=http%3A%2F%2Fwww.compliancehelp.net%2F&id=preview for his help with this article.
Monday, March 15, 2010
Tuesday, February 16, 2010
Equine Accounting: Seven tips for getting paid by your clients on a more timely basis...
You've got a barn full of boarders and lots of lessons scheduled. Everyone's happy with your services. But you are having trouble collecting from those clients. What can you do to make collection easier and faster?
1. Bill your clients on a timely basis. Your invoices for board should reach your clients at least one week before their payment is due. Take the time to create an actual invoice - even if the amount due stays the same from month to month. If you don't have the time to bill your clients, hire someone to do it for you. You know that the reason that you don't have time to do the billing is because you are too busy cleaning stalls, turning out and doing all the other things it takes to make your clients and their horses happy. But the message they get when you don't bill on time is that the money isn't that important to you. So why should it be to them? 2. Have new boarders sign a contract that specifies when board is due and have current boarders initial the contract yearly. It may not have a lot of legal clout but it reminds your clients that you are first and foremost a business and operate as such. If you use this procedure with everyone, you aren't likely to get objections to doing so.
3. Ask for a security deposit from new boarders. This is standard procedure when you rent an apartment so why should it be any different when someone rents a stall from you? Having the security deposit gives you a little cushion should someone get behind. But never offer the client the option to apply the security deposit to an arrears balance unless it is their last month of boarding with you. If you increase your board, then the client must increase the amount of the security deposit. Your state may have regulations relating to maintaining security deposits so check with them before setting up any policy.
4. Have clients prepay your boarding or lesson fees. Offer them the option to "buy in bulk". This is especially effective for lessons. Offer a package of ten lessons with a discount for prepayment. Boarding barns can offer a discount when payment is made in advance on a quarterly basis.
5. Offer clients the opportunity to pay by credit card. PayPal and Intuit offer affordable credit card services that you can access from a smartphone or computer. There are fees involved but accepting credit cards can save you the time you spend chasing clients for payment. But I would not suggest maintaining credit card information on file. Massachusetts is in the process of implementing a new privacy of information law that includes security of credit card information and your state may have a similar law in place. Instead, explain to clients that they will need to provide their credit card for each charge. Some barns currently will only accept credit cards as a form of payment. This eliminates the need to make bank deposits and the problem of a check returned for insufficient funds.
6. For invoices for board, consider e-mailing the invoices rather than handing them out or leaving them in tack trunks. Clients are more likely to forget the invoice at the barn, in the car, etc than an invoice delivered directly to their computer. Checkbooks are usually kept close to the computer so it's easy to write out the check right then and there. For lessons, you should not have to be sending invoices, unless it is for a prepayment package. If the client does not prepay, then payment should be made at the time of the lesson. 7. Some barns charge extra fees for time spent holding the horse for the farrier, administering meds, etc. You may get distracted during the day and forget to make a note that the client needs to be billed for those extras. So consider either increasing the monthly board to cover all of the extras or offering an annual charge (to be paid at the beginning of each year) to cover all of the extras. The fee wouldn't be mandatory for all clients but by discounting it, you can make it attractive enough that many of your boarders will sign on.
1. Bill your clients on a timely basis. Your invoices for board should reach your clients at least one week before their payment is due. Take the time to create an actual invoice - even if the amount due stays the same from month to month. If you don't have the time to bill your clients, hire someone to do it for you. You know that the reason that you don't have time to do the billing is because you are too busy cleaning stalls, turning out and doing all the other things it takes to make your clients and their horses happy. But the message they get when you don't bill on time is that the money isn't that important to you. So why should it be to them? 2. Have new boarders sign a contract that specifies when board is due and have current boarders initial the contract yearly. It may not have a lot of legal clout but it reminds your clients that you are first and foremost a business and operate as such. If you use this procedure with everyone, you aren't likely to get objections to doing so.
3. Ask for a security deposit from new boarders. This is standard procedure when you rent an apartment so why should it be any different when someone rents a stall from you? Having the security deposit gives you a little cushion should someone get behind. But never offer the client the option to apply the security deposit to an arrears balance unless it is their last month of boarding with you. If you increase your board, then the client must increase the amount of the security deposit. Your state may have regulations relating to maintaining security deposits so check with them before setting up any policy.
4. Have clients prepay your boarding or lesson fees. Offer them the option to "buy in bulk". This is especially effective for lessons. Offer a package of ten lessons with a discount for prepayment. Boarding barns can offer a discount when payment is made in advance on a quarterly basis.
5. Offer clients the opportunity to pay by credit card. PayPal and Intuit offer affordable credit card services that you can access from a smartphone or computer. There are fees involved but accepting credit cards can save you the time you spend chasing clients for payment. But I would not suggest maintaining credit card information on file. Massachusetts is in the process of implementing a new privacy of information law that includes security of credit card information and your state may have a similar law in place. Instead, explain to clients that they will need to provide their credit card for each charge. Some barns currently will only accept credit cards as a form of payment. This eliminates the need to make bank deposits and the problem of a check returned for insufficient funds.
6. For invoices for board, consider e-mailing the invoices rather than handing them out or leaving them in tack trunks. Clients are more likely to forget the invoice at the barn, in the car, etc than an invoice delivered directly to their computer. Checkbooks are usually kept close to the computer so it's easy to write out the check right then and there. For lessons, you should not have to be sending invoices, unless it is for a prepayment package. If the client does not prepay, then payment should be made at the time of the lesson. 7. Some barns charge extra fees for time spent holding the horse for the farrier, administering meds, etc. You may get distracted during the day and forget to make a note that the client needs to be billed for those extras. So consider either increasing the monthly board to cover all of the extras or offering an annual charge (to be paid at the beginning of each year) to cover all of the extras. The fee wouldn't be mandatory for all clients but by discounting it, you can make it attractive enough that many of your boarders will sign on.
Tuesday, January 19, 2010
Equine Accounting: Bartering- It’s not really income, is it?
You may trade services from your farrier for lessons for his daughter. Your favorite restaurant may provide goodies for your barn's Christmas party in exchange for the owner's occasional use of your indoor arena. But that's not actually income for you (and for the fellow barterer), is it?
There are two aspects of that question. Is it income to you for tax purposes and is it income to you for "business" purposes? First, the tax aspect: To quote the IRS: "Bartering is the trading of one product or service for another. Usually there is no exchange of cash. Barter may take place on an informal one-on-one basis between individuals and businesses, or it can take place on a third party basis through a modern barter exchange company. Income from bartering is taxable in the year it is performed."
An example of an even swap would be two hours of riding lessons (regularly priced at $50/hr) in exchange for having 5 horses clipped for winter (regularly priced at $20/horse). For tax purposes, you have $100 of income from your lessons and the person doing the clipping has $100 of income for clipping your horses. Cash might be included in a barter situation if you provided one hour of riding lessons but only had one horse to be clipped. The person doing the clipping might also pay you $30 in cash.
Income from bartering should be tracked separately from regular income. Any business expenses incurred in performance of the bartered transaction are deductible - e.g. the cost of ring fees for the lessons for your farrier's daughter if they are not held at your facility. The IRS offers guidelines on record keeping for barter transactions at the IRS Website.
Be sure to use a reasonable value for the property or services received in a barter transaction to include in your income. If you exchange a $2000 filly for 6 months board (in a barn where board is usually $500/month), there is a $1000 gross profit on the transaction because goods worth $2000 were exchanged for services worth $3000.
An especially tricky barter situation occurs if you are bartering and giving and/or receiving services that could be construed as employment. For example, you exchange barn help for a reduction in the cost of board. The IRS may consider this relationship to be employment on your part. In addition to reporting the barter income, you would also be responsible for the employer portion of Social Security and Medicare taxes.
Depending on the nature of the work, at the very least, the person doing the work might be considered an independent contractor by the IRS. If you provided $600 or more of some form of compensation to the worker, you would be responsible for providing them and the IRS with a Form 1099 at year end.
There can also be sales tax issues if the product/service that you barter is considered taxable in your state.
Second, the business aspect: if you are receiving vet services in trade for lessons for your vet's daughter and the daughter loses interest in horses, you now have to pay for your veterinary services. For future planning, you need to know how much you "spent" on vet services previously.
For some services, such as lessons, the cost is easy to quantify. You may charge $50/hr for a lesson. Your vet bill is $200 so you owe your vet four lessons. But what about something like exchanging handyman services for rough board? What may seem like a good deal when you have several stalls available and plenty of work to be done, might not be economically advantageous when you have someone willing to pay top dollar to rent your last stall.
If cash is in short supply or you are giving/receiving a commodity that is scarce, bartering can be a wonderful opportunity. But be aware that it is not as simple a transaction as it may seem.
See the IRS Bartering Center for more information.
There are two aspects of that question. Is it income to you for tax purposes and is it income to you for "business" purposes? First, the tax aspect: To quote the IRS: "Bartering is the trading of one product or service for another. Usually there is no exchange of cash. Barter may take place on an informal one-on-one basis between individuals and businesses, or it can take place on a third party basis through a modern barter exchange company. Income from bartering is taxable in the year it is performed."
An example of an even swap would be two hours of riding lessons (regularly priced at $50/hr) in exchange for having 5 horses clipped for winter (regularly priced at $20/horse). For tax purposes, you have $100 of income from your lessons and the person doing the clipping has $100 of income for clipping your horses. Cash might be included in a barter situation if you provided one hour of riding lessons but only had one horse to be clipped. The person doing the clipping might also pay you $30 in cash.
Income from bartering should be tracked separately from regular income. Any business expenses incurred in performance of the bartered transaction are deductible - e.g. the cost of ring fees for the lessons for your farrier's daughter if they are not held at your facility. The IRS offers guidelines on record keeping for barter transactions at the IRS Website.
Be sure to use a reasonable value for the property or services received in a barter transaction to include in your income. If you exchange a $2000 filly for 6 months board (in a barn where board is usually $500/month), there is a $1000 gross profit on the transaction because goods worth $2000 were exchanged for services worth $3000.
An especially tricky barter situation occurs if you are bartering and giving and/or receiving services that could be construed as employment. For example, you exchange barn help for a reduction in the cost of board. The IRS may consider this relationship to be employment on your part. In addition to reporting the barter income, you would also be responsible for the employer portion of Social Security and Medicare taxes.
Depending on the nature of the work, at the very least, the person doing the work might be considered an independent contractor by the IRS. If you provided $600 or more of some form of compensation to the worker, you would be responsible for providing them and the IRS with a Form 1099 at year end.
There can also be sales tax issues if the product/service that you barter is considered taxable in your state.
Second, the business aspect: if you are receiving vet services in trade for lessons for your vet's daughter and the daughter loses interest in horses, you now have to pay for your veterinary services. For future planning, you need to know how much you "spent" on vet services previously.
For some services, such as lessons, the cost is easy to quantify. You may charge $50/hr for a lesson. Your vet bill is $200 so you owe your vet four lessons. But what about something like exchanging handyman services for rough board? What may seem like a good deal when you have several stalls available and plenty of work to be done, might not be economically advantageous when you have someone willing to pay top dollar to rent your last stall.
If cash is in short supply or you are giving/receiving a commodity that is scarce, bartering can be a wonderful opportunity. But be aware that it is not as simple a transaction as it may seem.
See the IRS Bartering Center for more information.
Monday, December 14, 2009
Equine Accounting: Donating a horse to a Charitable Organization
Wednesday, November 11, 2009
Equine Accounting: Home, Sweet Home (Office Deduction)
If you use a portion of your home for business purposes, you may be able to take a home office deduction if you meet certain requirements. In order to claim a business deduction, you must use part of your home for one of the following two reasons: 1. Exclusively and regularly as either: your principal place of business, or as a place to meet or deal with clients in the normal course of your business. To meet the test for exclusive use, you must use use a specific area of your home only for your trade or business. And you must have no other fixed location where you conduct substantial administrative or management activities of your trade or business. For example, if you conduct part of your business from an office located in your barn, you could not also claim home office expenses for the same business activity. And you must use this space regularly, rather than incidentally or occasionally.
2. On a regular basis for certain storage use -- such as storing inventory or product samples -- as rental property, or as a home daycare facility.
The use of the office must be for “substantial managerial or administrative activities” such as billing customers, keeping books and records and scheduling appointments. The business activity associated with the home office need not be your main activity but the home office must be the principal place of business for your sideline activity. For example, an attorney working full time may judge at horse shows on weekends. If the home office is not used for purposes other than those associated with being a judge, the expenses associated with the home office should be deductible for tax purposes. Generally, the amount you can deduct depends on the percentage of your home that you used for business. Usage is commonly allocated based on the percentage of square footage allocated for business use but any other reasonable method would be acceptable.
Different rules apply to claiming the home office deduction if you are an employee. For example, the regular and exclusive business use must be for the convenience of your employer. If you own your home and qualify to deduct expenses for its business use, you can claim a deduction for depreciation. Depreciation is an allowance for the wear and tear on the part of your home used for business. You cannot depreciate the cost or value of the land.
HOWEVER (you knew there had to be a downside), if you sell your house, any depreciation taken on a home office after May 6, 1997 must be recaptured at the rate of 25 percent (for taxpayers in tax brackets over this amount). You cannot use the home sale exclusion to offset this tax. You cannot avoid the recapture by not reporting depreciation. Recapture applies to depreciation both claimed and claimable. If you want to avoid the depreciation recapture, you must choose to sidestep the deduction entirely by disqualifying the home office (by NOT using the space entirely for business). You will miss out on the depreciation expense but can still deduct related costs such as office maintenance.
For more information, see IRS Publication 587.
2. On a regular basis for certain storage use -- such as storing inventory or product samples -- as rental property, or as a home daycare facility.
The use of the office must be for “substantial managerial or administrative activities” such as billing customers, keeping books and records and scheduling appointments. The business activity associated with the home office need not be your main activity but the home office must be the principal place of business for your sideline activity. For example, an attorney working full time may judge at horse shows on weekends. If the home office is not used for purposes other than those associated with being a judge, the expenses associated with the home office should be deductible for tax purposes. Generally, the amount you can deduct depends on the percentage of your home that you used for business. Usage is commonly allocated based on the percentage of square footage allocated for business use but any other reasonable method would be acceptable.
Different rules apply to claiming the home office deduction if you are an employee. For example, the regular and exclusive business use must be for the convenience of your employer. If you own your home and qualify to deduct expenses for its business use, you can claim a deduction for depreciation. Depreciation is an allowance for the wear and tear on the part of your home used for business. You cannot depreciate the cost or value of the land.
HOWEVER (you knew there had to be a downside), if you sell your house, any depreciation taken on a home office after May 6, 1997 must be recaptured at the rate of 25 percent (for taxpayers in tax brackets over this amount). You cannot use the home sale exclusion to offset this tax. You cannot avoid the recapture by not reporting depreciation. Recapture applies to depreciation both claimed and claimable. If you want to avoid the depreciation recapture, you must choose to sidestep the deduction entirely by disqualifying the home office (by NOT using the space entirely for business). You will miss out on the depreciation expense but can still deduct related costs such as office maintenance.
For more information, see IRS Publication 587.
Saturday, October 10, 2009
Equine Accounting: Franchises-The more we get together, the happier we'll be
Don't have $150,000 for a Grand Prix horse capable of competing on a national level? Just find 14 friends each with $10,000 to spare and create a syndicate. Is it that easy? No, not really. But syndicates, which have been popular for some time for race horses and breeding, are becoming a useful way to finance the purchase of a competition horse. Several friends of mine who were all students of a well-known dressage trainer combined funds and expertise with other interested parties and created a syndicate to allow the trainer to purchase a very talented horse that he had in training. One of my friends jokingly says that she "owns the tail".
What is a syndicate? A syndicate is a division of ownership. Each shareholder or member contributes a portion of the cost to purchase and/or maintain a horse or horses. Generally, the syndicate's legal form of organization is either a partnership or an LLC (Limited Liability Corporation). What does the Syndicate Agreement include? Generally, the agreement should include:1. the rights, interests, obligation and privilege of each member.2. identification of the animal(s) and where it will be held.3. warrants as to the health and title of the animal(s).4. conditions for transferability of shares.5. designation of syndicate manager and explanation of his/her duties and compensation.6. provision for the tax treatment of the syndicate.7. establishment of liability insurance coverage and in the case of stallion/mare, any warranties of fertility.8. any timelines for when the horse will be sold or the syndicate will terminate.9. explanation of procedure to modify current agreement, if necessary. What is the cost to purchase a share in a syndicate? The biggest variable in determining the cost of a share is the cost of the horse. Another variable is the issue of who bears the cost of future expenses. Many syndicates require that members make an annual contribution for the cost of maintaining the horse - feed, board, vet bills, farrier as well as costs for competition and shipping. However, some syndicates offer their shares at a one-time fee. This is more often the case if the current owner of the horse cannot afford the future costs of training and competing and creates a syndicate to obtain funding to campaign the horse further. In this case, there is no actual purchase of a horse. The revenues from sales of shares are used to fund future endeavors. What are the benefits of syndication? For members, the risk of ownership is significantly decreased. If the horse is not a successful performer or in injured, the loss is only a fraction of the purchase price. It is a relatively safe and inexpensive way to get involved in racing, breeding or competing and provides the opportunity to participate on a much higher level than individual ownership. Some syndicates offer perks such as the opportunity for members to attend select competitions with access to VIP hospitality or to obtain lessons on their own horses at discounted rates. For the trainer/rider, it provides funds to purchase a horse that may otherwise have been unobtainable. Because a syndicate is composed of many members and designation of the trainer has been included in the syndicate agreement, it provides a much more stable relationship for the trainer with the owners and the likelihood of a horse being moved from trainer to trainer is considerably diminished. What about taxes? An attorney, knowledgeable in this subject, is essential. A syndicate is treated under tax laws as either a joint ownership of property or as a partnership. The activities of the syndicate determine how it is treated for tax purposes. When the syndicate is treated as a joint ownership of property, each member files their tax return as a sole proprietor. They report their share of income and expense of the syndicate with no computation of the income and expense of the syndicate included with their return. They can choose the method of depreciation that is most beneficial to their tax situation. If the syndicate is treated as a partnership for tax purposes, Form 1065 K-1 (IRS filing on partnership informational return) must be included with each member's personal return and the method of depreciation is determined by the syndicate. Depending on the activities of the syndicate and the structure of the syndicate agreement, there is the possibility that syndicate shares may be treated as a security would be subject to specific requirements by the SEC (U.S. Securities and Exchange Commission). There are also murky tax issues such as "at-risk rules" and possible tax shelter status. So be sure to have an attorney that represents you look over the syndicate agreement.
What is a syndicate? A syndicate is a division of ownership. Each shareholder or member contributes a portion of the cost to purchase and/or maintain a horse or horses. Generally, the syndicate's legal form of organization is either a partnership or an LLC (Limited Liability Corporation). What does the Syndicate Agreement include? Generally, the agreement should include:1. the rights, interests, obligation and privilege of each member.2. identification of the animal(s) and where it will be held.3. warrants as to the health and title of the animal(s).4. conditions for transferability of shares.5. designation of syndicate manager and explanation of his/her duties and compensation.6. provision for the tax treatment of the syndicate.7. establishment of liability insurance coverage and in the case of stallion/mare, any warranties of fertility.8. any timelines for when the horse will be sold or the syndicate will terminate.9. explanation of procedure to modify current agreement, if necessary. What is the cost to purchase a share in a syndicate? The biggest variable in determining the cost of a share is the cost of the horse. Another variable is the issue of who bears the cost of future expenses. Many syndicates require that members make an annual contribution for the cost of maintaining the horse - feed, board, vet bills, farrier as well as costs for competition and shipping. However, some syndicates offer their shares at a one-time fee. This is more often the case if the current owner of the horse cannot afford the future costs of training and competing and creates a syndicate to obtain funding to campaign the horse further. In this case, there is no actual purchase of a horse. The revenues from sales of shares are used to fund future endeavors. What are the benefits of syndication? For members, the risk of ownership is significantly decreased. If the horse is not a successful performer or in injured, the loss is only a fraction of the purchase price. It is a relatively safe and inexpensive way to get involved in racing, breeding or competing and provides the opportunity to participate on a much higher level than individual ownership. Some syndicates offer perks such as the opportunity for members to attend select competitions with access to VIP hospitality or to obtain lessons on their own horses at discounted rates. For the trainer/rider, it provides funds to purchase a horse that may otherwise have been unobtainable. Because a syndicate is composed of many members and designation of the trainer has been included in the syndicate agreement, it provides a much more stable relationship for the trainer with the owners and the likelihood of a horse being moved from trainer to trainer is considerably diminished. What about taxes? An attorney, knowledgeable in this subject, is essential. A syndicate is treated under tax laws as either a joint ownership of property or as a partnership. The activities of the syndicate determine how it is treated for tax purposes. When the syndicate is treated as a joint ownership of property, each member files their tax return as a sole proprietor. They report their share of income and expense of the syndicate with no computation of the income and expense of the syndicate included with their return. They can choose the method of depreciation that is most beneficial to their tax situation. If the syndicate is treated as a partnership for tax purposes, Form 1065 K-1 (IRS filing on partnership informational return) must be included with each member's personal return and the method of depreciation is determined by the syndicate. Depending on the activities of the syndicate and the structure of the syndicate agreement, there is the possibility that syndicate shares may be treated as a security would be subject to specific requirements by the SEC (U.S. Securities and Exchange Commission). There are also murky tax issues such as "at-risk rules" and possible tax shelter status. So be sure to have an attorney that represents you look over the syndicate agreement.
Wednesday, August 12, 2009
Equine Accounting: Hobby vs Business...What the IRS says
To you, it's a way to combine your passion with the need to eat and have a roof over your head. It's a business. But the IRS might have an alternative view. How do they decide and what difference does it make to you?
The IRS has created the Hobby Loss Rule for unincorporated businesses that it determines to be created mainly for recreation, sport or personal enjoyment. In addition to horses, examples of other activities that might qualify under this heading would be coin/stamp collecting or dog/cat breeding. For the IRS to classify your activity as a business, there must be a presence of a profit objective. The owner must have entered into or continued with the activity with the objective of making a profit.
The profit motive can be inferred by the IRS by examining the following factors (commonly known as the 9 Factors Test):
1. Is the activity carried on in a business-like manner - business records are separate from personal records, the business has a long-range business plan (preferrably written) and complete and accurate books are kept?
2. Does the owner invest a significant amount of time in the business?
3. Does the owner depend on the income from the activity for his/her livelihood?
4. What is the amount of occasional profits, if any?
5. Has the activity been profitable in some years and how much profit is realized?
6. Does the owner have the expertise to carry on the business? Do they solicit the advice of experts?
7. Are there elements of personal pleasure or recreation involved?
8. Is there an expectation that the assets used in the activity will appreciate in value?
9. Has the owner had success in other similar ventures?
The burden of proof is on the taxpayer. IRS regulations state that in determining whether an activity is enaged in with a profit motive, the IRS will look to "objective standards, taking into account all the facts and circumstances of each case."
What can you do to avoid having your business classified as a hobby activity? As a business owner, you need to operate in a way which conforms to the factors that indicate a profit motive. Available on the IRS website is the Audit Techniques Guide for Farm Hobby Losses with Cattle and Horse Activities. This guide is available to auditors, prior to visiting a horse/cattle activity. Read it and familiarize yourself with the areas are important to the IRS regarding this issue.
Another factor for you to consider is the possibility of timing the profit and loss years. In IRS terms, this situation is known as the "General Presumption" or more commonly as the "Two out of Seven Rule". This is a lengthy subject and will be discussed in a later issue of this newsletter.
If you think that your business is too big, has been in business too long, etc. to be determined to be a hobby by the IRS, consider this; in 1958, Tempel Smith decided to build a herd of Lipizzan horses and create an organization in the U.S. similar to the Spanish Riding School. Tempel Farms showed consecutive losses over the period from 1958-1976, totalling approximately $5.9 million dollars. By 1976, the herd size was approximately 400 horses. In Smith v Commissioner 1979, the IRS challenged the profit presumption and tried to establish that Tempel Farms was a hobby activity. Fortunately for Tempel Farms, the U.S. Tax Court disagreed with the IRS position.
If your activity IS determined to be a hobby, income is reported as other income on Form 1040 and deductions are reported as miscellaneous itemized deductions on Schedule A. However, any expenses your business sustains may not be deductible in excess of business income and the unused losses cannot be carried over to another year.
In these tough times, your business may not be able to show a profit. But you can operate your business with consideration for the eight factors listed above. Plan ahead.
The IRS has created the Hobby Loss Rule for unincorporated businesses that it determines to be created mainly for recreation, sport or personal enjoyment. In addition to horses, examples of other activities that might qualify under this heading would be coin/stamp collecting or dog/cat breeding. For the IRS to classify your activity as a business, there must be a presence of a profit objective. The owner must have entered into or continued with the activity with the objective of making a profit.
The profit motive can be inferred by the IRS by examining the following factors (commonly known as the 9 Factors Test):
1. Is the activity carried on in a business-like manner - business records are separate from personal records, the business has a long-range business plan (preferrably written) and complete and accurate books are kept?
2. Does the owner invest a significant amount of time in the business?
3. Does the owner depend on the income from the activity for his/her livelihood?
4. What is the amount of occasional profits, if any?
5. Has the activity been profitable in some years and how much profit is realized?
6. Does the owner have the expertise to carry on the business? Do they solicit the advice of experts?
7. Are there elements of personal pleasure or recreation involved?
8. Is there an expectation that the assets used in the activity will appreciate in value?
9. Has the owner had success in other similar ventures?
The burden of proof is on the taxpayer. IRS regulations state that in determining whether an activity is enaged in with a profit motive, the IRS will look to "objective standards, taking into account all the facts and circumstances of each case."
What can you do to avoid having your business classified as a hobby activity? As a business owner, you need to operate in a way which conforms to the factors that indicate a profit motive. Available on the IRS website is the Audit Techniques Guide for Farm Hobby Losses with Cattle and Horse Activities. This guide is available to auditors, prior to visiting a horse/cattle activity. Read it and familiarize yourself with the areas are important to the IRS regarding this issue.
Another factor for you to consider is the possibility of timing the profit and loss years. In IRS terms, this situation is known as the "General Presumption" or more commonly as the "Two out of Seven Rule". This is a lengthy subject and will be discussed in a later issue of this newsletter.
If you think that your business is too big, has been in business too long, etc. to be determined to be a hobby by the IRS, consider this; in 1958, Tempel Smith decided to build a herd of Lipizzan horses and create an organization in the U.S. similar to the Spanish Riding School. Tempel Farms showed consecutive losses over the period from 1958-1976, totalling approximately $5.9 million dollars. By 1976, the herd size was approximately 400 horses. In Smith v Commissioner 1979, the IRS challenged the profit presumption and tried to establish that Tempel Farms was a hobby activity. Fortunately for Tempel Farms, the U.S. Tax Court disagreed with the IRS position.
If your activity IS determined to be a hobby, income is reported as other income on Form 1040 and deductions are reported as miscellaneous itemized deductions on Schedule A. However, any expenses your business sustains may not be deductible in excess of business income and the unused losses cannot be carried over to another year.
In these tough times, your business may not be able to show a profit. But you can operate your business with consideration for the eight factors listed above. Plan ahead.
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