Your Intent Justifies Tax Deductions
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By William Given
The deadline to file your 2016 income tax return is April 15th, and it will be here before you know it. Whether you have recently had your first litter or your last, or are anxiously awaiting the arrival of your next litter, you may have found yourself asking, “Will the Internal Revenue Service allow me to write off the costs associated with breeding and raising a litter?” The rapid response is: “Not very likely.” But a more accurate and complete answer is: “Yes, the IRS may allow breeders to deduct the expenses of breeding, raising and selling of a litter of purebred puppies.” That is, if you have taken the time and expended the energy to turn your hobby into a real business with the INTENT of making a PROFIT.
I have been an owner, breeder and exhibitor for more than thirty years. I am a former Supervisory Tax Examiner, with twelve years of experience working for the Internal Revenue Service and feel fully confident in telling you that your intent is the basis for justifying your small-scale breeding operation as a business and not a hobby. I know of at least four cases in which breeders were deemed to be a hobby by the IRS.
The first case concerned a man who established a large kennel of gun dogs. He put experienced and highly qualified personnel in charge. Over a period of more than ten years, the business failed to show any sign of profit. The other three cases involved men and women who bred, raised, exhibited and sold purebred show dogs. Yes, they derived good income but they all experienced even greater expenses and failed to meet the three years out of five profit rule.
The Courts ruled these were in fact businesses and allowed the deductions based on a preponderance of the evidence that the businesses were started in good faith with the intention to make a profit, and because the time and effort put into the operational and administrative aspects of their businesses by the owners was commensurate with their financial investment, despite their amateur standing.
Without having complete details of the deductions claimed and those which were allowed, I cannot unequivocally state that you too could claim the deductions for all of your losses. However, the verdicts rendered in these cases, which allowed the deductions for the losses incurred, were based on a factor which the individuals had to prove existed, i.e., they had to prove that the businesses in which the losses occurred were established with the genuine intent of making a profit.
With that said, here are a few tips which will help you substantiate your INTENT and allow you to receive a more favorable business tax treatment for the pursuit of your passion:
Explore the profit potential. The Internal Revenue Service will assume that a prudent business person would conduct some type of inquiry into the profit potential prior to the commencement of business operations. The breeder should have some kind of breeding plan, sales policy and sales contract. Your breeding plan and sales policy is open to change over the years that your breeding program is in operation, but the existence of a breeding plan, sales policy and sales contract helps to establish the intent of the breeder.
Have a business plan. Remember, the Internal Revenue Service looks for business-like activity. One of the items on the auditors’ checklist is a business plan. Prepare one and make it professional, whether or not you stick to it. Businesses review and revise their business plans periodically. Your goal is to appear business-like in all things you do. For example, your plan should include a business overview, a market analysis, an assessment of the competition, an advertising & marketing plan, operating plan, financial plan, and an exit strategy for discontinuing the business should it become an unsuccessful venture. A well-written business plan will serve as an element of proof to the IRS and the Court that you are in fact a legitimate business owner and entitled to the benefits provided to home -based business owners.
Know the details of your business. Fully acquaint yourself with the administrative and operational aspects of your business, and study those things that will make you successful in business. Keep your overhead to a minimum. Sometimes it is not so much about how much you make, but rather how much you keep. Work where you are more productive, even if it is outside the home. I get a significant amount of my work completed sitting undisturbed in fast food restaurants. Never underestimate the importance of branding and being professional. Branding is particularly important when building an identity for you, your dogs and your kennel. Your professionalism will confirm your credibility, promote a connection with your puppy purchasers, motivate your buyers and secure their loyalty.
Understand your business risks. Let your records show that you have discussed the risks and problems with long-time breeders who have been highly successful in the business. Your records might include the results of discussions with a veterinary reproductive specialist concerning the differences between the timed breeding method versus the use of artificial insemination, the benefits of using fresh-chilled extended semen compared to frozen semen, and success rates utilizing transcervical insemination or intrauterine surgical insemination. Record the outcome of visits to your municipal zoning office to investigate your city’s zoning laws to ensure you can legally operate such a business out of your home.
Maintain accurate records now. The IRS provides individual taxpayers and businesses numerous opportunities to save money on their taxes. However, it is ultimately your responsibility to keep accurate records to prove your deductions in the event of an audit. Collecting and organizing your records throughout the year will make it easier to prepare your return, and reduces the likelihood of errors but more importantly it shows the IRS that you are operating in a business-like manner. Your records are the foundation of your defense in the event you are unsuccessful at making a profit and the IRS chooses to dispute your return.
Engage experts and become one. If you retain the assistance of an expert, and are taking active steps to become an expert, the more business-like you will look. If you have a college degree or are working to gain a degree or otherwise have in some way obtained significant expertise in the activity, the more business-like you will look. If you do not have a degree, but have completed extensive research in an area, keep records of that research in the event you need to show the amount of time, effort and energy you have invested. Similarly, if you hire an experienced consultant to help you complete a thorough pedigree analysis of potential sires, research the major and minor faults of conformation of the stud dogs on your list, or study the congenital health concerns in your breed, you will have a head start on convincing the IRS of your business status.
Get out and get noticed. Build a professional website, and do not underestimate the importance of having a presence on social media. Be on Facebook, and create a Twitter cccount and a LinkedIn profile. Be in as many places at one time as you can. Use services such as Reporter Connection, Pitch Rate and ProfNet to connect with reporters and be quoted in traditional media. HARO, Reporter Connection and Pitch Rate are free. Consider writing articles for show dog magazines and breed journals. I would suggest topics such as selecting a suitable sire, the importance of the foundation bitch and the proper analysis of pedigrees. Some of your reading audience will be potential puppy buyers, and they will connect your name with your kennel name. Your written work will show you know what you are doing and demonstrate your expertise.
Make yourself the example. Join a local all-breed kennel club and your breed’s National Specialty club. Exhibit your puppies at sanctioned matches and your dogs at point shows. Subscribe to show dog magazines and breed journals, and build a reference library of books on your breed and breeding. Even if you have to start small and in selected issues (such as the stud dog and brood bitch issues), advertise in show dog publications. It would also be wise to register your kennel name with the American Kennel Club; it will set you apart from a lot of your competition. Use your kennel name on business cards and on all advertising. Require your kennel name be used as part of the AKC registered name of the puppies you sell.
Stay a step ahead. Keep abreast of current trends and developments in the field of canine reproduction. Locate and attend conferences and seminars on canine reproduction. Presentations will be made by veterinary canine reproductive specialists and will cover a wide variety of topics including genetic health concerns and advancements in canine reproductive technology. They will be sponsored by the American Kennel Club, local kennel clubs or schools of veterinary medicine. Keep and file any certificates of participation and your receipt of payment for those seminars.
Do it full-time if you can. In most cases the IRS will question the tax returns of breeders who attempt to write off his or her expenses against the other income from their regular job. If you work 40 hours a week in an office and breed purebred dogs on the side, does that mean you have no profit motive and breeding dogs is just a hobby? No, of course not. You can still have a business that is part-time. In fact, you can have multiple side-line dog businesses. Nevertheless, the Internal Revenue Service is more likely to consider your breeding activity a true business if you are able do it full-time. In any case, make every effort to run your business according to the standards established by your full-time competition.
Combine business activities. If your breeding activity consistently produces losses, it will be more at risk of being treated as a hobby by the Internal Revenue Service. But if it can be combined with a profitable activity, the IRS should have no issue with it. The IRS policy is that your characterization of what constitutes a single activity will be accepted unless it is artificial and cannot reasonably be supported by the facts and circumstances. That means you cannot combine your profits from your primary employment as a software engineer or school teacher with your losses from breeding and report them as a single business activity. However, if you have a profitable sideline selling antique and contemporary dog figurines or handcrafted silver dog jewelry at dog shows and also happen to have a somewhat unprofitable sideline breeding dogs, you are able to combine the two on a single Schedule C, making it more likely that you will show a profit three years out of the five.
The actions that I suggest will help you establish and prove that your INTENT was to establish and operate a PROFITABLE business breeding purebred dogs. It also substantiates that the losses you claim were sustained in the proper and prudent operation of such a business. Intent is primarily an intangible factor, but by maintaining a written record of all transactions including appointments with the names, dates, results with notes, and figures to support your claims, you need to have no fear of the Internal Revenue Service disallowing justifiable expenses and the resulting losses.
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Posted by ralbee
on Feb 24 2016. Filed under Current Articles, Editorial, Featured.
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