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The Manner in Which the Taxpayer Carries on the Activity - Business Plans

The IRS will evaluate if you carry out your horse business as businesslike What does this mean? Listed below are questions to ask yourself.

  1. Do you have a business plan?
  2. Do you keep accurate records including records of the time you spend on your horse activity?
  3. Do you market the business?
  4. Are new techniques used in the operation?
  5. Are unprofitable strategies abandoned?

The business plan is essential.  I was audited after the first year of setting up my horse business as a business. The first thing I did was call an accountant that knew something about Student Field Trip to Prairie Meadows Racetrackhorse business’s. In fact the accountant went to the audit with me. I had used a company that set the business up on a Schedule C for small businesses. Setting my business up as a schedule C was one of the problems the accountant stated. The business should of been set up on a schedule F for agriculture. The auditor knew nothing about a horse business. We had to show them the business plan as well as explain the business plan. My late husband was excellent at explaining the business plan.

The business plan is a working tool that provides a road map for an auditor, bank, creditor or others in the horse industry. Business plans should provide a vision and mission statement. The plan should explain the key elements of your business as well as the current status of the business.  Plans should describe your current and future goals. List the management structure of the business including the number of employees. Business plans should define your service or product – what is unique about your business, what differentiates it from others in the market, and why will people use your service or product. The plan should define your market – who do you sell your service/products to and how big is your market. In the audit my husband actually discussed the reining and cutting industry so that the auditor became familiar with the horse industry. Plans should list who your competition is and why a customer will choose your business. Business plans should include a marketing plan that describes what outlets you plan to use as well as what it will cost. Financial data is very important. What are your financial projections for the next year, three years, and five years. What do you need to accomplish your projections – money, time, personnel and equipment? A business plan should include income and expense projections, cash flow projections and provide a balance sheet. Last of all the plan should be regularly updated in case you need to change directions in your business.


The Expertise of the Taxpayer or His/Her Advisors

The second criteria used by the IRS to determine if you have a business are The Expertise of the Taxpayer or His Advisors. I have a PhD in Animal Nutrition with emphasis in horse Master Equine Managers Evaluating Hayresearch. So for me it is easy to defend my expertise in horse knowledge. However, I am not an accountant so I use the expertise of my tax accountant, who is knowledgeable about horse businesses. No one knows everything about a business. Therefore one should strive to learn! For your business did you consult with experts in the field or what is your knowledge in the field? Did you consult with professional breeders or trainers to start your business? Did you work in a tack shop followed by opening one of your own? Did you attend farrier school? Even if you have been in the business for years continuing to engage with professionals to learn is a plus in terms of the IRS. This means attending courses on aspects of the horse industry. Another area they will take into consideration is any magazines you subscribe to or books you read. Keep accurate notes and/or documentation on programs you attend and printed material you use to learn more about the horse industry.  It is not only the horse industry to learn about; how to run a business is important. How do you evaluate the profit margin of your business? Have you sought advice from experts on profits, expenses, cash flow projects etc.? Do you evaluate your business and make necessary changes to make it more profitable?  I use Quicken and Excel to keep tract of my income and expenses.  I can easily show what items cost and what income I obtain from the business. Next what are your bloodlines and the potential of that bloodline in the industry? When we were audited, Rich, my husband went through each horse’s pedigree and discussed the horse’s purpose in the business. Finally if you use consultants did you make changes based on their advice, are these changes implemented or ignored?


Time and Effort Devoted to the Business Activity

The time & effort expended by horsemen varies from operation to operation. One person may work with horses full-time while others work with horses part-time. I work full-time and work at my barn part-time. I do most of the feeding, fix fence, clean stalls, etc. It is easy for me to defend my time & effort in the business. Some owners hire competent individuals to manage the business. The amount of time devoted to a horse business is a factor the IRS uses to determine if the operation is a business. Neither case above by itself has more or less impact in the determination of a profit motive. A taxpayer is materially active if they meet one of following:

  1. If the taxpayer spends >500 hours on the activity/yr. = substantial participation. 500 hrs. is equivalent to 9.6 hrs./wk.
  2. If the taxpayer spends less than 500 but greater than 100 hours may also = substantial participation provided certain “other circumstances” exist.
  3. Participates for more than 100 hours and participation is not less than the participation of any other individual
  4. Materially participated in the activity for any 5 years in the preceding 10 years
  5. Personal Service Activity and has materially participated for any 3 year period

Women with horseHours spent by a husband and wife can be combined to accommodate these requirements. Activities of others (family members and employees) will not automatically be attributed to the horse owner. If the taxpayer spends less than 100 hours/yr. does not equal participation in the business.

The kind of activities that a taxpayer should be able to document during each year may include the following: consulting with advisers or other experts in the industry; speaking with vendors on the phone or in person; attending horse races, sales or shows; attending horse shows, horse sales, or races; meeting with a trainer and watching a horse being worked; implanting and revising business plans; keeping records or maintaining financial data; grooming horses; riding or driving horses; maintaining a property and performing the many additional tasks required for a horse business. It is imperative that records be kept to reflect the number of hours involved and the number must be 100 or more hours per year.


The Manner in Which the Taxpayer Carries on the Activity

We are still on Rule 1 of the 9 the IRS used to determine if your horse business is a business or hobby. The Manner in Which the Taxpayer Carries on the Activity is the most important rule of the 9 and is composed of a number of items. As described previously record keeping is a necessity. If you do online banking and do not receive paper copies make sure you print off a copy for your records. You have to keep receipts for 7 years. It is costly and difficult to go back and obtain copies from a bank or entity if a printed copy was not kept.

What additional items pertain to the manner in which the taxpayer carries on the activity?Peggy and Foal

  • Are you involved in your industry – do you attend seminars, meetings, subscribe to trade journals, have memberships in your industry? In my case it is unique in that I am the extension specialist, however, I do list webinars and keep a record of those. I also keep a record of clinics I attend.
  • Do you use advertising? Advertising/marketing is a must for a business. It also shows that you are trying to obtain clients. Keep a record of all advertising  and copies of any newspaper ads or paper based ads. I have switched to primarily Horse Boarding and use Craigslist for advertising. Although it is free it is a good way to find local clients. –
  • Do you keep a balance sheet showing what profit you expected and what you earned? A balance sheet is a must when it comes to having a business. This goes back to keeping records of income and expenses as discussed in previous blogs. My expectation for my boarding business has fell short this fall. Part of the reason is the distance to Ames, IA and part could be due to my working on the stalls and arena to try to get them ready for boarders.
  • Are you involved in your industry? Being involved means attending seminars, breed or discipline meetings, serving on boards, subscribing to trade journals, etc.  Again keep a record of everything you do pertaining to your horse business
  • Have  you made changes in operating methods, adopted new techniques or abandoned unprofitable methods? My husband and I use to breed 3 to 4 mares per year to quality stallions and then sell the offspring. This has become more difficult as the horse industry has so many unwanted horses. We started boarding horses 4 years ago to help with the business. Now my business is mainly boarding. I am planning to breed 2 mares in 2013.
  • Lastly do you keep records of your horses and horse activities? You should keep detailed notes on business activities which includes medical records, dates and location of events you attend, performance records of your horses, etc.

As described record keeping of all business activities is a must for a horse business. Records should be kept for at least 7 years which is the time that the IRS can ask for your records.


The Manner in Which the Taxpayer Carries on the Activity - Record Keeping

Is the business carried on in a business-like manner? First a separate business checking account should be maintained. This illustrates to the IRS you are serious about having a business. You will need a properly registered business name to obtain a checking account. A registered name also helps with your brand identity including web-page design and it is protected for the long term. Pick a business name that is web ready. Check whether a domain name (or web address) is available. You can do this using the WHOIS database of domain names.  If it is available, be sure to claim it right away. This guide explains how to register a domain name.  Next register your trade name. Registering your business name involves a process known as registering a “Doing Business As (DBA)” name or trade name. Registering your “Doing Business As” name is simply the process of letting your state government know that you are doing business as a name other than your personal name. If you are operating under your own name, then you can skip the process. Learn about the requirements in your state and how to file in this Registering Your Doing Business As Name guide.

Second you must keep good records. Record keeping is one of those items that is a necessity. Records include everything from a receipt for a shovel to a record of income for the business. One should also keep track of horses and their uses. I keep all receipts for any products I purchase for the farm. For example if I go to Theisans and purchase a halter and lead rope and I also purchase dog and cat food I would only record the halter and lead rope expense. The reason for this is 1) Honesty and 2) When I was audited the IRS goes through every receipt to see if the totals match up to the expenses one records for the year. The other day my electric fence unit went out and it was less then 30 days old. I contacted the company and they told me to take it back to the store if I had the receipt. I could not find the receipt but I knew I kept all receipts and it had to be somewhere. Finally I remembered I had purchased a tire that day and a warranty for fixing flat tires but I had to keep the original receipt with it. I looked in my glove compartment and there was the receipt for the electric fencer.

There are many ways to keep records.  You can write them in a ledger or use a computer program. I personally use Quicken for Home and Business to record my purchases. I can use “split” and record a purchase from a receipt that has both business and non-business purchases. QuickBooks is a good program as well as Horsemen’s Income  Record Keeping System. One could also use Excel. I actually transfer my horse business purchases and income to excel at the end of the year to match up receipts and add cash purchases before I meet with my accountant. My late husband did not record his purchases and kept receipts in piles all over the place. I would have to go through each receipt and record the purchase at the end of the year in Excel. I could also match the date, location and mileage using Excel. For example let’s say I had a purchase at Lowe’s for fence posts. I could post next to it 20 miles (10 miles each way). At the end of the year I would add my mileage plus add any other mileage for the business such as attending a show or sale.

Remember The Manner in Which the Taxpayer Carries on the Activity is extremely important if the IRS decides to audit your business.


The Manner in Which the Taxpayer Carries on the Activity - Business Activities

Besides records of income and expenses, they should be kept on what your business is about. Important records to keep tract of are records of events which affect your current or future income. For example deaths of horses, slipped foals, drought, disease or anything else that required unusual expenditures. My husband and I would breed 2 to 4 mares per year to excellent stallions. In one year we had a mare have a foal in the pasture while we were at work. We never found the foal (only part of an amniotic sac) – we think coyotes got the foal. That was a big loss because the stallion became infertile so we could not breed back to him. Another year the veterinary school could not get our mares bred. We used fresh and/or frozen semen and for some reason only 2 out of 4 mares conceived, even with multiple breedings. Both of these incidents resulted in lostincome and in the latter case high breeding expenses.

One should also keep records of business activities such as the date of events, location and programs your horses were used in. This is especially true to demonstrate how you market your horses. Any showing, racing, driving event can be a type of marketing your horse(s). If they win that is even better. Medical records should also be kept. Medical records can include deworming, vaccinations, emergency care, and farrier work. All of these records can be used in an audit to demonstrate how you manage your business and what if any unusual circumstance had a role in the profit margin.

Another record or summary to keep is if you make changes in your operational methods including adopting new techniques or abandoning unprofitable methods. For example over the Horse Businessyears marketing of my business has gone from print to web-based. For boarding I also use craigslist which is free. In fact some magazines have gone out of business since I started. Record when and if you use social media or a web-page. Another change may be how grain is fed. I use to get bulk grain but have since gone to 50 lb. bags. The primary reason is the 50 lb. bags were approximately the same price and in my case when I owned and also leased a barn it was easier to work with the bagged feed.

Remember the goal of a business is to make a profit. If you are audited, the auditor will typically know nothing about horses and it is your job to describe your business as thoroughly as possible.