Hobby or Business

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					   Hobby or Business?

ANSC 236 Equine Business Mgt.
         Spring 2010
      Elaine Long Bailey
         Hobby vs. Business . . .

• Business: “intent to make a profit . . .”
• Revenue from horse “interests. . .”
  – Declare as income, business or not
  – Hobby Loss Rule (IRS) limitations
IRS Business Factor Test

            • 1: Activity carried out
              in a businesslike
              manner?
            • Accurate records
            • Separate accounts
            • Time records (daily
              business operations)
            • Business plan
            • Financial statements
 2: Time & effort reflect efforts to
         generate profit?
• Material participation (>500 hours/yr.)
• Partial withdrawal from other profession?
• Employ competent, qualified persons to
  conduct the business
• “The fun” vs. “the chores”
3: Dependence on income?

            • Supported from other
              sources?
            • Taxpayer’s financial
              status
            • Hobby Loss Rule*
            • IRS prevents large
              businesses from
              reducing taxes on
              other income
 4: Normal startup costs or
catastrophic circumstances?
• Lag time in breeding
  operation
• When do we sell our
  product in the cycle of the
  business?
• When is expected “pay
  day?”
• Disease problem: MRLS or
  EHV-1, e.g.
• IRS: profit 2 years out of 7
  (horse businesses ONLY)
  [typical business profit
  required 2 years out of 5]
5: Changes to improve
     profitability?
           • KEY FACTOR
           • Goes back to success
             in previous
             businesses (mgt.
             skills)*
           • Cut costs
           • Increase revenue
           • Business plan
             review/update*
     6: Knowledge to be successful

•   Horse experience and skills
•   Learn from others in business
•   Financial, business and management skills
•   Classes or workshops (UME, e.g.)
•   Show records/training records/successes
•   Certifications (ARIA, CHA, e.g.)*
•   Engage professionals (financial, legal, etc.)
7: Past record of running
  profitable businesses
             • Management
               professionals who
               change “products”
             • How turn businesses
               around, financially?
             • Previous business
               ventures
             • Previous business
               track records
    8: Does the business make a
              profit?
• Balance of profit vs. loss
• WHY profits occur?
• Small profits occasionally vs. large losses
  commonly
• Speculative ventures*
        9: Future profit from
         appreciated assets?
• Real estate vs. horses
• Imported foals sold as
  “under saddle”
• Purchase of
  performance horses
  w/no show record
  (train and show)
• Breeding stock
  (progeny’s successes)
Business vs. Pleasure?

           •   Recreational activity*
           •   Business
           •   Income generators
           •   Family “pets”
           •   Use percentages: 3
               days/wk. for lessons
               vs. 3 days/wk. for
               pleasure (50% of
               expenses deductible)
                 IRS Audits

• Beware “red flags” that trigger IRS
  attention/audits
• Large losses from “hobby” enterprises
• Business: records, records, records!
• Respond to the IRS audit letter!!!
• Get appropriate professional assistance!!!
       Tips to Avoid IRS Challenges
•   Advance planning & written records
•   Separate bank accounts
•   Accurate, complete records
•   Business plan
•   Disprove recreational or pleasure motive
•   Adequate time & money spent on business
•   Expert consultation
•   Document excessive losses
•   Create profit when feasible*
                          IRS Form 5213

If no profit in 2 out of 7 years . . .
• http://www.irs.gov/pub/irs-
  pdf/f5213.pdf
• IRS postpones
  determination of profit
  intention
• KEEP records
     – Catastrophic circumstances
     – Natural disasters
     – Other unpredictable
       occurrences
Forms of Doing Business

            • Type of ownership
            • Sole proprietorship
            • Partnership (general
              or limited)
            • Corporation (regular,
              limited liability or
              subchapter S)
             Sole Proprietorship

•   Most popular & least complicated
•   Individual in business
•   “Tax shelter” farms*
•   Material participation**
    – >500 hours tax year, e.g.
    – See text for “tests”
    – Documentation of time use for business
                 Partnership

• Two or more individuals in business
• In what way are individuals involved?
  – Money
  – Property
  – Business expertise/effort
  – Share profits/losses
• Agreement in WRITING!
              Comparisons

• General partnership       • Limited partnership
• Management “say” in       • Little or no management
  decisions                   responsibility
• Unlimited liability*      • Reduced liability
• Partnership must          • Partnership must
  complete separate tax       complete separate tax
  return
                              return
• Profits/losses flow
  through to each partner   • Profits/losses flow
• Partnership not taxed;      through to each partner
  individuals taxed per     • Partnership not taxed;
  profits/losses              individuals taxed
               Corporations

• Need legal assistance to form
• Certificate of Disclosure
• Incorporators: organize, promote, raise funds,
  do paperwork
• Statutory agent to represent entity
• Transfer funds, issue stock
               Comparisons

• Regular Corporation          • Subchapter S
• Its own entity, from tax       Corporation
  stance
                               • Like partnership, from
• Files tax return, pays its
                                 tax stance
  own taxes
                                 (individuals)
• Funding advantage
• Limit to debts, losses,      • Shareholders report
  negligence (individuals)       income or loss
• Protects personal assets
   Limited Liability Corporation
               (LLC)
• Why LLC?
• LIMITED liability
• Protect personal
  assets
• Family farms or
  businesses
• More later
Syndicates

     • Common interest:
       stallion shares, e.g.
     • One-time breeding rights
       sold by shareholders or
       lifetime
     • “Security” requires
       attorney services
     • Within syndicates,
       various agreements
       (partnerships, e.g.)
          A Few Resources . . .

• http://mredc.umd.edu/hotlistHorseBoarding.htm
• http://mredc.umd.edu/rootbeginning.html
• http://www.agnr.umd.edu/MCE/Publications/Publica
  tion.cfm?ID=97&cat=C
• http://www.agnr.umd.edu/MCE/Publications/Publica
  tion.cfm?ID=102&cat=C
• http://www.agnr.umd.edu/MCE/Publications/Publica
  tion.cfm?ID=3&cat=C
 My contact info:
Elaine Long Bailey
elbailey@umd.edu

  Good luck!!

				
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posted:8/25/2011
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