The Tax Court disallowed an IRS auditor’s deductions for breeding greyhounds as a hobby loss. Ralph Thomas Whitecavage bred and raised the dogs for racing. He received a percentage of their race winnings but did not realize a profit. The IRS determined deficiencies totaling $18,601 for tax years 2001 through 2003 stemming from nearly $75,000 in net losses that Whitecavage claimed on Schedule C over the three years.
Under IRC § 183(b)(2), absent a primary goal of earning a profit, deductions related to an activity are allowed only to the extent of the related gross income. The taxpayer generally bears the burden of establishing a profit motive for the activity. The determination is based on all relevant facts and circumstances, with a focus on nine factors:
(1) Manner of carrying on the activity. Whitecavage failed to carry on his greyhound activities in a businesslike manner, since he failed to maintain complete and accurate books and records. Nor did he have a written business plan, and he did not prepare contemporaneous budgets or financial analyses.
(2) Expertise of the taxpayer or advisers. Extensive study of an activity, including its accepted business, economic and scientific practices, may indicate a profit motive. Whitecavage was unable to demonstrate personal expertise in running his greyhound activities profitably and had not consulted economic experts.
(3) Time and effort expended in activity. During the years under review, Whitecavage was a full-time IRS employee, which limited his time spent on greyhound breeding (he retired from the Service in 2006). The operation bred only one litter of pups each year, while profitability would have required three to four litters per year, evidence indicated.
(4) Expectation that assets may appreciate. Although Whitecavage claimed that at least one of his greyhounds could become a winning “stakes dog” worth $100,000 to $250,000, his dogs generally depreciated in value. At trial, no evidence was presented that a single dog was ever sold. Further, no evidence was presented to indicate that a kennel Whitecavage built in 2002 would be sold for a profit.
(5) Success in other activities. Whitecavage had not previously engaged in any similar activities.
(6) History of income or losses from activity. Whitecavage realized losses from greyhound breeding for 10 consecutive years as of 2003.
(7) Amount of occasional profits. He never realized any profit. IRC § 183(d) provides a presumption of a profit motive if taxpayers show a profit in three out of five years.
(8) Financial status of taxpayer. Having significant financial resources from other activities may indicate lack of a profit motive. His full-time employment by the IRS provided substantial income, the court determined.
(9) Elements of personal pleasure. The presence of personal pleasure or recreation may indicate lack of a profit motive, as it did here, the court said. With all nine factors weighing against Whitecavage, the Tax Court determined that he lacked a profit motive. Furthermore, the court upheld a 20% accuracy-related penalty for 2002, since Whitecavage failed to show reasonable cause and good faith regarding a substantial understatement of tax liability.
n Ralph Thomas Whitecavage v. Commissioner, TC Memo 2008-203
By Beth Howard, Ph.D., assistant professor of accounting, and R. Dan Fesler, CPA (inactive), DBA, CIA, CMA, professor and chair of accounting, both of Tennessee Technological University.