The need for formalized business plans
After about 30 years handling tax audits, appeals and U.S. Tax Court cases, it seems to me that the IRS is taking a more aggressive approach against people in various industries—including livestock and horse activities. If you are audited by the IRS and you have a history of losses with little or no profits, the following advice pertains to you.
At an initial interview with the IRS, you likely will be asked the following questions, based on protocol followed by agents under IRS Audit Technique Guide governing audits for cattle and horse activities. Of particular importance are questions concerning whether you have a formal business plan.
On that point, the revenue agent will ask the following: Do you have a written business plan? How was this business plan prepared? When was this business plan formalized into writing? (At the commencement of the activity or for the purpose of the examination?) Who assisted with the preparation of the business plan?
Does the business plan cover all years of the activity’s history as well as forecasting into future years?
Does the business plan allow for any contingencies due to unforeseen circumstances? How does the business plan determine gross receipts for each year? Is the gross receipts computation reasonable? How were the expenses determined or estimated for use in the forecast? What justifies the reasonableness of the forecasted expenses? During what specific year does the economic forecast show the activity will turn around and become profitable? What events and circumstances will cause the activity to be profitable in that particular year?
If the business plan does not present any form of an economic forecast, when do you foresee the activity becoming profitable? What specific event will have occurred to enable this turnaround? Why have you not abandoned the activity in light of the history of losses? If this activity should never be likely to generate a net profit, would you abandon the activity?
In addition, the agent will want to know if you relied upon any experts or advisers prior to entering the venture, and to cite instances where you have chosen to implement your advisers’ recommendations. Also, the agent will want to know how the advisers’ recommendations impacted the performance of the activity, and for you to describe any instances when you have chosen not to heed the advice and why.
If you are already undergoing an audit, it is too late to implement a business plan for the current audit. The IRS wants to see business records that are maintained in the ordinary course of your activity, not those that you might decide to prepare once you have been notified that you are being audited.
The major red flags that indicate an unbusinesslike business plan are: (1) failure to utilize an expert in preparing the plan; (2) failure to have any economic forecast; (3) failure to forecast when the activity will become profitable; and (4) unreasonable computation of gross receipts.
Whom should you engage to prepare a business plan and financial projections for a cattle or horse activity? It is important to have the plan prepared by someone familiar with the industry, and for cost projections to be realistic. Be aware that there are internet services offering to prepare plans, and these are generally not a good choice.
The reason why the IRS is auditing more cattle and horse farms is that, often, taxpayers incur losses that they utilize to offset sizable income from other sources, and this provides an obvious tax benefit. And the IRS is looking to raise revenue so as to help the federal deficit. The best way to help withstand IRS scrutiny, in case you are unlucky enough to be audited, is to take a pro-active approach beforehand.
— John Alan Cohan [John Alan Cohan is a lawyer who has worked in the livestock, horse and farming industries since l98l. He serves clients in all 50 states, and can be reached at: 3l0/278-0203 or by e-mail at JohnAlan Cohan@aol.com. The website is: www.JohnAlan Cohan.com.]