The powers of the IRS commissioner
The president has substantial power to implement policy within the IRS, and the IRS is the enforcer of tax laws. The IRS commissioner is appointed by the president, with the consent of the Senate, for a five-year term. The commissioner administers, manages, enforces, and supervises the application of IRS laws and related statutes. The term of the present IRS commissioner, Douglas Schulman, expires in November, and a new appointee will be named by the president, subject to Senate confirmation.
Section 183 of the IRS Code pertains to activities “not engaged in for profit.” This provision is used to disallow deductions for all farming-ranching activities as well as other ventures ranging from multi-level marketing to air charters. How this provision is applied and interpreted is something that the IRS commissioner can and does influence.
Many people do not make a profit in their farming ventures—and the IRS is well aware of this fact. For most farmers and ranchers, the activity is not the taxpayers’ primary occupation. One Tax Court case said that it would be “foolish” for a taxpayer to give up other employment until he was sure he could support himself with the proceeds from farming or livestock.
The IRS is particularly interested in how you keep books and records of the activity. One case described the importance of proper books and records this way: “The purpose of maintaining books and records is more than to memorialize for tax purposes the existence of the subject transactions; it is to facilitate a means of periodically determining profitability and analyzing expenses such that proper cost saving measures might be implemented in a timely and efficient manner.”
It is important to keep hard copies of all evidence that shows your manner of keeping records and that might reflect your business motives. For example, keep originals of magazine advertisement (including the entire magazines in which they appear). If you update written business plans, it is important to retain the earlier versions (all of which should be dated) rather than superseding them in a computer generated update. With respect to payment to vendors, you should always insist on obtaining invoices from vendors, and keep them as part of your permanent records.
The IRS has a reputation for indifferent customer service, long wait times on calls, and abuse towards taxpayers who are supposed to be served. In situations where taxpayers have a history of losses, revenue agents tend to view business records of such taxpayers with heightened scrutiny.
The recent trend in audits has been to regard livestock activities as hobbies. A document relied on by auditors, referred to as the Market Segment Specialization Audit Technique Program Guide (“MSSP”), encourages auditors to presume that taxpayers in the livestock and horse industries are motivated by personal pleasure and recreation.
The document, which the IRS commissioner could amend, directs auditors to inquire about business plans: “The taxpayer should have a formal written plan. This plan should demonstrate the taxpayer’s financial and economic forecast for the activity. The plan should show a short range and long range forecast for the activity. The forecast should allow for changes due to potential unforeseen and fortuitous circumstances.” Auditors are asked to be on alert for “canned” business plan documents.
Revenue agents are also advised to challenge the taxpayer’s “material participation” in the activity. Under this legal test, you are permitted to deduct losses relating to a ranching venture against your other income only if, among other things, you “materially participate” in the activity. This is often a difficult standard to meet if managers are hired to attend to important details of ranch management.
Audits are the “lifeblood” of collecting additional revenue for the U.S. Treasury, but IRS philosophy has, for many years, made it difficult for taxpayers to defend themselves. In the event you are audited by the IRS, you should seek legal advice at the earliest stage and work with legal counsel and your accountant to convince the IRS of your intentions.
Audits are always a difficult experience for taxpayers. Changes in IRS policy depend on who the next IRS commissioner will be, and that will depend on who the next president will be. — John Alan Cohan [email at email@example.com. ]