Assuming that reasonable people want to place their money in financial arrangements they understand, you might expect they would seek thorough explanations about complex tax consequences from an investment. But, the allure of avoiding the taxman seems to overwhelm common sense and stifle the rational act of consultation with an Enrolled Agent tax expert.
Former NFL player Bill Romanowski was known for standout performances and occasionally reckless acts. His irresponsible style seems to have remained with him in retirement. The Tax Court recently denied a $13 million loss deducted on the joint 2003 tax return of Romanowski and his wife. This results in a tax liability of approximately $4.6 million.
People like Romanowski often mistakenly believe their superiority in one field is sufficient for comprehending all income tax matters. The value of someone with an Enrolled Agent career is the clarity provided by routing the discussion to basic principles. The Romanowskis’ tax deduction was denied simply because their investment in a horse breeding business lacked a profit motive.
Notwithstanding the idea that any investment decision based solely upon tax considerations is unwise, consultation with a tax expert is called for whenever financial loss is expected from an activity. A common element in an Enrolled Agent course is the limitation on deducting losses for any activity that doesn’t have an expectation of profit. Several factors are considered when deciding if an endeavor is a business or a hobby. One of these considerations is whether the taxpayer studied the activity and received advice. Romanowski had advisers, but their expertise seems to have been confined to promoting fraudulent tax schemes.
The trouble for Romanowski started in 2003 when he learned about ClassicStar. The enterprise leased mares by providing boarding and breeding services. Investors owned any foals produced from the operation. An accountant for ClassicStar illustrated for the Romanowskis a Net Operating Loss scenario. An NOL exercise is familiar to tax professionals from Enrolled Agent preparation. The Romanowskis magically carried back a 2003 loss of $13,092,732 to entirely extinguish their taxable income from 1998 through 2002.
The horse breeding operation didn’t exactly proceed as expected by the Romanowskis. Most of the initial pairings produced quarter horses instead of thoroughbreds. Still, the Romanowskis continued with the program. A 2003 report showed no revenue, but expenses that produced the expected loss. By carrying back an NOL, the Romanowskis received a $4 million tax refund. Subsequent examination by the IRS resulted in a denial of the loss under the hobby loss rules.
The Tax Court agreed with the IRS after finding that the horse breeding arrangement had no intention of generating a profit. Every tax practitioner with Enrolled Agent training will find the court’s conclusion doesn’t demand a deep analysis of facts. The Romanowskis kept no business records, failed to supervise ClassicStar operations, and never consulted with any industry expert to identify means of profiting from the money-losing activity. As any EA could have informed them, a pursuit strictly motivated by tax benefits is not deductible.
IRS Circular 230 Disclosure
Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.