Some people seem to think the IRS will overlook just about anything. But a dead horse? That’s hard to miss. When a California-based horse enthusiast and IT business owner’s last horse died in 2008, being horseless didn’t stop her from continuing to claim business deductions for her horse-related endeavors.

The IRS noticed and took a closer look. It disallowed all the deductions that she claimed for the horse business. In the process, the IRS spotted an unrelated $70,000 lawsuit settlement award that should have been reported as taxable income. That finding contributed to the IRS disallowing additional deductions for legal fees and for a home office for her IT business as well.

This tale holds a few lessons for the rest of us. Here are some key points:

• She had sued her homeowner’s association for “alleged nuisances, claims of emotional distress, libel, slander, invasion of privacy and construction defect” and received a settlement for $70,000 during the tax year in question. The lawsuit had nothing to do with either her horse or her IT business. While the IRS acknowledges most of that award was used to pay attorney fees and liens, that doesn’t disqualify it from being income (as we’ve stated before). “After all, gross income is all income ‘from whatever source derived,’” the U.S. Tax Court opinion states.
• Her expenses listed on her Schedule C for “horse breeding/showing” were disallowed because she failed to show she was “regularly and active” in the business during that year and hadn’t had a “profit motive” or a business plan for the business in years. She did let it be known that she was in the market for a new horse and most of her expenses were related to travel and activities surrounding horse shows and horse viewing. However, those activities were sporadic and certainly not full-time (since she had a full-time IT job and was heavily engaged in litigation activity that year).

And then things with her IT business deductions got muddled as well.

• She deducted insurance, utilities, depreciation, and other expenses related to her home office. Only her home office happened to be located in the main living room area, so she claimed the deduction for 50% of her one-bedroom apartment. While the Tax Court didn’t doubt that area was her principal place of business for her “IT and database management services,” it wasn’t the only activity conducted there. Besides it being a main living area, she admitted to conducting horse-related activities there as well as work related to her litigation activities.

All-in-all, the opinion letter lists dozens of issues combining the tax complexities of hobbies versus businesses, litigation income, work-from-home business ownership and more. It’s worth a read. And if the issues raise any questions for you, feel free to contact us.

Photo by Chema Photo on Unsplash