The year 2018 marked a significant change in U.S. tax law, affecting many industries. Equine tax law is no exception, and it is more important than ever for people who work with horses to be familiar with the tax treatment of their activities.
This blog series will provide an introduction to U.S. horse tax law. We will cover tax laws that affect U.S. taxpayers who have income and/or losses from horse-related activities, beginning with an overview of the tax distinction between a business versus a hobby. We will then explain the benefits of incorporation and equine tax deductions, and conclude with a few words about the tax aspects of breeding, buying, selling, and trading horses.
What are the new tax changes for the equine industry?
The new hobby loss rules have had the biggest impact on horse owners. The basic rule is this: If you have business losses during the year, you can deduct the full amount on your tax return. You can’t do this if the IRS views your activity as a “hobby”. The inability to deduct amounts spent for recreational activities is referred to as the “hobby loss rule.”
The federal tax rules for deducting losses from hobby activities were never favorable. Before the tax law changes, you could write off hobby-related expenses as a miscellaneous itemized deduction only up to the amount of your income from that activity, and only to the extent that those expenses exceeded 2% of your adjusted gross income (AGI). You couldn’t deduct them at all if you were subject to the alternative minimum tax (AMT).
The Tax Cuts and Jobs Act of 2017 eliminated miscellaneous itemized deductions that were subject to the 2% AGI threshold, including hobby losses. These new tax rules are effective from 2018 through 2025. What this means is that hobby-related expenses are no longer deductible – at least for the next seven years.
Hobby activity income, however, must still be reported!
Working toward reclassification
The new tax law denying the itemized deduction may not make much of a difference to most hobbyists. However, for horse owners – who clearly have significant expenses – this tax change can have a big impact on their finances.
Many “hobby loss” cases are disputed, and over the years the Tax Court has ruled that a number of unprofitable activities may be classified as for-profit ventures rather than hobbies. To get the deduction, you must show that your horse-related activity is at least partially motivated by profit – and isn’t just something you just do on the side for fun.
In our next post, we will discuss the factors taken into consideration by the court, and how to ensure that your horse-related activities are classified by the IRS as a for-profit business and not a hobby.
* The information contained in this blog should not be used as a substitute for a consultation with an equine tax accountant and/or attorney.