The U.S. Tax Court is a federal court system which hears petitions by taxpayers who wish to contest deficiencies made against them by the IRS. There are about two dozen federal appointed judges, all of them experts in tax law. As the tax law is ambiguous in many areas, especially in the hobby loss area that affects ranchers and farmers, the results of a case may depend on the leanings of the particular judge. Some are more empathetic to the cattle and other ranching industries than others. So to some extent, if you have one of the “more difficult” judges, it is all the more important for your lawyer to present as strong a case as you have, together with good documentary evidence showing the businesslike manner in which you conduct the activity.
Harland and Shirley Stonecipher of Coal County, Oklahoma, lost their Tax Court case when the judge sided with the IRS and ruled that their cattle ranching activities constituted a hobby, not a business.
Mr. Stonecipher grew up on a family ranch in Oklahoma. As a youth, he was responsible for various chores on the ranch, helping to maintain and manage it and to care for the few head of cattle raised there.
He purchased over 4000 acres in Oklahoma, and leased out about half of that. He made improvements related to raising cattle, including a barn, a cabin, fencing, ponds, and sheds. For several years he sold the cattle that they raised each year, including all the male and female calves. Then, for about four years, due to falling market prices, he retained most of the female calves. Afterwards, he started selling regularly again.
The Stonecipher ranch was a no-frills cattle operation. Their improvements were not extravagant. They did not use the ranch very much for recreational purposes. There was no swimming pool, golf course, tennis court, Jacuzzi, or other significant recreational amenities.
They raised Brahman crossbreed cattle suited to that part of Oklahoma because of their ability to tolerate rough grazing conditions, and their thin hides enable them to tolerate the Oklahoma heat better than other cattle.
Mr. Stonecipher, according to the judge, was “thrifty and frequently looked for bargains in managing his cattle ranch.” For instance, among other things to cut down on costs, Mr. Stonecipher made a bargain purchase of 26 tons of feed pellets.
But the judge said that Mr. Stonecipher “maintained no formal books and records relating to the cattle ranch, no records of the cattle inventory, and no ledgers, written business plans, or written cost analyses. He maintained no records of which cows were bred, nor of which cows were calved and sold.” Instead, Mr. Stonecipher “made some miscellaneous handwritten notes about the cattle on scratch pads, which he generally kept on the dashboard of his truck.”
The judge apparently felt the lack of formal business records was strong enough to outweigh the many other positive qualities of his operation.
The judge also noted that Mr. Stonecipher had losses over a 14-year period. These losses helped offset and reduce Mr. Stonecipher's substantial taxable income from a company he owned.
The judge also noted that Mr. Stonecipher didn't have a business plan, although he testified that he intended to build up the total ranch acreage, and intended to retain female calves born each year so that, by breeding the cows, he could build up a herd of 500 mature cows. He expected that by selling female calves that would be born each year, his ranch could provide comfortable retirement income for himself and his wife.
The court said this strategy was undermined by Mr. Stonecipher's lack of breeding and calving records. “These circumstances speak loudly to the nonprofit nature of petitioners' cattle ranch activity,” the judge said.
I think the judge was unduly harsh in his decision. The judge seized upon the fact that the Mr. Stonecipher did not have a written business plan, income projections, or profit plans. But these are very often not in writing, and business plans are often expressed in action and in verbal discussions, not in writing. In another Tax Court case, Phillips v. Commissioner, T.C. Memo 1997-128, the court said a written financial plan was not required for a 32-horse farm where the business plan was evidenced by action.
The Stonecipher case underscores the importance of obtaining expert advice regarding your ranching activities. My clients who have been audited by the IRS have done very well because they have made it a point to obtain a tax opinion letter that evaluates their activity and provides advice on how to conduct the activity in as businesslike manner as possible.
[John Alan Cohan is a lawyer who has served the livestock and farming industries since l98l. He serves clients in all 50 states, and can be reached at: (3l0) 278-0203 or via e-mail at [email protected]]