by: John Alan Cohan
Attorney at Law

In a new Tax Court case, Freddie and Edith Stromatt won on the question of whether their cattle activity was to be treated as a business [T.C. Summary Opinion 2011-42]. This underscores the fact that an unfavorable result at the audit stage can be reversed if you are determined to fight it.

The issue was whether the taxpayers conducted their farming activity for profit within the meaning of section 183 of the IRS Code. They failed to generate a profit during the years at issue, while allocating substantial funds and time to the venture.

They purchased a 15-acre farm near Dickson, Tennessee, and both taxpayers were retired. They constructed a modest house in which Mrs. Stromatt's father resided, and cleared the acreage, which was overgrown with brush and trees, to prepare it for use as pasture, including the production of hay. They installed fencing and fertilized. They sold the hay, and these sales constituted the only income generated from the farming activity.

They obtained knowledgeable advice from Mrs. Stromatt's father, who had been a farmer. He provided advice on farming, including the number of cattle that could be supported on the property. The farm did not offer significant recreational opportunities.

Mrs. Stromatt maintained a ledger for recording farming activity expenses, and kept all receipts that related to farming activity expenses, often making additions more than once per week.

After three years the taxpayers acquired six pregnant heifers, and soon owned 17 head of cattle. The IRS had argued that the taxpayers did not own any cattle during the years in issue and were instead only harvesting hay.

In the court's ruling, the following points were made:

1. In noting that a three-year period elapsed between completing of fencing the taxpayers' acquisition of cattle, the court said: “A period of land preparation before the commencement of cattle operations is not unusual and does not show lack of a profit objective. ... The delay in commencing cattle operations was not unreasonable and, in view of the fact that petitioners were producing and selling hay in the interim, we are satisfied that they had an honest, good-faith intention to develop a cattle operation.”

2. The court said that the taxpayers' farming ledger was a sufficient and accurate bookkeeping method. “While the farming ledger was informal at best, the recordkeeping required for a small farming operation is not rigorous.”

3. The court said that the taxpayers' reliance on advice from Mrs. Stromatt's father, an experienced farmer, shows that they sought expert advice on how to support a successful cattle operation.

4. The court said that despite the lack of specific evidence that the land had appreciated in value, “it is apparent that clearing and fencing neglected land would likely increase its value.”

5. The court noted that the audit pertained to the startup phase: “The years at issue are the third, fourth, and fifth years of operations. While there were losses in all these years, it is not a lengthy history and may reflect a reasonable startup period.”

6. The court found that the taxpayers had substantial outside sources of income which was offset to the extend they claimed the farm losses, but nonetheless, based on all the facts, ruled in favor of the taxpayers.

7. The court concluded: "An activity is engaged in for profit if the taxpayer entertained an actual and honest, even though unreasonable or unrealistic, profit objective in engaging in the activity. ... We conclude that petitioners engaged in their farming activity with an actual and honest profit objective. They and family members expended substantial amounts of physical labor to reclaim and fence land in an effort to establish a viable cattle operation. They did so at a pace that was not unreasonable in the circumstances, and they offset some losses by initially selling hay.”

The taxpayers did not have a business plan as such. Still, the court ruled in their favor. Were the taxpayers lucky to get a judge sympathetic to their case? Perhaps so, but so long as you have some measure of good facts to work with, it is prudent to appeal an adverse IRS determination. Also, it is always wise to have a written business plan so that the elements of the plan can be proven by documentary evidence.

[John Alan Cohan is a lawyer who has served the livestock, horse, and farming industries since 1981. He can be reached at: (310) 278-0203, by e-mail at [email protected], or you can see more on his website:]

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