Deductions Were for For-Profit Ranching Activities, Not Rodeo

Bench Opinion by Judge Richard T. Morrison

March 22, 2023

THE COURT: The Court has decided to render oral findings of fact and opinion in this case and the following represents the Court's oral findings of fact and opinion. The oral findings of fact and opinion shall not be relied upon as precedent in any other case. The oral findings of fact and opinion are made pursuant to the authority granted by section 7459(b) of the Internal Revenue Code and Tax Court Rule 152. Rule references in this opinion are to the Tax Court Rules of Practice and Procedure, and section references are to the Internal Revenue Code, in effect at all relevant times.

This proceeding is a small tax case subject to the provisions of section 7463 and Rules 170 through 174. Except as provided in Rule 152(c), this bench opinion shall not be cited as authority, and pursuant to section 7463(b) the decision entered in this case shall not be treated as precedent for any other case.

On March 24, 2021, the Commissioner mailed to the petitioners, Mrs. Leslyn Jo Carson and Mr. Craig Carson, a notice of deficiency determining deficiencies of $23,633 for 2017 and $21,628 for 2018. The notice of deficiency determined that the activity or activities reported on the Schedules F for these years was not engaged in for profit under section 183. We hold that it was engaged in for profit.

What follows is the Court's findings of fact.

The Carsons resided in Oklahoma at the time they filed their petition.

In 1999, Mrs. Carson's grandmother assigned a quarter section of land in Gate, Oklahoma, and the cattle ranch on the land, to Mrs. Carson's mother.

In 2009, Mrs. Carson's mother transferred most of her property, including the ranch, to a revocable trust that she controls during her life. Mrs. Carson's mother is still alive. Under the revocable trust, if Mrs. Carson's mother dies, and is predeceased by Mrs. Carson's stepfather, the property of the trust is to be distributed to Mrs. Carson and her brother equally. If Mrs. Carson's mother dies, and Mrs. Carson's stepfather is still alive, the property of the trust will become a life estate of Mrs. Carson's stepfather, and then at his death, will be distributed to Mrs. Carson and her brother equally.

In two successive agreements dated 2013 and 2016, respectively, Mrs. Carson agreed with her mother that she, Mrs. Carson, would contribute financially to the ranch; and that every year Mrs. Carson and her mother would jointly agree about how much, if any, cash distributions would be made from the ranch to Mrs. Carson.

From 2014 to 2019, Mrs. Carson made substantial financial contributions to the ranch by paying its expenses. By then the ranch included land adjoining the quarter section. This land was owned by the trust. It served as pasture. The ranch made money mainly by selling cattle. The receipts from cattle sales were reported on the returns of Mrs. Carson's mother. The Carsons did not generally report the ranch's income on their returns because they did not receive any cash distributions from the ranch pursuant to the 2013 and 2016 agreements.

The Carsons' two children lived at the ranch helping in the ranch's business of raising cattle for sale. For this purpose, the children used horses, some of which they also used to compete in cash-prize rodeos. The children also performed manual labor for neighbors of the ranch.

During 2017, Mr. Carson received wages of $69,514 from Conant Construction LLC, a construction company. Mrs. Carson received $55,926 of wages from Elite Endeavors LLC, a feed company.

During 2018, Mr. Carson received wages of $33,318 from Conant Construction LLC and $38,279 of wages from Centennial Contractors, another construction company. Mrs. Carson received $62,848 of wages from Elite Endeavors LLC and $4,688 of wages from Irsik Doll Feed Services.

For 2017, the Carsons filed a Schedule F for their "livestock" activity. The Schedule F reported gross income of $2,741, consisting of rodeo competition winnings of the Carsons' children. The Schedule F claimed deductions for total expenses of $128,990.

The Schedule F for 2018 reported gross income of $8,063, consisting of $1,867 in compensation for labor performed by the Carsons' children for local ranchers, and $6,196 in rodeo competition winnings of the children. The Schedule F claimed deductions for total expenses of $133,929.

For both tax years 2017 and 2018, the Schedules F reported no gross income from the ranch's activities, except for the gross income amounts already discussed, because this gross income was reported on the returns of Mrs. Carson's mother.

During the six years 2014 to 2019, the Carsons reported cumulative losses of $502,742 on the Schedules F. For each year, these losses not only dwarfed the gross income reported on the Schedules F (consisting mainly of rodeo winnings), but they largely offset the Carsons' ordinary income in the form of wages. It is perhaps no surprise that the deductions from the losses came under scrutiny by the IRS.

The examining agent determined that the activity reported by the Schedules F was rodeo, not ranching. The main reason the examining agent determined that the activity reported on the Schedules F was rodeo, and not ranching, was that the only gross income reported on the Schedules F was from rodeo winnings (and from some compensation for the children's work for neighbors) but not ranching income. The examining agent interviewed Mrs. Carson, but ignored her explanation that the Schedules F expenses mainly related to ranching activity through which Mrs. Carson participated through the agreements with her mother. He determined that the activity reported on the Schedules F was not an activity engaged in for profit under section 183. The determination was reflected in the notice of deficiency, which disallowed all deductions claimed on the Schedules F for 2017 and 2018.

I now give the legal analysis.

Section 183(a) generally disallows deductions attributable to an activity that is not engaged in for profit.

Section 183(c) defines an "activity not engaged in for profit" as "any activity other than one with respect to which deductions are allowable for the taxable year under section 162 or paragraph (1) or (2) of section 212." Treasury Regulation § 1.183-2(a) provides that the determination whether an activity is engaged in for profit is to be made by reference to objective standards, taking into account all of the facts and circumstances of each case. It further provides that the determination whether an activity is engaged in for profit is made by giving greater weight to objective facts than to the taxpayer's mere statement of intent. Treasury Regulation § 1.183-2(b) names nine nonexclusive factors that should normally be taken into account: the manner in which the taxpayer carries on the activity, the expertise of the taxpayer or advisors, the time and effort expended by the taxpayer in carrying on the activity, the expectation that assets used in the activity may appreciate in value, the success of the taxpayer in carrying on other similar or dissimilar activities, the taxpayer's history of income or losses with respect to the activity, the amount of occasional profits, if any, which are earned, the financial status of the taxpayer, and elements of personal pleasure or recreation.

Mrs. Carson testified credibly at trial that the Schedules F expenses mainly related to the ranch rather than to rodeo. The Commissioner's litigating position is premised on the Schedule F expenses being related to the rodeo activity. For example, the litigating position supposes that the Carsons lost approximately $120,000 per year entering their children in rodeos. In reality, the Carsons lost this money primarily in ranching activities, the profit objective of which the Commissioner does not directly challenge. In summary, the Commissioner's position under section 183 makes no sense in light of our view that the deductions reported on the Schedules F mainly related to ranching.

The Court declines to refocus the Commissioner's challenge to the Schedules F deductions by determining what relatively small part of the activities reported on the Schedules F consisted of rodeo activities rather than ranch activities. To do so would be difficult in this case. Although Mrs. Carson kept meticulous details of the expenses that were deducted on the Schedules F, and although these records would have allowed the Court to more precisely sort the expenses between ranching and rodeo, Mrs. Carson did not bring the records to trial. She believed — correctly — that the Commissioner did not challenge the substantiation behind the deductions. Without the substantiation, the Court cannot sort the deductions between ranch and rodeo without resorting to rough justice. Under these unique circumstances, I hold that the Commissioner has waived the right to refocus his challenge on the relatively narrow rodeo activities. I further hold that the activity or activities reported on the Schedules F for 2017 and 2018 were engaged in for profit.

In so doing, I recognize that the Commissioner contends that there is a mismatch of income and expenses in that the revenue from the ranch, which consisted primarily of proceeds of selling cattle, was reported on the returns of Mrs. Carson's mother, while expenses of the ranch were reported on the Carsons' Schedules F. This mismatch appears to be primarily attributable to the business arrangement between Mrs. Carson and her mother, whereby Mrs. Carson paid expenses of the ranch and her mother received the revenues from the ranch, rather than the hobby-loss distinction made by section 183. A mismatch of income and deductions is not prohibited under the Code per se, but may be relevant in determining the appropriateness of accounting methods and in determining the appropriate allocation of income and deductions between partners. However, these legal issues are not before the Court.

I now address some procedural matters.

At trial the Court reserved ruling on Mrs. Carson's objection to paragraph 14 of the stipulation of facts. This paragraph reflects losses reported on Schedules F for years not at issue. I will overrule the objection. The losses for the relevant activity for years not at issue are theoretically relevant to whether the activity is engaged in for profit under section 183.

Mr. Carson did not appear for trial. On March 21, 2023, the Commissioner moved to dismiss him for lack of prosecution. The motion will be granted and a deficiency will be entered against Mr. Carson in the same amount as the deficiency entered against Mrs. Carson.

An appropriate order will be entered overruling Mrs. Carson's objection to paragraph 14 of the stipulation of facts and dismissing Mr. Carson from the case.

The parties will recompute the deficiencies under Rule 155 given today's holding.

This concludes the Court's oral findings of fact and opinion in this case.

(Whereupon, at 9:28 a.m., the above-entitled matter was concluded.)