There is currently a plethora of cases involving horse breeding or other horse related activities flooding the U.S. Tax Court. One such recent case, involved former San Francisco 49er linebacker Bill Romanowski. In the typical hobby loss case, the taxpayer puts a lot of time, energy and money into an activity without a realistic expectation of making a profit from his endeavors.
Mr. Romanowski invested $13 million into the horse breeding business, run by Classic Star, which appears to have been intended as a tax shelter from the outset. In 2009, Classic Star pled guilty to conspiring to defraud the U.S. by running an illegal tax shelter.
During October 2003, Mr. Romanowski met with Mr.[Rodney] Atherton at the Greenberg Traurig office in Denver. At the meeting they discussed petitioners' real estate investment issues as well as certain other issues. Mr. Atherton told Mr. Romanowski about a horse-breeding business, ClassicStar, which had retained Greenberg Traurig in July 2003 in connection with certain transaction and tax issues, including review of a tax opinion ClassicStar had received from another law firm. ClassicStar was working with Mr. Atherton, among others at Greenberg Traurig, to review the tax opinion.
The program provided for net operating loss refunds being distributed during a specified time period, and even provided Mr. Romanowski with "NOL illustrations."
In the NOL illustration Mr. Green estimated that petitioners needed an NOL of $13,092,732 to offset their taxable income from 1998 to 2003. Mr. Green prepared the NOL illustration using certain items of petitioners' financial information which had been provided to him.
Internal Revenue Code Section 183 provides nine non-exclusive factors, which if answered in the affirmative, are indicative of a for-profit business. Generally, the factors are as follows:
1. The manner in which the taxpayer carries on the activity. Does he complete accurate books? Were records used to improve performance?
2. The expertise of the taxpayer or his advisers. Did the taxpayer study the activities business practices? Did he consult with experts?
3. The time and effort expended by the taxpayer in carrying on the activity. Does he devote much of his personal time and effort?
4. The expectation that the assets used in the activity may appreciate in value. Is the plan to generate profits through asset appreciation?
5. The success of the taxpayer in carrying on similar or dissimilar activities. Has he converted other activities from unprofitable to profitable?
6. The taxpayer's history of income or losses with respect to the activity. Has the taxpayer become profitable in a reasonable amount of time?
7. The amount of occasional profits. Even a single year of profits can be a strong indication that an activity is not a hobby.
8. The financial status of the taxpayer. Does the taxpayer have other income sources that are being offset by the losses of the activity?
9. Does the activity lack elements of personal pleasure or recreation? If the activity has large personal elements it is indicative of a hobby.
The Court ultimately found that only one of the nine factors favored the taxpayers and ruled that Mr. Romanowski was not engaged in the horse breeding business for profit.
There is, however, a small silver lining for Mr. Romanowski. The Court did not find Mr. Romanowski liable for Accuracy Related Penalties, because of Mr. Atherton's conflict of interest. Apparently, Mr. Atherton received substantial fees from the horse breeders for the client referral. The Court states:
While a taxpayer familiar with the field of tax would have done several things differently from petitioners, petitioners were not sophisticated or knowledgeable in the field of tax. Petitioners had good reasons for the trust they placed in Mr. Atherton.
At the same time, the Court had no problem believing that the Mr. Romanowski's, "participation in the program was almost entirely motivated by tax benefits available to through such participation." Indeed, the Court appears convinced that Mr. Romanowski's participation in the activity was a tax shelter from the beginning. The Court has often times held that such motivation is enough of a factor to sustain the Accuracy Related Penalties, particularly when the promoters of the shelter have already been found guilty. Considering the penalties amounted to nearly one million dollars, the Romanowskis should consider themselves quite fortunate.