Keeping a Record of Business Hours can be Important – By John R. Bullis, CPA

Kim Pilant John's Articles

Robin Robison and Shane Robison have a 500 acre ranch in southern Utah. He was a successful computer science executive who earned over 10 million in 2010 and in 2011 he retired from Hewlett Packard. In 2012 he earned over 4 million.

The ranch was operated as a husband-wife partnership and filed partnership returns. The returns for over 15 years showed losses that were offset against their other income for major tax savings.

IRS audited and determined the ranch operations did not have a profit intent, so the losses were disallowed. The Tax Court reviewed the operations for years 2010-2014 and found the Robisons did have a profit intent as business owners. They had a full-time ranch manager and a ranch hand.

IRS claimed if the losses were allowed, the losses were passive (as an investor) and could only be used to offset passive income or be a deduction when the ranch was sold.

The Judge found the Robisons failed to establish material participation that satisfied any one of the seven tests provided in the IRS regulations.

One of the tests was “…The individual participates in the activity for more than 500 hours during such year…”. The Judge found the time records presented to the court were prepared after the IRS audit and contained many hours that were in the nature of being an investor, not an operator. The taxpayers failed to show what they did each day and how much time was spent on matters directly relating to the ranch operations.

The other test was relevant was “…Based on all of the facts and circumstances…the individual participates in the activity on a regular, continuous, and substantial basis during such year…”. The Judge found the taxpayers did not show they met that test. Much of their time was spent more as an investor than a business operator.

All is not lost for the Robisons. If they sell the ranch for the listed 10 million, they will recoup their initial purchase of 2 million and much of the accumulated losses. They just don’t get the deduction for passive losses in years 2010 until they sell the ranch. So, they paid additional taxes for the years under audit since the partnership losses were passive instead of active business losses.

If they had kept daily time records as the days went by and those records showed how they were involved in the business operations, maybe the Judge would have found the losses were not passive.

Did you hear “I’m a fallible human being—but if I were to react to that knowledge with fear and defensiveness, then how would I move forward?” Jay Woodman