In a June 9 opinion, the Tax Court held that a married couple were not engaged in horse breeding and training activities for profit and sustained the IRS’s disallowance of the taxpayers claimed loss deductions for three tax years.  The opinion is a helpful reminder to taxpayers and their tax advisors that substantiating profit motive is crucial when dealing with horse-related activities that could be considered a hobby rather than a business.

In Schumacher v. Commissioner, T.C. Memo. 2026-47, the taxpayers were a veterinarian (“Duke“) and teacher (“Velvet“) that bred and trained horses (“Horse Activities”) through a sole proprietorship (“SQH”).  During the tax years at issue (2017-2019), Duke worked 60 hours or more per week at his veterinarian practice and Velvet worked 40 hours per week as a teacher.  In addition to their full-time jobs, Duke and Velvet each spent time working on the Horse Activities and derived a great deal of satisfaction and pleasure from doing so.  The taxpayers also enlisted their son to help with the Horse Activities, but only for 15-20 minutes per day. While the taxpayers’ horses were highly successful, the costs greatly outweighed any profits during the tax years at issue.  To cover the excess costs, the taxpayers regularly transferred personal funds to SQH’s business account, and frequently paid horse-related expenses from their personal checking account.  The taxpayers kept handwritten notes and some receipts related to the Horse Activities but their CPA relied almost exclusively on their bank statements to report SQH’s expenses on the taxpayers’ returns. During the tax years at issue, the taxpayers reported approximately $450,000 in losses related to the Horse Activities.

The IRS audited the taxpayers 2017-2019 tax returns and determined that the Horse Activities were not conducted with a profit motive as required by Section 183. 

The Tax Court considered nine factors in determining whether Duke and Velvet operated SQH for a profit:

6 factors favored the IRS, 2 favored Duke and Velvet, and 1 was neutral which led the Court to conclude that they did not have an actual and honest objective to operate SQH for a profit during the years at issue. 

Although the IRS asserted accuracy-related penalties, the Court held that the taxpayers had reasonable cause and reduced the penalties to $0. And that makes sense. The taxpayers were not tax experts and relied on their CPA to advise them as to whether they could deduct losses from the Horse Activities during the tax years at issue. The Court noted that the taxpayers provided all relevant information about the Horse Activities to their CPA, the CPA discussed the Section 183 factors with the taxpayers each year, the CPA concluded that SQH was operated for profit, and the CPA prepared the taxpayers’ returns reflecting loss deductions related to the Horse Activities.

Taxpayers engaged in horse-related businesses should pay close attention to the substantiation (or lack thereof) in Duke and Velvet’s case.  Maintaining receipts and detailed records of business-related activities is important to ensure a smooth ride and avoid having to pony up when the IRS comes calling.