If your question is, "Should I leave $5,000 income off the return because my client told me to?" the answer is No.
Have you gone through the checklist? We can’t give you an answer if you don’t tell us which one bothers you. You do know there is a checklist, right?
Section 1.183-2(b),Income Tax Regs., lists the nine factors to consider:
• manner in which the taxpayers carry on the activity;
• expertise of the taxpayers or that of their advisers;
• time and effort expended on the activity;
• expectation that assets used in the activity may appreciate in value;
• success of the taxpayers in carrying on other similar or dissimilar activities;
• history of income or losses with respect to the activity;
• amount of occasional profits, if any, from the activity;
• financial status of the taxpayers; and
• any elements of personal pleasure or recreation.
You can read dozens of Tax Court cases where this checklist is methodically applied to the facts. Many of the cases involve horse farms, because those are more likely to involve $50K, not $5K in losses. But the same rules apply to all (if you are using the “taxpayer always wins” rule on burden of proof, the number of years before a profit is shown is higher for horses).
My favorite opinions are those by Judge Holmes, who often includes some wordplay. For example, see the 2015 case of Metz at
https://ustaxcourt.gov/UstcInOp/OpinionViewer.aspx?ID=901
It’s 66 pages of easy reading, but you don’t have to get past Page 5, which explains:
Horse-farm cases come in herds and not in single stallions, and are among the most frequently litigated under section 183. Each case turns on its facts, see, e.g., Pederson v. Commissioner, T.C. Memo. 2013-54, at *59 (comparing a small sample of five horse-breeding cases with different outcomes), which can vary widely. They range from the wealthy businessman who runs a real business but keeps a gentleman’s farm as a weekend retreat whose expenses he tries to subsidize through deductions to sophisticated, well-run operations that just haven’t been able to consistently make a profit. See Helmick v. Commissioner, T.C. Memo. 2009-220, 2009 WL 3012725, at *7
These cases blaze a helpful trail to the facts that we should look at in any individual case, but they are not precedents from which one can derive ever more precise statements of law. We must not lose sight of the Ninth Circuit’s lodestar:
“The proper focus of the test to be applied * * * is the taxpayer’s subjective intent.” Wolf, 4 F.3d at 713 . . .
