The Hobby-Business Mash-Up

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Fact # 3

Our third case, Carson, presents a very strange fact pattern. Ms. Carson’s mom created a grantor trust and transferred mom’s cattle ranch to it; Mom was trustee. Mom and stepdad were the life beneficiaries of the trust. Ms. Carson and her brother were the remaindermen. During the tax years at issue (2017-2018) Mom and stepdad were living.

Per written agreements, Ms. Carson was obligated to pay the expenses of the ranch. But she was not entitled to any of the income from ranch unless both she and her mom agreed to it. Thus between 2014 and 2019 “[Ms.] Carson made substantial financial contributions to the ranch by paying its expenses. *** The ranch made money mainly by selling cattle. The receipts from the cattle sales were reported on the returns of [Ms.] Carson’s mother.” Oral Transcript at 3. That’s just weird. Normally parents try to assign income to their children, deductions!

It is not clear from the opinion but it appears that the Carsons lived on the ranch. At any rate Judge Morrison says that “the Carson’s 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.”

For the tax years at issue (2017 and 2018) the Carson’s filed a Schedule F, reporting a “livestock” business. However, the only income they reported each year was the cash prizes the kids won in rodeos and the money the kids made from neighbors: some $2,700 in 2017 (all from rodeo prizes) and some $8,000 in 2018 ($6,200 from rodeo prizes). Against that modest income they reported all the expenses Ms. Carson had agreed make: $139,000 in 2017 and $134,000 in in 2018.

This had been the pattern since 2014: “During the six years 2014 to 2019, the Carson’s reported cumulative losses of $502,742 on the schedules F. For each year, these losses not only dwarfed the gross income reported on the schedule F...but they largely offset the Carson’s ordinary income [from] wages.” Yessir, assignment of deductions!

On audit, the IRS disallowed all the Schedule F deductions in excess of the Schedule F income because the IRS Revenue Agent thought that the Carsons had mis-labeled the activity and it should have been reported as a rodeo activity, not a ranching activity. And the rodeo activity was a hobby, not a business. The Carsons petitioned the Tax Court. I cannot tell whether they were represented.


Lesson #3: Hobby + Business = Business?

The basic problem, Judge Morrison decides, is that the IRS mis-analyzed how the Carsons messed up their return. The Carsons' error was mashing up the rodeo activity and ranching activity on the same Schedule. That led the IRS to mis-analyze the return by ignoring the documented arrangement between Ms. Carson. The IRS approach “supposes that the Carsons lost approximately $120,000 per year entering their children in rodeos. *** [That] makes no sense in light of our view that the deductions reported on the Schedules F mainly related to ranching.” Transcript at 8.


Here, unlike our other two cases, the taxpayers kept good records. Transcript at 8. (Ms. Carson “kept meticulous details of the expenses that were deducted on the Schedule F.”). Those records showed most expenses related to the ranching activity and only a “relatively small part” related to the rodeo activity.  Id. Judge Morrison declines to parse the expenses because the IRS “did not challenge the substantiation behind the deductions” id. and thus he was not going to ding Ms. Carson for not bringing records with her to trial.


Bottom Line #3: Don’t try this at home, but once Judge Morrison accepted that the ranching activity was legit, then mashing up the hobby and business was basically harmless error. Sure, the Carsons should have reported the rodeo income on Schedule 1 and not Schedule F. Sure, they should have reported the rodeo expenses on Schedule A (and, of course, for 2018 they would not have been able to deduct any rodeo expenses because of evil §67(g)). The proper reporting position, however, would not have affected their bottom lines very much if at all. The ranching net losses would have still been able to be used to offset the modest rodeo income they had as well as most of their wage income.


Coda: The real issue here—that the IRS just missed—was the assignment of deductions. Judge Morrison notes the weirdness of allocating all the ranching income to Ms. Carson’s mom and allocating all the ranching expenses to Ms. Carson but tells us that 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.”



Maximize Your Tax Savings: The Importance of Keeping Home Improvement Records Before Selling Your Home

July 28, 2025
Many taxpayers don’t feel the need to keep home improvement records, thinking the potential gain when they sell their home will never exceed the amount of the tax code’s exclusion for home gains explained as follows. Under the current version of the tax code, you are allowed to exclude from your income up to $250,000 ($500,000 for married couples) of gain from the sale of your primary residence if you owned and lived in it for at least 2 years (24 months) of the 5 years before the sale. You also cannot have previously taken a home-sale exclusion within the 2 years immediately preceding the sale. There is no limit on the number of times you can use the exclusion if you meet these time requirements; however, extenuating circumstances can reduce the amount of the exclusion. The home-sale gain exclusion only applies to your main home, not to a second home or a rental property. As noted above, you must have used and owned the home for 2 out of the 5 years immediately preceding the sale. The years don’t have to be consecutive or the closest to the sale date. Vacations, short absences, and short rental periods do not reduce the use period. If you are married, to qualify for the $500,000 exclusion, both you and your spouse must have used the home for 2 out of the 5 years prior to the sale, but only one of you needs to meet the ownership requirement. When only one spouse in a married couple qualifies, the maximum exclusion is limited to $250,000 instead of $500,000. If you don’t meet the ownership and use requirements, there are some situations in which a prorated exclusion amount may be possible. An example of this situation would be if you were required to sell the home because of extenuating circumstances, such as a job-related move, a health crisis or other unforeseen events. Another rule extends the 5-year period to account for the deployment of military members and certain other government employees. Please call this office if you have not met the 2 out of 5 rule to see if you qualify for a reduced exclusion. But what if your home sale gain is more than the home sale exclusion? Then it is in your best interests to have kept home improvement records, since the costs of improvements can be added to your purchase price of the home to be used in determining the gain. So keeping the receipts for the improvements, even if only in a folder or a shoe box, may be useful in the future when you sell your home. Here are some situations when having home improvement records could save taxes: The home is owned for a long period of time, and the combination of appreciation in value due to inflation and improvements exceeds the exclusion amount. The home is converted to a rental property, and the cost and improvements of the home are needed to establish the depreciable basis of the property. The home is converted to a second residence, and the exclusion might not apply to the sale. You suffer a casualty loss and retain the home after making repairs. The home is sold before meeting the 2-year use and ownership requirements. The home only qualifies for a reduced exclusion because the home is sold before meeting the 2-year use and ownership requirements. One spouse retains the home after a divorce and is only entitled to a $250,000 exclusion instead of the $500,000 exclusion available to married couples. There are future tax law changes that could affect the exclusion amounts. Everyone hates to keep records but consider the consequences if you have a gain and a portion of it cannot be excluded. You will be hit with capital gains (CG), and there is a good chance the CG tax rate will be higher than normal simply because the gain pushed you into a higher CG tax bracket. Before deciding not to keep records, carefully consider the potential of having a gain more than the exclusion amount. Home improvements include just about anything that will increase the value of the home, from big ticket items like remodeling a kitchen, adding another room or a swimming pool, and landscaping to smaller items like ceiling fans. But there are some home improvements that cannot be included in the cost of home improvements, or may be only partly included. Examples are items which qualify for tax credits such as home solar, home energy efficient improvements or those that qualify for a tax deduction such as handicap improvements. In addition, the costs of general maintenance or repairs, such as fixing leaks, painting (interior or exterior), and replacing broken hardware do not count as improvements. If you have questions related to the home gain exclusion or questions about how keeping home improvement records might directly affect you, please give this office a call.

Expiring Tax Credits

July 24, 2025
With the signing of the One Big Beautiful Bill Act (OBBBA) many of the environmental credits that were in place and set to expire sometime in the future have now been moved up in their expiration dates. Below is a list of the credits set to expire and when they are to expire. Expiring after September 30, 2025 • Previously Owned Clean Vehicle Credit • Clean Vehicle Credit • Qualified Commercial Clean Vehicle Credit • Alternative Fuel Vehicle Refueling Property Credit To claim credit before the expiration date, you must purchase/install and have title to the property. Expiring after December 31, 2025 • Energy Efficient Home Improvement Credit • Solar Energy Credit • New Home Energy Efficient Home Credit To claim credit before the expiration date, the property must be installed, be functional and if necessary, approved by local agencies before the expiration date. If you have any questions about any of these credits, please contact your tax advisor or call us to discuss.

Summer Hiring? Here’s How to Handle Seasonal Workers, Interns, and Payroll Compliance Without the Headache

July 14, 2025
Hiring for the summer?
That’s exciting—until the IRS gets involved. While onboarding interns or part-time help sounds simple enough, summer hiring is one of the most common ways small business owners get tripped up on payroll, compliance, and classification. And yes, even a single misstep—like putting a W-2 employee on a 1099 “just for the summer”—can cost you big. Let’s Clear This Up: Not Everyone’s a Contractor You’re not alone if you’ve ever said: “We’re just paying them a flat rate—it’s easier that way.”
“They’re only here for 10 weeks.”
“They’re a student; it’s not really a job-job.” Here’s the hard truth:
If you control when, where, and how someone works—you’re probably supposed to issue a W-2. The IRS doesn’t care if it’s part-time, seasonal, freelance, or “just a favor.” If they look like an employee, they are one—and they want to see payroll taxes, not contractor payments. Need the official word? See IRS guidelines on worker classification Interns? Yes, They Usually Count Too. Many businesses think unpaid internships are a gray area. But unless it’s tied to a formal educational program with no expectation of compensation, the Department of Labor may classify your intern as an employee. That means: Minimum wage laws apply You may owe payroll taxes Workers’ comp coverage could be required Rule of thumb: If they’re contributing to your business, they probably need to be on payroll. Don’t Miss Out on This: The Work Opportunity Tax Credit (WOTC) Here’s some good news: If you’re hiring people from certain target groups—like veterans, long-term unemployed, or summer youth employees—you might qualify for the WOTC, which can reduce your federal income tax liability by up to $2,400 per qualifying hire. But: You have to apply before hiring The paperwork needs to be filed with your state agency Most businesses never realize they’re eligible More info? Explore the WOTC program here Other Things to Nail Down (Before Your First Payday) Set up correct federal and state withholding Ensure you have an active payroll system (manual payments often miss required filings) Collect and retain Form I-9s and W-4s Check if local labor laws require sick leave or additional reporting for part-time workers Know if you need to pay overtime—even if it’s “just for the summer” The Bottom Line: Don’t Wing Payroll We get it—your focus is on growing your business, keeping clients happy, and getting help in the door. But ignoring payroll compliance (even for “just a few weeks”) can lead to: Penalties for misclassification Missed tax credits State audits Unhappy former employees filing claims you didn’t see coming Need a Hand Sorting It Out? Call Us Before You Hire We’ve helped hundreds of small business owners set up summer payroll the right way—without overcomplicating things or drowning in red tape. If you’re planning to bring on part-time, seasonal, or intern help in the next few weeks, let’s talk.
 We’ll help you stay compliant, minimize tax risk, and maybe even find some credits you didn’t know existed. Contact our office before you run that first paycheck—we’ll help you do it right from the start.