Court Rejects Football Star’s Business Deduction, Imposes Liability of $4M

A former football star and his wife were among the latest taxpayers to discover that their mare leasing business was a losing bet. The U.S. Tax Court concluded that the taxpayers did not enter into the horse leasing arrangement to make a profit, making the operation a hobby, not a business, and rendering most of the taxpayers’ stated losses not deductible.

In 2003, NFL linebacker Bill Romanowski and his wife, upon the suggestion of their attorney, invested in a horse breeding business. The business involved leasing mares from ClassicStar, and breeding them, with the foals becoming the property of the Romanowskis. A CPA at an accounting firm affiliated with ClassicStar created an illustration, which he sent to the taxpayers’ attorney, showing that the couple needed a net operating loss of $13,092,732 on their horse business to wipe out their lax liabilities from 1998 to 2003. The taxpayers’ CPA vehemently advised against the deal, believing it was a tax dodge.

The Romanowskis, however, did not follow their CPA’s advice, instead investing in the mare leasing program. Although ClassicStar was supposed to breed the couple’s mares with thoroughbred horses, only a small fraction were. The taxpayers ultimately contributed their few thoroughbred foals to a company with close ties to ClassicStar, which sold the foals at a “fire sale” price.

A 2003 statement from ClassicStar to the Romanowskis showed zero income and expenses of exactly $13,092,732. The taxpayers claimed the loss on their 2003 taxes. The loss offset, once claimed and carried back to 1998-2002, offset their income for the entire period.

Unsurprisingly, the Internal Revenue Service disallowed the losses, and notified the couple of deficiencies in their income taxes for the entire period. The taxpayers sued, but to no avail, as the court held them liable for roughly $4.6 million in additional tax. The court explained that, in order to take the business losses claimed by the couple, an activity must be operated with a good faith expectation of profit as its objective.

The Romanowskis’ horse operation had no such “profit objective,” the court concluded. The taxpayers never consulted any experts about succeeding in the horse breeding business, and did not maintain their own records for their business, instead leaving that task entirely to ClassicStar. The court noted that the taxpayers took no action when ClassicStar failed to deliver all thoroughbred foals as promised under the contract, then contributed their few thoroughbreds to a company they knew was closely connected to ClassicStar. These acts were particularly harmful to the couple’s case. “These are not the markings of an activity which is carried on for profit… Rather, we believe petitioners’ participation in the program was almost entirely motivated by tax benefits available to them through such participation,” the court wrote. In a small piece of good news, the court decided that the taxpayers did not owe an accuracy-related penalty for the incorrectly claimed deductions. The court determined that the couple “reasonably and in good faith” relied upon their attorney and their tax preparer in claiming the deductions.

While the decision to go into business may have several motivations, one of which may be tax planning, the operation must have, as its central focus, the generation of profit, if it is to pass the IRS’s scrutiny. To ensure that your activity qualifies as a legitimate for-profit business, consult the tax attorneys at Samuel C. Berger, P.C. and the CPAs at S.C. Berger, P.C., who help people throughout New York and northern New Jersey a variety of business and income tax matters. To consult our attorneys and CPAs, contact us online or call (201) 587-1500 or (212) 380-8117.

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