Animals and Taxes
By Anthony A. (Tony) Hilliard
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Anthony A. (Tony) Hilliard, JD CPA, former President of the Arkansas Bar Association, practices tax, estate planning, probate and corporate law with the Ramsay, Bridgforth, Robinson & Raley LLP law firm in Pine Bluff, Arkansas. He is pictured with his wife Mary and dog Annie.
22
The Arkansas Lawyer
www.arkbar.com
n 2020 my wife, Mary, and I decided to get a puppy. Mary, newly retired, grew bored cooped up by herself during the pandemic. I wanted a manly-man hunting dog. Mary wanted a Maltese. We compromised and got a Maltese. After learning the price, I strongly suggested we start breeding Maltese. Mary then asked the most important question every person must consider before entering into any new enterprise: “What do you know about breeding dogs?” I knew you needed a boy dog and girl dog, but not much else. Annie (because we got her on our Annie-versary) is now a happy, spoiled dog, fixed and costing us more money on vet bills and special diet food, with no chance of ever deducting those expenses on our taxes. Pets don’t qualify as a dependent. The federal and Arkansas tax codes allow business deductions for activities entered into with the intent to make a profit.1 However, the codes limit hobby deductions to the gross income from the hobby.2 Hobby income includes all gains from the sale or other disposition of property and all other gross receipts derived from such activity reduced by the cost of goods sold.3 The IRS knows high income taxpayers will often report “business losses” for taxpayer activities not engaged in for profit.4 Several years ago Dr. Knudsen, an OB/GYN physician, and his wife decided to raise parrots. Dr. Knudsen spent his spare time working in their exotic animal breeding operation called El Rancho Exotica (“Exotica”). Mrs. Knudsen managed Exotica. Mrs. Knudsen completed 32 hours of business courses but did not hold a business degree. She had no formal training in animal care or zoo science. Dr. and Mrs. Knudsen believed a great market existed for parrots trained to eat from the owner’s hand. The Knudsens read several books, attended a seminar on hand raising parrots, and read “Bird Talk” magazine as well as met with its editor on raising parrots. Otherwise, the Knudsens had no experience in raising parrots for profit. Further, they had no business plan or economic projections to show they could make a profit in the business. Eventually they expanded Exotica to include different types of birds, camels, llamas and other exotic animals on a farm they bought to support Exotica. As you would expect, between 1995 and 2002 the Knudsens wrote off over $2,860,000 in tax losses from Exotica.5 The Knudsens noted that they also expected the appreciation in value of the animal assets as the herd or flock grew in number would generate profits for them. The Tax Court agreed that “profit” for this purpose includes appreciation of the assets over several years but noted the huge expenses the Knudsens incurred in feed and other expenses made it highly unlikely they would ever make a profit with Exotica.6 After reviewing the relevant factors the Tax Court concluded that the Knudsens had no specific knowledge related to the breeding of animals, had not consulted with experts, had not taken the time to learn how to make the business profitable and had
