Bill Romanowski, former American football player. (Photo credit: Wikipedia)
During his 16-year NFL career, former 49ers/Eagles/Broncos/Raiders linebacker Bill Romanowski was no stranger to controversy. Whether he was breaking QB Kerry Collins? jaw in a preseason game, spitting in the face of opposing wide receiver J.J. Stokes, or ending the career of a teammate with a punch to the eye during a training camp scuffle, Romanowski had a habit of making news for all the wrong reasons; his propensity for poor decisions often overshadowing his consistently solid play.
It would appear Romanowski?s decision-making didn?t improve with retirement, because earlier today it was revealed that immediately after Romanowski stopped playing on Sundays, he got caught up in a tax shelter. As a result, the Tax Court denied $13 million worth of losses taken on the Romanowskis? 2003 tax return from a purported horse-breeding business, holding the footballer liable for approximately $4.6 million in additional tax.
In 2003, Romanowski got hooked up with a Denver attorney who immediate began singing the praises of ClassicStar, a horse-breeding business. In short, the program involved leasing mares owned by ClassicStar, which in turn would provide boarding and care for the mares and breed the mares to stallions. Any foals produced from the breeding would belong to the Romanowskis.
In October 2003, an accountant of ClassicStar worked up an ?NOL illustration,? indicating that in order to offset their taxable income from 1998 through 2002, the Romanowskis would need to generate a loss of $13,092,732 from their horse-breeding activity. Thus, it was decided that the Romanowskis would invest that amount in the program to produce foals. ?(As an aside, let it be noted that basing an investment on the amount of loss necessary to wipe out previous tax liabilities, rather than a motivation for profits, will never be viewed favorably by the IRS.)
Soon after joining the program, things began to turn sour for the Romanowskis, and they were partly to blame. When they signed the mare lease agreement, the Romanowskis? had not negotiated or seen a list of the horse pairings they would receive for their breeding program. Rather, they relied on ClassicStar to pick the horse pairings they would receive.
This reliance on ClassicStar was clearly misplaced, because despite the fact that the Romanowskis were promised 68 pairings of thoroughbreds, the horses actually received were more Mr. Ed than Secretariat. In fact, only four of the 68 listed pairings were thoroughbred horses; the remaining pairings were quarter horses.
Even though over 90% of the horses on the schedule were not delivered as promised, the Romanowskis chose to continue with the program, explaining to the court that they had reached an oral agreement from ClassicStar under which it would substitute an unknown number of thoroughbred pairings in for the listed quarter horse pairings.
The Romanowskis received an income and expense summary for 2003 from ClassicStar which showed no income and total expenses of $13,092,732. The resulting loss offset their 2003 income, and net operating losses were carried back to 1998, 1999, 2000, 2001, and 2002, resulting in a federal tax refund of nearly $4 million.
The IRS denied the loss in full, arguing that the Romanowskis? horse-breeding activity was not entered into for profit and was thus governed by the hobby-loss rules of Section 183.
As a reminder, if an activity constitutes a for-profit trade or business, expenses may generally be deducted in full under Section 162. To the contrary, if an activity is not entered into for profit, it is a hobby, and expenses can only be deducted to the extent of any income generated by the activity.
To help taxpayers and the IRS decide if an activity is entered into for profit or a hobby, the regulations under Section 183 (the so-called ?hobby loss rules?), provide? nine factors, which if answered in the affirmative, are indicative of a for-profit business.
1. The manner in which the taxpayer carries on the activity. Does he complete accurate books? Were records used to improve performance?
2. The expertise of the taxpayer or his advisers. Did the taxpayer study the activities business practices? Did he consult with experts?
3. The time and effort expended by the taxpayer in carrying on the activity. Does he devote much of his personal time and effort?
4. The expectation that the assets used in the activity may appreciate in value. Is the plan to generate profits through asset appreciation?
5. The success of the taxpayer in carrying on similar or dissimilar activities. Has he converted other activities from unprofitable to profitable?
6. The taxpayer?s history of income or losses with respect to the activity.? Has the taxpayer become profitable in a reasonable amount of time?
7. The amount of occasional profits. Even a single year of profits can be a strong indication that an activity is not a hobby.
8. The financial status of the taxpayer. Does the taxpayer have other income sources that are being offset by the losses of the activity?
9.? Does the activity lack elements of personal pleasure or recreation? If the activity has large personal elements it is indicative of a hobby.
In Romanowski, the Tax Court analyzed these factors and overwhelmingly concluded that the Romanowskis did not enter into the breeding arrangement with ClassicStar with the intent to make a profit. They Romanowskis kept no records; rather, they relied on ClassicStar to do everything. They neglected to fight for their bargained-for number of thoroughbreds, a clear indication, in the court?s eyes, that they were not carrying on the activity in a businesslike manner.
In addition, the Romanowskis never consulted with industry experts on how to turn a profit through horse breeding. Lastly, and most damning, the Romanowskis used the resulting $13 million loss to wipe out all current year income and generate a $4 million tax refund.
After weighing the nine factors, the court?s decision was easy:
We believe petitioners? participation in the program was almost entirely motivated by tax benefits available to them through such participation?.we find that petitioners? horse-breeding activities were not engaged in for profit, and the related expenses are therefore not deductible under section 162 or 212 for the years at issue.
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