Racing As A Trade Or Business

 I am reading a case that made me grimace. The following is a total NO-NO if you are unfortunate enough to be selected for audit:

As part of the audit RA Chavez issued information document requests to petitioners requesting their accounting records for 2013, but petitioners did not respond. RA Chavez completed his audit without receiving any additional information from petitioners …”

The abbreviation “RA” means revenue agent; those are the IRS folks who do the examinations.

This is not going to turn out well.

… respondent issued … revenue agent reports (RARs) to petitioners with proposed adjustments to tax and accuracy-related penalties. Petitioners did not respond to the … RARs.

Chances are very good that I would have resigned from this representation or refused to accept the client in the first place.

We have, for example, a client who has not filed returns for years. There are mitigating reasons, but not that many or reasons that persuasive for the number of years. My partner brought them in; I looked at their stuff and gave them a list and timetable of what we needed. I reached out to the IRS, explained that they had just hired tax representation and requested time.

I am not going to say that the IRS is always hospitable, but in general they tend to be reasonable if someone is truly trying to get back into the system (except during COVID; the COVID procedural issues have been extensive, unrelenting and extremely frustrating. The IRS really should have stopped issuing notices like government stim checks until it could at least open its mail on a timely basis).

What did my partner’s client do?

They gave us nothing. Two weeks became two months. Two months became three. I received exculpatory e-mails that read like a Grateful Dead tour.

My - and our - credibility with the IRS took a hit.

If they were my client, I would have dismissed them. They are not, however, so I did the next emphatic thing I could do: I will not work with them. We have a younger tax pro here at Galactic Command, and he will take this matter over. He has a nice background in preparation, and I would like to expose him to the representation side of practice. He is somewhat interested (at least, not uninterested), and if he remains in a CPA firm as a career it will be a nice addition to his skill set.

Back to our case.

There is a lot going on, but I want to focus on one issue.

Two families own a construction S corporation (Phoenix). The IRS disallowed $121,903 in 2013 related to car racing activities. More specifically, the racing was by a son of the owners, and his car of choice was a 1968 Camaro.

He started racing it in 2014.

One has to be very careful here. One is taking an activity with a high level of personal interest and gratification and jamming it into a profitable company. It would take minimal tax chops to argue that the racing activity is a hobby or is otherwise personal. The purported advertising cannot be “merely a thin cloak for the pursuit of a hobby.”   

The company fired back with three arguments:

(1)  The racing expenses were ordinary and necessary advertising expenses.

(2)  Phoenix purchased the car as an investment.

(3)  Racing was a separate trade or business from Phoenix and was engaged in for profit.

I do not know if these arguments existed when the return was prepared or dredged-up after the fact, but still … kudos.

Except …

The racing was not conducted under the Phoenix name. There was no company logo on the car, with the possible exception of something minimal on the rear window. There were no photographs or videos of the car on the company’s advertising.

One more thing.

Phoenix did not even separate the car racing expenses as Advertising on its tax return. Instead, it just buried them with “Construction Costs.”

Folks, the IRS does NOT like it when one appears to be hiding something iffy in a big, enveloping category of other expenses. It is, in fact, an indicium of fraud.

The first argument whiffed.

One BTW does not race a car that is held for investment. One stores a car that is held for investment, perhaps taking it to an occasional show.

The second argument collapsed.

That leaves a lot of pressure on the third argument: that the car was its own separate trade or business.

You know what the car did not do in 2013 (the year of examination)? It did not race, that is what it did not do. If one were to argue that the car was a separate trade or business, then one would have to concede that the activity started the following year – 2014 – and not in 2013. All those expenses are what the tax Code calls “startup expenses,” and – with a minimal exception - they have to be amortized over 15 years.

Let me check: yep, this is a pro se case, meaning that the taxpayers represented themselves.

We have said it before: hire a pro, spend a few dollars. You do not know what you do not know.

What would I have advised?

They should have posted photos and videos of that car everywhere they advertised, and I would have recommended adding new advertising venues. I am thinking a video diary: the purchase of the car, its modification, interviews with principal parties, technical issues encountered and resolved, anticipated future race sites and dates.

And yes, I would have put the company name on the car.

Our case this time is Berry v Commissioner, T.C. Memo 2021-42.