Amy, a self employed US customs broker, obtained a customs broker’s license from US Customs and Border Protection in 1991. Since 2003 Amy has operated a customs brokerage business, Atlantic Air Express, LLC, (Atlantic Air), from her home. For 2004 Amy reported self employment income of $45,649. From this activity, Amy reported a net profit on Schedule C, Profit or Loss From Business, for each year from 2005 to 2011. For 2007 the year in issue, Amy reported a net profit of $130,872 on Schedule C.
Amy began breeding Great Pyrenees dogs in 1994 on a half acre of property in New York, where she sets up kenneling facilities. Amy incurred expenses to set up the kennel and to purchase dogs, food, grooming supplies and equipment, a vehicle to transport the animals, and advertising. From 1994 to 1999 Amy sought to build the prestige and reputation of the dog breeding operation, Impyrial Great Pyrenees (Impyrial), by producing a robust stock of Great Pyrenees dogs and showing the dogs at dog shows. She spoke with experienced Great Pyrenees breeders and visited various successful kennels to gather information for developing a breeding program. Amy’s dog breeding activity sustained losses every year until 2010, for which she reported a small net profit.
In 1999, when Amy owned five dogs, she moved Impyrial to a 15-acre farm in Orange County, New York. The purpose of the move was to accommodate a large breeding program. Amy also obtained a purbred dog license from the New York State Department of Agriculture and Markets, which is available only for kennels that maintain more than 10 dogs. By 2007 Amy owned 26 dogs.
Amy’s main source of income from the dog breeding activity is the sale of puppies. Amy typically charges $1,200 for a puppy but charges as much as $4,000 for a puppy sired from one of her top winning show dogs. Amy sold approximately six puppies between 1994 and 1999. During 2000 and 2001 Amy’s dogs produced six litters. In 2002 the dogs began to have fertility problems. Amy’s dogs had other health problems that also disrupted the breeding program, including Lyme disease, bacterial infections, and thyroid problems. From 2002 to 2009 Amy attempted to breed 46 female dogs, resulting in 17 pregnancies. The pregnancies produced 13 litters. In 2009 after consultations with veterinarians and fertility specialists Amy administered a month long antibiotic treatment to all of the dogs and treated some of the female dogs with thyroid medication. Amy’s dogs produced two litters shortly after the medical treatment. These were the first pregnancies in nearly 18 months. Amy sold 18 puppies in 2010.
In addition to selling puppies, Amy sells semen from the male dogs to breeders and charges stud fees ranging from $1,200 to $2,500 for top winning show dogs.
Amy reported profit or loss on Schedule C for Impyrial as follows:
Year Income Expenses Gain or (loss)
2005 $4,729 $76,590 ($71,861)
2006 6,900 96,996 (90,096)
2007 4,600 71,116 (66,516)
2008 4,500 69,340 (64,840)
2009 6,800 30,790 (23,990)
2010 33,600 30,120 3,480
2011 8,320 27,369 (19,049)
Amy reported the income and expenses attributable to Impyrial on a Schedule C attached to her 2007 Federal income tax return. Amy asserts that (1) she engaged in the activity with the intent to make a profit and (2) that her return for taxable year 2002 was examined and that the Commissioner of Revenue allowed her to treat Impyrial as a trade or business.
Commissioner of Revenue determined that Amy did not engage in the dog breeding activity for profit and disallowed Amy’s expense deductions claimed in excess of the reported income.
Please note that Amy began Impyrial in 1994. Impyrial sustained losses every year from 1994 to 2009. The record does not reflect the amounts of Impyrial’s income, expenses, and losses between 1994 and 2004.
Based on the facts presented and information presented in chapter 6, do you believe that Amy’s activity constitute a trade or business. EXPLAIN
Assume that you work as an agent of the IRS and you are challenging Amy’s tax position. What argument will you present against Amy?
3) Assume that Amy is your client and was audited by the IRS. What arguments will
you present to defend your Client?