Judge Urda picked the shortest day of the year to issue an opinion that can serve as a Christmas present to taxpayers vulnerable to Code Section 183, the hobby loss rule. William R. Huff TCM 2021-140 is the first, and likely the only, taxpayer victory in a Section 183 case in 2021. And keeping with the Christmas theme it is about donkeys, albeit miniature donkeys, who probably could not help Santa quite as much as Dominick did in Lou Monte\’s song.
William H. Huff appears to be a remarkable fellow. Coming from very modest circumstances he created a top notch asset management company. According to this story by this 2005 Forbes story. Don\’t Mess With Bill by Dyan Machan, he had a net worth of $750 million in 2005. Have to wonder how he did not make it into the billionaire clique, but so it goes. Mr. Huff had grown up in the Hell\’s Kitchen neighborhood of Manhattan. The Huffs owned 31.5 acres in New Jersey that was subject to conservation restrictions, but usable for equestrian and agricultural purposes. In the late 1990s they purchased adjacent acres for their daughter Jennifer.
Taking Judge Urda\’s narrative as our guide, Huff and his wife Cathy Markey Huff did not raise their daughter Jennifer to be a trustifarian. Mr. Huff capitalizing on her love of animals and her experience in greyhound rescue had helped her start Doggy Styles a pet grooming business. He was concerned however that it was not enough so he and his wife started Ecotone.
The driving factor in deciding to embark on this enterprise was not a late-discovered passion for adorable little animals. Mr. Huff instead was animated by concern over the relatively modest earnings of Jennifer. In addition to working at Doggy Styles Jennifer raised chickens and other animals on her property, supplementing her income by selling eggs, honey, and produce from her garden. Although Mr. Huff assisted his daughter in starting Doggy Styles and had purchased her land for her, she was otherwise independent from the Huffs.
Mr. Huff believed that he could turn the miniature donkey operation over to his daughter once the breeding program had been properly established, allowing her to benefit from his sweat equity. He was particularly enamored with this idea given Jennifer\’s passion for animals and the proximity between their farms. During the years at issue Jennifer had no familiarity with the miniature donkey breeding operation aside from occasionally caring for the donkeys and a general understanding that the operation would be hers if and when it turned a profit.
That\’s the overriding narrative. The IRS saw it differently, but in the end it is the story that Judge Urda believes that matters.
The audit was for 2013 and 2014 with losses of $87,236 and $47,039 respectively. Deficiencies were $37,022 and $19,615. As is routine in these cases the IRS asserted accuracy penalties. Total losses from 2010 through 2017 were $399,085 with nary a profit year. And here come the really amazing numbers AGI for the deficiency years was $21,469,246 and $29,814,468. With that sort of AGI I have to wonder about the accuracy penalty crossing the 10% threshold, but I may be missing something.
I will say that even as I have become more inclined toward being aggressive on hobby loss, I think I would have advised Mr. Huff with AGI north of $20M that it was not worth bothering with. Regardless I am glad that he chose otherwise and fought on.
Judge Urda did the standard nine factor drill of Reg 1.183-2(b), what Judge Posner calls the \goofy regulation\. You have probably memorized the factors but you have to consider the other readers.
Section 1.183-2(b), Income Tax Regs., lists nine objective factors to be considered in this regard: (1) the manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or his advisers; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer\’s history of income or losses with respect to the activity; (7) the amount of occasional profits, if any, from the activity; (8) the financial status of the taxpayer; and (9) elements of personal pleasure or recreation. Neither a single factor, nor the existence of even a majority of the factors is controlling, but rather an evaluation of all the facts and circumstances is necessary.
That thing about neither a single factor nor the existence of even a majority of factors being controlling is part of the goofy regulation but it is not a good predictor of judicial behavior. Many cases are decided on a holistic basis without using the factors, but when they are used I have found only two instances where the factor count did not match the outcome and only one in which a taxpayer was judged businesslike (Factor 1) and did not prevail.
This decision followed those rules but Judge Urda had some takes on a couple of the factors that I found rather unusual.
The judge ruled favorably on Factor 1 (Businesslike Manner) although he was critical on Huff not paying enough attention to expenses. Factor 2 (Expertise) also went in favor of the taxpayer. The IRS used its standard argument that the expertise he sought was just about breeding miniature donkeys rather than making money at it, but the judge felt that Huff\’s investment background had that covered. Factor 3 (Time and Effort) also came out favorably although the judge give a lot of credit to the time and effort of people Mr. Huff hired.
Factor 4 (Expectation of Appreciation) ended up being in favor of the IRS. Among other issues there was no evidence introduced. In my mind this factor should at worst be neutral to the taxpayer, but that is not the only factor that went in an odd way. Factor 5 (Success in Other Activities) weighed heavily in favor of the Huffs since Mr. Huff is \ a businessman who devoted his life to using his keen business acumen and sharp eye for assets to turn a profit\.
Factor 6 (History of Income or Losses) seems like it should have been a gimme for the IRS, but Judge Urda ruled that the years at issue were still in the startup phase. Factor 7 (Occasional Profits) was the gimme to the IRS that you would expect, since there had been no profitable years. The finding in Factor 8 requires some discussion, so we will move onto Factor 9 (Elements of Personal Pleasure or Recreation). Mr. Huff managed to convince the judge that he didn\’t even like miniature donkeys describing them as \quite ugly\ and looking like \gigantic hairballs\ . Jennifer backed him up describing her dad as \kind of a business guy – not the cuddly animal type\.
The Amazing Ruling On Factor 8
I always think that Factor 8 (Financial Status) tends to be a gimme for the IRS. If you don\’t have substantial other income being sheltered by the loss, there is no reason to be even having the discussion. Judges sometimes rule this factor to be neutral even when the taxpayers have very deep pockets. My theory is that it is one of their fudge factors that they use to get the factor score to come out in line with their opinion even thought that is not really supposed to matter.
Judge Urda takes thing in a pretty amazing direction.
During the years at issue, the Huffs plainly had substantial income from other sources. The losses from the miniature donkey operation during the years at issue (again, $87,236 in 2013 and $47,039 in 2014) were dwarfed by the Huffs\’ adjusted gross income of $21,469,246 and $29,814,468 in 2013 and 2014, respectively. This case consequently does not present the situation where a taxpayer is engaged in generating paper losses for the purpose of sheltering unrelated income or enlisting the Government as an unwilling partner in a hobby.
It seems like he is saying that their income was too big for them to care about recording five figure losses. There is a bit more to it but it really seems like Judge Urda is turning Factor 8 on its head as he rules that it favors the Huffs.
Judge Urda does not give us a count. I make it 6-2 in favor of the taxpayer.
This opinion really merits study. I will be going deep into next time I present my seminar to the Boston Tax Institute. It is a sharp contrast to the recent Skolnick opinion by Judge Lauber.
In looking into the background on Dominick, I was pleased to find that Lou Monte grew up in Bergen County NJ. Lately I have been absorbed in a recent book touching on Bergen County\’s Italian heritage – Paradise Atop The Hudson by Sammy Juliano.
Jeffery Leon has Miniature Donkey Farm Qualifies for Tax Deductions, Court Rules at Bloomberg Tax. I am amused by the notion of \miniature\ modifying farm and am picturing something that could be set up on a card table.
Lew Taishoff has HEE HAW! which he opens with \Paging Peter Reilly\.
Wm. R. wasn’t burying telephone numbers of income in donkey droppings. His losses went down during the years at issue; loss-leader sales were to show farm income to justify the NJ benefits. And if he wanted to give Jenny money, “there were other, significantly easier ways to do it.” 2021 T. C. Memo. 140, at p. 39.
Ultimately, when you show eight figures of AGI and a three-quarter billion-with-a-B net worth, $30K of write-off isn’t much of a shelter. Note that the donkey business was the only thing for which IRS nailed Wm. R. and Cathy for years at issue.
So, as we remember the late great Brig. Gen. Jimmy Stewart, USAF, in “It’s a Wonderful Life,” let’s repeat the immortal greeting “Hee Haw!”