Question

In: Accounting

John and Kathy Brown have just been audited and the IRS agent disallowed the business loss...

John and Kathy Brown have just been audited and the IRS agent disallowed the business loss they claimed in 2015. The agent asserted that the activity was a hobby, not a business.

                John and Kathy live in Rochester, New York, near Lake Ontario. Kathy is a CPA, and John was formerly employed by an insurance firm. John’s firm moved in 2006 and John resolved not to move to the firm’s new location. Instead of seeking other employment John felt he could supplement his income by using his fishing expertise. He had been an avid fisherman for 15 years, and he owned a large Chris-Craft fly-bridge that he chartered to paying parties.

                In 2012, Kathy and John developed a business plan, established bank account for the charter activities, developed a bookkeeping system, and acquired insurance to cover the boat and the passengers. John fulfilled all the requirements to receive a U.S. Coast Guard operating license, a New York sport trolling license, and a seller’s permit. These licenses and permits were necessary to legally operate a charter boat. The first year of their activity was 2012.

                John advertised in local papers and regional sport fishing magazines. He usually had three or four half-day paying parties each week. John spent at least one day maintaining and repairing his boat. Kathy usually accompanied John on charters three or four times each year.

                John’s charter activity was unprofitable the first two years. In 2014, John and Kathy restructured the activity to improve profitability. The restructuring included increasing advertising, participating in outdoor shows, an negotiating small contracts with local businesses. After the restructuring, the activity provided a small profit in 2012 and 2013.

                In 2015, John started working with another insurance company in the area on a full-time basis. Even though he returned to the insurance business, John normally took two paying parties and one nonpaying, promotional party each week throughout the fishing season. John’s costs unexpectedly increased and he lost $8,000 in the activity during 2015. John and Kathy deducted the entire loss on Schedule C of their 2015 tax return.

Required: John and Kathy come to you seeking advice. Prepare a memo recommending what position they should take with the IRS regarding the fishing charter activity and why.

Solutions

Expert Solution

13th March 2018

To John and Katy

Sub: Position with IRS with regards to deduction of expenses

Considering the facts of the case I would recommend you to file a form 5213 with the IRS. This form should be filed for the year 2015. Form 5213 is used for the purpose of postponing an IRS determination as to whether the presumption applies that an activity is engaged in for profit (or not). As per IRS criteria an activity is presumed to be engaged in for profit (and not a hobby) if the activity is profitable in three out of the five consecutive years. Use of form 5213 will enable you to have the IRS wait until the first five years are up before examining the profitability of your business. This form is to be filed within three years of the due date of the return for your first year in business.

Secondly you should provide IRS with the facts associated with your activities to prove that the time and effort being put by you clearly indicates an intention to generate profit. John can also prove that he has an extensive knowledge (considering his fishing expertise) that is needed to carry on this activity as a successful business.

When you are able to prove the above mentioned points and present the IRS with the facts and figures then the onus will shift to IRS and they will now have to prove, based on the facts, figures and circumstances, whether this activity will be considered as a business activity or a hobby.


Related Solutions

4-63 When the IRS audited Winter Corporation’s current year tax return, the IRS disallowed $10,000 of...
4-63 When the IRS audited Winter Corporation’s current year tax return, the IRS disallowed $10,000 of travel and entertainment expenses incurred by Charles, an officer-shareholder, because of inadequate documentation. The IRS asserted that the $10,000 expenditure was a constructive dividend to Charles, who maintained that the expense was business related. Charles argued that he derived no personal benefit from the expenditure and therefore received no constructive dividend. Prepare a memorandum for your tax manager explaining whether the IRS’s assertion or...
The IRS revenue agent who audited Mr. and Mrs. Marlow's 2015 Form 1040 assessed a $49,200...
The IRS revenue agent who audited Mr. and Mrs. Marlow's 2015 Form 1040 assessed a $49,200 tax deficiency. The Marlow's strongly disagree with the result of the audit. What is their first step in contesting the result? They may request that a different revenue agent conduct a second audit. They must file a petition with the U.S. Tax Court. They must appeal the result of the audit to the regional Appeals Office of the IRS. They must pay the deficiency...
John and Jane Brown have been living at their present home for the past 6 years....
John and Jane Brown have been living at their present home for the past 6 years. During that time, they have replaced the water heater for $375, have replaced the dishwasher for $599, and have had to make miscellaneous repair and maintenance expenditures of approximately $1,500. They have decided to move out and rent the house for $975 per month. Newspaper advertising will cost $75. John and Jane intend to paint the interior of the home and power-wash the exterior....
You have just gotten a new audit client that had been audited by another firm for...
You have just gotten a new audit client that had been audited by another firm for many years. In assessing how effective or ineffective the current internal controls are, what factors will you examine?
JOHN-JOHN’S SWEET TABLE John Brown and Eric Johns, both in their late 20’s, have been best...
JOHN-JOHN’S SWEET TABLE John Brown and Eric Johns, both in their late 20’s, have been best friends since elementary school.  They discovered early in high school that they both have exceptional baking skills.  Both have taken baking classes and have each worked in respectable, prestigious bakeries and restaurants. Over the years they have united their baking skills and baking passions and have taken advantage of every opportunity to distribute their baked good to family and friends.   It did not take long before   their mere...
Maria and John have been married for 2 years and just learned that they are pregnant....
Maria and John have been married for 2 years and just learned that they are pregnant. They have been renting a small apartment but decide to purchase a house. They find one that is selling for $525,000. They decide to make a 15% down payment. Maria and Jon are considering 2 financing options: Option 1: a 4.0% interest 30-year mortgage Option 2: a 3.25% interest 15-year mortgage Answer the following questions showing all your work to reach each answer. A....
1. Your client has just had a visit from an IRS special agent who suggested the...
1. Your client has just had a visit from an IRS special agent who suggested the possibility of a charge for tax evasion. Discuss the following: A. What is tax evasion? B. Who investigates? C. Can the IRS require you to turn over your client’s tax documents? D. Are there any civil penalties involved?
1.​Maria and John have been married for 2 years and just learned that they are pregnant....
1.​Maria and John have been married for 2 years and just learned that they are pregnant. They have been renting a small apartment but decide to purchase a house. The one they have found has a selling price of $300,000. They will make a 20% down payment. They are considering 2 financing options at their credit union: Option 1: ​ 3.125% interest 30-year mortgage:    Option 2: ​2.5% interest 15-year mortgage: Answer the following questions showing all your work to reach...
Miller Orchard Case - Paul and John Miller have just been presented with an offer from...
Miller Orchard Case - Paul and John Miller have just been presented with an offer from their uncle.  Uncle Joe can no longer manage his orange orchard, which produces orange juice that is bought by local restaurants and diners to serve their customers; he has offered to turn it over to his nephews to manage as they like if they can provide him a small annual return (10% of sales revenue) to supplement his retirement.  Paul and John have grown up with...
John Brown has been depicted as both a patriot and a terrorist. Which do you think...
John Brown has been depicted as both a patriot and a terrorist. Which do you think is the best description of him and why?
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT